Executives
John Homier - President and Chief Executive Officer
Steve Gardner - Chief Financial Officer
Kelly Plato - Senior Vice President
Analysts
Carl Drake - Suntrust Robinson Humphrey
Scott Valentine - FBE Capital Markets
Henry Coffey - Ferris, Baker Watts
NGP Capital Resources Co. (NGPC) Q3 2007 Earnings Call November 12, 2007 11:00 AM ET
Operator
Welcome to your NGP Capital Resources Company Third Quarter 2007 Earnings Call. At this time all lines are in a listen-only mode with the question-and-answer session to follow. (Operator Instructions) As a reminder, this conversation is being recorded.
And now I would like to turn the call over to your host, NGPC President and CEO, Mr. John Homier. Mr. Homier, please go ahead, sir.
John Homier
Thank you, Eric. Good morning, everyone, and thanks for joining us again today for this call to discuss our results from the quarter ending September 30, 2007. With me on the call today are Steve Gardner and Kelly Plato.
After my opening remarks today, Steve is going to summarize our financial results for the third quarter of 2007. When Steve is finished I will give you an update on the performance of the company and our investment portfolio, and I will conclude with some comments on our business model and its role in the overall energy economy.
Finally, at the end of the call Kelly, Steve and I will answer any questions that you may have. The third quarter of 2007 saw us continue to grow our targeted investment portfolio primarily to follow on investments with existing portfolio companies.
As you are aware, the third quarter was a volatile time in the capital markets and we, like many other prudent investors, were cautious with new investment opportunities. We still believe that the recent events in the capital markets will result in opportunities for us, but we think that it remains a time to tread carefully.
During the quarter our funded targeted investments grew by $42 million from $220 million to $226 million. As of September 30th our total committed and available for funding was approximately $331 million. We’ll talk more about our portfolio and subsequent investments later in our remarks.
Our earnings release was distributed on Friday as the market opened. And for those of you that did not receive a copy of the release, you can call us or you can download it as always from our website, which is as you know, www.ngpcrc.com.
Also for anyone wishing to listen to a recording of our prepared comments today, we will have a replay available by phone through next Monday. The call will also be available through a link on the Investor Relations page of our website for the next 30 days.
I'd like to remind you at this point that our remarks today may include comments which could be considered forward-looking statements, and as such, statements are subject to many factors that could cause actual results to differ materially from our expectations as expressed in those forward-looking statements.
These factors are described in our SEC filings, and I refer you to our website or to the SEC website to review those filings. We undertake no obligation to publicly update or revise any forward-looking statements. With that, I will turn the call over to Steve.
Steve Gardner
Thanks, John. Good morning everybody. During the third quarter of '07 one new transaction plus additional fundings on existing deals added $42 million to our targeted investment portfolio. We ended the quarter with commitments of approximately $331 million of which $262 million was funded.
The value of our targeted investment portfolio at the end of the quarter was $267.5 million. As of September 30, 2007, the weighted average yield on our targeted investment portfolio was 12.2%. Historically this is ranged from 10.2% to 13%, and we expect that the current income portion of our return on our targeted investment portfolio to remain in this area for the foreseeable future.
Overall, we believe our investment portfolio continues to build momentum for earnings and dividend growth and we do expect to realize unrealized depreciation and depreciation embedded in our portfolio investments, but as we've stated before, we manage our business with a goal of providing the highest return and some quarters may have realizations and/or unrealized depreciation and some may not.
As we've been operating on leverage for some months now we've initiated efforts to expand the capital that we have available for targeted investments. Absent realizations our funding commitments currently come close to utilizing all of our undrawn borrowing capacity.
As it stands today, we have $269 million funded in targeted investments. We also have $58 million in unfunded commitments on our existing portfolio. Given that we currently have borrowed on our investment facility approximately $35 million, that means we have $65 million in debt capacity to fund the existing commitments and to make new investments.
To provide additional growth capacity for our target investments last month we obtained $20 million of additional commitments for our investment facility, increasing the borrowing capacity from $80 to $100 million. And we are currently working to increase that amount.
Also in the third quarter we obtained an additional $26 million of commitments on our treasury facility, which as you know helps us to manage our diversification requirements as a RIC. As most of you are aware, our diversification requirements limit our ability to make investments that individually are greater than 5% of our total portfolio to no more than 50% of the total asset base.
As we approach the end of the third quarter we can see that our big basket of investments was nearly full. Where we not able to expand the treasury facility we would have had to sell down a portion of one or more of our big basket investments. Given that these investments earn roughly 12% on average excluding capital gains potential, expanding the treasury facility to enable us to hold more of that investment is clearly accretive.
As we continue to grow the portfolio, the need for the treasury facility to manage our diversification requirements will abate as will the drag of the cost of employing it, allowing even better net earnings performance by our portfolio of investments.
As to the results of the quarter the one item I would highlight is the net investment income of approximately $0.30 per share, which is our highest quarter to date and it's an indicator of the earnings strength of our core investment portfolio. The financial statements are included in the earnings release and I'll answer any questions you might have at the end of the call.
Now I will turn the call back over to John.
John Homier
Thanks, Steve. I would like to take a minute to follow on your discussion related to increasing our debt capacity and emphasize some of the benefits of the larger portfolio of targeted investments. As Steve said, a larger portfolio allows us the ability to hold more of our larger deals, and also allows us a more diverse population of transactions.
Thus we feel generating better risk-adjusted returns on the entire portfolio. It also provides a mechanism to spread fixed costs, giving the company better operational efficiency and we expect better metrics.
Finally, a larger portfolio will allow us to see realization events on a more regular basis, helping to smooth what could otherwise be a lumpy pattern of realizations. Turning to the performance of the company. We declared and paid a $0.35 dividend for the third quarter, putting us at $0.915 for the first three quarters of the year. This is in comparison to $0.66 in the first full-year of the company's operations in 2005 and $0.92 for the second year of operations in 2006.
The Board will be considering, and we will be announcing the fourth quarter dividend sometime in the month of December. In spite of the third quarter credit market dislocation, 2007 as a whole has continued to see a good deal of activity. We have reviewed 136 prospective transactions having total potential investment value of $2.3 billion.
We've obtained investment committee approval for nine of those transactions, three of which were follow-on investments and six were to new portfolio companies, totaling $221 million. We issued commitment letters for all of those approved transactions and closed eight of the nine approved transactions by the end of the third quarter.
We expect to close the ninth in late November or early December. We have extended new commitments in 2007; totaling $289 million and thus far in 2007 through today have funded investments totaling $211 million. Offsetting that build in the targeted investment portfolio, we had realizations, as you will remember of $114 million so far in 2007.
Since the end of the second quarter we have added one new portfolio company. On August 1, 2007 we purchased $5 million of the $85 million second lien term loan for Excel Mining Systems LLC, a private company headquartered in Ohio.
The second lien term loan earns interest at LIBOR plus 725 basis points and is secured by second liens on substantially all of Excel's assets. Additionally during the third quarter we made advances of $37 million under previous commitments.
To recap the targeted investment portfolio, at the end of 2006 we had outstanding fundings and targeted investments of $172 million, with an additional $33 million committed in available for a total of $205 million. At the end of the second quarter our outstanding fundings were $220 million with an additional $118 million committed and available for a total of $338 million. And as of the end of the third quarter, we had investments in 16 targeted portfolio companies.
Our outstanding fundings were $262 million with an additional $69 million committed and available for a total of $331 million. Since the end of the quarter we have funded an additional $12 million on those unfunded commitments and have had one $5 million retirement.
We anticipate that just as we have done in the past we may need to sell participations in some portion of these outstandings and commitments in order to maintain our compliance with the RIC diversification requirements that Steve mentioned previously.
As the portfolio stands today, these diversification requirements could necessitate the sale of up to $50 million of total investments and commitments by year end, absent growth in are overall capital base.
As we look to the future, our current deal pipeline consists of 29 potential transactions in various stages of evaluation. The risk target holds amounts for these transactions is approximately $100 million. Of that we have one commitment outstanding currently for $15 million.
Turning to credit quality, as you may remember from our previous calls, we maintain a system to evaluate the credit quality of our investments. While incorporating quantitative analysis this system is a qualitative assessment.
The system is intended to reflect the overall performance of a portfolio company's business that collateral coverage of an investment and other relevant factors. Based on this system, the overall credit quality of our targeted investment portfolio remains satisfactory in the third quarter ended September 30th.
Of the 19 rated investments as of September 30th six improved in rating, five declined in rating and 8 have the same rating when compared to the prior quarter end. Investments approximating $28 million or approximately 10% of the $267 million in targeted investments are carried on our watch list, due to slower than expected development of the assets supporting the investments are to deterioration in asset coverage.
During the quarter ended September 30th we recorded additional unrealized depreciation of $2.1 million on our targeted investments reflecting the fair value of expected future income and gains from those investments.
Also during the quarter ended September 30th we recorded aggregate unrealized depreciation of $2.8 million in the fair value of targeted investments to reflect the potential of loss of capital inherent to those investments.
This unrealized depreciation is due primarily to weaker than expected development performance in three of our portfolio companies, and while we continue to work with the management of those companies to maximize our performance or maximize the performance of those investments, our valuation methodology has led us to record unrealized depreciation at this time. We placed one of those investments on non-accrual status effective July first.
The net change in value of our portfolio resulting from these revisions is a $700,000 increase in unrealized depreciation for the quarter ended September 30th.
At the end of the third quarter our targeted investments had an average risk rating of 3.7 on a dollar weighted basis, which is consistent and compares favorably with 3.9 at the end of the second quarter.
Our distribution of rankings is as follows; $5 million was rated two, $98 million was rated three, $131 million was rated four, $25 million rated five and $3 million rated six. No investments were rated 1 or 7. But in summary, our portfolio remains sound with good potential for appropriate risk-adjusted returns.
I would like now to reprise comments that we made last call regarding our business model and its placement in the overall energy economy. NGPC is by and large an asset-based investor in companies that operate in the energy industry.
Generally our clients directly own and develop and produce oil, natural gas, coal or other fundamental energy products. And in a few instances they use their hard assets to provide services to companies that produce these natural resources.
Of course, the market prices for oil, natural gas and coal continue to be at historically strong levels worldwide and in the US. Total demand for energy continues to grow albeit on a lower rate than overall GDP.
For example, the US GDP has grown at an annual rate of 3% per year over the last three decades. And energy growth has grown about 0.85% per year over that same period, indicating significant gains in energy efficiency.
But despite those gains, demand for energy in the US has grown 30% over the past three decades, while GDP of course has tripled. For the foreseeable future most energy consumed both worldwide and in the US will be hydrocarbon based. Apparently 87% of US energy demand comes from fossil fuels. The good news is that the US will continue to produce the majority of what it consumes, currently about 70% of US energy consumption is produced domestically.
Now before producers can grow energy production, they must first replace the inventory of reserves that they produce and energy production requires constant and substantial investment to maintain and expand capacity. Because of this, demand for energy capital looks to remain strong into the foreseeable future.
And this of course is where we play, providing mezzanine capital to Small Cap companies in the energy industry to help them acquire and develop energy assets, accelerate growth and create value.
As you know, our investments are either secured by our borrower's assets or otherwise often at an upward level in our borrower's capital structure. Today our target investments are 70% secured, either senior or subordinate and another 24% of our investments while not secured in a traditional sense have limitations on capital senior to us, ensuring NGPC a high level of asset coverage for its investments.
Our investment criteria remains sound. And we look to make engineering based development oriented investments in the energy industry that are not purely price technology or exploration plays. We invest with experienced management teams who bring a knowledge edge to the transactions we invest in, be that regional asset, technical or transactional, and we structure our transactions for the particulars of the deal in which we are investing.
And we structure an appropriate total return for the risk that we believe we are undertaking. As we've said many times before for new deals we continue to screen approximately 30 deals in order to do simply one.
We feel this combination of assets, security, diligence, structure and appropriate pricing provides a good risk reward for our investors. We look forward to continuing strong demand for the type of capital we provide to the energy industry and to growing opportunities in the marketplace.
That concludes our prepared comments. I would now like to turn the call back to the operator to facilitate Q&A. Steve, Kelly and I will be handling your calls or your questions. Thank you.
Question-and-Answer Session
Operator
(Operator Instructions) And for our first question we will go to Carl Drake with SunTrust Robinson Humphrey.
Carl Drake - Suntrust Robinson Humphrey
Good morning.
Steve Gardner
Hi Carl.
Carl Drake - Suntrust Robinson Humphrey
Question on leverage, in terms of increasing the debt capacity, how should we be thinking about, I know the credit markets have tightened here in the last three to four months but what should we be think about in terms of your ability to increase leverage going forward before potential issue in equity?
Steve Gardner
Well, we have increased our current capacity from the level of commitments to $100 million from $80 million. The facility itself is $175 million facility, and as I mentioned we are still out trying to bring some new banks into the facility and increase the commitments of existing banks.
So it has been more difficult, I think because of the turmoil in the credit markets we've just met credit committees have tightened up and while I do not think it is a serious issue in the energy industry, it just takes a little more time.
I really don't have a number about what we expect the increase, but it wouldn't surprise me if we got another 20 to $30 million currently added to the facility.
Carl Drake - Suntrust Robinson Humphrey
Are there any portfolio companies that you could liquidate that might be lower yielding in the portfolio? That you take action on to re-deploy in higher yielding assets?
Steve Gardner
Yes, there are; both our corporate notes that we have, as well as for example, TENNECO is trading right around par and it is fairly liquid. So, there are a couple of opportunities we have there. We look at that pretty much on a regular basis.
Carl Drake - Suntrust Robinson Humphrey
Okay, next question in terms of credit. You had pretty stable there is Rubicon looks like a promising potential exit at some point, maybe you could comment on Rubicon and also the two BSR Alto and Chroma that were devalued during the quarter.
Steve Gardner
Sure. Yes, Rubicon is one of our star players. They have been growing through some small acquisitions and development work in the Permian Basin and in North Texas. They have a fair amount of capital work that they want to continue doing during the next 12 months and certainly they get inquiries all the time.
They are a candidate that whose assets make sense for a lot of the MLPs. But I think the management and us as well, still want to do a little bit more development in their core areas. And there are no plans to exit that deal anytime soon. But probably sometime next year they will be thinking about it.
Carl Drake - Suntrust Robinson Humphrey
Okay. Is the appreciation reflective of just better than expected drilling performance, cash flow growth?
Steve Gardner
Exactly.
Carl Drake - Suntrust Robinson Humphrey
Okay. And then on the other two, what led to that and what recoveries.
Steve Gardner
On the BSR deals, there are two that are similar transactions with the same management teams. There are some drilling deals we did in East Texas and frankly the performance just didn't quite turn out like we had hoped.
It was really reserve oriented; they just didn't have the recoveries that we expected on the wells. They still have some acreage value and there is still some additional capital work that could be done and there are players in the area that are interested in the properties.
The management team is still working through the best way to develop these properties, and we are working closely with the management team. And just based on our normal valuation process it looked like it was time to be conservative with these and make sure we mark them appropriately.
Carl Drake - Suntrust Robinson Humphrey
And on Chroma?
Kelly Plato
Chroma is a similar situation, although we were really expecting some kind of transaction to happen soon. And that’s been going slower than we thought. So, they’re still operating. They are still intend to grow the company and we just had expected something to happen towards the end of the year and it looks like it may be a little slower.
John Homier
Either developmentally for the Company or otherwise… Karl, the mechanics of taking unrealized appreciation on an investment is well, it has a judgment factor involved in it. There is also mechanical.
We look at a variety of metrics, multiples and EBITDA, reserve multiples, production multiples and so on. And as Kelly said, looking at those against these three particular investments, it is difficult to assume or conclude that that mechanic gives you a full valuation of the invested capital.
Having said that, that is not to say that things that we would necessarily be sellers at those market values and we think that the market often times provides a premium above the for assets above the mechanic that we go through in the rational objective mechanic that we go through in assigning fair value.
Carl Drake - Suntrust Robinson Humphrey
Would you say these two are more company specific, there is nothing or is it perhaps, it’s not a rig availability?
John Homier
No. This is not systemic; this is related to particular transactions and to the particular reserves that the companies have.
Carl Drake - Suntrust Robinson Humphrey
Okay. And then on the dividends, you all have some excess dividends I believe that you pay now greater than NOI this quarter. What is the fourth quarter look like in terms of the excess dividend that you might have that has been realized and what is your policy on that? In the past you've tended to pay that out.
Steve Gardner
Right, we don't intend to change the policy. We haven't had the discussion yet with the Board but we've been consistent in paying out capital gains, so we had I believe roughly $0.18 of undistributed capital gains earlier in the year.
We distributed effectively $0.05 of that this quarter; I would expect the balance of that would come out in the fourth.
Carl Drake - Suntrust Robinson Humphrey
Wasn't there an offset though with the depreciation?
Steve Gardner
Well, unrealized depreciation is not a taxable event and so we run off a realized number, so whatever the unrealized depreciation might be of …
Carl Drake - Suntrust Robinson Humphrey
Got it. That’s right, thank you.
Steve Gardner
And likewise, with the unrealized appreciation that is not a distributable item either.
Carl Drake - Suntrust Robinson Humphrey
All right. Thank you.
Steve Gardner
Thanks Carl.
Operator
And we go next to Scott Valentine with FBR Capital Markets.
Scott Valentine - FBE Capital Markets
Good morning. Thanks for taking my question.
Steve Gardner
Hi Scott.
Scott Valentine - FBE Capital Markets
Just wondering, if you can give us more color about the macro environment. You mentioned energy prices near record levels, which seem to be a great environment for your customers.
But on the flip side if they are getting $100 a barrel for oil, whatever it may be, there may be less demand for financing. Can you talk about the balance there between energy prices and the demand for financing?
John Homier
This has been a, I wouldn't say an issue but it has been something that has dogged us since the beginning of our company three years ago when prices shot up quite a bit.
And you're absolutely right on one hand the higher prices make one type of investment less, well, one type of investment becomes, we see less and less of the classic mezzanine type of investment, which is fixing up old fields, buying older, in the case of E&P buying older producing oil and gas fields and fixing them up, because as you point out correctly, they are generating a lot of cash.
These things when they generate a lot of cash people tend to hold onto them rather than selling them to other small companies, which are the stock and trade of the mezzanine financers like us.
But the high prices also take a different or make a different type of project an attractive project for mezzanine financers and those are things that people already own that are more developmentally oriented.
Clearly $100 oil makes a lot of projects economic or even $70 oil make a lot of projects economic that were not economic at a $30 or $40 price range. So a lot of projects come off the shelves and need to be funded in order to develop and these are things that may not have particularly very much cash flow at time 0.
So the high prices tend to stimulate that activity while at the same time they are depressing some of this activity in the companies or the projects that are related to companies that have divestitures to be sold to or divestiture assets to be sold to small companies.
And the other thing that is really interesting in the high-priced environments is that we can now hedge at levels we could never hedge at in historical timeframe, which can be used to provide a floor on the fixed charge coverage and so on for transactions thus providing us with some level of surety of our cash flows as we develop the project.
So the long way that’s making a long answer out of a short question, but the point is that there are transactions that have quite correctly fallen off, because they have existing cash flows and the existing producers want to keep those cash flows, not sell them into the acquisition market.
But at the same time another class of projects has been developed and that provides a lot of the impetus for mezzanine financing this current high-priced environment.
Scott Valentine - FBE Capital Markets
Okay Just following up on that theme, you mentioned about a 3%, you see 30 applications or 30 projects you may end up funding one of those, about a 3% approval rate.
Is that been hurt by a lot of new people coming into the sector that don't have a lot of experience in the sector because the high price of oil and high cash flows have made them.
I guess braver, to speak and that the companies you are lending to will have tremendous cash flow?
John Homier
I’ll let Kelly talk a little bit about that, but I don't know this is not the late '70s and early '80s. There have been certainly high prices just as the caveat to what I just said about seeing more projects come in because of high prices. Certainly high prices stimulate a goofy deal factor that we have to strain through quickly.
And so there is certainly a lot of that that you've got to wade through, but over history it has always been sort of about a 3% hit rate on de novo transactions. Kelly, do you have anything to add to that?
Kelly Plato
It doesn't seem to be much different than it has the competitive landscape doesn't seem much different than it has been in the past. In '05, we saw a large number of new entrants come in and out, but never really made any significant presence.
They would come in, you would seem them on a transaction here or there and the next transaction there would be another new group coming in. But…
John Homier
You're talking about financers.
Kelly Plato
Financers, yes, and they were, they seemed very interested but they never got to the end. More recently we still see a number of hedge funds that are very interested in the space and other institutional investors are very interested in the space but they seem to be more cautious and they want to partner up with guys who have been experienced in this space. And so it really seems to be the same six or eight steady players who have been around for a while that are competing with us.
On the other side of the coin John mentioned the goofy deal factor; during the third quarter we saw a marked increase in strange deals that were just very new management teams that were new to energy, seeing high prices and with very speculative business plans.
Other than that, I don't think the competitive landscape is much different than it has been.
Scott Valentine - Friedman, Billings, Ramsey
Thanks very much.
Operator
(Operator Instructions) We go next to Henry Coffey, with Ferris Baker Watts.
Henry Coffey - Ferris, Baker Watts
Yes. Good morning. And listening to your plans to build a balance sheet and leverage, how would that impact, really there are two questions which are obviously somewhat related, how would that impact the treasury portfolio? And can you articulate for us the terms of your new management agreement as it applies to that portfolio?
Steve Gardner
Sure Henry. It is our expectation as the balance sheet grows organically either through debt and/or equity that we’ll see less and less need for the treasury facility we expect to go down over time. That is the answer I think to your first question.
We did have the new management or the management agreement was approved again by the Board at a recent Board meeting and specific to the treasury assets and the management fee, which we as you know discussed previously, what the investment adviser proposed to the Board and the Board agreed to was that for treasury assets exceeding the $100 million have been on the balance sheet for the last 12 or 13 months or so, they would not charge the management fee on.
Henry Coffey - Ferris, Baker Watts
Thank you.
Steve Gardner
Your welcome.
Operator
(Operator Instructions) And with that, ladies and gentlemen, we have no further questions on our roster and this will conclude your NGP Capital Resources Company third quarter 2007 earnings conference call. We do appreciate your participation, and you may disconnect at this time.
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