NGP Capital Resources Q3 2007 Earnings Call Transcript

| About: OHA Investment (OHAI)

NGP Capital Resources Co. (NGPC) Q3 2007 Earnings Call November 12, 2007 11:00 AM ET


John Homier - President and Chief Executive Officer

Steve Gardner - Chief Financial Officer

Kelly Plato - Senior Vice President


Carl Drake - Suntrust Robinson Humphrey

Scott Valentine - FBE Capital Markets

Henry Coffey - Ferris, Baker Watts


Welcome to your NGP Capital Resources Company Third Quarter2007 Earnings Call. At this time all lines are in a listen-only mode with thequestion-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 forjoining us again today for this call to discuss our results from the quarterending September 30, 2007. With me on the call today are Steve Gardner andKelly Plato.

After my opening remarks today, Steve is going to summarizeour financial results for the third quarter of 2007. When Steve is finished Iwill give you an update on the performance of the company and our investmentportfolio, and I will conclude with some comments on our business model and itsrole in the overall energy economy.

Finally, at the end of the call Kelly, Steve and I willanswer any questions that you may have. The third quarter of 2007 saw uscontinue to grow our targeted investment portfolio primarily to follow oninvestments with existing portfolio companies.

As you are aware, the third quarter was a volatile time inthe capital markets and we, like many other prudent investors, were cautiouswith new investment opportunities. We still believe that the recent events inthe capital markets will result in opportunities for us, but we think that itremains 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 totalcommitted and available for funding was approximately $331 million. We’ll talkmore about our portfolio and subsequent investments later in our remarks.

Our earnings release was distributed on Friday as the marketopened. And for those of you that did not receive a copy of the release, youcan call us or you can download it as always from our website, which is as youknow,

Also for anyone wishing to listen to a recording of ourprepared comments today, we will have a replay available by phone through nextMonday. The call will also be available through a link on the InvestorRelations page of our website for the next 30 days.

I'd like to remind you at this point that our remarks todaymay include comments which could be considered forward-looking statements, andas such, statements are subject to many factors that could cause actual resultsto differ materially from our expectations as expressed in thoseforward-looking statements.

These factors are described in our SEC filings, and I referyou to our website or to the SEC website to review those filings. We undertakeno obligation to publicly update or revise any forward-looking statements. Withthat, I will turn the call over to Steve.

Steve Gardner

Thanks, John. Good morning everybody. During the thirdquarter of '07 one new transaction plus additional fundings on existing dealsadded $42 million to our targeted investment portfolio. We ended the quarterwith commitments of approximately $331 million of which $262 million wasfunded.

The value of our targeted investment portfolio at the end ofthe quarter was $267.5 million. As of September 30, 2007, the weighted averageyield on our targeted investment portfolio was 12.2%. Historically this isranged from 10.2% to 13%, and we expect that the current income portion of ourreturn on our targeted investment portfolio to remain in this area for theforeseeable future.

Overall, we believe our investment portfolio continues tobuild momentum for earnings and dividend growth and we do expect to realizeunrealized depreciation and depreciation embedded in our portfolio investments,but as we've stated before, we manage our business with a goal of providing thehighest return and some quarters may have realizations and/or unrealizeddepreciation and some may not.

As we've been operating on leverage for some months nowwe've initiated efforts to expand the capital that we have available fortargeted investments. Absent realizations our funding commitments currentlycome close to utilizing all of our undrawn borrowing capacity.

As it stands today, we have $269 million funded in targetedinvestments. We also have $58 million in unfunded commitments on our existingportfolio. Given that we currently have borrowed on our investment facilityapproximately $35 million, that means we have $65 million in debt capacity tofund the existing commitments and to make new investments.

To provide additional growth capacity for our targetinvestments last month we obtained $20 million of additional commitments forour investment facility, increasing the borrowing capacity from $80 to $100million. And we are currently working to increase that amount.

Also in the third quarter we obtained an additional $26million of commitments on our treasury facility, which as you know helps us tomanage our diversification requirements as a RIC. As most of you are aware, ourdiversification requirements limit our ability to make investments thatindividually are greater than 5% of our total portfolio to no more than 50% ofthe total asset base.

As we approach the end of the third quarter we can see thatour big basket of investments was nearly full. Where we not able to expand thetreasury facility we would have had to sell down a portion of one or more ofour big basket investments. Given that these investments earn roughly 12% onaverage excluding capital gains potential, expanding the treasury facility toenable us to hold more of that investment is clearly accretive.

As we continue to grow the portfolio, the need for thetreasury facility to manage our diversification requirements will abate as willthe drag of the cost of employing it, allowing even better net earningsperformance by our portfolio of investments.

As to the results of the quarter the one item I wouldhighlight is the net investment income of approximately $0.30 per share, whichis our highest quarter to date and it's an indicator of the earnings strengthof our core investment portfolio. The financial statements are included in theearnings release and I'll answer any questions you might have at the end of thecall.

Now I will turn the call back over to John.

John Homier

Thanks, Steve. I would like to take a minute to follow onyour discussion related to increasing our debt capacity and emphasize some ofthe benefits of the larger portfolio of targeted investments. As Steve said, alarger portfolio allows us the ability to hold more of our larger deals, andalso allows us a more diverse population of transactions.

Thus we feel generating better risk-adjusted returns on theentire portfolio. It also provides a mechanism to spread fixed costs, givingthe company better operational efficiency and we expect better metrics.

Finally, a larger portfolio will allow us to see realizationevents on a more regular basis, helping to smooth what could otherwise be alumpy pattern of realizations. Turning to the performance of the company. Wedeclared and paid a $0.35 dividend for the third quarter, putting us at $0.915for the first three quarters of the year. This is in comparison to $0.66 in thefirst full-year of the company's operations in 2005 and $0.92 for the secondyear of operations in 2006.

The Board will be considering, and we will be announcing thefourth quarter dividend sometime in the month of December. In spite of thethird quarter credit market dislocation, 2007 as a whole has continued to see agood deal of activity. We have reviewed 136 prospective transactions havingtotal potential investment value of $2.3 billion.

We've obtained investment committee approval for nine ofthose transactions, three of which were follow-on investments and six were tonew portfolio companies, totaling $221 million. We issued commitment lettersfor all of those approved transactions and closed eight of the nine approvedtransactions by the end of the third quarter.

We expect to close the ninth in late November or earlyDecember. We have extended new commitments in 2007; totaling $289 million andthus far in 2007 through today have funded investments totaling $211 million.Offsetting that build in the targeted investment portfolio, we hadrealizations, as you will remember of $114 million so far in 2007.

Since the end of the second quarter we have added one newportfolio company. On August 1, 2007 we purchased $5 million of the $85 millionsecond lien term loan for Excel Mining Systems LLC, a private companyheadquartered in Ohio.

The second lien term loan earns interest at LIBOR plus 725basis points and is secured by second liens on substantially all of Excel'sassets. Additionally during the third quarter we made advances of $37 millionunder previous commitments.

To recap the targeted investment portfolio, at the end of2006 we had outstanding fundings and targeted investments of $172 million, withan additional $33 million committed in available for a total of $205 million.At the end of the second quarter our outstanding fundings were $220 millionwith an additional $118 million committed and available for a total of $338million. And as of the end of the third quarter, we had investments in 16targeted portfolio companies.

Our outstanding fundings were $262 million with anadditional $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 thoseunfunded commitments and have had one $5 million retirement.

We anticipate that just as we have done in the past we mayneed to sell participations in some portion of these outstandings andcommitments in order to maintain our compliance with the RIC diversificationrequirements that Steve mentioned previously.

As the portfolio stands today, these diversificationrequirements could necessitate the sale of up to $50 million of total investmentsand commitments by year end, absent growth in are overall capital base.

As we look to the future, our current deal pipeline consistsof 29 potential transactions in various stages of evaluation. The risk targetholds amounts for these transactions is approximately $100 million. Of that wehave one commitment outstanding currently for $15 million.

Turning to credit quality, as you may remember from ourprevious calls, we maintain a system to evaluate the credit quality of ourinvestments. While incorporating quantitative analysis this system is aqualitative assessment.

The system is intended to reflect the overall performance ofa portfolio company's business that collateral coverage of an investment andother relevant factors. Based on this system, the overall credit quality of ourtargeted investment portfolio remains satisfactory in the third quarter endedSeptember 30th.

Of the 19 rated investments as of September 30th siximproved in rating, five declined in rating and 8 have the same rating whencompared to the prior quarter end. Investments approximating $28 million orapproximately 10% of the $267 million in targeted investments are carried onour watch list, due to slower than expected development of the assetssupporting the investments are to deterioration in asset coverage.

During the quarter ended September 30th we recordedadditional unrealized depreciation of $2.1 million on our targeted investmentsreflecting the fair value of expected future income and gains from thoseinvestments.

Also during the quarter ended September 30th we recordedaggregate unrealized depreciation of $2.8 million in the fair value of targetedinvestments to reflect the potential of loss of capital inherent to thoseinvestments.

This unrealized depreciation is due primarily to weaker thanexpected development performance in three of our portfolio companies, and whilewe continue to work with the management of those companies to maximize ourperformance or maximize the performance of those investments, our valuationmethodology has led us to record unrealized depreciation at this time. Weplaced one of those investments on non-accrual status effective July first.

The net change in value of our portfolio resulting fromthese revisions is a $700,000 increase in unrealized depreciation for thequarter ended September 30th.

At the end of the third quarter our targeted investments hadan average risk rating of 3.7 on a dollar weighted basis, which is consistentand compares favorably with 3.9 at the end of the second quarter.

Our distribution of rankings is as follows; $5 million wasrated two, $98 million was rated three, $131 million was rated four, $25million 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 appropriaterisk-adjusted returns.

I would like now to reprise comments that we made last callregarding 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 theenergy industry.

Generally our clients directly own and develop and produceoil, natural gas, coal or other fundamental energy products. And in a fewinstances they use their hard assets to provide services to companies that producethese natural resources.

Of course, the market prices for oil, natural gas and coalcontinue to be at historically strong levels worldwide and in the US. Totaldemand 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 energyefficiency.

But despite those gains, demand for energy in the US hasgrown 30% over the past three decades, while GDP of course has tripled. For theforeseeable future most energy consumed both worldwide and in the US will behydrocarbon 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 itconsumes, currently about 70% of US energy consumption is produceddomestically.

Now before producers can grow energy production, they mustfirst replace the inventory of reserves that they produce and energy productionrequires constant and substantial investment to maintain and expand capacity.Because of this, demand for energy capital looks to remain strong into theforeseeable future.

And this of course is where we play, providing mezzaninecapital to Small Cap companies in the energy industry to help them acquire anddevelop energy assets, accelerate growth and create value.

As you know, our investments are either secured by ourborrower's assets or otherwise often at an upward level in our borrower'scapital structure. Today our target investments are 70% secured, either senioror subordinate and another 24% of our investments while not secured in atraditional sense have limitations on capital senior to us, ensuring NGPC ahigh level of asset coverage for its investments.

Our investment criteria remains sound. And we look to makeengineering based development oriented investments in the energy industry thatare not purely price technology or exploration plays. We invest with experiencedmanagement teams who bring a knowledge edge to the transactions we invest in,be that regional asset, technical or transactional, and we structure ourtransactions for the particulars of the deal in which we are investing.

And we structure an appropriate total return for the riskthat we believe we are undertaking. As we've said many times before for newdeals 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 ourinvestors. We look forward to continuing strong demand for the type of capitalwe provide to the energy industry and to growing opportunities in themarketplace.

That concludes our prepared comments. I would now like toturn the call back to the operator to facilitate Q&A. Steve, Kelly and Iwill be handling your calls or your questions. Thank you.

Question-and-Answer Session


(Operator Instructions) And for our first question we willgo 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 debtcapacity, how should we be thinking about, I know the credit markets havetightened here in the last three to four months but what should we be thinkabout in terms of your ability to increase leverage going forward beforepotential issue in equity?

Steve Gardner

Well, we have increased our current capacity from the levelof commitments to $100 million from $80 million. The facility itself is $175million facility, and as I mentioned we are still out trying to bring some newbanks into the facility and increase the commitments of existing banks.

So it has been more difficult, I think because of theturmoil in the credit markets we've just met credit committees have tightenedup and while I do not think it is a serious issue in the energy industry, itjust takes a little more time.

I really don't have a number about what we expect theincrease, but it wouldn't surprise me if we got another 20 to $30 millioncurrently added to the facility.

Carl Drake - Suntrust Robinson Humphrey

Are there any portfolio companies that you could liquidatethat might be lower yielding in the portfolio? That you take action on tore-deploy in higher yielding assets?

Steve Gardner

Yes, there are; both our corporate notes that we have, aswell as for example, TENNECO is trading right around par and it is fairlyliquid. So, there are a couple of opportunities we have there. We look at thatpretty much on a regular basis.

Carl Drake - Suntrust Robinson Humphrey

Okay, next question in terms of credit. You had prettystable 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 thatwere devalued during the quarter.

Steve Gardner

Sure. Yes, Rubicon is one of our star players. They havebeen growing through some small acquisitions and development work in thePermian Basin and in North Texas. They have a fair amount of capital work thatthey want to continue doing during the next 12 months and certainly they getinquiries all the time.

They are a candidate that whose assets make sense for a lotof the MLPs. But I think the management and us as well, still want to do alittle bit more development in their core areas. And there are no plans to exitthat deal anytime soon. But probably sometime next year they will be thinkingabout it.

Carl Drake - Suntrust Robinson Humphrey

Okay. Is the appreciation reflective of just better thanexpected drilling performance, cash flow growth?

Steve Gardner


Carl Drake - Suntrust Robinson Humphrey

Okay. And then on the other two, what led to that and whatrecoveries.

Steve Gardner

On the BSR deals, there are two that are similartransactions with the same management teams. There are some drilling deals wedid in East Texas and frankly the performance just didn't quite turn out likewe had hoped.

It was really reserve oriented; they just didn't have therecoveries that we expected on the wells. They still have some acreage valueand there is still some additional capital work that could be done and thereare players in the area that are interested in the properties.

The management team is still working through the best way todevelop 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 beconservative 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 reallyexpecting some kind of transaction to happen soon. And that’s been going slowerthan we thought. So, they’re still operating. They are still intend to grow thecompany and we just had expected something to happen towards the end of theyear 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, ithas 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, lookingat those against these three particular investments, it is difficult to assumeor conclude that that mechanic gives you a full valuation of the investedcapital.

Having said that, that is not to say that things that wewould necessarily be sellers at those market values and we think that themarket often times provides a premium above the for assets above the mechanicthat we go through in the rational objective mechanic that we go through inassigning fair value.

Carl Drake - Suntrust Robinson Humphrey

Would you say these two are more company specific, there isnothing or is it perhaps, it’s not a rig availability?

John Homier

No. This is not systemic; this is related to particulartransactions and to the particular reserves that the companies have.

Carl Drake - Suntrust Robinson Humphrey

Okay. And then on the dividends, you all have some excessdividends I believe that you pay now greater than NOI this quarter. What is thefourth quarter look like in terms of the excess dividend that you might havethat has been realized and what is your policy on that? In the past you'vetended to pay that out.

Steve Gardner

Right, we don't intend to change the policy. We haven't hadthe discussion yet with the Board but we've been consistent in paying outcapital gains, so we had I believe roughly $0.18 of undistributed capital gainsearlier in the year.

We distributed effectively $0.05 of that this quarter; Iwould 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 sowe run off a realized number, so whatever the unrealized depreciation might beof …

Carl Drake - Suntrust Robinson Humphrey

Got it. That’s right, thank you.

Steve Gardner

And likewise, with the unrealized appreciation that is not adistributable item either.

Carl Drake - Suntrust Robinson Humphrey

All right. Thank you.

Steve Gardner

Thanks Carl.


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 themacro environment. You mentioned energy prices near record levels, which seemto be a great environment for your customers.

But on the flip side if they are getting $100 a barrel foroil, whatever it may be, there may be less demand for financing. Can you talkabout 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 beensomething that has dogged us since the beginning of our company three years agowhen prices shot up quite a bit.

And you're absolutely right on one hand the higher pricesmake one type of investment less, well, one type of investment becomes, we seeless and less of the classic mezzanine type of investment, which is fixing upold fields, buying older, in the case of E&P buying older producing oil andgas fields and fixing them up, because as you point out correctly, they aregenerating a lot of cash.

These things when they generate a lot of cash people tend tohold onto them rather than selling them to other small companies, which are thestock and trade of the mezzanine financers like us.

But the high prices also take a different or make adifferent type of project an attractive project for mezzanine financers andthose are things that people already own that are more developmentallyoriented.

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 $40price range. So a lot of projects come off the shelves and need to be funded inorder to develop and these are things that may not have particularly very muchcash flow at time 0.

So the high prices tend to stimulate that activity while atthe same time they are depressing some of this activity in the companies or theprojects that are related to companies that have divestitures to be sold to ordivestiture assets to be sold to small companies.

And the other thing that is really interesting in thehigh-priced environments is that we can now hedge at levels we could neverhedge at in historical timeframe, which can be used to provide a floor on thefixed charge coverage and so on for transactions thus providing us with somelevel of surety of our cash flows as we develop the project.

So the long way that’s making a long answer out of a shortquestion, but the point is that there are transactions that have quitecorrectly fallen off, because they have existing cash flows and the existingproducers want to keep those cash flows, not sell them into the acquisitionmarket.

But at the same time another class of projects has beendeveloped and that provides a lot of the impetus for mezzanine financing thiscurrent high-priced environment.

Scott Valentine - FBE Capital Markets

Okay Just following up on that theme, you mentioned about a3%, 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 thesector that don't have a lot of experience in the sector because the high priceof oil and high cash flows have made them.

I guess braver, to speak and that the companies you arelending to will have tremendous cash flow?

John Homier

I’ll let Kelly talk a little bit about that, but I don'tknow this is not the late '70s and early '80s. There have been certainly highprices just as the caveat to what I just said about seeing more projects comein because of high prices. Certainly high prices stimulate a goofy deal factorthat we have to strain through quickly.

And so there is certainly a lot of that that you've got towade through, but over history it has always been sort of about a 3% hit rateon 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 thecompetitive 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 reallymade any significant presence.

They would come in, you would seem them on a transactionhere or there and the next transaction there would be another new group comingin. But…

John Homier

You're talking about financers.

Kelly Plato

Financers, yes, and they were, they seemed very interestedbut they never got to the end. More recently we still see a number of hedgefunds that are very interested in the space and other institutional investorsare very interested in the space but they seem to be more cautious and theywant to partner up with guys who have been experienced in this space. And so itreally seems to be the same six or eight steady players who have been aroundfor a while that are competing with us.

On the other side of the coin John mentioned the goofy dealfactor; during the third quarter we saw a marked increase in strange deals thatwere just very new management teams that were new to energy, seeing high pricesand with very speculative business plans.

Other than that, I don't think the competitive landscape ismuch different than it has been.

Scott Valentine - Friedman, Billings,Ramsey

Thanks very much.


(Operator Instructions) We go next to Henry Coffey, withFerris Baker Watts.

Henry Coffey - Ferris, Baker Watts

Yes. Good morning. And listening to your plans to build abalance sheet and leverage, how would that impact, really there are twoquestions which are obviously somewhat related, how would that impact thetreasury portfolio? And can you articulate for us the terms of your newmanagement agreement as it applies to that portfolio?

Steve Gardner

Sure Henry. It is our expectation as the balance sheet growsorganically either through debt and/or equity that we’ll see less and less needfor the treasury facility we expect to go down over time. That is the answer Ithink to your first question.

We did have the new management or the management agreementwas approved again by the Board at a recent Board meeting and specific to thetreasury 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 wasthat for treasury assets exceeding the $100 million have been on the balancesheet for the last 12 or 13 months or so, they would not charge the managementfee on.

Henry Coffey - Ferris, Baker Watts

Thank you.

Steve Gardner

Your welcome.


(Operator Instructions) And with that, ladies and gentlemen,we have no further questions on our roster and this will conclude your NGPCapital Resources Company third quarter 2007 earnings conference call. We doappreciate your participation, and you may disconnect at this time.

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