Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

MCG Capital Corporation (NASDAQ:MCGC)

Q2 2012 Earnings Call

July 31, 2012 9:00 a.m. ET

Executives

Richard Neu - Chief Executive Officer

Hagen Saville - President and Chief Operating Officer

Keith Kennedy - Chief Financial Officer, Executive Vice President and Managing Director

Tod Reichert - General Counsel, Chief Compliance Officer, Corporate Secretary and Senior Vice President

Analysts

Greg Mason - Stifel Nicolaus

Mike Turner - Compass Point Research

Richard Fearon - Accretive Capital

Operator

Good day ladies and gentlemen and welcome to the MCG Capital Q2 2012 Earnings Investor Call. At this time all participants are in a listen-only mode. Later we will have a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder today's conference is being recorded for replay purposes. (Operator Instructions)

I would now like to turn the conference over to your host for today, Mr. Rich Neu, Chief Executive Officer. Sir, you may begin.

Richard Neu

Thank you, operator, and welcome to the call. I am here with Hagen Saville, MCG’s President and Chief Operating Officer, and Keith Kennedy, MCG’s Chief Financial Officer. Before we get started I will ask Tod Reichert, MCG’s General Counsel, to highlight our forward-looking disclosures. Tod?

Tod Reichert

Thanks, Rich. Good morning everyone and thanks for joining the call. Before we begin we would like to remind you that various statements that we may make during this morning’s call will include forward-looking statements as defined under applicable securities laws. Management’s assumptions, expectations and opinions reflected in those statements are subject to risks and uncertainties that may cause actual results and our performance to differ materially from any future results, performance or achievements discussed in or implied by such forward-looking statements and the company can give no assurance that they will prove to be correct. Those risks and uncertainties are described in the company's earnings release and in its filings with the Securities and Exchange Commission.

With that I will turn the call back over to our CEO, Rich Neu.

Richard Neu

Thanks, Tod. In the context of executing our strategic plan, the second quarter was an excellent quarter for MCG, and puts us well on our path to our previously stated objective of returning to our roots as a strong middle market lender. Absence the previously announced charge relative to Broadview Networks Holdings, portfolio performance from a valuation standpoint was generally in line with our expectations. Net operating income adjusted for cost associated with our transition plan was $0.11, which was consistent with our internal forecast.

Our liquidity position enabled us to return capital to our stockholders in the form of a $0.14 dividend on July 13, 2012, to shareholders of record on June 13, 2012. Additionally, we used approximately $12 million of our excess capital position, to repurchase approximately $2.7 million shares of our common stock. Similar to last quarter, the two areas that were outside of our internal forecast were originations, which came in below our target for the quarter, and debt payoffs, which exceeded our internal forecast.

As a result, we are carrying a total cash position at June 30 of just under $300 million, which is well above our previous second quarter target. This level of un-invested cash together with the current pace of originations will create some earnings pressure as we enter 2013. Subject to the pace and yields of new investments as we redeploy our excess liquidity, we now anticipate a 2013 earnings level of $0.45 to $0.55, down from our previous 2013 target range of $0.50 to $0.60 per share.

As Hagen and I communicated last November, the primary goal of our strategic plan was to create a company with less credit and leverage risk, yet one as of sustainable and predictable level of NOI and dividend generation. I am pleased to say that in our view, our transformation is substantially complete. Our equity investment position has been substantially reduced and our overall credit profile has been substantially improved. Our leverage risk profile has been substantially reduced and our infrastructure has been right sized to a smaller and simpler operating profile.

The final phase of our transformation, which I will ask Hagen to comment on, is validation of our internal managed BDC business model and the underlying portfolio of management and leverage assumptions that we have previously set out for you. I will turn it over to Hagen now, thank you.

Hagen Saville

Thank you, Rich, and good morning everyone. I would like to give some additional context to Rich’s remarks and provide some thoughts about the state of our business. As Rich mentioned, we have demonstrable progress in the execution of our business plan. Our equity portfolio is steadily being reduced and our loan book is becoming more granular, as a results our risk profile has been reduced. Furthermore, our cost reduction initiatives combined with our internally managed [status], will enable us to operate very efficiently with incremental asset growth being accretive.

Generally, I am very pleased with where we sit, halfway through 2012, as a transition year for MCG. During the quarter, our investment portfolio declined from $666 million to $453 million including the sale of three meaningful equity investments where we also own loans. Orbitel Holdings, $34.8 million, Garden State, $32.4 million, and Stratford School, $27.6 million, as well as repayment of several standalone loan assets. We made one new loan during the quarter, an $8 million subordinated debt investment in a healthcare company.

The remaining portfolio continues to meet our expectations with a majority of our names experiencing favorable sequential operating trends and improved credit metrics. Given the significant repayments on the quarter, we have experienced an imbalance between ordinary course origination and payoff activity. As a result, today our balance sheet is roughly only two-third employed. This imbalance is attributable to, one, the robust loan repayment and asset sale activity during the quarter. Two, weak market conditions; and three, the MCG reorganization, which is now essentially complete.

It’s important to note that our asset managers have been intimately involved in the time consuming sales process for certain investments. This no doubt has impacted the pace of new originations during the first half. As you can see from our press release, we currently have over $200 million of unencumbered and restricted cash available for new investments. The slower pace of origination compared to payoffs is the principal reason for our reduced guidance.

This slower origination pacing is not a long-term concern of mine. We currently have two new deals under signed LOIs along with several other actionable opportunities for Q3. The two LOIs are sponsors new to MCG, a positive statement about the status of our business. I would say the deal flow we are experiencing is a result of our calling efforts and our industry expertise in certain sectors, not a material improvement in market conditions.

While the pace of new originations is behind plan and subject to future market conditions, I remain confident that we can manage the business to optimize balance sheet utilization and restore the proper balance of ordinary course capital recycling. On a previous call, I described an economic model comprised of a pool of senior unsubordinated loan assets providing an all in IRR of 12% to 13%, a debt to equity ratio of 0.4 to 0.7 times, cash operating costs of approximately equal to 2% of assets, and long run credit charges of 2% to 3%, all delivering a return on equity of 10% plus.

I continue to believe we can achieve these results as we fully deploy our resources. The BDC space appears to be one of the few segments within financial services experiencing a favorable regulatory environment. House Bill 5929 would increase permissible leverage to one, and we classify preferred stock as equity not debt. Senate Bill 2136 would authorize the SBA to expand the SBIC debenture program from a current aggregate limit of $225 million to $350 million per issuer. These bills enjoy bipartisan support and if they come to pass we would have positive implications for MCG.

In summary, our portfolio performance is in line with expectations. Our economic model is intact, origination activity is picking up, and our industry appears to be on the verge of several positive regulatory developments. Keith, will now provide an overview of the quarter.

Keith Kennedy

Thank you, Hagen. For the three months ended June 30, 2012, our net operating income or NOI was $5.6 million or $0.07 per share. As previously noted during the second quarter, we incurred $3.1 million or $0.04 per share in transition cost, consisting of $1.8 million in severance related expenses. $800,000 in accelerated, deferred financing fees associated with the payoff of our SunTrust Warehouse financing facility, $300,000 in retention and inducement payments, and $200,000 in restricted stock amortization expense associated with a realignment of our workforce.

We anticipate incurring no more than $3 million of onetime costs in the second half of the year to substantially complete our transition. We are confirming our guidance for projected 2012 core NOI of $0.35 to $0.40 per share excluding transition expenses. We recognized a net loss of $7 million or $0.09 per share. Our net loss for the second quarter was driven by a $12.3 million net loss on our investment portfolio. Our net loss included an $8.9 million write-down of our equity position Broadview Networks. $5 million in other marks on our investment portfolio, and $1.6 million realized gain on the monetization of our debt and equity investments which includes a reversal of previous marks on such investments.

We have made significant strides to reposition our investment portfolio away from principal equity investments to middle market leveraged loan. In the second quarter we made the following significant strides in repositioning our balance sheet. First, we monetized approximately $213 of investments consisting of $40 million of equity investments and $173 million of loans. The results being that debt investments now made up 92% of our investments of fair value. Second, we reduced total borrowings by $63 million. As a note, in July, we used approximately $91 million of cash and securitized accounts to reduce our borrowings and to improve our total debt to equity ratio form 1:1 at December 31, 2011 to 0.7:1 as of July 28, 2012.

Third, we increased our investable cash to approximately $204 million, which converts to available liquidity to make ten or more new loans at our average target size of approximately $15 million. Four, our average total yield on our loan portfolio remained above 10% for the quarter, even after adjusting for the acceleration of unearned fees on monetization of loans. Finally, and as Rich preciously mentioned, during the quarter we repurchased approximately 2.7 million shares at an average price per share of $4.36, which equated to approximately a 20% discount from our quarterly net asset value per share.

As we monetize investments and accrued various loans, the balance of loans on non-accrual at fair value declined from $23.2 million to $12.4 million, from March 31, 2012 to June 30, 2012. Non-accruals as a percentage of fair value are approximately 3%. And with that I will turn it back to Rich.

Richard Neu

Thank you, Keith. Let me close by updating on our current dividend and stock repurchase thoughts. From a dividend standpoint, we will pay the $0.14 per dividend declared on July 27, 2012, on August 31 of 2012. Additionally, it is anticipated that the dividend to be declared at our October board meeting will be paid at the end of November. We have shortened the time between declaration and payment of our dividend at the request of several shareholders. Based on our current forecast, the shortening of our dividend payment cycle this year, means that the five dividends to by paid by MCG in 2012 should represent a return of capital in the range of 85% to 90%.

Although we are not providing guidance on future dividend levels, we would anticipate that beginning in the fourth quarter and continuing into 2013, future dividends will began to more closely approximate NOI excluding any remaining transition costs. Based on our evaluation of our current liquidity and medium term earnings profile, this would imply a fourth quarter dividend of 12.5 cents per share. Our ultimate goal is to pay a dividend that is well covered by our NOI results.

From a stock repurchase standpoint, we continue to anticipate being active under our stock repurchase program depending on prevailing market conditions and other factors. We are approximately $18 million in repurchasing authorization remaining under our $35 million program. With that I would say thank you for your support, and we are now available to answer any questions you may have. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Greg Mason from Stifel Nicolaus. Your line is open.

Greg Mason - Stifel Nicolaus

Just on your last comment on the share repurchase. Given that you have an excess cash level, what are your thought about accelerating the deployment of cash in the share repurchase program and potentially upsizing that and continuing to do more in the future?

Richard Neu

Hi, Greg, this is Rich. At this point in time the program is being conducted under 10-B18. We have made a lot of progress in terms of the amount of share activity that we have purchased. So we still have (inaudible) sort of a tender offer and what not. And that’s something at this point in time that we have tossed it around as a board but think the current program is the one that makes the most sense for us.

Greg Mason - Stifel Nicolaus

And is there any thought that once you fully utilize the current program that you could put in place a new program?

Richard Neu

Yeah, I think, I just view capital management is sort of our normal course responsibility that we have as a board and management team. And we have obviously completed half the program and once we get that program done in place we will have to look at reinvestment opportunities and obviously the stock price level comes into play as well. And we will take that all under due consideration. But good points and those that we think about normal course.

Greg Mason - Stifel Nicolaus

Great. And then Hagen, you talked about originations came below your expectations, but that can be a lumpy business. What is your target level of expectations recognizing that this can be a lumpy business?

Hagen Saville

Greg, as I said in the past, I think given the capital that we control, originations and the 30-40-$50 million per quarter range on an ordinary course is what I would expect in normal market conditions. If we have got total assets of $500 million to $600 million and an average life of 2 years to 30 months, I think that implies something on the order of $150 million per year. So depending upon market conditions, the average life of the portfolio, I think that would be what I would expect.

Greg Mason - Stifel Nicolaus

The potential $3 million of additional onetime cost for the remainder of the second half of 2012, is that any -- can you give us kind of any guidance as to what might come in the third versus fourth quarter?

Richard Neu

Greg, this is Rich. I am not sure which quarter and most of that would be related to the timing. We are going to be moving our -- we plan to move our headquarters facility, and so most of that is going to be sort of a non-cash fixed asset related. At this point my best guess would be fourth quarter, slight chance we might move that up but we have some leasehold improvements to write-off and possibly some unpaid rent or additional rent. The current lease expires in February 2013 and the expectation based on yesterday at least is that we will likely be moving around the first week of November. So most likely fourth quarter, could be third but I would guess fourth.

Operator

(Operator Instructions) Our next question comes from Mike Turner from Compass Point. Your line is open.

Mike Turner - Compass Point Research

Just where would say yields are today maybe versus last quarter. Are you seeing, widening spreads, tightening spreads, increased competition? I guess where in general are you targeting the senior and sub returns and where is the environment relative to that?

Richard Neu

I don’t see any meaningful change in trends. I think that we have got industry expertise in a handful of sectors where we are seeing loan activity where we have got some strong relationships and particular sector expertise. But I don’t really see demonstrable trends and spreads. Obviously interest rates are very low and I would say quality is not great. But I don’t -- quarter-to-quarter, I don’t see any demonstrable trends which would make me change my views about the business.

Operator

(Operator Instructions) Our next question comes from Rick Fearon from Accretive Capital. Your line is open.

Richard Fearon - Accretive Capital

This just a question to follow up on a previous caller’s question. That relates to the $80 million of available cash for corporate purposes and the $300 million cash balance now. Is there any opportunity to drive up NAV per share with a more aggressive repurchase program? And I know Rich you mentioned that you have tossed around the concept of the tender offer to accelerate the program, but it really does appear the discount to NAV today of 14% or so and the dividend yield just appears to be really attractive investment. And it sounds like the 10-B18 program has been more effective this past quarter. But it would seem that that could be a meaningful driver of improving NAV, and if not, are there other -- can you talk about any other drivers of increasing NAV?

Richard Neu

Well, the ideal driver would be redeployment of that capital at the types of risk-adjusted returns that Hagen alluded to. I think at this point we are trying to do both. I guess kind of a strategic question that we grapple with is what's the appropriate level of permitting capital to be operating with. And so once we get through this buyback, I think we have to look at where we stand, what's the appropriate leverage profile. As you know because you have been a long time investor, we have been operating on the last nine to twelve months without a bank revolver facility. We have communicated in our press release and we further articulated in our Q to be filed in a little bit here, that we do intend to file a second license.

So I think as we formulate the appropriate capital profile for the company and then wrap that in to where the stock price is trading, I think we have to throw all that into the mix and see what makes the most sense for us. So I think the good news is as we are falling up along now, where we are getting I think great visibility on what the earnings profile is. I think the sort of the last two pieces is the redeployment of the liquidity process from the asset management group that we have that we are pleased -- very very pleased with the team that we have in place, and then kind of wrap that into what the appropriate capital structure is given some additional leverage opportunities that may or may not be out there which Hagen alluded to.

Richard Fearon - Accretive Capital

Thanks. And then you have addressed most of the other questions I had Rich, but just sort of the continued success which have demonstrated since you have taken over the role of CEO. Are strategic alternatives on the table for MCG and is the company open to considering as well as with the public BDCs are just so compelling to your point about the appropriate cash level and the appropriate size for BDC. Certainly the larger BDCs can't be -- should be more efficient than the small ones trying to operate a public enterprise.

Richard Neu

My view of the public company world is not the just the BDC space, is that we always have an obligation to consider strategic alternatives to the extent they present themselves. When you look at what we have tried to accomplish in the last nine months, which I truly think that we are about 90% there, it’s all about trying to control your own destiny and controlling what you can control. And maximizing the earnings profile which for an internally managed BDC, it’s a very interesting model if you can run it efficiently and then if you can redeploy those assets in an appropriate risk adjusted manner. Which when you get right down to it is where we have struggled in the past. And so that’s probably the most important role we have going forward.

So we are trying to -- we are in the process of -- we have put a plan in place to control our investments. Now having said that, if there is another party out there, public or not, that presents something to us that provides value, that we look at, that we believe that we can't get to on our own in a prudent manner, then we would have an obligation to look at it and act accordingly. But I think, to me that’s our job. Where the stores of capital you have given us and we will do the best we can on our own and if someone comes along and can pay for the permanent capital base and synergies and what not, then that’s something we would have to consider from a fiduciary standpoint.

Richard Fearon - Accretive Capital

Well, thanks so much and congratulations to the team in successfully monetizing investments and deleveraging the company as you have.

Operator

Thank you. I am showing no further questions at this time and would like to turn the conference back to Mr. Rich Neu for closing remarks.

Richard Neu

Okay. Thank you, operator. And thanks again to our stockholders and employees and other constituents and we look forward to speaking with you in three months. Thank you.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may all disconnect at this time.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: MCG Capital's CEO Discusses Q2 2012 Results - Earnings Call Transcript
This Transcript
All Transcripts