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Triangle Capital Corporation (NYSE:TCAP)

Q3 2012 Earnings Call

November 8, 2012 9:00 am ET

Executives

Garland Tucker – Chairman, President, Chief Executive Officer

Steven Lilly – Chief Financial Officer

Brent Burgess – Chief Investment Officer

Sheri Colquitt – Vice President, Investor Relations

Analysts

Robert Dodd – Raymond James

John Hecht – Stephens

Greg Mason – Stifel Nicolaus

Mickey Schleien – Ladenburg Thalmann

Operator

Good day ladies and gentlemen and thank you for standing by. At this time, I’d like to welcome everyone to Triangle Capital Corporation’s conference call for the quarter ended September 30, 2012. All participants are in a listen-only mode. A question and answer session will follow the company’s formal remarks. If you should require operator assistance during the conference, you may press star then zero on your touchtone telephone. Today’s call is being recorded and a replay will be available approximately two hours after the conclusion of the call on the company’s website at www.tcap.com under the Investor Relations section.

The hosts for today’s call are Triangle Capital Corporation’s President and Chief Executive Officer, Garland Tucker; Chief Financial Officer, Steve Lilly; and Chief Investment Officer, Brent Burgess.

I would now like to turn the call over to Mr. Garland Tucker.

Garland Tucker

Thank you and good morning to everyone. We appreciate your joining us for our third quarter 2012 earnings call. Before we begin, I’d like to ask Sheri Colquitt, our Vice President of Investor Relations to provide the necessary Safe Harbor disclosures.

Sheri Colquitt

Thank you, Garland. Good morning. Triangle Capital Corporation issued a press release yesterday afternoon with details of the company’s quarterly financial and operating results. A copy of the press release is available on our website. Please note that this call contains forward-looking statements that provide other than historical information, including statements regarding our goals, beliefs, strategies, future operating results, and cash flows. Although we believe these statements are reasonable, actual results could differ materially from those projected in forward-looking statements. These statements are based on various underlying assumptions and are subject to numerous uncertainties and risks, including those disclosed under our section titled Risk Factors and Forward-Looking Statements in our annual report on Form 10-K for the fiscal year ended December 31, 2011 and quarterly report on Form 10-Q for the quarter ended September 30, 2012. Each is filed with the Securities and Exchange Commission. TCAP undertakes no obligation to update or revise any forward-looking statements.

And now, I’ll turn it back over to Garland.

Garland Tucker

Okay, thank you Sheri, and again I’d like to welcome everyone to today’s call. At the outset of the call, I’d like to make a few comments about our industry and then I’ll make a few comments about TCAP’s results for the quarter before I turn the call over to Steven and Brent to provide some additional details with regard to our financial results and investment portfolio activity.

First from an industry perspective, we believe the BDC business model is continuing to be understood and appreciated by a growing audience of investors. As some of the best analysts covering this space have recently noted, the BDC industry has an impressive lending and investing track record with non-accrual and loan loss rates generally better than FDIC-insured commercial banks but with much more conservative capital structures and with much more transparent financial reporting. Some BDCs such as Triangle have been able to generate net long-term gains so that from a capital preservation perspective, there have been no historical net loan losses on a cumulative basis.

When Triangle went public almost six years ago, the BDC industry was comprised of 18 companies. Today there are approximately 40 companies with two new IPOs in the last 30 days. The market is continuing to realize that our industry provides investors the ability to realize double-digit annual returns by coupling current dividend income with potential annual share price appreciation. Additionally, bond investors are recognizing the low overall leverage in the BDC operating model and are awarding high-quality BDCs with access to long-term fixed rate debt on attractive terms.

To the extent BDCs can continue to provide shareholders with a low beta dividend income stream, they should be well positioned for growth as a sector in much the same way that REITs and MLPs did over the last two decades. So in conclusion, let me say that we feel very fortunate to be able to operate in this expanding industry.

Now I’d like to move to a few Triangle-specific comments. The third quarter of 2012 was another very active quarter for our company. We were active in terms of new investments, we generated net investment income that was in excess of our dividend, we raised our quarterly dividend from $0.50 to $0.52 per share, we maintained our portfolio credit quality, we generated 1.6 million in realized gains, we expanded our operating team, and we closed on a new significantly larger senior credit facility. So not only were we busy this quarter, we were able to be productive on a number of important fronts.

Our quarterly NII of $0.58 per share comfortably covered our $0.52 per share quarterly dividend. Our efficiency ratio, defined as total G&A expenses divided by total investment income or revenues, was 18.1% during the third quarter, which continues to be one of the lowest efficiency ratios in the BDC industry. Our dividend increase during the quarter represented an 18.2% year-over-year increase and a 4% quarter-over-quarter increase, and while the dollar amount of the dividend alone is attractive, we think it’s equally important that we have continued to earn our dividend on a cumulative basis as our cumulative net investment income has exceeded our dividends paid by $0.35 per share since our IPO almost six years ago. We have said consistently that earning our dividend is a key strategic focus for us, and our continued success in that regard has resulted in a dividend coverage ratio that we believe provides room for future dividend growth.

We were active from an investment perspective during the third quarter with eight new portfolio company investments totaling approximately $72 million. We have announced one new investment totaling 14.5 million subsequent to quarter-end. Credit quality continues to be a key focus for us and we remain pleased with the overall performance of the investment portfolio.

Finally, we have continued to add to our operating team over the last several months. Today, Triangle has 22 professionals compared to just seven at the time of our IPO, so our investment portfolio has steadily grown, so has our professional staff. The research triangle area is an excellent location which certainly facilitates our recruiting efforts. As we prepare for 2013 and beyond, we will continue to try to maintain our industry-leading efficiency ratio while simultaneously focusing on adding quality people to our operational team at the appropriate time.

And with that, I’d like to turn the call over to Steven.

Steven Lilly

Thanks, Garland. In this section of the call, I’ll focus on our financial results for the quarter and then I’ll spend a little time focusing on our capital markets activity and liquidity position, and after that I’ll turn the call over to Brent to discuss our third quarter investments and some of the trends we are seeing in the mezzanine market.

As most of you know, yesterday after the market closed we filed our earnings release and 10-Q. During the third quarter, we generated total investment income of approximately 24.3 million, which represented a 50% increase over the 16.2 million of total investment income during the third quarter of last year. The increase in our investment income was primarily attributable to a year-over-year increase in the size of our investment portfolio. I should call out that of the 24.3 million in total investment income, a little more than $700,000 or approximately $0.03 per share was related to a non-recurring dividend from a portfolio company.

Our total expenses during the third quarter were 8.5 million, consisting of interest expense and other financing fees and general administrative expenses. For the three months ended September 30, interest expense and other financing fees totaled approximately 4.0 million as compared to 2.9 million for the third quarter of 2011. The increase of 1.1 million in interest expense and other financing fees was primarily due to the issuance of our 7% senior notes issued in March of this year. Our G&A expenses for the third quarter of 2012 totaled approximately 4.4 million as compared to 2.9 million for the third quarter of 2011. The $1.5 million increase in G&A was primarily attributable to increased salary and compensation costs as well as increased public company-related expenses.

Net investment income for the quarter was 15.9 million or $0.58 per share as compared to NII of 10.4 million or $0.52 per share during the third quarter of 2011. During the third quarter this year, we recorded total realized gains of approximately 1.6 million associated with the sales of three portfolio investments. Aside from our 1.6 million in realized gains during the quarter, we recorded approximately $587,000 in unrealized depreciation relating almost entirely to reclassification adjustments as investments moved from unrealized gains to realized gains. Perhaps more important, on a year-to-date basis, our net realized gains during 2012 total approximately 5.2 million, and since our IPO in February of 2007, our net realized gains total approximately 12 million. These financial metrics directly underscore the importance of maintaining a diversified investment portfolio with a variety of equity positions in a very high percentage of our portfolio companies.

As a result of our operating activities, our net increase in net assets from operations was 16.2 million for the three months ended September 30, 2012 or $0.59 per share as compared to 17.5 million or $0.87 per share for the period ending September 30, 2011. At quarter-end, our total investment portfolio had a fair market value of approximately 631 million, representing an increase of approximately 124 million from December 31, 2011, or said another way year-end of last year; and our net asset value as of September 30, 2012 was $15.33 per share, representing an increase of $0.65 per share since December 31 of last year.

Turning to liquidity and capital markets activities, from a liquidity perspective, Triangle is – just to be very, very blunt – in an incredibly fortunate position. During the third quarter, we closed on a $165 million four-year senior secured credit facility comprised of nine lenders. Our new senior credit facility has an accordion feature which allows for an increase in the total loan size of up to 215 million and also contains two one-year extension options, bringing the total potential term to six years from closing. We were extremely pleased with the strong support we received in the bank market, and we were even more delighted to be able to increase the size of the facility from an originally contemplated amount of 150 million to 165 million.

In addition to our credit facility, in October we priced a public offering of 70 million of 10-year, 6 3/8ths percent interest senior unsecured notes. On Tuesday, the underwriters fully exercised their greenshoe option, bringing the total gross proceeds of the bond offering to 80.5 million, which thankfully was well in excess of our originally contemplated 50 million size at the time we launched the offering.

Also in September, we elected to prepay 30.4 million in SBA debentures. The SBA was once again a wonderful partner to us, and in October they confirmed a recommitment of new debentures for us, thereby giving us the ability to proactively manage our balance sheet from a material and cost of capital standpoint. The weighted average interest rate on the debentures we prepaid in September was almost 6.5%. Taking into account the availability of the 10.4 million in debentures that we had prepaid earlier this year, we currently have access to a total of 40.8 million in SBA guaranteed debentures which we would reasonably expect to draw over the next few months. With the presidential election now behind us, we hope that the proposed legislation to expand the SBA debenture program will be approved and that we will be able to expand further our almost decade-long relationship with the SBA.

So taking all these things into account, here’s a quick snapshot of our current liquidity position. On a pro forma basis, as of September 30, 2012 cash on hand equals almost 100 million, available SBA debentures equal 41 million, and availability under our senior credit facility equals 165 million. All of this equates to total available liquidity of approximately 300 million, which we believe provides us with a very clear path to continue looking for investment opportunities in the lower middle market, which continues to be so attractive.

In addition to our total amount of liquidity, as Garland touched on in his opening comments, we are particularly pleased that the cost of both equity and debt capital for virtually all BDCs is continuing to decline as our industry continues to earn a positive reputation with investors of all types. Indeed, when you consider that less than two years ago there was not a developed bond market for the BDC industry, you would probably be as pleased as we are to know that during 2012 nine BDCs have accessed the bond market in 13 different transactions, and specifically in terms of Triangle, just two years ago our capital structure included only equity and SBA debentures and had a weighted average cost of debt of 5.3% and a weighted average life of approximately eight years. Today, our capital structure includes our equity base, our SBA debentures, two bond issuances, and our 165 million senior credit facility. In addition, today our weighted average cost of debt is 5.2% and the weighted average life is still longer than eight years. Finally, as we stand today, 100% of our balance sheet is currently fixed as we have currently no borrowings outstanding under our senior credit facility, which provides a path of stability for us on a go-forward basis, we believe for the next several years.

And with that, I’ll turn the call over to Brent to discuss our portfolio activity in the mezzanine market.

Brent Burgess

Great, thanks Steven. The third quarter was active for us from an investment perspective with eight new investments totaling almost $72 million. Six of those transactions included some component of equity, which as you know is an important part of our investment strategy.

During the third quarter, we had four full loan repayments and partial loan repayments totaling approximately $39 million, bringing net investments during the quarter to approximately $33 million; and as Steven mentioned, we recorded net realized gains during the quarter of approximately $1.6 million related to the sale of three portfolio investments, bringing our year-to-date total realized gains to $5.2 million. At September 30, our portfolio consisted of 77 companies with a fair value of $631.3 million.

The weighted average yield on our debt investments was 14.7% at the end of the third quarter, down slightly from 15% last quarter but still well above the median of our historical range. Since our IPO, our WAY – weighted average yield – has ranged from a low of 13.7% to a high of 15.4%. In my long experience in the lower middle market in a wide variety of market conditions, this range has proven to be stable and consistent and is one of the many aspects of the lower middle market that we find attractive.

While some BDCs have recently indicated they are experiencing significant yield compression, we think that is occurring more in the large market and particularly with unitranche loans, which are having to compete with more aggressive senior lenders. Certainly a few of our more recent mezzanine investments have had coupons in the 13% range. Generally speaking, these have been larger companies with top tier sponsors. Still, over the last six quarters, our weighted average yield on new investments has ranged from 14.4% to 15.1%, again very consistently within our long-term historical range.

As Garland mentioned in his opening remarks, from a credit quality perspective we continue to be very pleased with our portfolio company performance. Non-accruals fro the quarter were 1.5% on a cost basis and 0.4% on a fair value basis, essentially unchanged from the second quarter. These numbers are at the low end of the spectrum for the BDC industry, and when you couple them with our historical net realized gains across our investment portfolio, you can see yet another reason why we believe that our strategy of building a broadly diversified portfolio of mezzanine loans with equity upside in lower middle markets is the best way to focus our efforts.

In terms of the current status of the mezzanine market, the private equity partners with whom we routinely work are still finding numerous investment opportunities that they perceive to be attractive. While we may not always share their enthusiasm in the sense that we tend to pass on a high percentage of the potential investment opportunities we review, it is also accurate to say that our investment team is extremely active as we believe there are still many M&A opportunities in the lower middle market that can be attractively structured both in terms of purchase price multiple and in terms of overall capital structure.

As Steven touched on in his comments, we deliberately are in the position of not needing to aggressively deploy capital and therefore we have the luxury of being able to be selective with our investment dollars. Just to put specifics around that concept, it’s comforting for us to know that even if we didn’t make any additional investments for the remainder of this year and in fact well into 2013, we could still continue to earn our current dividend which, as you know, is a very important part of our strategy. While we don’t think that it’s likely to happen as we were actually very busy with deal flow this quarter, it’s a good demonstration of our continued ability to make investments at a deliberate pace driven by transaction quality, as opposed to being pressured to chase riskier yields associated with lesser quality opportunities.

With that, I’ll turn the call back over to Garland for a few concluding comments before we open the call to questions.

Garland Tucker

Thanks, Brent. Let me say that it’s a pleasure to be able to deliver better than expected results, and I’d like to congratulate our entire team for its focus and dedication. Before we open the call to questions, let me circle back to our industry for just a brief comment.

For the BDC market in general, the last 24 months had been a period of returns to shareholders in terms of stock price appreciation, increasing net asset values, and declining non-accruals versus the longer term industry average. For investors of all types across almost all companies, a lot of easy money, so to speak, has been made in this industry. As we move into 2013 and beyond, I believe the most successful BDCs will continue to possess the following three characteristics: number one, a rigorous, disciplined approach to investing; number two, a strong balance sheet relying principally on equity and long-term fixed rate debt; and third, a low operating efficiency ratio. Let me assure you in closing that TCAP remains committed to these three goals.

With that, Operator, you can now open the call for questions.

Question and Answer Session

Operator

Sure, thanks. [Operator instructions]

Our first question comes from Robert Dodd with Raymond James. Please go ahead, your line is open.

Robert Dodd – Raymond James

Congratulations. One housekeeping one, if I can – in G&A, you mentioned non-recurring fee and dividend income. Was there anything non-recurring or catch-up in the G&A in terms of catch-up accruals or bonuses earlier in the year or anything like that, or is this kind of the current run rate we should expect? I mean, obviously it’s still a very good efficiency ratio, but just trying to get an idea of the scope of what the recurring level going forward is.

Steven Lilly

Robert, hey, it’s Steven. Thank you for your question. There aren’t any catch-up items in G&A, I think was really the specific first part of your question. I would say that at G&A range on a quarterly basis of 4 to 4.5 million is—you know, I think 4.4 for this quarter is probably reasonable based on the things that we touched on in the call of, number one, the team is significantly larger now than it has been, and also let’s just call a spade a spade – it cost a little bit of money to operate a publicly-held company these days. So I think that’s a pretty good number for you to use in your models.

Robert Dodd – Raymond James

Okay, appreciate it. Turn kind of to the market—maybe Brent can address this one. How is the fourth quarter looking? There’s a lot of expectations that maybe taxes on capital gains particularly change next year, or the change doesn’t get prevented might be a better way of putting it. How are activity levels stacking up right now in terms of what you’re seeing? To put it in perspective, maybe—I mean, there was a lot of concern back in the fourth quarter 2010 that things were going to change and it was a very active period for you. Last year, though, there wasn’t a lot of concern about those things so a much less active period. Can you qualitatively give us an idea of how you would rank current activity levels in the marketplace, what you’re seeing, quality of deals you’re seeing, and is this more like a 2010 or more like a 2011?

Brent Burgess

Thanks Robert, this is Brent. As you know, we don’t discuss our pipeline, and certainly some BDCs are saying they’re seeing an enormous wave of deals. You know, people have been saying that kind of all year, and this year has for many firms and for the industry as a whole, I think, been a little bit disappointing in terms of transaction volume. We have seen some building of activity here as we move towards the end of the year, but as I said in my comments, I wouldn’t expect Q4 to be outside the range of kind of what the norm has been for us in the last six to eight quarters. It’s possible, but we’re not seeing, I would say, this big wave that other people are talking about. We’re certainly seeing a healthy amount of activity out there, and obviously Q3 was a very healthy quarter for us. Really, our deployments have been reasonably strong all year, so I think in a lot of ways, again, we’re sort of a little bit maybe underneath some other folks in the market in terms of playing it a bit in a smaller market, and maybe the smaller market doesn’t quite follow the same trends as maybe the larger market does.

Steven Lilly

And Robert, this is Steven. I’d add to what to Brent said, and I think he touched on it a bit in his comments in the call as well, that we are active right now, which is great; but yet from a capital structure standpoint, from an operational standpoint, we are positioned so that we don’t have to make a significant amount of new investments on a go-forward basis to have the sustainability of the current dividend. So it really to us—and you’ve heard us say this before when we’ve had different capital raising events, so it’s a key part of the strategy, but it’s nice to be in that position where we can be prepared for the worst, so to speak, in a market that’s not very active or one that we don’t find very attractive, but yet also hope for the best. And again, with our guys being active, I think easy to conclude that.

One other comment I will add, Robert, is as always is the case, we have a number of our companies in a sale process, and both on those companies and in new opportunities we’re looking at, we have experienced Hurricane Sandy-related delays as a lot of people in New York have been without power and their offices have not been functioning. A lot of deals lost a week or more, which can be pretty critical at this time of year. So I think other firms are going to experience some delays related to that as well, both on the new transaction side as well as the exit side.

Robert Dodd – Raymond James

Okay, appreciate that. If I can ask one more quickly about credit quality – obviously your Venture Technologies Group now on PIK non-accrual. Any update there? And then that’s an asset that’s obviously been a lot of stress for a while has been showing up in your fair value marks on that, so the disclosure has been helpful. There’s a couple of new assets that suffered some—I don’t want to say too substantial, but the mark-downs, Xchange Technologies and Minco Technologies, their fair value marks came down fairly substantially. I mean, any color you can give on those in terms of what’s going on there and is there a material risk. Obviously the question we’re always asking – is there a material risk those guys are going to end up on accrual?

Brent Burgess

That’s a lot of ground to cover in one final question there, Robert. Let me tackle them in the order that you mentioned them. First of all, VTG and HP, which are PIK non-accrual assets, both of these investments have had operational challenges since fairly close to closing, which is the reason for the PIK non-accrual classification on our investment roll. Both investments continue to service their cash interest obligations to us and both appear to have relatively good liquidity. We’re working with both companies and management teams to provide longer term solutions to their operational challenges.

Even, however, if both accounts were to go on full non-accrual at some point in the future, we would still be able to earn our quarterly dividend and our total portfolio non-accrual rate would still be significantly lower than the industry average. So while we’re not pleased with either investment at the current time, we are thankful that we’re in a healthy position where we can take what we hope will be the right steps to work towards a good, long-term solution for each company.

I think the second company you mentioned or asked about was XTG. XTG was an investment that we committed to in April of this year and on which we closed in early June. The company had been working with the same lender and growing at a very rapid rate during this period of time for almost six years, and we worked closely with that senior lender during our underwriting process. In August, however, we were very surprised to receive notice that the senior lender was accelerating its loan and took very aggressive action. This process culminated in a new senior lender purchasing the incumbent lender’s debt at a discount to par, and as part of that process we agreed to lower our interest rate from 18% to 8% with a catch-up provision at the end of our investment period, and also with some substantially increased equity upside. So not a typical situation for us by any means, but the company continues to perform and execute, and so we hope to see some improved results there.

Finally, you asked about Minco. We voluntarily lowered our interest rate from 16.25 to 10% in September in conjunction with an equity investment from the sponsor. We anticipate that this pricing action will be temporary and we will be able to restore our interest rate in the future.

One item just to keep in mind with regard to all of these companies is that we have originated approximately $600 million of investments with zero cash non-accruals, so in that regard—since 2009 or something, so in that regard we’re obviously pleased with the overall performance of our portfolio. And relative to my previous comments, we have 77 portfolio companies and we deliberately pursue a very broadly diversified investment strategy. So to have sort of a small handful of companies that are underperforming is not surprising with a portfolio of that size.

Robert Dodd – Raymond James

I appreciate the comments.

Operator

Thank you, sir. The next question comes from John Hecht with Stephens. Please go ahead, your line is open.

John Hecht – Stephens

And another successful quarter. First just to round out the credit discussion, with respect to the remaining portfolio, can you just discuss factors around revenue growth and EBITDA growth and any trends you’re seeing, both good or bad?

Brent Burgess

Sure, John. The year-over-year increase in EBITDA for the portfolio as a whole is just under 10%, which is healthy but not spectacular growth, and I think obviously relative to the economy is better growth than the overall economy is experiencing. I would say we’re very pleased that we continue to see the equity portion of the portfolio grow in value and indeed offset some dilution or some degradation we’ve experienced in the debt portion of the portfolio.

Certainly from a big corporate standpoint, earnings growth is really declining. I would say we haven’t seen that yet in our portfolio as a whole; and again, there’s always some performers that are better and some are worse, but we continue to see in general growth both at the revenue and at the EBITDA lines. I think in the one-time dividend that we had in Q3, that’s a company that we closed on a year ago, a little more than a year ago now, and has experienced very rapid growth and very rapid deleveraging.

So we’re overall very pleased with the financial performance of the portfolio.

Steven Lilly

And John, this is Steven. I’d just add one thing to what Brent said. He was giving you the year-over-year increase in the portfolio from a financial performance, which is exactly accurate. If you go back and look at the entire portfolio relative to the date the investment closed and measure performance since that time, it’s a very similar percentage to the 10% that Brent gave. So it’s not just that we’ve had good performance with the portfolio in one year. It really hearkens all the way back to closing, which we’re obviously very pleased to see.

John Hecht – Stephens

Okay. And have you guys been able to conduct a portfolio review and determine does any of your portfolio companies have any sort of operational exposure to an area that might have been impacted by Hurricane Sandy?

Brent Burgess

Yeah, we have, John, and no real impact on the portfolio as a whole. Again, the industry, I think, will see bigger impacts just from delays.

Steven Lilly

Banker delays with M&A processes—

Brent Burgess

Yeah, bankers, lawyers, private equity sponsors. In any middle market, lower middle market M&A transaction, as you know, you have at least half a dozen parties, and all it takes is for one of those two parties that were based in the northeast that had their communications cut off, if not worse, and that obviously causes delays in the whole process.

John Hecht – Stephens

Yeah, I understand. Moving on to cost of funds, the $41 million of SBA debt that you’re going to roll from 6.5%, do you know what the price would be if you rolled that right now to a new set of debt?

Steven Lilly

Well John, the best proxy to use for that – and appreciate the question – is, I guess, the last time that we locked into the 10-year debentures, and that pricing was 3.39%. So it’s clearly a more favorable market for that and we should benefit from it. If you were using 3.5 or something like that in your model, that’d be fine.

John Hecht – Stephens

Okay, great. And then you guys talked about your kind of end market conditions from a flow perspective, and then you talked about yields in that 14 to 15% range. Just thinking forward, is there anything, maybe, over the last 60, 90 days that would give you some opportunity to tell us, hey, for the next few months or quarters you would expect yields to be in this part of that range, or do you just of think down the middle of that range is as good of a guess as you can give right now for new originated assets?

Steven Lilly

I’ll give you a quick answer, and Brent and Garland may elaborate more, give you more color. I think from a modeling standpoint and forward look, I think what we would encourage you and other folks, too, to use is the reason we give long-term range of 13.7 to the low 15’s is it’s just great to work with from a projection standpoint. So I think if you were to use somewhere close to the lower end of that range, then that’s a good place for you to start from a modeling and a projection standpoint. And certainly, we would hope to perform a little better than what you might project, but there’s nothing that we see out there right now that would say we should lower the range from what it has been and what our experience has been historically.

Brent, would you add anything, or Garland would you add anything to that?

Brent Burgess

Yeah, I’d just say—really focused on Q3, John, 14.4% was the weighted average yield of the new loans in Q3. Obviously our portfolio WAY went from 15 to 14.7. What’s happening there is that some of the older loans in our portfolio that were originated in ’07,’08, ’09, maybe even ’10 with higher yields are being repaid, and so the slight decline in the WAY, it actually has less to do with the yields on new loans and more to do with just exiting older, higher yielding loans.

John Hecht – Stephens

All right, thanks. That’s great color.

Operator

Thank you, sir. The next question comes from Greg Mason with Stifel. Please go ahead, your line is open.

Greg Mason – Stifel Nicolaus

On that last question, you were talking about yields. What are you seeing in terms of leverage multiples on the marginal new deals – are they holding in, or are they starting to creep up?

Brent Burgess

Yeah, we’re seeing leverage ticking up here definitely. When we look at our whole portfolio, again, we are very pleased with the overall leverage in our portfolio. Leverage is picking up. We still think the market is acting quite rationally, and I would say that leverage is moving up to levels that are probably still very sustainable and very reasonable. So we’re not concerned at this point yet, Greg, that the market is overheating, but definitely—you know, we’ve come out of really historically low leverage periods, and so leverage had nowhere to go but up. But again, that’s not a concerning trend to us at this point.

Greg Mason – Stifel Nicolaus

Okay, great. And then Steven, you talked about the amount of capital you have to deploy right now. If we think about kind of drawing on that revolver, you could potentially leverage your balance sheet to almost 0.75 from a regulatory basis and maybe even as high as 1.25 on a total leverage basis. What is your view in terms of the right leverage that you guys would be comfortable going to in your portfolio?

Steven Lilly

Greg, thanks. I think on a—as you say, where we are today in that kind of 0.75 or so range, we look at it as, number one, we want to keep bank debt as a percentage of our total capital structure, we want to keep it very, very low. So we think about it in the—call it 10 to 15% range of our total capital structure. We recognize with the new facility that we are large enough now from a total balance sheet standpoint where it’s appropriate, and we’ve said on these calls before to have some permanent bank financing, so to speak, and so I think when you see us draw on the revolver, that’s just a normal course thing on a go-forward basis.

In terms of leverage, we analyze it both ways of since the SBA debt for SEC purposes is really counted as equity, and you think about that as real equity ballast in our capital structure, so from a regulatory perspective we’re still, I guess, relative to the 200% asset coverage ratio test, we’re at 520% or something like that. So we could draw substantially all the facility and still be north about 2.5 times, 2.6 times from a regulatory standpoint.

But again, there are going to be guides to that internally. It doesn’t scare us, given the strength of the capital structure, to be levered on a total debt basis the 0.8 to 0.9 times, because you have to balance it with what we are really from a regulatory perspective, which is exceedingly lowly levered. Thankfully the business, with the regulations that are in place, it’s close to impossible to over-lever a BDC, which I think is one of the reasons the proposed legislation is out there to allow the entire industry to increase its leverage a bit.

Greg Mason – Stifel Nicolaus

Great, thanks. And one final question – you mentioned some hopefulness about the SBIC expansion now that the election is over. I know you guys are tied into the SBA and the Small Business Investors Alliance, the lobbying group. Do you have any color from any of those parties about the potential likelihood of the SBIC expansion?

Steven Lilly

Hope springs eternal! You know, hopefully with the election behind everybody and some of the decisions that really need to be made in Washington, given that this has enjoyed bipartisan support, that someone will have the good sense to attach a really healthy addition to a bill and get it done. But no, we don’t have any more color there, I think, than anybody else who tries to be involved and hopefully is being constructive to the process.

Greg Mason – Stifel Nicolaus

All right, great. Thanks. Great quarter, guys.

Operator

Thank you, sir. Our next question comes from Mickey Schleien with Ladenburg. Please go ahead, your line is open.

Mickey Schleien – Ladenburg Thalmann

Wanted to clarify the non-recurring portion of investment income. The Q talks about 1.5 million for the quarter. Does that include the 0.7 million of non-recurring dividends?

Steven Lilly

Mickey, no, it does not. We tend to—I think what the Q says is that we had 1.5 million in non-recurring fee income compared to 100,000 of non-recurring fee income in the third quarter of 2011, something to that effect. So the third quarter—what’s really going on there is the third quarter of last year was, I think, our lowest quarter ever as a publicly held company in terms of the fee income that we generate. We jokingly sometimes internally when we’re talking to the Board, say there is a level of a non-recurring fee activity that does tend to happen every quarter, and this quarter we’re pretty solidly in our range as a percentage of revenue from a historical standpoint, that type of thing. The third quarter of last year, we were just overwhelmingly light from a standpoint, so—

Brent Burgess

After the second quarter, which was extremely heavy last year.

Steven Lilly

Yeah, the second quarter—right, the second quarter last year had been fairly heavy, so it was really taking the whole year together, we’d averaged out. So the dividend that we we received from a portfolio company of north of 700,000, that was in addition to the, quote, normal level of fee activity, so that’s why we called out those $0.03 to the market.

Mickey Schleien – Ladenburg Thalmann

Fair enough. I want to touch on the level of originations. Although they are still healthy, they declined pretty materially from the second quarter. I wanted to understand whether that was your concern with the sort of terms that were available in the market, or was it just general lumpiness in the business or something else?

Steven Lilly

Mickey, it’s Steven. I’ll give you a quick answer and then let Brent give you a little more color, maybe. Personally, I would say it’s general lumpiness with the business. I wish we were smart enough to predict with accuracy every quarter what we’re going to do. I’m not sure anybody is that good, but I know we’re not.

Brent, I don’t know if you have any additional color?

Brent Burgess

Yeah, the second quarter two factors there, Mickey – number one, we closed seven deals in the second quarter versus eight in the third quarter. They just happened to be substantially larger deals in the second quarter, so fairly unusually high in terms of the average deal size. Also, second quarter was, I believe, a record quarter of deployments for us. So yes, it really is just lumpiness and timing where things fall and how, and certainly don’t draw any trend lines off the second quarter. But the third quarter was probably a more normal quarter for us in terms of both average check size, actually a little small on the third quarter on average check size, and sort of total gross deployments.

Steven Lilly

And I’m sorry, Mickey, but just to round out on the color there, if you look at the second quarter, I think our average investment size was about 15 million. If you looked at the third quarter, our average investment size was, like, 9 million. Taking the two quarters together, the average investment size is 12, which is exactly on our true average. So just to round out on the color there.

Mickey Schleien – Ladenburg Thalmann

Okay. So circling back—

Brent Burgess

What I will say also, while I have the mic, that there have been a number of deals that we have chosen—we had signed up and we chose not to move forward with related to kind of the overall color that leverage is higher, pricing is a little bit down, and so we certainly could have deployed more aggressively and chose to not do so in the third quarter specifically on a couple of companies.

Mickey Schleien – Ladenburg Thalmann

Okay. So circling back to the fee revenue, I’m assuming some of that is generated by new business or as a result of origination fees. Fee revenue was up in the quarter – it was 1.5 million in the third quarter versus about a million in the second quarter. So can you help me reconcile that to the pace of originations?

Steven Lilly

Well Mickey, it doesn’t really tie to the pace of originations for us. As I think you know, we do not take any meaningful amount of structuring fees like some BDCs do. There are certain BDCs that if they have a very heavy quarter from an origination standpoint, you’ll see additional NII, or as they would report it, additional NII because they would take substantially all or really all of their upfront fee into income Day One. We sort of believe the accounting guidance within the land of GAAP tells you that you should amortize your upfront fee over the life of the contract, so that’s how we’ve always done it and I think we’ll continue to.

So the difference in fee activity, again it’s kind of, I think, the most color we can give, is it’s just normal activity within the portfolio. When you touch a portfolio company, you provide an amendment, you do something that is adding value in the half a decade long process that you’re investing in a company; and as we said earlier, it just cycled last year that we had a lot of that activity in the second quarter, not much in the third, and this quarter we had sort of normal activity.

Mickey Schleien – Ladenburg Thalmann

Okay. Last question, sort of a housekeeping question – I think early in the call, Garland mentioned a $0.35 per share. I’m not sure if that was spillover taxable income or—could you just go back and define what you were referring to with that $0.35 number?

Steven Lilly

Mickey, it’s Steven again, and not to speak for Garland but just given the nature of the question, I think what we were touching on there is really the long-term track record of over-earning the dividend, having NII be cumulatively since the time of our IPO in excess of the dividend. I think you’re right that over some period of time, if you had capital gains that you didn’t distribute or pay tax on or do a deemed distribution, in addition to that you’d have spillover income that you would have to pay out. We monitor our spillover income every quarter, report it to the Board, so we’re in a good healthy position there. Obviously there is a little bit since we’re over-earning the dividend, but it’s very much within the range where we’re comfortable with it.

So again, I think if anything, it portends to when you couple the existing dividend with the fact that we’re earning it on a quarterly basis, the fact that we don’t have to make any additional portfolio investments to continue earning the dividend coupled with the fact of the liquidity that we have, we hope that will lead us all as we move into 2013 and beyond to have as healthy a company at that time as we feel like we do now.

Mickey Schleien – Ladenburg Thalmann

Okay, thanks for your time this morning.

Steven Lilly

Great, thank you so much.

Operator

Thank you. At this time, I’m showing no additional phone questions. I’d like to turn the program back over to Mr. Tucker for any additional or closing remarks.

Garland Tucker

Okay, I would just thank everybody for being on the call this morning. We appreciate you attention and appreciate your questions. Don’t hesitate to call us if you have additional questions, and we’ll look forward to getting back together as a group next quarter. Thanks again.

Operator

Thank you, presenters. Again ladies and gentlemen, this does conclude today’s conference. Thank you for your participation and have a wonderful day. Attendees, you may disconnect at this time.

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