TCP Capital's CEO Discusses Q2 2013 Results - Earnings Call Transcript

| About: TCP Capital (TCPC)


Q2 2013 Earnings Call

August 08, 2013 01:00 PM ET


Jessica Ekeberg - IR

Howard Levkowitz - Chairman and CEO

Raj Vig - President and COO

Paul Davis - CFO


Chris Kotowski - Oppenheimer

Greg Mason - KBW

Robert Dodd - Raymond James

Boris Pialloux - National Securities


Ladies and gentlemen, good afternoon. Welcome everyone, to the TCP Capital Corp Second Quarter 2013 Earnings Conference Call. Today’s conference call is being recorded for replay purposes. During the presentation, all participants will be in a listen-only mode. A question-and-answer session will follow the company’s formal remarks. (Operator Instructions).

And now I’d like to turn the call over to Jessica Ekeberg, Vice President of the TCP Capital Corp Global Investor Relations team. Jessica, please proceed.

Jessica Ekeberg

Before we begin, I would like to note that this conference call may contain forward-looking statements based on the estimates and assumptions of management at the time of such statements and are not guarantees of future performance. Forward-looking statements involve risks and uncertainties, and actual results could differ materially from those projected. Any forward-looking statements made on this call are made as of today and are subject to change without notice.

During today’s call, we will refer to a slide presentation which you can access by visiting our website, Click on the Investor Relations link and select Events and Presentations. Our earnings release and 10-Q are also available on our site.

I will now turn the call over to Mr. Howard Levkowitz, Chairman and CEO of TCP Capital Corp.

Howard Levkowitz

Thanks, Jessica. We would like to thank everyone for participating in today’s call. I am here with our President and COO Raj Vig; our Chief Financial Officer Paul Davis; and other members of the TCPC team.

This morning, we issued our earnings release for the second quarter ended June 30, 2013 and posted a supplemental earnings presentation is posted to our website. We will refer to this presentation throughout our call. We will lead off with an overview of TCPC’s investment activities and performance. And then, Paul will provide more details on our financial results. I will then be back with some further prospective before we take your questions.

First, key highlights from the second quarter. We are pleased with our second quarter results and to report that our portfolio generated net investment income of $0.38 per share. Second, we declared a quarterly dividend of $0.36 per share, that is payable on September 30, 2013 to shareholders of record on September 9, 2013. Third, our earnings per share was $0.40 and our net asset value increased from $14.91 to $14.94 per share. Fourth, we deployed a $131 million in new investments during the quarter with net deployments of $61 million. In addition, we had a very successful quarter in increasing our sources of capital and financing flexibility. We closed a follow on offering of 5.175 million shares at $15.63 for net proceeds to the company of $78.2 million. We also closed a new $50 million credit facility which has an accordion feature that allows our expansion of the facility up to a $100 million. Finally, we received a green light on our application for an SPIC license which I will address in more detail later.

Now moving on to a summary of the market environment in the second quarter, we saw an increased level of activity during the quarter. Over the last four quarters we invested over $360 million on a gross basis and over a $117 million on a net basis. About one third of the deployment was completed this quarter. As we deployed the proceeds from our follow on offering, we continued to focus on allocating our capital to income producing securities.

Spreads and covenant packages in the middle market continue to be more attractive than those in the large leverage loan market. However, the tighter spreads in the broadly syndicated market have influenced terms in our market. Against this backdrop, we are highly selective in choosing investments and we’ll continue to carefully analyze each investment opportunity through our intensive and proven due diligence process.

Turning now to TCP Capital’s second quarter performance, TCP Capital generated $0.38 per share in net investment income on a diluted basis, after preferred dividends and incentive compensation, excluding incentive compensation on realized gains. And we will pay a quarterly dividend of $0.36 per share at the end of September. Substantially all of our income was generated from recurring income.

Our recurring income is growing but we would like to remind people that our originations and repayments are lumpy. Since our IPO in April of last year we have distributed $1.85 per share, an increased NAV by $0.19 per share.

In addition, our second quarter net increase in net assets from operations was $0.40 per share. Paul will cover this in more detail. For those viewing our presentation, please turn to slide 9. Our highly diversified portfolio was in good shape at the end of the second quarter with a fair value of $571.8 million invested in 57 companies.

On slide 10, you can see the continued transformation of our portfolio since the beginning of 2012. During the second quarter we maintained our high percentage of debt investments as well as the percentage invested in senior secured debt and floating rate investments. At quarter end, approximately 93% of the portfolio was invested in debt securities, 97% of which were senior secured debt. 74% of the debt positions were in floating rate debt, 93% of which had interest rate floors.

During the second quarter we invested approximately $130.6 million in 13 different transactions, comprised of eleven new and two existing portfolio company positions. We invested approximately $117 million in senior secured floating rate loans. We also invested approximately $13.6 million in senior secured notes.

Of five largest investments during the quarter include; a $17 million senior secured loan to a specialty cable network which was part of a $75 million single trench loan made by Tennenbaum Capital Partners. A $15 million senior secured loan to a technology company focused on web security solutions. A $14 million senior secured loan to a telecommunications and information management provider, $14 million of senior secured notes to a leading specialty lined pipe supplier to the oil and gas industry and a $13 million senior secured loan to a business communications and data solutions provider.

New investments made in the second quarter had a weighted average effective yield of 9.5% compared to an 8.9% average yield for the investments that we exited during the quarter. Even though we have seen a decline in yields, the yields on new investments were 60 basis points higher than the yields on investments we exited. Our overall effective portfolio yield was 10.9%.

In Q2 we exited $70 million of investments, most of which were low yielding. These investments included $16 million of senior secured notes to International Wire Group, a $10 million senior secured loan to Granite Broadcasting and $8 million senior secured loan to Encompass Digital Media and $8 million senior secured loan to Expert Global Solutions and an $8 million senior secured loan to Sum Total Systems.

Now, I will turn the call over to Paul for more detailed report on our financial results for the second quarter. After Paul’s comment, I will provide some additional prospective on what we are seeing in the market then we will take your questions. Paul?

Paul Davis

Thanks, Howard. We are pleased with our results for the three months ended June 30, 2013. As you can see on slide eight, total investment income was approximately $14.5 million. Per share total investment income was $0.61 of which $0.60 per share was recurring income, this included peak income of $0.01 per share and discount accretion of $0.02 per share.

As mentioned in prior calls, it is our policy generally to amortize upfront economics on debt investments rather than recognize the income all at once at the time the investment is made. Cash income from the aircraft leases of $0.04 per share was offset by depreciation expense of $0.03 per share producing the fund taxable income.

Total operating expenses for the quarter were approximately $3.0 million or $0.13 per share. We also accrued dividends on the preferred leverage facility of $0.4 million or $0.02 per share. Our annualized operating expense ratio including preferred dividends but excluding incentive compensation was 3.7% of average net assets.

We began incurring incentive compensation on January 1st, 2013, to the extent that our total return exceeds the hurdle rate of 8% annually. Incentive compensation is calculated by multiplying net investment income after preferred dividends and net realized gains to reduce by any net unrealized losses by 20%. Incentive compensation from net investment income for the quarter was $2.2 million or $0.09 per share and incentive compensation on realized gain was $0.3 million or $0.01 per share.

For purposes of computing incentive compensation, realized gains on investments acquired before January 1st, 2013 are measured by comparing investment disposition proceeds to the fair value of the investment of January 1st, 2013 when the incentive compensation period began.

For book purposes, our reserve amount is also calculated based on any additional incentive compensation that would have been payable had we liquidated that net asset value on the balance sheet date. This reserve is not payable unless the associated gains are actually realized and is subject to reversal. At June 30, this reserve amount was approximately $344,000, a reduction of $127,000 or a $0.50 per share from the end of prior quarter.

Net investment income before dividends on the preferred equity facility and incentive compensation was approximately $11.5 million or $0.48 per share. Net investment income after preferred dividends and the incentive compensation on net investment income was approximately $8.9 million or $0.38 per share. The difference between this amount and our net increase and net assets from operations are $0.14 per share was primarily comprised of net realized and unrealized gains of approximately $0.7 million or $0.03 per share and an incentive compensation on realized gain is $0.03 million or $0.01 per share.

Net realized losses were $4.1 million which primarily reflected a charge on the recapitalization of AGY, a transaction in which we received both new debt and preferred equity in a deleveraged company.

The initial AGY investment was part of our legacy distress debt strategy and it’s since generated substantial cash interest income. Net realized losses for the quarter were more than offset by net unrealized gains of $4.8 million.

As a reminder, over 95% of our quarter-end valuations are from market quotations or nationally recognized third-party valuation services. As of June 30, we continue to have no investments on non-accrual status. After paying our second quarter dividend, which totaled $9.6 million, we closed the quarter with tax basis undistributed ordinary income of approximately $26.7 million.

Available liquidity at the end of the quarter totaled approximately $100.6 million which was comprised of available leverage of $108 million, and cash-on-cash equivalence of $40.1 million, less investment commitments of $47.5 million.

Net combined leverage at quarter end was approximately 0.44 times common equity; however, our deployment in the third quarter to date has been significant. TCP Capital continues benefit from an attractive operating expense structure. As noted, total second quarter expenses including all cost of leverage but excluding incentive compensation were 3.7% of average net assets on an annualized basis. This is due in part to TCP Capital’s low cost of leverage as highlighted on slide 11.

Our total weighted average interest rate on amounts outstanding on our combined leverage facility was 1.39% at the end of the quarter. Amounts drawn on new supplemental credit facility accrued interest at the rate of LIBOR plus 275 basis points, amounts drawn on a preferred equity facility accrued dividend at the rate of LIBOR plus 85 basis point, and borrowings on a continuing original credit facility bear interest at a rate of LIBOR plus 44 basis points which is our primary incremental borrowing cost.

Now, I will turn the call back over to Howard.

Howard Levkowitz

Thanks, Paul. I will briefly cover what we’re currently seeing in the market and then I will open the line for questions. So far on the third quarter of 2013, we’re seeing a continuation of the favorable trends we mentioned in last quarter. The pipeline of deal flow remains robust with a wide range of opportunities across a variety of industries. There is an increased flow of re-financing, another loan activity for middle market companies and need of more flexibility.

As always we continue to take a selective approach to new investments due to lower market spreads and some spillover in our market from looser terms on broadly syndicated loans. That being the case, we would not annualize our second quarter investment pace. Through August 5, 2013, we have invested approximately $59 million in six senior loans to five new companies and one existing portfolio company with an effective yield of approximately 11%.

Expanding our earnings by effectively putting our existing liquidity to work and optimizing our portfolio is our primary focus. We continue to evaluate potential options to expand our capital base and liquidity in a prudent manner, so that we can continue to capitalize on the attractive opportunities we are seeing. In this regard, we submitted an application for a SBIC license and we have received a Green Light letter from the SBA inviting us to proceed with the application process and an acceptance of our follow-up application.

We are pleased to be moving forward on this opportunity which if accrued will provide an incremental $150 million of borrowing capacity at favorable terms, which we would deploy consistent with our investment philosophy. We have an extensive history of investing in companies that are positioned for long-term value creation with sustainable competitive advantages, and that generates significant cash flow and/or have significant asset coverage.

We set the bar high with our intensive due diligence process and remain selective in our choice of investments with a focus on both achieving high risk adjusted returns on preserving capital. We believe our portfolio is well positioned to deliver strong risk adjusted returns for the remainder of 2013 and beyond.

Before we take your questions, I would like to remind you of the attractive structural features of our company that Paul described earlier. Our origination income recognition practices are conservative. We have a low-cost structure and a shareholder-friendly fee structure.

In addition, we have voluntarily locked up our own personal pre-IPO holdings of approximately $10 million in investments in TCP Capital for three years from the IPO and several members of the management team and the board of directors bought shares in the market after our IPO.

We hope that we can see that management’s interests are clearly aligned with our shareholders. We would like to thank our shareholders for your investment and confidence in us.

And with that, operator, please open the call for questions.

Question-and-Answer Session


Thank you. (Operator Instructions). Our first question comes from the line of Chris Kotowski from Oppenheimer.

Chris Kotowski - Oppenheimer

I wonder if you could walk us a little bit through the mechanics of the AYG Holdings restructuring and how impacted that net realized and unrealized losses and I guess I’m looking at that it was carried at 9.2 million at year end and the new loan seems to be something like to have a fair value of I think it was 2 million unchanged, and can you just add, how much of realized and unrealized losses related to AYG?

Paul Davis

Sure, the $2 million loan you looking at is a new investment in a senior secured term loan. The original investment in the secondly note was restricted in two parts, half of it was paid down and we received payments in form of preferred stock and on that portion we recognized the realized loss. The other portion, the maturity was extended and because of our improved position in the holding there is an unrealized gain on that portion of the investment.

Chris Kotowski

But was that holding that majority of the movement in the realized and unrealized holdings or is it all across the portfolio?

Paul Davis

The majority of the realized loss was the charge on the receipt of the preferred equity and the majority of the unrealized gain was the reversal of that loss, as noted most of that loss was already recognized in the NAV at the beginning of the quarter.

Howard Levkowitz

Chris this is Howard thanks for the question, just for a little bit more of an overview on that Paul walked you through the technical accounting on it. We had a position that we acquired many years ago received a lot of income on that was marked at very discounted price that we recapitalized basically with a new debt instrument that is fair valued around where the pre-existing bonds were marked at the last quarter. And we now have a preferred instrument in addition to that with significant upside and control of the company. So this was a distressed purchase we made under the strategy we de-emphasized the legacy strategy.

And today I think we're at a much better position and that we have a debt instrument with around the same value of what we had last quarter and control of the company which is now deleveraged and a strong management team and upside was preferred.

Chris Kotowski - Oppenheimer

And then switching gears to the potential SBIC sub, would you be making the same kinds of loans, or are those typically smaller more typically fixed rate kind of loans?

Raj Vig

To answer that question our anticipation is that we will be making very much the same types of loans, in certain cases we're not looking to change our approach or our quality control if you will given where we focus in the middle market. We did actually do a historical analysis of our deployment before the application process and sound that a lot of our loans given SPA's criteria did in fact qualify. So our view is that we'll be able to utilize it, we utilize it judiciously in addition to some of our other capital availability, but our intent is not change our focus or process for the under-writing.


And our next question comes from the line of Greg Mason from KBW. Go ahead sir.

Greg Mason - KBW

First Howard could you talk a little bit about the new investments that you made. How many of those were say club deals versus syndicated opportunities, versus kind of sole managed deals?

Raj Vig

I will walk you through, but we can't disclose around the 13 new investments. And generally speaking most of them what I would call lead or meaningfully involved in clubs with a few on the syndicated process. And one in particular which I think a number of BDCs that participated in blue coat has a little more history with our firm and with that company that I can touch on in a second.

But what we can say is that three of the 13 were lead managed deals including the largest investment for the quarter. Several others without disclosing a specific number, where, I would call either close clubs or meaningful position and a reasonable size tranche versus a broadly syndicated or large capital structure. And in the case of Blue Coat the funny thing here in the deals we do investing that I think are more appropriately described as syndicated. They will always be something that we that we have an industry exposure and comfort with like everything we do. In the case of Blue Coat our history goes back many years, back to the current CEO's prior company we were actually one of his largest lenders in his prior company and had a very good ability to diligent him as an individual on his capability. When he moved over to Blue Coat we had another opportunity on private side diligence process to get a really deep look at the company before it went private, we track the company through its post buy out period over the last several quarters and its outperformance which is I think an appropriate characterization of how they performed through the quarters.

And then at the time of their most recent second lien, where we have comfort both in the enterprise value coverage the business thesis, the sponsor who we have high regard for, effectively got invited in as a participant and at that point fell comfortable on both the risk reward and term to the second lien and that's one, I would call it two syndication processes that we got involved in this period. So, that’s how I would kind of characterize the 13 new investments.

Greg Mason - KBW

Great color, I appreciate it. On the exits and repayments in the quarter, the press release sounded like there was no significant prepayment income in the quarter. I just wanted to make sure that, that is correct. And then would you quantify those as given their low yields, were you actively selling those off or were these just still a function of just repayment activity and they just happen to be lower yielding.

Paul Davis

Thanks for the question. The prior two quarters we have unusually high prepayment income and in both of those we noted that and suggested that people not annualize it arguably this quarter it was unusually low. And it was a function of two things, some of the loans that were repaid no longer had repayment premium associated with them and also of the exits almost half of them were positions that we sold outright. And we did this as the matter of portfolio management some of it selling lower yielding positions and at least one position case because of our concerns with credit quality and our ability to still get a nice premium on it. And we did that as we were in the process of doing our secondary and adding our leverage facility and wanting to be mindful of keeping liquidity for better yielding options.

Greg Mason - KBW

Great, thank you very much. And then in the press release you talked about Michael Tennenbaum stepping off of the investment committee. Can you just give us a quick discussion on why just anything to be concerned about there?

Paul Davis

Nothing to be concerned about, this is a transition process that’s commenced really five years ago Michael’s name is obviously on the name of our management company at the same time and we have a very robust team and the other two co-founders Mark Holdsworth and I remain here, and the rest of our team that’s been here for many years. Phil Tseng, who is stepping on has been with us for almost a decade and is very active and in fact Michael hasn’t been involved in investment committees of our more recent funds. But continued on this one because of the fact that we converted some funds that were started over a decade ago we’ve been on and originally but he’d been increasingly sort of less active on a day-to-day basis in that but he remains a significant part of the firm and involvement.

Greg Mason - KBW

Great, I appreciate it. And then just one last thing on the SBIC congrats on the Green Light, just curious of how long it took from when you submitted your initial application to the receipt of your Green Light letter how long was that process?

Paul Davis

We haven’t disclose the date and so far we’ve been very pleased with our interaction with them, and if things have gone smoothly. But we’ve heard enough I think and seen enough about how these processes can go to be sort of cautious about any specific predictions or disclosures around timing on those one.


And our next question comes from the line of Robert Dodd from Raymond James.

Robert Dodd - Raymond James

On the fixed (side) obviously you continued to shift towards floating rates and obviously seeing that kind of goes hand in hand. Can you give us some color on what you’re seeing in the flows that you’re getting on the new investments and then any that you’re taking out of the portfolio? So historically you had a relatively higher average flow on your floating rates. So can you give us any color on that?

Paul Davis

Sure. Addressing the first part, it’s been a very deliberate strategy to shift to floating rate. On our call just three months ago I think we were asked why we were doing that and we noted that after 30 years of falling rates at some point we thought they were more likely to go up down and we just thought it was worth giving up some rate to position and floating rate. With respect to the flows, our average is 1.3%. We do work hard to try and minimize that. We have some situations in which we don’t have it. They become a convention where borrowers are accustomed to getting them when ironically they were initially something that lenders wanted. But each and every case it’s a different discussion.

Robert Dodd - Raymond James

Any color on how those are shifting in terms of your originations, I mean, do you expect that to drift up, down, go sideways?

Paul Davis

It’s a negotiation with borrowers in every case. And interestingly people have very different opinions on this. So I am hesitant to make generalization about the market and where these are going. Going back four or five years, you almost never use to see them and today they become very common and something the borrowers want and their councils and there were bankers offer advise them to get. So I am hesitant to predict where they are likely to go.

Robert Dodd - Raymond James

On the industry profession, you got a very diversified portfolio right now. I mean any particular areas you’re seeing out there that look particularly appealing and is there any desire to get the SBIC license some other than the cheap cost capital, obviously but is that indicative of wanting to focus on particular small business areas, small manufactures anything like that.

Raj Vig

It’s sort of I’m reading that question little bit as indirectly you’re asking about the pipeline. So, if I just use that as the answer that we continue to see good opportunity and relatively diverse range of opportunities with many of the businesses has been characterized in more asset like call it business service arena but with variety of end market exposure from healthcare to consumer to communications and we like these businesses and continue to focus on them because we do think there is good enterprise value that we can determine in some cases publically but in many cases privately. We like the cash flow conversion of these types of businesses EBITDA really does mean cash earnings given the unlimited and identified by working capital change but more importantly not lot of CapEx leakage.

So, going back to (umbrella) point that we always focus on things in our industry group but the business model itself which is more of a service type model, more asset like in cash flow visible is what we’ve been focusing both in the existing quarter and I would say in the pipeline generally. In terms of the SBIC I would reradiate my comments to I think Chris’s question earlier, it is not an intent to change meaningfully what we do or very comfortable with our segment, we believe the companies we work with and focus on have a reason to exist and we think that’s partly because of size versus very small companies but also because of the business models and their place in the world.

So, I don’t think that SBIC should be viewed as a way to do very different things versus doing what we do and have done since inception with a more diversified capital.


Thank you. And our next question comes from the line of Boris Pialloux from National Securities.

Boris Pialloux - National Securities

I guess one question. You mentioned on distributed income, do you have any plan regarding that, I think you mentioned like 26.7 million.

Paul Davis

Sure. Our plan is to focus on our steady dividend as you know we’ve also had two special dividends in Q4 of last year and Q1 of this year. We’ve been earning income at a rate that’s higher than our dividend which we’re pleased with and we continue to assess though what the most appropriate thing is to do with that excess dividend as we go through the rest of the year.

Boris Pialloux - National Securities

And second is regarding the TCP funding facility, do you have any commitment fees associated or…

Raj Vig

Yes, we do. As of June 30th, there was not in the month it was undrawn so there weren’t any for quarter but it is 75 basis points of commitment fees or its undrawn more than 33% than its 1%.

Boris Pialloux - National Securities

And I noticed that’s your new investment it seems to be or maybe concentrated in the telecoms and our cable industry. Is there lots of M&A activity in this field? So, it that’s, how should we read that directly?

Paul Davis

Sure. First of all, I would say there are the largest investment was in the cable but it’s more in the content arena versus the cable providers and our one or two other that are related to telecom, but I don’t necessarily view it as concentration across the board. There are others that are more in the software arena and there are others across the different end markets like I mentioned in terms of what we’re focused. The firm does have a very good competency and capacity and tech media telecom broadly which we utilize but I don’t necessary view the last quarter is been concentrated in telecom per say although there maybe some items that are related to those fields as an end market.


Thank you. And that concludes our question and session today. I would like to turn the conference back to TCP for any conclusion remarks.

Howard Levkowitz

We appreciate your questions in our dialog today. I would like to thank our I’d like to thank our experienced, dedicated and talented team of professionals at TCP Capital Corp. Thank you again for joining us. This concludes today’s call.


Ladies and gentlemen. Thank you for your participation in today’s conference. This does conclude the program and you may now disconnect. Everyone have a good day.

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