BlackRock Capital Investment's (BKCC) CEO Steve Sterling on Q2 2016 Results - Earnings Call Transcript

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BlackRock Capital Investment Corp (NASDAQ:BKCC)

Q2 2016 Earnings Conference Call

July 28, 2016, 10:00 ET


Laurence Paredes - General Counsel & Secretary

Steve Sterling - Chairman & CEO

Michael Zugay - Head, Investments for U.S. Private Capital Group

Donna Milia - CFO & Treasurer


Jonathan Bock - Wells Fargo Securities

Arren Cyganovich - D.A. Davidson

Ryan Lynch - KBW


Good morning. My name is Katie and I will be your conference facilitator today for the BlackRock Capital Investment Corporation Second Quarter 2016 Earnings Call. Hosting the call will be Chairman and Chief Executive Officer, Steven F. Sterling; Head of Investments for BlackRock's U.S. Private Capital Group, Michael J. Zugay; Chief Financial Officer and Treasurer, Donna M. Milia; General Counsel and Corporate Secretary for the Company, Laurence D. Paredes; and Nik Singhal, Investor Relations and Strategy. [Operator Instructions].

Thank you. Mr. Paredes, you may begin.

Laurence Paredes

Good morning and welcome to BlackRock Capital Investment Corporation's second quarter 2016 earnings conference call. Before we begin our remarks today, I would like to point out that certain comments made during the course of this conference call and within corresponding documents contain forward-looking statements subject to risks and uncertainties. Many of these forward-looking statements can be identified by the use of words such as anticipates, believes, expects, intends, will, should, may and similar expressions. We call to your attention the fact that BlackRock Capital Investment Corporation's actual results may differ from these statements.

As you know, BlackRock Capital Investment Corporation has filed with the SEC reports which list some of the factors which may cause BlackRock Capital Investment Corporation's results to differ materially from these statements. BlackRock Capital Investment Corporation assumes no duty to and does not undertake to, update any forward-looking statements. Additionally, certain information discussed and presented may have been derived from third-party sources and has not been independently verified. Accordingly, BlackRock Capital Investment Corporation makes no representation or warranty with respect to such information.

Please note we have posted to our website an investor presentation that complement this call. Shortly, Steve will highlight some of the information contained in the presentation. The presentation can be accessed by going to our website at and clicking the July 2016 investor presentation link in the presentation section of the Investor Relations page. Thank you.

I would now like to turn the call over to Steve Sterling, BlackRock Capital Investment Corporation's Chairman and Chief Executive Officer, who will provide an update on your quarterly results.

Steve Sterling

Thank you, Larry. Good morning and thank you for joining us for our second quarter 2016 earnings call. This week, the Board of Directors unanimously approved Donna Milia's appointment as the Company's Chief Financial Officer and Treasurer. We're extremely pleased to have Donna in this role and look forward to her continued dedication and contribution. Additionally, I would like to welcome Mark Lies to the Board of Directors. Mr. Lies was elected to the Board of Directors at the Annual Meeting of Stockholders. Mr. Lies brings significant leverage finance, capital markets and investing experience to the Board.

Finally, I would like to thank Brian Finn for his service on the Board. Brian Finn has been a valuable contributor to the Board and a terrific resource to me. Mr. Finn stepped down from the Board effective this past money, July 25. He will be missed and we wish him well. During the second quarter, the Company's summary financial results, capitalization and liquidity were relatively strong. And importantly, the Company ended the period with substantial financial flexibility to support growth in total investments and the elevated portfolio credit volatility pertaining to legacy assets. Our investment screens remain highly selective, even as the volume of deals we saw remained consistent with historical levels.

During the period, we realized prepayments that were buoyed by the strong risk-on environment. Our closing of BCIC Senior Loan Partners which we shall refer to as the SLP, was later than expected, closing in late June near quarter end. These factors led to a negative net new capital deployment during the quarter. The SLP will provide the Company exposure to more traditional first-lien senior secured loans. Initially, the SLP is sized at $300 million, with a capitalization of $200 million of debt and $100 million of equity, of which the Company has committed to invest $85 million over time as capital is deployed by the SLP.

Once substantially deployed, the Company's invested capital in SLP is anticipated to generate low double-digit cash returns, although there can be no assurances. From a growth perspective, we have now created for the Company flexibility to invest across a range of opportunity types intended to support our focus on risk adjusted returns and pace of capital deployment as we continue rotating the legacy portfolio into a more diverse pool of investments with higher cash flow predictability. Investment options now include our customary higher-yielding direct investments; continued follow-on investments in our portfolio company, Gordon Brothers Finance Company which primarily invests in first-lien asset-based loans; and new investments in BCIC Senior Loan Partners which again provides exposure to traditional first-lien loans.

Over the longer term, we believe this construction of our portfolio affords us meaningful flexibility to consistently deliver investment performance for our client shareholders. In regards to investment performance, the portfolio experienced an incremental decline in fair market value, largely relative to the previously discussed legacy investments. I am pleased with the team's tireless effort, collaboration and resourcefulness in working diligently to protect value in the challenged investments, particularly Hunter Defense and Vertellus, given the size of the exposures and timing of these processes which are now well advanced.

While there can be no certainty of ultimate outcomes and patience will be required, the Company is well-positioned under the circumstances to maximize value. I should note that three of the five non-accrual legacy investments, representing 73% of the non-accruals at the end of the first quarter by cost, are now on a reasonably visible path of restructuring. Now we'd like to highlight specific results. During the period, total investment income in NII, as adjusted, grew sequentially by 12% and 24%, respectively. NII, as adjusted, finished the quarter at $0.30 per share as compared with $0.24 per share during the first quarter. Subsequent to quarter end, our MediMedia investment was unexpectedly prepaid as a result of its acquisition by a large pharmaceutical firm.

Run rate NII, as adjusted, calculated based on average fee income over the trailing four quarters and after giving effect to the MediMedia prepayment, was $0.22 per share, implying a distribution coverage of 103%. From a capitalization and liquidity perspective, the Company ended the period with net leverage of 52% and total liquidity of $245 million, both of which improved on a pro forma basis, with the MediMedia prepayment to 41% and $313 million, respectively. The Company's low leverage and significant liquidity are supportive to portfolio investment growth.

We remain constructive on the U.S. economic picture, but as pointed out previously, remain guarded given modest growth and heightened global risk. We continue to believe that market volatility will likely sustain. And as such, the market will present attractive investment opportunities, particularly in customary higher-yielding direct investments. Financial market conditions have improved during the period as global liquidity flows benefited the U.S. market, particularly on the back of the Brexit vote. Our investment preferences remain unchanged, focusing on companies with durable business models, strong management teams, appropriately capitalized balance sheets and soundly structured instruments.

As noted, the launch of BCIC Senior Loan Partners has created an opportunity for exposure to traditional first-lien loans. Our portfolio construction tilt remains toward more diversity with a strong preference for senior secured risk which now comprises 72% of our investment portfolio. We will seek to increase the Company's currently low net financial leverage to a moderate, balanced level, ensuring continued flexibility and support for investments that may generate growth in net investment income.

At this point, Mike will review our investing activity during the period.

Michael Zugay

Thank you, Steve. On our last call, we highlighted that the middle market was beginning to show signs of stability and there was an uptick in activity from our sponsor clients. The positive tone and deal momentum continued throughout Q2 2016. Despite big headlines around the Brexit vote and the short period of volatility that followed, it did not have an adverse impact on demand for U.S. middle-market investments. As a matter of fact, we saw increased demand for new issue first- and second-lien paper and more depth to the market than we had seen in recent quarters, albeit with limited supply.

Further, in situations that involved borrowers with strong credit profiles, pricing often cleared inside of the initial talk for both first- and second-lien loans. We had first-hand experience of the increased M&A activity in Q2 with a few sizable exits in our portfolio, like Quality Home Brands, also known as Generation Brands which traded to another financial sponsor and Pittsburgh Glass Works which was acquired by a larger public company.

Additionally, we had a few smaller second-lien position that were opportunistically refinanced. In the case of Learfield, the existing first-lien tranche was upsized in order to take out the entire second-lien tranche. And in the case of Novolex, M&A activity resulted in the second lien being repaid.

We're now seeing investors who were previously sitting on the sidelines coming back into the market. The result is a further tightening of new issue spreads and also [indiscernible] on some structural elements, such as maintenance covenants, especially for larger middle-market issuers. As we look to deploy capital, we remain focused on credit quality and discipline in how we structure and document our investments. As Steve highlighted, having multiple investment options to optimize risk-adjusted returns is important.

Turning to our investment activity in the quarter, we had approximately $85 million net decrease in our portfolio, primarily due to the repayments of our aggregate $60 million position in Quality Home Brands and our $35 million second-lien position in Pittsburgh Glass Works. It's also worth noting that we had a total of eight exits in the quarter, the two I just mentioned, coupled with six smaller positions with aggregate proceeds of approximately $19 million. The total repayments, excluding the Hunter Defense equitization, were approximately $139 million for the quarter.

Our gross deployments in the quarter, excluding the aggregate Hunter Defense activity which includes $7.9 million investment in a first-lien loan, totaled approximately $46 million, the preponderance of which consisted of incremental capital into three existing portfolio companies. First being $6.2 million of 12% subordinated debt in First Boston Construction Holdings, LLC, as well as $1.5 million of additional equity interests. Proceeds were used to fund growth initiatives.

Second being $13.1 million of LIBOR plus 1100 unsecured debt and approximately $700,000 of preferred equity in Gordon Brothers Finance Company, also used to support the Company's growth initiatives. And third being $20.1 million of LIBOR plus 900 first-lien DIP term loan to Vertellus Specialties, Inc. which was used to partially refinance the previously existing revolver and to provide liquidity through the bankruptcy proceeding. As Steve mentioned, we also closed BCIC Senior Loan Partners. We have committed to fund up to $85 million of equity capital which we expect to ramp up over the coming months as SLP begins executing on its first-lien strategy. We believe that once SLP is invested in a diversified pool of senior loans it will provide a solid stream of lower volatility cash returns to the Company.

Currently, we believe there is a good pipeline a first-lien opportunities for SLP. Excluding the Hunter Defense first lien which was acquired and converted to equity during the course of the quarter, the weighted average yield on all income bearing investments deployed in the quarter was substantially similar to the yield on the exited investments at approximately 11%. Moving to nonaccruals, Advanced Lighting, New Gulf, Shoreline and Vertellus remain the only investments that were on nonaccrual status at the end of Q2 2016.

With the completion of the Hunter Defense restructuring in the quarter and its removal from nonaccrual status which I will speak to in more detail, nonaccruals now represent $43.3 million at fair market value as compared to $78.3 million as of last quarter end. In percentage terms, the non-accruals represent 5% of the debt portfolio at fair market value and 12.7% at amortized cost, a decline from 7.8% and 15.3%, respectively, as of March 31, 2016. With regard to Hunter Defense, our team worked diligently and provided leadership to the second-lien investor group during the restructuring process. We also made the strategic decision to purchase first-lien paper at a price of 70 due to the value the investment represented, with the added benefit that it improved our negotiating position as we contemplated the out-of-court restructuring.

Pursuant to the restructuring, our debt investments in Hunter which includes the first lien purchased at a discount, have all been converted to an aggregate $22.5 million of preferred and common equity. We believe that the restructuring has placed the company on sound footing and the right leadership is now in place to execute the business strategy. We continue to monitor the investment closely. Vertellus filed its U.S. operations for Chapter 11 bankruptcy protection on May 31. We're part of the ad hoc group of term loan lenders that has provided a credit bid of $453 million as part of the 363 sale process. Third parties can submit competing bids for the assets in advance of the August 29 bid deadline, as per the court approved bid procedures.

We continue to be supportive of the company and as a member of the ad hoc group, we committed and funded $20.1 million in a DIP financing. Although length of bankruptcy is hard to predict, we believe the debtor has ample liquidity. On Advanced Lighting, we continue to explore ways to engage with management and the sponsor to develop restructuring options aimed at reducing its debt burden.

With regard to Shoreline, we continue to work with our petroleum engineers, management and their advisors on constructive ways to move forward. But as you could see from our filings, we have marked the position to zero as we continue to explore all avenues to get a recovery on our investment. Finally, on New Gulf Resources, May 13, 2016, marked the effective date of the plan of reorganization. The next major milestone will be for the borrower to emerge from bankruptcy, but there is no official timeline or date for that to occur.

With that, I would like to turn the call over to Donna for some additional details regarding our financial results.

Donna Milia

Thank you, Mike. I will take a few minutes to review additional financial and portfolio information for the second quarter of 2016. For the second quarter 2016, GAAP net investment income and net investment income, as adjusted, were both $21.6 million or $0.30 per share. This represents an increase of 18% on a GAAP basis and 28% on an as-adjusted basis when compared to the second quarter of 2015.

The growth in net investment income in the current quarter, both on a GAAP and an as-adjusted basis, was primarily driven by an increase in fee income of $2.2 million and a decrease in borrowing costs of $2.1 million. As compared to the full fiscal year 2015 average, our six-month 2016 weighted average cost of debt decreased more than 100 basis points to 4.23%. This was primarily driven by refinancing our $158 million, 6.5% senior secured notes with proceeds from our credit facility and the subsequent lowering of the interest rate margin on the credit facility pursuant to the amendment and restatement, as disclosed earlier in the year.

During the quarter, there was no accrual for incentive management fees based on gains, due largely to the net unrealized depreciation in the portfolio as of June 30, 2016. Furthermore, no incentive management fees based on income were earned and payable for the quarter, as the distributable income amount was reduced below the hurdle by the net unrealized depreciation in the portfolio for the trailing four quarter period. Relative to distributions declared of $0.21 per share, our NII distribution coverage was 142% for the quarter. As of quarter end, our run rate net investment income, as adjusted, based on average fee income over the trailing 12 month period, is $0.25 per share, implying a distribution coverage of approximately 117%.

As Steve indicated, pro forma for the MediMedia prepayment, the same run rate NII measure was $0.22 per share, implying a distribution coverage of 103%. The composition of our portfolio remained fairly stable in the second quarter as compared to the first quarter. Secured debt decreased 3 percentage points to 72%, largely as a result of the prepayments mentioned earlier. Unsecured and subordinated debt remained unchanged at 14%. Equities increased 3 percentage points to 14%, mainly due to the Hunter Defense restructuring.

During the second quarter, net unrealized depreciation increased approximately $200,000, bringing total balance sheet unrealized appreciation to $94.4 million. Gross unrealized depreciation of $34.4 million during the quarter was offset by $7 million of gross unrealized appreciation due to changes in portfolio valuations and $27.2 million of unrealized appreciation due primarily to the reversal of previously recognized unrealized depreciation from the Hunter restructuring.

At June 30, we had total liquidity of $244.5 million, consisting of $7.5 million in cash and $237 million of availability under our credit facility. At June 30, our net leverage stood at 0.52 times, we had an asset coverage ratio of 287% and we were in compliance with all financial covenants under our debt agreements. During the second quarter, we purchased 541,851 shares of our common stock on the open market for $4.1 million, including brokerage commissions, at an average price of $7.54 per share.

Repurchases during the second quarter of 2016 accreted over $0.01 per share to the Company's net asset value per share. The cumulative repurchases under BlackRock's management represents 66% of total share repurchase activity on a dollar basis since inception.

With that, I would like to turn the call back to Steve.

Steve Sterling

Thank you, Donna. The Company's summary financial results, capitalization and liquidity were relatively strong. Further, the Company's substantial financial flexibility and construction of its portfolio is expected to support growth in customary higher-yielding direct new investments and follow-on investments via Gordon Brothers Finance Company in asset-based loans and BCIC's Senior Loan Partners investing in traditional first-lien senior secured loans.

The Company's run rate NII, as adjusted, calculated based on average fee income over the trailing four quarters and after giving effect to the MediMedia prepayment, covers our shareholder distribution by 103%. And from a capitalization and liquidity perspective, pro forma for MediMedia, the Company ended the period with net leverage at 41% and total liquidity of $313 million, respectively. We continue repositioning the investment portfolio by driving increased quality and diversity with the goal of reducing volatility and increasing distribution paying capacity.

We will seek to thoughtfully increase net capital deployment and concurrently remain steadfast in our focus on managing our existing investments. Our U.S. market view is constructive, but as noted, global risks remain quite elevated and volatility will likely persist. Additionally, appreciating that middle market companies may encounter business challenges, management will remain measured in the degree of company financial leverage.

In closing, I would like to congratulate Donna Melia and Mark Lies in their new roles serving BCIC client shareholders. Finally, I would like to take a moment to thank each of you for your support and our team for their efforts. Operator, you may now open the call for questions.

Question-and-Answer Session


[Operator Instructions]. We will take our first question from Jonathan Bock with Wells Fargo Securities.

Jonathan Bock

A number of others I'm sure on this call are going to just ping on the energy investments and the markdowns, so that's fine. But what we're concerned about is the Quality Home Brands. And so, Steve, can you walk us through whether or not there was any interest income -- certainly the fee line was elevated this quarter, given prepayment activity -- but was there any impact on the interest income line that related to the make-whole that caused that interest income line to be relatively higher this quarter than we would have thought it would be, given the nonaccrual investments?

Steve Sterling

Let me just first remark on QHP overall and then Donna can speak to the specific accounting question. With respect to QHP, that's a name that for quite some time we've been associated with and have a very deep relationship with the management team at that company and we're very enthusiastic about supporting the company through the change of control transaction that took place in the second quarter. Ultimately that found its way into the broadly syndicated loan market. And with respect to junior capital, ended up being really taken by the LPs in that scenario.

So, while we would have been certainly very interested in remaining a part of it, we had elected, given the construct of how that deal was distributed, it no longer fit within the context of what we felt was our investment screen. So, with that, that's the backdrop around that particular situation. But with respect to the accounting point, Donna, if you want to speak to that?

Donna Milia

Yes. Jonathan, we took a small hit, nominal, on the NII line with respect to the exit, as we exited very close to the close of the quarter.

Jonathan Bock

So I'm actually curious -- one, did you receive a make-whole payment on that loan?

Donna Milia

Other than the prepayment fee, that was it.

Jonathan Bock

Okay. And where did you put that prepayment fee? Did all fee related income basically fall under the fee line or were there any other one-time related elements that were driving interest income? At times, if a BDC has accelerated OIB, sometimes make-whole, the classification of interest income versus fee income can be a bit nebulous, depending on the BDC's CFO or accountant. And so I'm just curious, were there any one-time related repayment items that infiltrated interest income this quarter?

Donna Milia

No, that was it. The $1.2 million fell in the fee line and then the prorated interest, as you would expect, in NII.

Jonathan Bock

And then turning to new investments, Steve, we understand markets swung away, etcetera, but yet still we find that new investment activity probably remains below where we would have expected someone of BlackRock's stature in the market to be originating.

And with big prepayments again coming next quarter -- the Vertellus loan will likely pay down on DIP, plus you've got MediMedia, etcetera -- how should we really be thinking about one's ability to ramp in this environment when we would have thought that this past quarter's volatility really would have played into your hands and allowed you to grow more than expected?

Steve Sterling

So, look, I think that, as we think about deployment, overall activity, as stated in the earnings call, from an idea generation perspective, was very much on par with what are very solid fourth quarter/first quarter deployment results. So, there was really no tail-off from our perspective in terms of the degrees of activity. The question really, one, is how well does it fit within the screens of which you put upon your business vis-a-vis the disciplines of investing capital.

You're right around volatility, but as we have observed over the last few years and certainly as it relates to the second quarter and my comments as it pertains to QHB I think relate to this and that is in the end of the first quarter and certainly into the second quarter, the risk-on dynamic regained footing in a pretty meaningful way. And so, as a result of that, things that you might not have thought would get done, particularly as it pertains to cyclicals, in fact did get done. And things that were very good quality, nice investments often times found their way into profiles of structure that didn't quite make sense, i.e. into stretch first or uni. I think as a lot of the borrowers in the face of volatility and the uncertainty of Brexit and the like, during the middle of that quarter or the back end of that quarter, people biased on balance toward structures that provided them certainty.

And so, single tranche structures certainly had a preferential position, I think, in a competitive field. So, activity level, very solid, very comparable; screens, much tighter. And the nature of activity biasing I think more into the stretch and uni-tranche part of the market for which they return profile isn't sensible to us. In the things that we saw we liked in junior capital, it didn't always necessarily manifest itself in such a structures, be it in the intra-credit agreement or in the direct agreement, that sort of fit within the standards that we thought made sense. Now, as we think prospectively in the ability to deploy, I think as we have been consistently communicating to the marketplace, we're pretty disciplined around capital deployment.

We feel very solid today as it relates to NII generation and the ability to meet distribution. We certainly anticipate increasing asset footings for the BDC to support NII growth and therefore distribution paying capacity. But we will do that in a fairly measured pace. And so I think that's consistent. I think our targets relative to leverage remain unchanged, in that 60% to 70% range. We can certainly do that very quickly, but we won't do it in a way that isn't responsive to the disciplines we've put around our business. So as we think about where we have now set up the business, we have three broad moves that we put in the platform that do a number of things for us and in large part they drive optionality.

So, we have the ability to do directs in a quality, very attractive junior capital type opportunities that generate the targeted returns, with the appropriate structures and credit quality that fit into the BDC on a single name basis. Number two, we have experienced very meaningful success with our Gordon Brothers Finance portfolio company. Bringing in Gene Martin as the CEO of that business and the work that he's done in growing that business has been fantastic. We had asset footings in that business that are greater than what has ever historically existed there and the company is doing extremely well. But it gives us exposure to asset-based loans where, in fact, what's happening from a regulatory point of view is quite favorable to that particular portfolio company's strategy.

So that's a second move. Our third move is the closing of the BCIC Senior Loan Partner relationship, where in fact it affords us the opportunity then to participate in circumstances -- traditional first-lien type opportunities. In many cases, the circumstances for which we may be passing because of suitability for the BDC as the borrower may tilt to, let's say, a first lien solution which no longer is -- fits within the profile of the BDC. Those are perfectly fitting for the SLP. So, with the three different channels of opportunity, what we have done then is, A, enhanced our ability to drive pace of deployment, but importantly, B, maintained the credit disciplines of our business such that we're optimizing risk-adjusted returns in the capital structure where they may exist.

As I said in the earnings release, I'm convicted that volatility has not gone away. It will be restored and in fact as a consequence of that, the direct investment opportunities we will do out of the BDC, we'll find opportunities where it does fit the screen. With return profiles, it's quite sensible that our client shareholders will be very happy with. So, long-winded answer covering what happened in the second quarter and what happens prospectively, but I think our client shareholders can take comfort that the way in which we have configured the platform is one in which ought to bolster confidence relative to capital deployment, but doing it in a way that optimizes risk-adjusted returns as opposed to chasing absolute return.

Jonathan Bock

And Steve, what comes in the front end is immensely valuable, how one handles the back end, namely the cost structure, just as valuable. So, we look at things in terms of math as it relates to dividends. And certainly looking at a cost structure, particularly the one you are about to implement, coming next year, likely will put a major pinch on net investment income as a result of the fact that we will have done away with the look back and while we have a lower incentive fee, it's marginal.

So, in light of what we're seeing with spread compression across the board, limited deal flow, etcetera, is now the time to really extract out additional incentive management fees, putting greater pressure on NOI in relation to the dividend? Because that's what's going to happen if you let the current fee structure arrangement that's been debated go into effect in early 2017.

Steve Sterling

Look, we all run math around how the NII and distributions in the interchange of that calculus. We obviously will run math against different scenarios. We certainly feel comfortable under the fee structures that exist today and prospectively relative to the earnings power of the business to support the distributions that we currently provide for. So, we don't see the scenario whereby you get an inverted outcome, for example.

That being said, as I've said repeatedly, we will always evaluate the appropriateness of our economic structures relative to investment management fees and incentive fees. And as we proceed through the remainder of the year and into the early part of next year, we will make some assessments as to what we think is appropriate for the market and appropriate for the value proposition offered by our platform to our client shareholders. We understand the importance of being able to generate competitive ROEs and we're very focused on that.

As I've shared with the group at large in the past, we're here building what we believe, over time, will be a great brand and reputation as a private credit investor. We have the good benefit of being part of a very prestigious organization with a terrific brand that offers us resources and support to execute on that vision and that strategy. And so, that in turn affords us flexibilities as it pertains to management fees and the like as to how we manage our business.

Point of fact, last year as you know, in the second quarter I took expenses down quite meaningfully in the business. That happened because I happen to reside within an organization that gave me resources that didn't exist previously in the same way. So, our track record of doing the right thing I think is there and you should anticipate that we will continue to do that.


We will take our next from Arren Cyganovich with D.A. Davidson.

Arren Cyganovich

Just in respect of the SLP, I was curious if you could talk about your expectations on the ramp there. How long would it take to get that fully invested? And you mentioned -- I think you said low double-digit types of cash returns. What kind of leverage is going to be associated with that? Is it like a 2 to 1, 3 to 1 type of leverage underneath?

Steve Sterling

So, I would say in terms of the ramp, obviously it's going to be market dependent. That being said, there is a reasonably robust set of opportunities up the capital structure. Obviously it's the preponderance of the debt issuance of any company out there. So, the relationships that we have with various sources of investable opportunities I think is quite substantial. But I think we feel very good about the pipeline in that space.

And so, as we think about the ramp, we're obviously very focused around the speed of that deployment and would certainly anticipate over the coming couple of quarters getting ourselves to a place there of optimization around that vehicle, such that the kinds of returns that were suggested or indicated in the earnings call are realized by our client shareholders. So we feel very good about that. In terms of leverage, we had the good fortune to be able to garner what we believe to be a quite accommodating and supportive financing structure with an important relationship of BlackRock.

And as a consequence, it gives us a lot of latitude and a lot of flexibility as we prosecute against the SLP. That being said, leverage is going to be a little bit different depending upon some of the flavor of what that exposure looks like. So, there isn't a standard answer that I can offer you universally, but directionally it wouldn't be a 3 times type leverage proposition, but something that's a bit more modest than that.

Arren Cyganovich

And getting back to the investing environment, if you look at the broader high-yield market, credit spreads have come in quite a bit, but they are still quite a bit wider than the tights of a couple years ago. It sounds as though your commentary is saying that there's been a pickup of competition at a pretty rapid pace in the middle market. Is there just a lack of supply and too much capital available on the sidelines with players? I'm just trying to think about this more broadly as to how it affects you and other players in the space.

Steve Sterling

Yes, so, what you have going on globally obviously is a hell of a lot of liquidity chasing investable opportunities and the prize is investment ideas. And I would argue that on the heels of Brexit and the Central Bank moves, it's only exacerbated that condition.

The U.S. is an attractive safe haven, as evidenced by dollar action and has been a beneficiary of inflows. And so, those inflows, because of the confidence of the economic picture in the U.S. stability, has manifested itself obviously in the financial markets of the U.S. But more importantly and more pertinent to what we're doing in private credit is you are finding increasingly investors who, in years past, would not have come into the private credit market, it didn't fit within the investment guidelines of those organizations, are now adapting and accepting and allocating capital into private credit. Where in fact the opacity of the market, the inefficiency of the market, lends itself to an opportunity for those who are willing to sell liquidity to garner excess returns.

And so, that capital that is coming in, in large part, we would believe, is coming in toward the absolute return end of the equation which is going to be your junior capital picture. Obviously the BDCs are there with permanent capital vehicles, but the competitive dynamics is probably most visible and most acute in the junior capital part of the capital structure of your typical borrower.

So, you do have, on balance, weaker supply on a year-over-year basis. And you have technical liquidity from the client investor side of the equation and particularly private capital, that is driving that competitive dynamic to a more intense set of circumstances. That being said, it's also quite fickle and the moment that you get the mixed economic data or Fed action, it wouldn't surprise us in the least that the volatility causes some of that capital to go to the sidelines and that will change that competitive dynamic and we saw some of that obviously at the end of last year and the early part of this year.

So I think we will continue to see the risk-on and the risk-off. And we'll continue to see inflows into private credit and the further evolution and legitimacy of private credit as an investable asset class to traditional asset allocators. So, that's our picture of it and I think you are seeing some of the effects of that manifesting itself in the market behaviors today.

Michael Zugay

And, Arren, this is Mike. I would just add to that, just putting a finer point on it. We did see some LPs provide some junior capital. We hadn't seen that in a few quarters, to Steve's point. In general it's probably equating to about a 50 basis point tightening in both the junior capital environment and the senior side of things, quarter over quarter.

Steve Sterling

So, I think for us as we think about deploying, as we have created three different paths of creating value, we will certainly continue to do, in a vigorous way, the direct investing that is the core of what our business is about. But we're not going to chase markets, either. Credit is the number one priority for us and credit quality has to be there. We're clearly in the later stage of a business cycle. That's not to call a turn, but I think any good investor sitting in illiquid risk of the middle market has to be prudent about how they are constructing the portfolio. And we've been that way from day one. There's no reason for us to change. The introduction of the SLP only creates another strategic move, tactical move for us, to drive consistent investment performance for the clients.


[Operator Instructions]. We will take our next from Ryan Lynch with KBW.

Ryan Lynch

My first question, I have actually a few questions on the new BCIC Senior Loan Fund. So, the first one is, can you guys just provide what you guys are targeting for the asset yields that are going to go into that fund? And also in regards to the ramping of that fund, do you anticipate deploying the $100 million of equity that you and Windward have deployed and then start adding on incremental leverage to that fund? Or is there going to be a mix and you guys will deploy some of the equity of that fund and then also deploy some leverage before you actually ramp the $100 million of equity that's actually deployed?

Steve Sterling

Yes, so, I think from a return point of view, it's a LIBOR plus 5 to 6 type range. And obviously it depends on where we're, at what part of the market, but it's in that context. With respect to equity versus debt, over the ramp period it would be a mix of each. That being said, as these things are oftentimes structured in those early days where you have obviously more concentrated risk, there's a heavier dose of equity vis-a-vis debt under those scenarios. To be clear around it, we hit the point of optimization of leverage under that vehicle that generates the double-digit returns at about 50%, plus/minus. So, that should help you with respect to how you build your models and how you think about ramp periods.

Ryan Lynch

And then one other question on the fund. So, can you just provide a little more background on Windward Investments? And do you guys see them more as a financial partner, providing the capital and also being on the investment committee? Or are they actually going to source deals and be part of the deal flow of deals that actually go into this fund?

Steve Sterling

So, this is a true partnership and it has an independent board and that board has its own investment process and will make decisions as it pertains to what goes into that partnership. With respect to sourcing of opportunities, both ourselves as well as Windward will generate ideas relative to investable opportunities for that partnership. With respect to Windward, Windward is a firm and the principals of which I have known for a decade. And I've done a fair amount of business with them when I was at Carlyle and they are fairly astute investors in credit. They do both investment management as well as advisory. So, the role that they play is a full partnership role in that partnership.

Ryan Lynch

Okay. And then moving on, can you just provide some background on two investments, SPV or SVP Worldwide as well as Red Apple Stores both had sizable markdowns in this quarter. They both are sitting at healthy discounts from par as well as your cost. So, trading at big discounts today or you guys have them marked at big discounts today and they took a sizable mark in this quarter. Seeing if you just can provide an update on how those businesses are performing?

Steve Sterling

So, let me ask Mike to speak to those two investments.

Michael Zugay

Sure. Let's tackle Red Apple first. As you are aware, we have a third-party valuation firm that goes through and looks at all the available information that we have on the company and provides a mark on that. So, the mark on Red Apple was 86 and moved down to 78, based on the information that they reviewed.

I could tell you primarily from an operational perspective, it was really a situation of slightly higher borrowings on the revolver and some new store openings that had increased costs and reduced EBITDA. So as the valuation provider goes through their analysis, it led to a mark on our investment there. So, as we look at it, the company is continuing to perform. It's more temporal in nature as we think about Red Apple going forward.

Steve Sterling

By the way, that's one, too, that over the last year that I'd certainly been around the name, you've seen this kind of up-and-down because of the way in which the valuation firms apply the metrics of determination of value. So, you are going to continue to see some of that up-and-down, but it's not a credit specific event.

Ryan Lynch

Okay. And how about SVP Worldwide?

Michael Zugay

Yes, so SVP, the mark I think you are referencing was 70 and it moved down to 63. There's a new CEO in place at the company. I think there's a lot of operational improvements that are going on, both on the revenue enhancing side and on the cost reduction side. So, as we sit here and look today, the forecast -- there's some headwinds to the forecast.

The movement in the British pound does not help the situation much, as there's operations worldwide. But from a just performance standpoint, they're performing close to budget. So, I think as the valuation firms look at that one, they just look at some execution risk around the business with the new CEO at the helm, who we have a lot of confidence in. He's got experience in managing worldwide businesses, currency issues and things like that in his past.

Steve Sterling

One thing I want to make a clarifying remark, I had commented around the SLP and the board as an independent board. It's not an independent board in the legal sense; it's a separate and distinct board that serves the purposes of the SLP. So just for the avoidance of doubt, that's the structure there.


[Operator Instructions].

Steve Sterling

Terrific. Thank you so much, everybody. We appreciate your participation in the call. To the extent that you have any questions, please do not hesitate to let us know and we're happy to field those. Have a good day. Thanks. Bye.


That concludes today's call. We appreciate your participation.

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