KCAP Financial (KCAP) Q4 2017 Earnings Conference Call March 8, 2018 9:00 AM ET
Executives
Dayl Pearson - President and Chief Executive Officer
Ted Gilpin - Chief Financial Officer
Analysts
Ryan Lynch - KBW
Operator
Good morning, ladies and gentlemen. And welcome to the KCAP Financial Inc. Conference Call. An earnings press release was distributed yesterday. If you did not receive a copy, the release is available at the Company's Web site, at www.kcapfinancial.com, in the Investor Relations section.
As a reminder, this conference call is being recorded today, Tuesday, March 8, 2018. This call is also being hosted on live webcast, which can be accessed at the Company's Web site, at www.kcapfinancial.com, in the Investor Relations section under Events.
Today's conference call includes forward-looking statements and projections, and we ask that you refer to KCAP Financial's most recent filings with the SEC for important factors that will cause actual results to differ materially from these projections. KCAP Financial does not undertake to update its forward-looking statements unless required by law.
I would now like to introduce your host for today's conference, Mr. Dayl Pearson, President and Chief Executive Officer for KCAP Financial. Mr. Pearson, you may begin.
Dayl Pearson
Good afternoon and thank all of you for joining KCAP Financial for a review of our full year 2017 results. Today, I'll review our key highlights from the year and strategy going forward, as well as provide contacts for our direct lending business and the performance of our Asset Manager Affiliates. I'll then turn over the call to our Chief Financial Officer Ted Gilpin, who'll provide a more thorough review of our full year operating and financial results and then open the line for your questions.
We accomplished a great deal in 2017 to lower our borrowing cost, optimize our balance sheet and put ourselves in a position to grow in 2018 and beyond. We're currently evaluating a number of potential transactions to support our capital and are excited about the opportunities we see in the market.
2017 was a year of transition for KCAP and that had a short term impact on our earnings, but was essential to position for future growth. Like the third quarter, the fourth quarter also included a number of changes to the balance sheet related to our strategy shift and make it difficult to compare asset composition quarter-over-quarter.
Two high level points, I'd like to call out on the composition of our balance sheet had a significant reduction on leverage year-on-year and the dry powder we currently have available for new investments. If you look to our overall leverage, you'll see that during 2017 our overall debt outstanding decreased by approximately $74 million and our asset coverage ratio now stands to 271% versus 205% at the end of 2016.
So we've taken the balance sheet from a position of doing very near maximum leverage to a place where we have a greater degree of flexibility in transactions that we take on and the way we structure those transactions. We recently entered into $50 million revolving credit agreement with the syndicate of banks to provide even additional dry powder.
The dry powder at year end I mentioned was in the form of approximately 77 million of short term investments in money market funds and T bills that were regularly accessed as of year-end. These funds made up about a quarter of our overall investment portfolio as compared to 28% at the end of 2016. Today we have approximately $30 million of cash for deployment plus $50 million in unfounded revolving credit facility or $80 million of total liquidity for new investments.
We have a number of new investment opportunities identified in the short term in excess of 25 million in the aggregate. As we discussed on our last quarterly earnings call, one of the key transactions in repositioning KCAP for growth was the joint venture we entered into with Freedom 3 and the redemption of 147 million in debt. As you know a part of the transaction is to set up a new fund owned by the JV which is managed by a wholly owned asset manager affiliate of KCAP.
The fund is now almost fully invested in approximately $300 million of primarily senior middle market loans. To give you better sense of the benefits, we're seeing during the fourth quarter of 2017, management fees were approximately $305,000 from this fund and investment income on the JV was approximately 264 million. Please bear in mind that the portfolio of loans was not fully ramped during the quarter and as a result this does not represent an actual full quarter of managing $300 million of assets.
We also have been very active in resetting certain of our CLO funds during the quarter. Specifically our Asset Manager Affiliates extended the term and increased the size of two managed CLOs and reduced the cost of capital of three managed CLOs. The resulting lower liability cross increased the value of their equity in the CLO funds to help to pick up and importantly the upsizing of these CLOs mix available a significant amount of investible funds.
Now, let me give you a high level summary of our 2017 fourth quarter and full year financial results before handing over to Ted. For the year ended December 31, 2017, our NII was approximately $11 million or $0.30 per share, our fourth quarter distribution was $0.10 compared to$0.12 paid in the third quarter. At the end of the quarter KCAP had approximately 77 million investible cash, which we intend to deploy in transactions, generate cash flows we need to further on distribution to shareholders.
Turning to our direct lending business and the performance of our Asset Manager Affiliates, during quarter we invested approximately $50 million in new originations with a yield of approximately 8.5%. We also have a robust pipeline of new opportunities for the balance sheet. Credit quality continues to be strong with no defaults and assets on partial picked accrual or we recognize all of the cash interest and the percentage of the pink interests.
In terms of the market for new CLO funds the environment is extremely active and we expect the positive momentum to continue into 2018. Our Asset Manager Affiliates were busy in Q4 2017 resetting and upsize two CLOs and aggressively lowering the debt cost of another CLO. And all three CLOs became risk retention compliant. Although we have a risk retention solution in place, we're hopeful that the expected finalization of the repeal of risk retention rules will further boost CLO issuance.
As of December 31, 2017, our weighted average mark-to-market on our debt securities portfolio was 94 compared to 95 at the end of 2016. In terms of our CLO portfolio, our weighted average mark-to-market was 48 as of December 31 versus the weighted average mark-to-market of 54 as of December 31, 2016.
We also call during the quarter our last one point CLO on Katonah 2007-1 and received a partial redemption of debt position of $10 million during the quarter. Our 100% ownership of our Asset Manager Affiliates was valued at approximately 38.8 million based upon the assets under management perspective and positive perspective cash flows and managed of approximately $3 billion of assets under management.
Our CLO equity portfolio at the end of the fourth quarter totaled approximately $52 million. At the end of the fourth quarter debt securities totaled approximately 118 million or represented 38% of the investment portfolio, first lien loans now representing about half of the debt securities junior loans represent about 40%.
Our CLOS managed by KDA and Trimaran continue to return on equity distributions and management fees. This income stream for our Asset Manager Affiliate allows them to make periodic distributions to us. During the quarter there were distributions totaling 12.9 million or 11.3 million of which was in '07-1, which is winding down as I mentioned earlier. Additionally as of December 31, 2017 our Asset Manager Affiliates had approximately $3 billion of hard assets on the planet.
And now I ask Ted Gilpin to walk through the details of our financials. Ted?
Ted Gilpin
Thank you, Dayl. Good morning everyone. As of December 31, 2017, our net asset value stood at 4.87 million which is down from 5.24 million at the end of 2016. Net investment income was 2.7 million or $0.07 per basic share for the fourth quarter of 2017, as compared to $0.07 per basic share in third quarter of 2017, down from 4.1 million or $0.11 per basic share in the fourth quarter of 2016.
Interest income on our debt securities for the quarter ended December 31, 2017 was 3.3 million or $0.09 per basic share compared with 2.5 million or $0.07 basic share for the third quarter of '17. Interest income on our debt securities was 4.7 million or $0.13 per basic share in the fourth quarter of 2016. Our debt securities portfolio contribution to total investment income for the quarter was 50%, which compares to approximately 39% for the third quarter and 58% for the fourth quarter of 2016.
Investment income for CLO funds securities climbed slightly to 2.5 million or $0.07 per basic share in the fourth quarter of 2017 versus 2.8 million or $0.08 per basic share reported in the third quarter 2017 and down from 3.2 million or $0.09 per basic share in the fourth quarter of '16.
We received distributions from our Asset Manager Affiliates of approximately $1 million in the fourth quarter of 2017, 750,000 of this fees was in excess of the AMAs estimated tax from earnings and profits, therefore treated as return in capital. There are no distributions in the AMAs in the fourth quarter of 2016.
For the three months ended December 31, 2017, total expenses increased by approximately 190,000 from the third quarter of '17 and as compared to a decrease of approximately 84,000 for the same period in 2016.
KCAP recorded net realized and unrealized losses on investments of approximately 1.5 million for the three months ended December 31, 2017, compared with net realized and unrealized gains of approximately 816,000 for the three months ended September 30, 2017 and realized and unrealized losses of approximately 4 million in the fourth quarter of 2016.
Like to now discuss some of the details of our full year results for 2017, interest income on our debt securities for the year ended December 31, 2017 was 15.1 million and 20.8 million compared as of year-end December 31, 2016, due primarily the redemption of KCAP senior funding or on balance sheet securitization.
Our debt securities portfolio contributed to total investment income for the year was 53 % or 58% in 2016. Investment income from CLO fund securities is 11.2 million for the full year compared to 13.3 million for 2016.
Received distributions from our Asset Manager Affiliates of 3.2 million during 2017 compared to 2.7 million in 2016, 460,000 under the 2017 distribution was recognize as dividend income whereas for 2016, 1.4 million the distribution was recognized as dividend income.
The company recorded net realized and unrealized depreciation on investments of approximately 3.5 million or $0.09 per basic share during the year ended December 31, 2017, as compared to net realized and unrealized depreciation of approximately 19.4 million or $0.52 per basic share for the year ended December 31, 2016.
For the liability side of the balance sheet as of December 31, 2017, par value of our debt outstanding was approximately 104 million, compared with 181 million on December 31, 2016. Our asset coverage ratio at the quarter and was 271%, volume of the minimum 200% required BDCs.
And with that we like to turn the call over to you for any questions. Operator
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] And our first question comes from Ryan Lynch with KBW. Your line is now open.
Ryan Lynch
Hey, good morning. First question I had, I noticed that you guys - the cost base of you guys debt portfolio decreased from - for the third quarter and into the fourth quarter and also you guys total investment portfolio excluding cash in money market and treasuries decreased from the third and fourth quarter, but I was trying to actually find could you disclose the individual movements. I didn't actually see what were the originations that you guys made into new investments this quarter as well as the repayments that you guys made?
Dayl Pearson
Sure, it's a little bit confusing because some of the stuff was related to the joint venture transaction and so we'll try to walk you through sort of step by step. So in terms of the loan portfolio, we had about 45 million - as I said 45 million of net originations at as I said, 8.44% was the average yield as of year-end. Those are almost all floating rate securities, so as of today that yield is probably another 25 basis points higher than 844, but as of year-end it was 844 and our cost basis on that was a little under 99.
Then let's talk a little bit about the joint venture. As you remember when we funded the joint venture in the third quarter we took $185million worth of assets off the balance sheet, went into the joint venture, our partner put in I think another 25 million, so we had about $210 million of capacity, which is all we really had at that point until we upsized or were able to upsize the debt which we did on October 31, to 300 million. So we had some additional assets on the balance sheet during the third quarter that were then sold in the fourth quarter into the joint venture and that totaled about $26 million and those were sold at market prices at par and a half roughly.
And then as part of the transaction for the joint venture in the fourth quarter, we also were able to redeem about $12 million worth of the equity which was in the joint venture as of the end of the third quarter, so we have were able to upsize and actually have less equity in the joint venture. In addition to that, we also - as I mentioned had a redemption, partial redemption of Katonah 2007-1, which was roughly $20 million position at the end of the third quarter as you see I think it's roughly $10 million position at the end of the fourth quarter that was all a pay down of cash, so that was $10 million.
We also received another partial redemption in the first quarter of about 5 million and we expect to have most if not all of the remaining 5 or 6 million redeemed before the end of the first quarter, so that's that. There was also as part of the upsizing of 14 - and resetting a 14-1 we had to in the interim basis buy more equity to get that transaction done, but we didn't want to have more than 24.9% of the equity and so we had - we sold 5 million of that equity in the fourth quarter, so that's a reduction of 5 million.
As part of the reset which occurred in the fourth quarter we had 1.5 million position in single BPs and 14-1 and that got redeemed as part of the resetting of the transaction. Does that form any sense?
Ryan Lynch
Okay. Yeah, I mean yeah. I know those are yeah definitely the details of the movements this quarter, so it's definitely helpful. Moving over to the joint venture, I just had a couple questions on that. I believe you guys within the joint venture issued a CLO in the quarter, like at least tap CLO financing, can you just walk us through exactly what went on in the joint venture because it also looked like your investment which in the third quarter was about $36 million equity investment in the joint venture is now split between about $25 million equity investment and then roughly 4.5 million debt investment into the JV. So if you can just walk through exactly what was the transaction or maybe CLO financing that the JV did this quarter? Also, how did the total AUM that the JV manages changed from the third and fourth quarter and then finally how will the J - how will you guys be receiving income from the JV, will it now be primarily received through interest income or are you guys still be receiving dividend income because I saw dividend income decreased from the fourth quarter versus the third quarter.
Ted Gilpin
I will start with the back end of that.
Dayl Pearson
Yeah, why don't you start with the back end of that.
Ted Gilpin
Okay, talk to you about this but the JV was doing. So the JV - again we'll receive investment income from the JV as it relates to its investment in –our equity investment in JV and its investment in its - into its portfolio of CLO portfolio. We receive dividend income from our Asset Manager Affiliates as it relates to their management of the CLO part of - of the CLO itself, so that will show up as dividend income from the Asset Measure Affiliates and then will receive investment income on the joint venture itself.
If you look at page 48 of our - finally you can see the line for the joint venture where there is 36.7 million and then you can see that the 11.8 million was sort of returned to us as Dayl said, it didn't need as much equity or as it had it, so that was actually returned to us that we could use for other things and then it had a mark-to-market adjustment on it, so that's what happened to the 36 is on page 48, but Dayl can tell you what's going on with the joint venture, so.
Dayl Pearson
Yeah, I think as we talked a little bit in August, we're sort of halfway through this, but we redeem kick up senior funding on its final - on our payment date which was July 21. We can only redeem it on a payment date, so any way we have a July 21 to October 21 and for a number of reasons we chose to do it on July 21 and we had an interim financing package in place, which allowed us to transfer those assets, take assets from our joint venture partner and have up to about $215 million to $220 million in capacity in the interim. And our target was always to get to 300 million and once the sign of financing was in place. And so we kept all of the equity which we had had in KCAP senior funding, our partner put in essentially their pro rata piece of the equity which got them roughly to 40% of the equity at that point.
Once we finalized the take out financing which happened in the end of October that provided us with a total of $300 million instead of $220 million in capacity. And it allowed us to also reduce our equity position from 36 to 24, we then chose to buy the double Bs that were offered as part of the financing package because from our perspective it was a very attractive risk return and a good use of funds. And so we chose to buy roughly $4.8 million of double Bs, our partner also bought some of the double Bs and there were some third parties that also bought double Bs. And we bought those at a price of a little over $0.90 of par, so we actually have some ability for some capital appreciation there and we've actually had a lot of inbound inquiries on selling that, but since we happen to like the yield on it at current time, we're not in any great hurry to do that, but that's what happened.
So then - so then as of October 31, we went from two roughly $225 million of assets under management to 300 million, but we didn't have $300 million of actual assets and there some of that was cash. And we were a little bit slower than we had hoped in closing transactions, we actually had a lot of transactions in the pipeline for that joint venture and al lot of those got delayed closings until December and into January which resulted in a lower distribution than we had hoped for originally, but we expect it to be more of a run rate distribution of what we had expected starting in Q1 and certainly Q2.
Ryan Lynch
So when I look at I guess 39 page 39 of your 10-K. basically has the subordinate securities in the JV yielding about 12.1%, do you expect that yield to go higher in Q1due to the JV kind of not being fully ramped in the fourth quarter. I guess what sort of yield now that - going into Q1 that you guys have - guarding up the debt financing in there and the assets seem like they're pretty much set or about to be funded late in the quarter at least, what sort of yields should we expect in your guys $25million investment going forward.
Dayl Pearson
Well I think the distribution that we made in the fourth quarter was not near the 12% because of the drag is very sad in terms of not being fully funded until the end of - actually early November and not being fully rampant until late December or early January, so I don't think you'll see the 12% or higher, but I think if you just do the math the distribution of the fourth quarter was not a 12 –not a 3% distribution.
Ryan Lynch
Okay, so 12% is going to be roughly the yield distribution you're going for -
Dayl Pearson
Yeah, I mean I think that's 12 and then again the other point being the management fee in the fourth quarter was not a full amount on 300 million, since we only had 300 million starting in November, so you had a month of management fees on 215 million and then two months of management fees on 300 million. So the management fee in the fourth quarter is a little bit late as well.
Ted Gilpin
You see those two things increase dividends from the AMA and the investment income on the joint venture should both go up, now that is ramped.
Ryan Lynch
Okay and then one specific company investment question, Grupo HIMA, that was an investment that you guys - I believe still have on accrual status and marked by 64% of cost. There are other BDCs in that that investment I know you guys can't speak to their process, valuation process, but they have a substantial - they have a more substantially lower than your cost and they actually have that on nonaccrual, so just wanted to know how you guys get comfortable with you guys mark and you guys expect that that loan to be on nonaccrual status in the first quarter.
Dayl Pearson
Not really going to comment on what we're going to have at the first quarter, but in terms of the mark I mean that was our internal mark, it was also validated by our third party valuation consultant and by our auditors' who all looked at the mark and were aware of the other marks out there. There's a lot of - there's one quote unquote quote out there that's never been a trader around, which I think has an impact on all of our mark, but we're very confident with the mark and the company has performed reasonably well through the - through a fairly difficult period of time. But as of today it's not a on a nonaccrual status and there's a lot of things going on at the company which we can't really comment on, but I think obviously the first lien is paying all of its cash interest and secondly as marked - were we haven't marked and everyone has it. It's a very fluid situation.
Ryan Lynch
Okay, but it is still paying interest income currently?
Dayl Pearson
On the first lien, yes and obviously the second lien is picking.
Ryan Lynch
Okay and then just one, you guys mentioned $50 million revolving credit facility closed in Q1 of '18. What was the pricing on that facility?
Dayl Pearson
LIBOR up by 325.
Ryan Lynch
Okay, that's all from me. Thanks taking my questions.
Dayl Pearson
Thank you, Ryan.
Operator
Thank you. [Operator Instructions] And our next question comes from Christopher Norn [ph] with Ladenburg Thalman. Your line is now open.
Unidentified Analyst
Hey guys, I'm picking up on Ryan's question on the revolver. Are you able to tap all of that capacity if you like given your current asset composition or does it require some sort of change in your asset composition?
Dayl Pearson
Doesn't require a significant change of our asset composition, but we don't have enough asset today to borrow $50 million. A lot of that's for new assets coming on board, so, but it is a mixture of - we have availability for both first lien, second lien and mezzanine assets as part of that facility.
Unidentified Analyst
So given your current assets, how much can you actually tap?
Dayl Pearson
Probably about 25 million today, but again we have plenty of cash, so we have a sort of redemption and I guess you see in subsequent events, the retired $20 million of our remaining $27 million of seven and three years baby bonds that are due within October '19, so we may end up tapping into that a bit as we redeem that debt.
Unidentified Analyst
And I didn't see any plans in terms of what you're going to replace it with, these seven and three years?
Dayl Pearson
Well, by and large I think to some extent, some of that gets replaced by the revolving credit which obviously is a significantly lower cost of capital we have - as you know we did 77 million or so of six and eight baby bonds in the third quarter.
Unidentified Analyst
Got you, okay, that's if for me.
Dayl Pearson
And then we have the ability to increase the size of that revolving credit as we increase the size of our balance sheet.
Unidentified Analyst
Okay, so effectively it's going to be somewhat contingent on you raising additional equity capital?
Dayl Pearson
No, I mean we have plenty of ability for more leverage, I mean, so we don't need to raise equity capital nor upsize the credit facility.
Unidentified Analyst
Great, thank you.
Operator
Thank you I'm not showing any further questions at this time. I'd like to turn the call back to Mr. Dayl Pearson for any further remarks.
Dayl Pearson
I thank everybody for taking the time and I will be speaking to you to soon about the first quarter Thank you.
Operator
Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a great day.
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