American Capital Senior Floating's (ACSF) CEO Kevin Braddish on Q4 2017 Results - Earnings Call Transcript

Mar. 14, 2018 4:04 PM ETAmerican Capital Senior Floating, Ltd. (ACSF)
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American Capital Senior Floating, Ltd. (OTC:ACSF) Q4 2017 Earnings Conference Call March 14, 2018 11:00 AM ET


Veronica Mendiola - Investor Relations

Kevin Braddish - Director, President and CEO

Penni Roll - Chief Financial Officer


Doug Crimmins - Relative Value Partners

Rose Ruben - Private Investor

Daniel Wright - of Banyan Global


Good morning welcome to the American Capital Senior Floating’s Fourth Quarter and Year Ended December 31,2017 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded on Wednesday, March 14, 2018. I will now turn the call over to Veronica Mendiola of Investor Relations. Please go ahead.

Veronica Mendiola

Thank you. Good morning and thank you for joining us today for our fourth quarter and yearend 2017 earnings conference call. I am joined today by Kevin Braddish, the company’s Director, President and Chief Executive officer and Penni Roll, the company's Chief Financial Officer.

Before we begin, I want to remind you that comments made during the course of this conference call and webcast and the accompanying documents contain forward-looking statements and are subject to risks and uncertainties. Many of these forward-looking statements can be identified by the use of words such as anticipate, believe, expect, contain, will, should, could, may and similar expressions. The company’s actual result could differ materially from those expressed in such forward-looking statements for any reason, including those listed in our SEC filings. American Capital Senior Floating assumes no obligation to update any such forward-looking statements. Please also note that past performance or market information is not a guarantee of future results. Certain information discussed on this conference call and webcast was derived from third party sources and has not been independently verify and importantly the company makes no representation or warranty in respect of this information. As a reminder, the company’s fourth quarter and year ended December 31, 2017 earnings presentation is available on the company’s website at by clicking on the Q4, ’17 earnings presentation on the homepage of the Investor Relations section.

American Capital Senior Floating’s earnings release and 10-K are also available on the company’s website. I will now turn the call over to Kevin Braddish. ACSF, CEO.

Kevin Braddish

Thank you, Veronica. Good morning and thanks to everyone for joining us. Let me start with some market commentary to put our fourth quarter and full year results into context. Looking back over 2017, the credit markets were characterized by continued strong demand for loans, driven by healthy CLO formation of rising LIBOR curve and relatively stable credit conditions. These conditions resulted in record loan volume in 2017 as well as meaningful spread compression.

Since taking over as ACSF's manager at the beginning of 2017, we've been very active in repositioning our loan portfolio with approximately two-thirds of this portfolio in new positions compared to the end of 2016. As one measure of success in the face of credit spread compression in the market, we managed to increase both the overall spread and yield on our loan portfolio throughout repositioning efforts in 2017.

Despite the weighted average all in spread decline of 43 basis points for the average BB and BB minus institutional loans in 2017. The weighted average spreading cost on our loan portfolio at year end increase by approximately 17 basis points compared to the fourth quarter of 2016.

Importantly, we generated the higher spreads, while maintain consistent exposure to second lien loans, this underscore the importance and the impact of our broad access to non-investment grade credit and our significant portfolio management resources which enable us to review a vast array of opportunities and select what we believe to be the best risk-adjusted returns.

In addition to these higher spreads, our loan portfolio benefited from the increase in LIBOR during the year. Collectively, the higher LIBOR improved spreads led to increase yield of 65 basis points year-over-year in our loan portfolio. For our CLO portfolio asset spread compression impacted the level of cash flows throughout the year, which in turn impacted the company yields on CLO investments. The weighted average yield that cost on the CLO portfolio as of December 31, 2017 was 10.59%.

In order to counter balance, the spread compression on the underlying asset side 38% of positions CLO positions in ACSF's portfolio at year-end had repriced their liability cost lower at some point during 2017. It is important to note that this percentage would be higher, but we often sell CLO equity positions following a liability reset as the price typically increases, allowing us to exit on more attractive terms.

Going forward, we believe that any continuous of the reset opportunity in the market could positively benefit some of our seasoned CLO investments and may support future yield improvement opportunities for this portfolio.

It is also noteworthy that a portion of the yield compression experience during 2017 on our CLO portfolio was the result of our conscious decision to exit more highly leveraged CLO structures in favor of CLO structures that we need more moderately leverage. During 2017, we exited $19.8 million dollars of CLO equity investments with a weighted average yield of 12.5% and reinvested in $18.6 million of CLO equity commitment with a weighted average yield of 11.1%. We believe these actions will position the portfolio for improved long-term risk adjusted returns with less earnings volatility.

Shifting now to our approach on credit, we're keeping a watchful eye on recent market volatility and how it may potentially impact future performance. Even with some volatility, credit conditions remain stable with strong corporate fundamentals a growing economy further supported by tax reform. With these tailwinds the credit performance of our portfolio continues to be strong. As of December 31, 2017, our non-accruals as a percentage of the total portfolio at cost and fair value was 0.6 and 0.3 percent respectively.

Let me touch on our fourth quarter earnings quickly before turning the call over to Penni. Compared to our third quarter our fourth quarter results were relatively stable with net investment income of $0.25 per share and net earnings increasing to $0.25 per share.

In addition, we announced that our board declared a monthly dividend of 9.7 cents per share in line with the previous monthly dividend level for shareholders of record on February 22, March 20 and April 19, 2018. Importantly, we estimate that our undistributed taxable income carry forward from 2017 into 2018 was approximately 2.1 million or $0.21 per share.

I'll now turn the call over to Penni who will provide more details on our recent financial results.

Penni Roll

Thank you, Kevin, and good morning. For the fourth quarter of 2017 we reported net investment income of $0.25 per share, a decrease of $0.01 per share from the third quarter of 2017 and $0.03 per share from the fourth quarter of 2016. The decrease as compared to the third quarter of 2017 was primarily a result of higher net expenses in the fourth quarter as operating expenses were higher and there were no expenses reimbursed by our manager Ivy Hill due to the higher voluntary expense cap level and effects for the fourth quarter.

As you may recall beginning in the first quarter of 2017 Ivy Hill voluntarily agreed to reimburse certain of our 2017 operating expenses subject to a cap. The cap was based on a percentage of our consolidated net assets each quarter and was intended to help with the higher costs incurred to transition to a new manager.

The expense cap percentage started at 0.75% for the first quarter of 2017 increasing to 1% for each of the second and third quarters of 2017 and then 1.25% for the fourth quarter of 2017. We had fairly minimal valuation changes during the quarter and reported net realized and unrealized gains of $47,000, resulting in net earnings of $2.5 million or $0.25 per share, compared to zero per share in the third quarter of 2017 and $0.77 per share in the fourth quarter of 2016.

For the year ended December 31, 2017 we reported net investment income of $1.06 per share, a decrease of 12% per share from the year ended December 31, 2016, the decrease in the prior year was primarily a result of higher interest expense on our floating rate credit facility as a result of the increases in LIBOR during the year, representing $0.07 per share of the decline with the remaining $0.05 per share coming from higher net operating expenses, which primarily increased as a result of the declining expense reimbursement during 2017 that I previously mentioned.

We do continue to focus on reducing the company's expenses. For the year ended December 31, 2017, the company had net losses on investments of $4.9 million as we rotated out of lower value higher risk investments during the year and reinvested in investment with what we believe to be better risk adjusted returns as Kevin mentioned. This compares to net gains on investments for 2016 of $18.7 million, where we significantly benefited from the recovery of asset valuations, particularly in the CLO market. For the year ended December 31, 2017 net earnings for the company were $5.7 million or $0.57 per share as compared to $30.5 million or $3.05 per share for the same period in 2016.

We ended 2017 net asset value of $13.09 per share as compared to $13.68 per share at the end of 2016.

Looking at the right-hand side of our balance sheet as of December 31, 2017, we had $87.5 million of debt outstanding on our credit facility and our debt to equity ratio was 0.67 to 1 down from the 0.74 to 1 at September 30, 2017.

Due to the timing of trade settlements, we also had $12 million of unsettled net trade payables which one set would have increased our debt to close $100 million bringing our leverage to a level more consistent with previous quarter end.

As of December 31, 2017, we believe ACSF is well positioned to benefit from horizon short-term interest rates given the asset sensitivity of the balance sheet. Using the composition of the balance sheet at December 31, 2017 and considering the impact of a change in interest rate on our loan portfolio and credit facility, we estimate that an incremental 100 basis point increase in LIBOR may benefit our earnings by $0.10 per share on an annual basis.

Turning to our portfolio composition, as of quarter end, we had $229 million portfolio at fair value composed of $171 million or 75% in first lien loans, $14 million or 6% in second lien loan and $44 million or 19% in CLO equity. The weighted average yield at cost for the entire portfolio as of December 31, 2017 was 7.05% which included a 6.08% weighted average yield on the loan portfolio and a 10.59% weighted average yield on our CLO portfolio.

As of December 31, 2017, our loan portfolio was highly diversified across 129 issuers and 37 industries with the largest issuer exposure at 1.4% of the total portfolio. Our CLO portfolio was invested in 25 issuers across 18 different CLO managers. Our overall average issuer concentration in the total portfolio was only 0.7% with the highest issuer concentration at 1.9%. Overall, we feel good about the mix and granularity of our portfolio.

And now, in fact, I would like to turn the call back over to Kevin for some closing remarks.

Kevin Braddish

Thanks, Penni. During 2017 the market witnessed significant demand for loans relative to supply, which in turn led to reduced credit spreads. So far in 2018 we've seen heightened volatility in the equity markets and a selloff in the U.S. Treasury markets as investors grappled with the prospects of higher interest rates, inflation, the potential unwind of an unprecedented amount of stimulus from central banks and new tariffs.

Despite this volatility prices in the loan market have been remarkably stable due to continued strong demand for senior floating rate loans principally from strong CLO formation. Based on solid investor confidence, strong corporate earnings and overall benign credit conditions we believe these dynamics may exist for some time. We're mindful of the changes in the capital markets and believe the breadth of our platform uniquely positions us to prudently invest in attractive credits.

Going forward we will seek to continue to adhere to our rigorous investment and diligence processes leveraging the strength of the Ares investment platform. We're focused on making investments in strong credits with high free cash flow generation and defensible market positions.

We believe we have positioned the portfolio to generate attractive risk-adjusted returns in a challenging yield environment and believe we are well positioned to potentially recognize an earnings benefit from higher short-term interest rates should that occur in the future.

Given the company's size we also recognize that ACSF lacks economies of scale that could benefit the company, importantly we continue to evaluate ways that the company could benefit from scale efficiencies that we believe could be in the best interest of shareholders.

Thank you everyone for your time today and that concludes our prepared remarks. Operator, would you please open up the line to see if there are any questions. Thank you.

Question-and-Answer Session


[Operator Instructions] The first question comes from Doug Crimmins with Relative Value Partners. Please go ahead.

Doug Crimmins

Hey Kevin and Penni, thanks for taking my question. We really appreciate, and you guys have done a really nice job with the portfolio and we own a bunch of other Ares products and we're big fans of what you guys do. But I just was wondering if you could really comment more specifically on the strategic vision of ACSF. I mean given its subscale size, you know highly liquid and transparent portfolio and trading at such a big discount, I mean where you take this thing strategically? Is there any conversation about potentially looking to do some sort of a liquidation, can you kind of help us with that?

Penni Roll

Sure, thank you for your question, this is Penni. Obviously, we've been only managing this for a year now, and we've been very focused on a number of things. One is the portfolio repositioning that Kevin talked about and our investment team has worked hard to maintain its price in what is really a challenging environment for maintaining portfolio yields, and we believe they've done a nice job doing that.

On the expense side we do look at ways to improve expenses in the context of what area and what we can bring to the platform generally, we’re looking at the cost of our capital and other operating expenses and have done that throughout ‘17 and will continue to do that in 2018.

There are a number moving pieces and things that we have to consider if you look at where the earnings are today we do have -- continue to pay the dividend that we paid at $0.097 per month to the shareholders. We feel like on a relative basis to what that translates into a quarterly dividend of about $0.29 that we do have some lever still that we can pull relative to where the earnings are in the context of potential upside for LIBOR raises which obviously we don't control but that is upsize in the earnings which we talked about to the tune of maybe up to $0.10 that we continue to get rate rises during the course of the year. And hopefully we can still continue to manage expenses.

So those are the things that we’re looking at doing as we look at where we think the company can go from here. I mean there obviously, you mentioned question around, are there other options like liquidation, I mean I think our view is we've been trying to manage this company in a way that we could try to stabilize the earnings in the context of continuing to pay the dividend but like we said there are things do take time that something we talk about internally and with our board and will continue to assess it depending on how these additional levers can come to fruition.

Kevin Braddish

I would just add. We at the end of our prepared remarks we clearly acknowledge that the platform needs scale and both the management and the board are cognizant of that and contemplating ways to achieve that scale. But to Penni's point we have spent the better part of the year trying to reposition this portfolio in a really, really challenging market environment relative to credit spreads.

Doug Crimmins

And I think you guys have done a wonderful job, but when I look at it, it's essentially BDC within a very large BDC and there is a confusion that feels like and that’s 16%, 17%,18% discount to what I think are pretty solid, liquid NAV. I just kind of question, how you scale this and whether it board discuss doing some sort of managed liquidation.

Penni Roll

I think, we do appreciate your comments, the scale hasn’t something we talked about for the last year in the context of where we are, I think you’re right on your observation that scaling in the context of where the stock prices today are hard to grow and that's something that we have to consider as well so. I think with that we can just say is something that we are looking at that were talking about consistently, as we've been waiting and to managing this and something to continue to consider as we move forward.


The next question will be from Angelo Guarino a Private Investor. Please go ahead.

Unidentified Analyst

First of all, I appreciate the scale discussion, especially in the context of expenses cap rollout, which I appreciated that was even extended as long as it was. I might certainly with board with considering the liquidation but we’ve said this before and I hopefully we guys are considering is that I will be supportive of a slightly sub NAV issuance to maybe 10% discount on a NAV or whatever if the stock ever gets back up there, just to get the scale, just to get the capital up. If you run the numbers that actually there is a wash for the shareholders. It’s the discount NAV slight and as a fair value shareholder I will be supportive of that. So, with the carryforwards, so you’re saying it’s $0.21 what was it the previous year was it $0.60?

Penni Roll

I believe it was about $0.32 last year.

Unidentified Analyst

Okay. So, we burn through $0.10 in a year. So, if we get $0.10 -- if the goal is that hopefully keep at the current scale and the current expense model if we are hoping that LIBOR going up a point or 1% is going to give us $0.10. Do you feel that there is $0.04 of expenses, some place to be found? When you’re talking about looking at your expenses and trying to bring it down in the context of expense cap being lifted and what that’s done to the business model, how much you think you can get I mean what would be the volume position for you guys looking at decreasing expenses under the current system?

Penni Roll

If you look at expenses right now ACSF runs one of the lowest expense ratios for similar type’s fund. But we continue to look at the vendors that we use and try to just manage them and keep expenses as low as possible.

How that translates, we will continue to look it’s not $0.04 from an expense saving perspective at least on the operating costs I guess that we are looking right now at our cost of capital and hope to see how that translate into expense saving as well, and as you mentioned we have some splintered our back we believe in the context of continuing LIBOR going up.

So, if you look at that then you look at the $0.21 of spillover income coming through that does help support the dividend in the near term at the current level. If you just do simple math and you look at where we are today and if you assume this stated $0.25 of earnings which we believe there is upside to that, there is still sufficient spillover income to support dividends going into 2018 to help cover the gap, but we are working to see what we can do to have that gap close.

Unidentified Analyst

Right. So, we can still have some time to let this all workout. So, I think in the last conversation we had about scaling it and trying to get this company to double its current size and expenses and everything seems to start making sense, actually it would operating at expense level be at levels pre-tack removal if you can double the size.

So I guess I would just say that I hope that you can put in place a question to shareholders to allow you to take advantage of market fluctuations if this stock gets within 90%, 95% of NAV, not to then have to go out to shareholders ask for permission, I encourage you to get the tools available under your belt so that you can act when you can if the market starts valuation, valuating the stock properly again.

Penni Roll

Thank you Angelo and we always appreciate your input and we will keep that in mind.


[Operator Instructions] The next question will be from Rose Ruben a private investor. Please go ahead.

Rose Ruben

I guess, when I look at its been long-time shareholders, when I look at your stock and discount NAV obviously, some of it is performance related but also when I look at shares, because of the CLO equity which could be very volatile, we have seen it a couple years ago and have a really dramatic impact on NAV and in a rough equity market. Do you think this is a -- how do you manage that and it is a structural problem because of the impact that can have on NAV that’s going to cause the market to always value your shares at a discount.

Kevin Braddish

One of the things that we’ve done over the course of the year [ph] that we have been a manager is to try to more conservatively position not only the loan book but the CLO book. And we've done that by trying to sell equity positions that have reset that we thought were fairly leveraged and then reinvest into CLO equity structures that have less leverage. And by nature, those vehicles that are less levered are going to have less deviation in to NAV based on underlying credit performance within those CLOs, so we think it's still the appropriate investment vehicle and we have taken the steps we think are necessary to try and more conservatively position that specific portion of the portfolio.

Rose Ruben

And I do appreciate that but it's still -- I think, I have CLO equity through other funds, even ifs its levered 8%, eight times or 10% or 11 times. I mean I think we all know that if we have a stock market correction, it's going to really lose a lot of impact to NAV. So, I’m just wondering if -- in a way I like the equity because it’s a nice kicker and it gives a higher yield but I’m just concerned that that’s going to cause you always to sell at a discount which is going to make it hard for you to raise equity assertively.

Penni Roll

There is no question that CLOs will have some valuations, fluctuations I mean honestly, we followed in 2015 and this is the following managed it and one of the reasons why 2016's earnings were so strong because we were recouping that market, dislocation that then brought the value of the CLs back. But I think what we’re trying to do is really look at CLOs that gives us a consistent level of cash flow and more better risk adjusted cash flow as Kevin was taking about to try to de-risk some of the volatility that we have in the portfolio. But on the other hand, this portfolio builds and I think the investment objectives were built to try to get a blended return that you get from having both a loan and a CLO portfolio, which is why the construction is what it is today because if you look at the overall portfolio you'll see it’s about 7%. The loan portfolios about 6% and the CLO portfolios about 10.5.

So, without that blended return the earnings on the aggregate portfolio if you went just to a pure loan portfolio would be lower and potentially would impact the dividend level that the company is able to pay. So, you have to look at the tradeoff of risk return and we hope that we've put together a portfolio that balances that out and considers aggregate return in how that lines up with the historical view of the level of dividends that the company has desired.

Rose Ruben

And I do appreciate it, I actually have mixed emotions, I mean I bought it because the CLO equity and the higher yield and I'm comfortable with the volatility, frankly that's the time to buy more shares is when you have a different NAV, like the other shareholders I'm just concerned about how do you really grow the portfolio, but I guess I'm comfortable with the volatility but I'm not sure I represent the market. No follow-up required on that.


Thank you, the next question will be from Daniel Wright, of Banyan Global, please go ahead.

Daniel Wright

Hi guys, thanks for taking my call. I would echo we can handle the volatility of our shareholder as well, but our concerns are similar to when do you let this dividend run out where say you don't get this raise on LIBOR, you do get some market volatility. At what point do you say we can't sustain this dividend and liquidate?

Penni Roll

I don't know that sustain a dividend and liquidating are necessarily contemporaneous. You could continue to -- you have to consider the level of dividend paying the following factors that we talked about in the context of the market and the general economic conditions and the yields that you can get etc. relative to your expenses and relative to the spillover that we have.

Yes, some things are in our control and some things aren't over time, and I think that the company and the board just have to consider a dividend level that makes sense relative to what can be earned in the market for these types of assets.

So even if you couldn't support the dividend because just the yields in these asset classes weren't supportive of that, that doesn't necessarily mean you would have to liquidate, you could readjust the dividends at the current level, earnings level and earnings power to the company and still continue on.

Daniel Wright

No. I totally understand that, [that's how the] BDC. My real question is because you are so small you don't really have that much flexibility, so it's a more pointed question, the dividend is really a reflection of your ability to earn and since the earnings are impacted so much by the expenses of scale if we're sitting in the same position a year from now, and the asset value of the company is at 12.50 and adjusting the dividend not going to, just going to drive the share prices down.

Penni Roll

I think if you look at where we're trading today at the discount to NAV, that the stock price is arguably adjusted to the current level of earnings of the company, but it is something that we continue to watch and it is something we have to keep in mind when we think about what's in the best interest of the company and what level of dividends makes sense to be paid from the company. I feel like we want to take the time to assess that, we want to watch to see how things play out before making those decisions but it is something that we also think about.


The next question is a follow up from Angelo Guarino with private investor. Please go ahead.

Unidentified Analyst

I forgot, when we talk about scale about a year ago, depending one of the issues was, okay say that I could double the company, say I got twice the capital at that point the issue you will be struggle of where to put it, how could we even place these investments to effectively keep the company doing as it was. Sounds like after your rotation of the assets and rebalancing it to something that you’re more comfortable with, if you had the ability to double the size of the company, do you feel you have opportunities in places to put it today?

Kevin Braddish

Good question it is taking a full year at a lot of work by a lot of people to reposition this portfolio and to modestly improve spreads in a market environment. We have given you the date of that is really, really compressing spreads, really across the globe. You could probably put it to work with doubling the size of the company. I think you would start to feel the way that that spread compression even more and you would be very, very challenged to put those dollars to work and maintain spreads. At least if the current market environment were to continue for a prolonged period of time.

Unidentified Analyst

So, I think when we think about as long term since the IPO and investing in this company, thinking about what it was -- as far as expenses were concerned, what it would take to grow the company. Because the company always even since the IPO was under an expense for variance. And it was always we got to get the company twice its size to the point where the expense forbearance would be moot.

If you look just from my knowledge and that’s still about the case, if you look at the company’s expenses when you took it over and the forbearance you were providing to make that make up, to make up that cap that’s now removed. Would you have to basically double the company to make it so that expense can come -- the expense cap that we were used to thinking about this company operating under this kind of moot, because the expenses are small enough.

Penni Roll

I don’t have the exact math, in my head right now but clearly a larger company would benefit from the expense load because certain of the costs reflects, some of them are variable too, it's not a perfect ratio to say that any cost we have today wouldn’t grow with the growth in the company.

As I mentioned before, we do have one of the lowest expense ratios in the industry even without the support from the manager we really tried to manage those costs as tightly as we can but scale will help. I think part of the challenge is just to add to a point that Kevin was making and to your question earlier could we go out and raise equity even if it was at 0.9 times booked.

If you raise equity at a discount to NAV you have to invest at a level that makes up for that discount. So, in the current spread environment that would be a challenge too for growth of the company probably more so than the expense load on the company.

Unidentified Analyst

I agree, but when you run the numbers because the expenses start getting less, there is actually a tradeoff, right. So, the expenses become smaller relative to the whole operation of the company. so you would necessarily have to be more aggressive. There is a discount in NAV which balances off the rightsizing of the senses. There is a certain number, I don’t know if it’s 95% to book or whatever it is. So that’s the tradeoff that I was looking at as an investor. It would be okay for me to take that on NAV, to get the expenses in the long-term run rate correct. But your point is well taken is that it will be a challenge to double the size of the company in the next year.

But we talked about the bunch of different things which are encouraging, right. LIBOR increasing is on our side, you’re continuing to look at expense savings and maybe increasing if we can find a way to increase the size of business by 30%, maybe there is a way to do a coalition here that makes it sort of that that $0.21 of carryforwards last 2 years or 2.5 years or 3 years or maybe eventually may end of that period is actually getting that back to maybe a merger.

I know we talked about that before but is there another small similar enough entity out there that’s also struggling because of scale that could be combined and if both entities are trading at this approximately same discounted NAV it will be a push to the current shareholders. So, I appreciate the fact that unprompted scale was brought up in the prepared comments. So anyways thank you.


Ladies and gentlemen, this concludes today’s question-and-answer session and thus concludes today’s conference call. If you missed any part of today’s call, an archived replay of this conference call will be available approximately 1 hour after the end of the call through March 28, 2018 at 5 pm Eastern Time to domestic callers by dialing 877-344-7529 and to international callers by dialing 1-412-317-0088. For all replays, please reference conference number 10117493. An archived replay will also be available on a webcast link located on the homepage of the Investor Resources section of our website. Thank you for attending today’s presentation. You may now disconnect.

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