Harvest Capital Credit Corp. (NASDAQ:HCAP) Q4 2018 Results Conference Call March 15, 2019 11:00 AM ET
William Alvarez - Chief Financial Officer
Joseph Jolson - Chairman and Chief Executive Officer
Richard Buckanavage - Managing Director and Head of Business Development
Conference Call Participants
Paul Johnson - KBW
Good morning. My name is Heidi, and I will be your conference operator today. At this time, I would like to welcome everyone to the Harvest Capital Q4 and Year-End 2018 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session [Operator Instructions]. Thank you.
William Alvarez, you may begin your conference.
Thank you, Heidi. Good morning, everyone. And thank you for participating in this conference call to discuss our financial results for the fourth quarter ended December 31, 2018. I am joined today by our Chairman and Chief Executive Officer, Joseph Jolson and by Richard Buckanavage, our Managing Director and Head of Business Development.
Before we start, I will provide a disclaimer regarding any forward-looking statements that we'll make during this presentation. This presentation contains forward-looking statements, which relate to future events or Harvest Capital Credit's future performance or financial condition. These statements are not guarantees of future performance, condition or results and involve a number of risks and uncertainties. Actual results may differ materially from those in the forward-looking statements as a result of a number of factors, including those described from time-to-time in our filings with the Securities and Exchange Commission. Harvest Capital Credit undertakes no duty to update any forward-looking statements made herein.
And now, I'll turn the call over to Joe.
Thanks, Bill. We reported fourth-quarter net investment income of $0.25 per share despite continued disappointing new investment activity. We believe the situation is temporary and we expect to earn our recently reduced dividend in the second half of 2019, assuming we close on currently mandated deals in our pipeline. Meanwhile, in accordance with the board authorization that expires in June of 2019, we continue to be active in repurchasing our shares at recent stock prices. These repurchases are immediately accretive to our book value per share and our core earnings per share, and is another means for us to deploy our capital and attractive returns on equity for our shareholders.
I'll turn the call over to Bill to give more details on the fourth quarter and then Rich will have some comments about the current investment climate and then I'll sum up. Bill?
Okay, thanks Joe. Net investment income for the quarter was $1.6 million or $0.25 per share compared to $1.9 million or $0.30 per share in the fourth quarter of 2017. For the year ended 2018, net investment income was $6 million or $0.93 per share versus $8.2 million or $1.28 per share for the 2017 year. Net income for the quarter was $1.5 million or $0.24 per share, flat when compared to $1.5 million or $0.23 per share in the fourth quarter of 2017. The $0.01 per share improvement was a direct result from our share repurchase program.
For the year ended December 31, 2018, net income was $5.1 million $0.79 per share compared to net income of $1.6 million or $0.25 per share for the year ended December 31, 2017. Notable in the fourth quarter; our net investment income decreased by $300,000 in 2018 as compared to 2017; as a result of higher expenses of $400,000, principally from recording incentive fee none in the comparable 2017 quarter, offset by recording income tax benefit of $100,000. During the fourth quarter the company recorded net realized and unrealized losses on investments of $43,000 as compared to the quarter ended December 31, 2017 where the company recorded net realized and unrealized losses on investments of $432,000.
We recognize fee amortization income of $305,000 in the three months ended December 31, 2018 as compared to $238,000 in the comparable 2017 quarter. The slightly higher fee amortization in 2018 resulted from the company exiting $18.6 million of investments in the fourth quarter of 2018. Our fees are deferred until they are either earned amortized into income over the life of the investment using the effective yields method or fully recognized when an investment pay-off occurs. In addition, we also recognized $340,000 of fees, which consists primarily of prepayment fees from the previously mentioned fourth quarter investment exits. As a result, our fees will fluctuate quarter-to-quarter depending on portfolio activity.
Net investment income for the full year of 2018 was $6 million as compared to $8.2 million recorted in 2017, a decrease of $2.2 million. The decrease was primarily due to a decrease of investment income of $2.5 million, resulting from lower portfolio, offset by lower expenses of approximately $1 million and recording $8.1 million of tax benefit. Net income for the year ended December 31, 2018 was $5.1 million compared to $1.6 million in 2017. The increase in net income for 2018 of $3.5 million was primarily attributable to $7.6 million positive change in net realized gains, offset by $1.9 million decrease in unrealized depreciation. As of December 31, 2018, the fair value of our portfolio was $94.9 million for the cost basis of $98.9 million, reflecting $4 million of net unrealized depreciation in the portfolio at the end of the year.
As of December 31, 2018, we had a debt balance of $45.8 million, consisting of $17 million of bank debt and $28.8 million in unsecured notes for debt to equity ratio of approximately 58%, relatively flat from approximately 56% at December 31, 2017. At year-end, we had $28.8 million of cash and approximately $7.3 million of undrawn capacity on our $55 million credit facility. Our cash and borrowing capacity provides us with sufficient liquidity in order for us to execute our business plans for 2019. As of year-end, our net asset value was $12.30 per share, down $0.36 per share from December 31, 2017, principally as a result of paying $1.16 in distributions for the year ended December 31, 2018 versus $0.79 of an increase in assets from operations in 2018.
For the quarter ended December 31, 2018, our net investment income was $0.25 per share, slightly below our distributions of $0.285 a share. Of the aggregate distributions declared and paid during the year ended December 31, 2018, the company determine that on a tax basis, those distributions were derived from the following sources; 86% ordinary income and $1 per share and 14% return of capital $0.16 per share, based on distribution of a $1.16 paid through December 31, 2018. These amounts are not being provided for tax reporting purposes and stockholders should rely on 2018 distributions reported on their individual Form 1099 DIB.
On November 1, 2018, the Board of Directors authorized an open market stock repurchase program to repurchase up to 250,000 shares in the aggregate of the company's common stock in the open market. Through March 13, 2019, the company purchased of 158,455 shares, of which 118,991 so far in 2019 and had 91,545 shares remaining to be purchased under its current repurchase plan, which expires on June 30, 2019.
Now, I want to turn the call over to Rich for some further discussion on the investment environment.
Thanks Bill. As Bill outlined in his remarks, we experienced a net portfolio decline during the fourth quarter 2018. Two unanticipated re-payments along with a known repayment, which include one of our largest investment occurred during the quarter. Unfortunately, this heavy repayment schedule came in conjunction with a lower than expected new deployment.
We had hoped to have one or two more transactions close during the fourth quarter, having carried a healthy pipeline into the quarter. For a variety of reasons, many of our new mandates incur delays in closing. And as a result, one closed in the current quarter while others remain active and are likely to close in Q2. While we remain keenly focused on growing our portfolio, we refuse to relax underwriting standards in order to achieve that objective. Given where we are in the credit and economic cycle, we believe our vigilance will be rewarded in the long run.
The current state of the market in which we compete continues to be very competitive. We are more selective than ever and decided that the capital work in junior secured debt investments and placed a greater emphasis on unitranche opportunities. Unfortunately, the current pricing environment for unitranche investments remains most competitive. While spreads have been stable now for the better part of two quarters, we will need to see spread expansion in order to pursue all unitranche financing opportunities that we uncover through our marketing efforts. During the fourth quarter, we again had to pass on a number of creditworthy unitranche financings due to spreads that would result in ROEs that would not be accretive to HCAP's dividend level. It is that dynamic in part that led us to the decision to lower our dividend. Despite the competitive landscape, our pipeline remains solid. The absolute number of opportunities currently is higher than in Q4, quality remains strong. The average investment size right now is lower than average, which means that we have to close a greater number of investments to achieve our desired growth objectives.
Subsequent to 12/31/18 in an effort to optimize our balance sheet, we have acquired two temporary syndicated highly liquid first-lien loans totaling $3 million each to better realize idle cash. We also closed three non-temporary additional investments totaling $15.3 million, two of which were syndicated first lien loans acquired in the secondary market, while the third was a core lower middle-market investment. Our ability to identify suitable investments, whether temporary or more permanent type opportunities in the syndicated loan market, enables Harvest to remain disciplined and patients while we diligence and close on our core lower middle-market investments. As we close future lower middle-market investments, we will rotate out of liquid first lien names and replay those proceeds into our core lower middle-market strategy.
With that, I'll turn the line back over to Joe.
Thanks Rich. As a team, we are intensely focused on improving our net investment income to levels that will meet or exceed our current dividend rate. We have four different levers to pull to achieve this objective. First, as Rich just discussed in his remarks, he and his team are working hard to originate new investments with risk-adjusted yields that will be accretive to our current dividend with a goal of reaching total leverage of roughly 1.2 to 1.3 to 1 by yearend 2020. While recent accelerated payoffs of well performing investments have extended this timeframe by a few quarters, we do remain confident that we'll get there in spite of the currently competitive lending environment.
Second, we have utilized the JMP credit advisors corporate credit team to source opportunities in the broadly syndicated loan market that meet our risk adjusted yield criteria and to temporarily invest some idle cash. As Rich mentioned, we made two lower yielding investments totaling $6 million in this current quarter to reduce the drag on our results from funding cash with long-term debt. These investments will be liquidated to fund core opportunities going forward. We also made two senior secured investments totaling $10 million at current prices that we believe will be accretive to our current dividend level. We are evaluating other opportunities in the broadly syndicated loan market, including second lien loans but have not made any new commitments at this time.
Third, we continue to repurchase our shares in open market transactions at prices that are immediately accretive to our net investment income and book value per share. On average, the recent shares purchased provide better than 9.1% return on investment assuming the current dividend level and on an unlevered basis. We are limited by the corporate buyback the rules to a percentage of daily volume and other timing restrictions. But nevertheless, over the past three months, we have repurchased roughly 2.3% of our shares outstanding. Lastly, we continue to be focused on converting our non-earning assets of roughly $11 million into productive investments. By far, the most significant of these is Infinite Care, which has shown good progress in last few quarters and we are optimistic that the improving trend could continue in 2019. At year-end, our risk rating actually improved to 2.24 compared to 2.35 in the previous quarter, despite the payoffs of well performing loans that shrunk the denominator in the calculation. We are all working hard to generate asset growth and to improve our existing 3, 4 and 5 rated credits, all of which would benefit the statistic and our net investment income.
In summing-up, I want to thank our team members and independent directors for their continued efforts and our shareholders for their patience as we work hard to achieve a favorable result.
Heidi with that please open the line for any questions.
[Operator Instructions] And we have a question in the queue from the line of Paul Johnson with KBW. Please go ahead.
Q - Paul Johnson
I just wanted to ask a few things. Not long ago, Rich stepped down to focus more on our origination. And over the last couple of quarters, we've seen a lot of repayments. I was just wondering in your view how has the transition worked so far. And then also, maybe just outline some of the headwinds that you guys have had disappointments originating over the past year or so?
Well, why don’t I have Rich comment on that and then I'll have some comments as well.
Yes, I guess I'll take the second part of that. And say that we are seeing -- we have seen and continue to see more opportunities than ever. And I think this is being driven by the exit of several BDCs that previously had participated in the lower middle market here, they've decided to go up market or have acquired by other entities and have just pursued other strategies. I think that’s certainly benefiting us. I think the lack of new capital formation in the SBIC front has also benefited us. I think the green-light letters are down something like 65% year-over-year. So we're seeing a lot of opportunities. The reality is that this is a late cycle. We're in the nice inning of the cycle. And we are being very judicious about where we want to invest. But I will also say that there's just honestly some bad luck. We have had a couple of investments that have fallen out of bed between the decision from the seller that has reversed course midstream not to sell their company but again temporary in nature. We are very optimistic about the current pipeline that we have. As Joe mentioned, we have several mandates in the pipeline that we expect to close, not probably this quarter but certainly early in the second quarter. So we are very, very optimistic about the near-term.
And then the second half of the year, obviously, with the newly granted leverage that occurs in May for us, we think it opens up a whole another universe of deals that did not make sense for us under the old 1: 1 leverage limitation that now become attractive to us. So we are actually very optimistic on the deployment front. Again, several factors I think have led to somewhat lackluster deployment track record. But also keep in mind that our investment professionals are not only originating transactions were also portfolio managers. And a big emphasis for our team over the last couple of quarters has been focused on 3, 4s and 5 rated credit. And obviously, we have made tremendous improvement there as Joe alluded to. One of our largest and our five rate credit, I think we have spent a tremendous amount of time. We've got some very good tailwind there. The management team there is doing a great job and we are very optimistic about the credit quality of this portfolio. So it's not just about deployment. I think you have to look at the success of our investment staff and really looking at two areas; one is deployment and one is portfolio management. And quite frankly, portfolio management especially in 3, 4s and 5s rated credits they take up a lot of time.
Paul, the other thing I would just add to that is that that change in responsibilities was also related to having the three of us, Rich, myself and Jim Fowler, who joined the team, be able to focus on things that we could do best and free up Rich to spend more time on his efforts. So, I think that that part of it seems to be working very well. We had that one thing six, or nine, 12 months ago, almost now in our last year's 10-K about efficiency that was remediated in September. We went through the Sarbox transition in good shape and filed our K on time and everything that was the division of labor. So, I think that that’s working very well. And I think that that leaves scalability overtime, Rich, mentioned the still competitiveness for unitranche deals. And I think that I would add to that a financial sponsor deals, in general.
We have a lot of relationships with middle market and lower middle market financial sponsors when we do a deal with those type of folks by the time we get involved and it it's pretty much buttoned down. There has been 90 plus percent of due diligence done. There's a package for us to evaluate that's pretty thorough and likelihood that that's going to close if we want to be involved and they mandate us within a couple of months. We can't get the yields in that but we haven't been able to get adequate yields through that channel for years now. So we've had to migrate more into independent sponsors and smaller funds. And these people have less resources and often times they lock up companies and then they start their due diligence and bring us in similar time, because they don't have the fund flow. So, we do get better returns, but it's a lot more work. And there is a higher risk that it won't close as we've seen. I don’t know if you have any comments on that, Rich, too add.
No, absolutely. I think, the independence sponsor channel, which we continue to be very active in. The reality is that if there is, it's just lower than you find in real traditional private equity environment. And we know we understand that. We try and manage our resources to participate in both sectors. But clearly, there is some dry well expenses associated with direct deals and independent sponsor deals versus more traditional private equity backed opportunities.
And my last question would be on your investment in Peerless Media during this quarter. I'm just curious since this was an investment with you JMP affiliate funds. Was this something -- I believe you may have said this. Is this something that was sourced on the JMP platform that Harvest participated in? Or is this something that was source at the Harvest platform that JMP co-invested alongside you on? And also could we expect more of this in the future?
This was sourced by the Harvest team. And we have been working on joint investments overtime, there's been a couple of others, this wasn't the first. And there are typically in the pipeline, there might be two, or three, or four things that we look at jointly. And often times, it's because of the deal size is a little bit bigger than harvest current hold to meet the diversity test under the RIC rules.
[Operator Instructions] And there are no further questions in the queue.
Well, speaking for Rich and Bill. I want to thank everyone for their interest in HCAP. And we look forward to updating you guys on our progress in a couple of months when we release Q1. Thank you.
And this concludes today's conference call. You may now disconnect.