BlackRock Capital Investment Corporation (NASDAQ:BKCC) Q4 2019 Earnings Conference Call March 5, 2020 10:00 AM ET
James Keenan - Chairman and Interim-CEO
Michael Pungello - Interim-CFO and Treasurer
Laurence Paredes - General Counsel and Corporate Secretary
Marshall Merriman - Head of Portfolio Management, BlackRock's U.S. Private Capital Group
Jason Mehring - Chairman, U.S. Private Capital Group's Investment Committee
Nik Singhal - Head of IR and Business Strategy
Conference Call Participants
Fin O'Shea - Wells Fargo Securities
Rick Shane - JPMorgan
Good morning. My name is Kathy and I will be your conference facilitator today for the BlackRock Capital Investment Corporation Fourth Quarter 2019 Earnings Call.
Hosting the call will be Chairman and Interim Chief Executive Officer James Keenan; Interim Chief Financial Officer and Treasurer Michael Pungello; General Counsel and Corporate Secretary of the Company; Laurence Dean Paredes; Marshall Merriman, Head of Portfolio Management for BlackRock's U.S. Private Capital Group; Jason Mehring, Chairman of the U.S. Private Capital Group's Investment Committee; and Nik Singhal, Head of Investor Relations and Business Strategy. [Operator Instructions]
Thank you. Mr. Paredes you may begin your conference call.
Good morning and welcome to BlackRock Capital Investment Corporation's fourth quarter 2019 earnings conference call. Before we begin our remarks today, I would like to point out that certain comments made during the 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 lists 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've posted to our website an investor presentation that complements to this call.
Shortly Jim will highlight some of the information contained in the presentation. The presentation can be accessed by going to our website at www.blackrockbkcc.com and clicking the March 2020 Investor Presentation link in the Presentations section of the Investors page.
I would now like to turn the call over to Jim.
Thank you, Larry. Good morning and thank you for joining our fourth quarter earnings call. I will start with an overview of the meaningful progress we have made on our core strategy and give an overview of the performance during the fourth quarter. I will then turn it over to Mike Pungello our Interim CFO to discuss the financial results in more detail before providing some closing remarks and opening the call to questions.
To reiterate, our goal continues to be to optimize our NII and reshape the portfolio to provide a stable stream of income with little volatility. Our strategy involves exiting non-core position, redeploying into core income producing senior secured investments and increase our target leverage to create a diversified stable portfolio. We achieve significant progress on these strategic objectives in 2019. Our net leverage ratio increase from 0.36 times to 0.7 times, bringing it closer to our desired leverage levels.
During the year, we had gross deployments of $304 million, including first or second lien loans to 25 new portfolio companies. At the same time, portfolio composition improved meaningfully with increased diversity and increased income producing secured investments. A number of portfolio companies increased from 27 to 47. First lien investments increased from 24% to 34% by fair market value and secured investments increased from 47% to 57%. We accomplished this as a non-core exposure decline to 16% of fair market value compared to 33% at the beginning of 2019.
As we announced last quarter, the Company's Board of Directors approved a reduction of the Company's minimum asset coverage requirement from 200% to 150%. After careful consideration of the progress made in achieving our strategic goals of exiting non-core assets and improving portfolio mix. With the support of the Board, we intend to also seek shareholder approval for the same at the Annual Meeting of stockholders to be held on May 1, 2020.
Additional information will be provided in our proxy statements, which we expect to file shortly.
If shareholder approval is obtained, then the reduced asset coverage shall become effective today after such approval. We believe that the added leverage flexibility will allow the company to continue to pursue its goal of improving return-on-equity, while creating a more diversified portfolio of security income producing investment.
As we achieve further progress with non-core exit, we will endeavor to prudently increase leverage from current levels with a steady state leverage target of 0.95 time to 1.25 times. With the added flexibility, we will continue to increase diversity in the portfolio with a target portfolio account of 65 to 75 names and increasing the percentage of first lien investments in our book to greater than 50%. Although other factors may impact the portfolio composition at any given time.
At the time, that the reduced asset coverage becomes effective, we intend to lower the base management fee rate for the company from 1.75% to 1.5% with an additional reduction to 1% on assets that exceed 200% of NAV.
Additionally, at the same time, we intend to reduce the rates for incentive fees based on income and capital gains from 20% to 17.5%. The Company has benefited from the significant investments made by the advisor across our platform and sourcing channel, including the integration of Tennenbaum Capital Partners, along with other resources within BlackRock. The advisor now has over 50 investment professionals dedicated to our U.S. middle-market direct lending strategy. It is our intention to continue to invest in additional sourcing and underwriting capability. Additionally, our ability to co-invest with certain affiliates under our co-investment order is enabling the company to construct a more diversified portfolio with reduced idiosyncratic risk. And, we expect this trend to continue.
We remained confident in the continuation of our strategy or creating shareholder value through a more stable income oriented book. We believe that this strategy will result in improved return-on-equity and bring the earnings power of the company in line with the sector, while driving enhanced shareholder returns.
Turning to the fourth quarter results, the net investment income for the quarter was $0.14 per share. We deployed $73 million during the quarter which was offset by repayments and other exit totaling $38 million for an approximately $35 million net increase in the portfolio due to investment activity. During this quarter, we added a total of five new names to the portfolio, which are detailed along with repayments in our earnings press release.
With a net deployment activity this quarter, the portfolio now has a fair market value of $750 million across 47 companies. The weighted average yield of income-producing securities at fair market value was 10.9% as of December 31, down 5 basis points since last quarter. Quarter end leverage was 0.7 times increased from 0.61 times from the prior quarter. We have ample liquidity of $187 million to support new investment activity. And we have no debt maturing until 2022.
Net asset value decreased 2.5% from $6.49 per share last quarter to $6.33 per share, as of December 31 driven by net unrealized and realized losses of $11 million. These markdowns were largely related to non-core legacy investments in the portfolio, including a $9 million related to the company's legacy investment in AGY Holdings Corp. AGY’s markdown was in part driven by reduced profitability due to a significant and atypical spike in one of the metals used in their production process.
I’ll now discuss our progress on rotating out of the legacy non-core portfolio, which as of December 31, reduced to 16% of the portfolio by fair market value, down from 18% last quarter. This part of the book is comprised of, first performing debt and income-producing securities at 13% by fair value. With AGY first lien, Sur La Table and Red Apple stores being the 3 largest holdings.
Second, non-earning equities at approximately 1% by fair value primarily consisting of U.S. Well equity. And third, investments on non-accrual at 2% by fair value, including AGY 2 lien and preferred stock Advantage Insurance preferred stock and Advanced Lightning 2 lien.
During the fourth quarter $1.6 million of proceeds were realized from the partial redemption of the Advantage Insurance preferred stock. Since BlackRock began managing the company in March of 2015, our team has deployed approximately $1.3 billion into new investments, $421 million of which has been exited with a realized IRR of 14.1%. As of December 31, over 84% of the company's investment portfolio by fair market value constitutes investments made by BlackRock.
Before I turn the call over to Mike Pungello, I'd like to emphasize the company's continued transformation and progress towards the strategic objectives. As evidenced by the strong deployments in 2019, increased diversity in the portfolio and improved portfolio composition, each of which is a trend that we expect to continue.
Over to you, Mike.
Thank you, Jimmy. I will take a few minutes to review additional financial and portfolio information for the fourth quarter 2019. GAAP net investment income NII was $9.6 million or $0.14 per share for the three months ended December 31, 2019. Relative to distributions declared a $0.14 per share, our NII distribution coverage was 100% for the quarter. Total investment income decreased $1.5 million or 7.4% as compared to the fourth quarter a year ago.
Excluding fee income and other income total investment income decreased by approximately 5.9%, primarily attributable to a decrease in dividend income from BCIC Senior Loan Partners and a decreased in interest income from AGY second lien notes as a result of this non-accruals debt.
At quarter-end, there were 4 non-accrual investments representing 2.4% and 6.9% of total debt and preferred stock investments at fair value and cost respectively. This compares to non-accrual investments of approximately 1.6% and 7.1% of total debt and preferred stock investments at fair value and cost respectively at December 31, 2018.
Our average internal investment rating at fair market value at December 301, 2019 was 1.39 as compared to 1.38 as of the prior quarter end.
Total expenses increased $0.6 million or 7 % for the three months ended December 31, 2019 from the comparable period in 2018, primarily due to increases in net incentive fees based on income and interest and credit facility fee.
During the quarter, there was no accrual for incentive management fees based on gain. In the fourth quarter, we voluntarily and partially waived incentive fees of $1.1 million bringing our cumulative incentive fees waived since March 2017 to $23.4 million. In the fourth quarter, net realized and unrealized losses were $11.2 million, primarily due to depreciation and non-core legacy investments in portfolio valuation during the quarter.
During the fourth quarter of 2019, no shares were repurchased. As of December 31, 2019, 5 million shares are made available for repurchase under the current program. We closed the quarter with a strong liquidity positions to fund a robust pipeline of new investment opportunities, including approximately $187 million of availability under our credit facility and in cash and cash equivalents.
With that, I’d like to turn the call back to Jimmy.
Thank you, Mike. Before we conclude, I'd like to comment on the uncertainties in the economy created by the impact of the COVID-19 or Corona virus, as well as this potential impact on our portfolio. A wide range of outcomes are possible regarding the speed of the virus contagion, as well as its harmfulness. Irrespective, we believe that near-term disruptions are likely in several industries with first order impacts, such as those where the supply chain or manufacturing is impacted, and those where demand will likely suffer such as travel, leisure, live events or conferences. We believe that our portfolio is relatively less exposure to businesses with first order impact, but potentially only one portfolio company in the transportation and logistics sector reporting tangible decline in business activity reportedly due to COVID-19. We are monitoring each of our investments closely and expect that the impact will become clearer to businesses over the course of the next several weeks. As more data becomes available regarding the virus, as well as its impact.
We get comfort in, one, the underlying diversity of our portfolio, and two, the fact that the majority of the portfolio investments are secured. The underlying portfolios of the largest unsecured and equity exposes, such as BCIC Senior Loan Partners, and Gordon Brothers Finance
Company are also diversified secured debt position.
In closing, I’d like to take a moment to thank our shareholders for their continued support as we make progress on the company strategy and recognize our team for their continued hard work towards achieving our portfolio objectives.
This concludes our prepared remarks.
Operator, we would like to open the call for questions.
Thank you. [Operator Instructions]. And we'll go first to Rick Shane of JPMorgan.
Hey, guys. Thanks for taking my questions this morning. Really, two things. The strategy and portfolio location in part is the way you guys described it is to reduce idiosyncratic risk, in constantly that suggests that you are shifting server from an alpha strategy to a beta strategy. Is that a good way to characterize it? And does that make sense sort of more than indexed approach of given the fee structure?
Thanks, Rick, it's Jim, I wouldn't describe it as they trying to move towards the beta strategy. I think, when we looked at the legacy portfolio or the historical file, it had taken far more concentrated positions into more equity oriented or distressed risk in a portfolio that was trying to produce a more stable or income stream. So, we've seen that in the experience with regards to the legacy book and the volatility that has marks with the volatility may have on the NII stream and the potential risk of impairments associated to that.
When you look at our team and our structure, what we are trying to rotate into, I would say our conversion rate of the deal flow that we see is probably around between 5% and 7% at any one period of time. And there’s a significant amount of work that gets done. So, I wouldn't look at any one of the positions as being beta-oriented. There's a fair amount of diligence and structuring and protections that are built-in. That being said, relative to reducing some of the vulnerability that exists in the kind of the broad markets and the economy over a period of time relative to these liquidity investments, we will try and get more diversification associated to that, right, and remember that we are co-investing a long side a variety of different strategies within the advisor.
So, we are taking significant positions within any one of these assets, but we are translating that from a portfolio construction to having a more diversified heavy selection, but a more diversified portfolio to reduce any kind of outside risk that we've seen happen to anyone that we've experienced in some of the legacy books. And I think that will lead to a more consistent NII and dividend stream in the future.
Yes, and presumably the other aspect of that, and I think the challenge has been – been fair about waiving fees in order to support the dividend out of NII. And I think there is a challenge has been is on demand side and presumably, the other part of this strategy is to reduce that downward pressure that we've seen on that over time.
Absolutely, yes, we have waved just north of $23 million in fees over the last several years. And intent there is to continue to work through that transition of that legacy book. And, yes, if you look at all the new investments that we have made since March of 2015, they've been far more stable, a lot less risk of impairment. And the impairment of the NAV volatility as well as the NAV destruction has come from legacy assets that were bought by the prior advisor. So, I don't -- our goal is to reduce that experience and then we got experience on a go forward basis.
Got it. So that’s my one question and follow up. Thank you, guys.
And now, we will go to Fin O'Shea of Wells Fargo Securities.
Hi, good morning. Thanks for taking my question. Can you guys give us some background on the added investment in Gordon Brothers this quarter?
Hey, it's Jason. As it relates to our incremental investment in Gordon Brothers, as they continue to make incremental investments in their own diversified portfolio. We fund incremental capital to support [set] investments. So, I think, what you would -- you'd see from quarter-to-quarter is you may see some fluctuation as that portfolio either increases in size or decreases in size.
Just to add on. Yes, the nature of that portfolio inside of Gordon Brothers is a more shorter duration, secured portfolio. So, we tend to have and you'll see this quarter-by-quarter a frequency of both deployments and repayments into that vehicle, because the duration of those assets are shorter tenure than what we see in our profit earning book.
Right. And, did that come with any contribution from third-party investors or you just….?
We have a partnership with the other shareholder in that business whereby when we make incremental investments to support their growth, it's made alongside that investor. But, we have not added new investors to the mix.
Okay, thank you. And on the -- Jim, you mentioned one of your distribution related company post quarter has felt a direct impact from slowdown and that sort of activity. Can you give us any guidance as to what might be the unrealized impact in real-time today?
Thanks, then obviously, I think we along with everyone are trying to assess the true and potential impact of the Corona virus as it rolls into the United States and more globally. And, we -- I would say the range of outcomes is pretty broad-based of the potential spread and the impact that received, but even more so, from an economic standpoint. It is the level that which the response to that or the means of which governments, corporates, and local municipalities are trying to go into prevention mode from the overall spread.
So, obviously as we're trying to assess all of our companies, we try to highlight some of the areas where I think we have generally minimal exposure at the overall portfolio level. But, things that are I think it is more congregation of human beings, to the airlines and the lodging spaces, or in convention centers are all more at risk.
There's going to be some volatility associated to supply chains, which I think will be more temporal. And everything will be an area where there'll be some dispersion between industry. So, what we are looking at right now, some of our portfolio complex will actually see some benefits based off of probably a pull forward in demand.
And then, there are other areas that we think are a little bit more vulnerable. And I wouldn't say, we've necessarily seen that all come to fruition yet, but we do think that over the next couple of quarters, as we start to assess the data around that prevention, there could be some volatility around some of the earnings of certain industries that we have. It's tough to call the magnitude now at this point, though.
Okay. Thank you. And just one final question, [you did] buyback program, can you give us some color on how you are viewing that lever today and context of where you are and legacy rotation leverage valuation and so forth?
Yes, Hi Fin. It’s Nik. So our share repurchases are conducted under a [indiscernible] plan, with the established terms which are said by the Board. So, last quarter the plan was in effect however, the repurchases are not figured based on the terms of the plan. That's the plan we reevaluate every quarter and the board does. And the goal of our plan is really in Q4 one is to provide stability in the stock price in event of market dislocation and also to buy back stock and attractive yield. So, that continues to be a part of our strategy. We are -- the other key components of our strategy are one, reducing non-core assets, which over the last three quarters, we've made significant progress and in exiting [more tellers] and de-risking Sur La Table in reducing our exposure, for Advantage Insurance, etc. And also redeploying and increasing leverage more at current target levels and really diversify senior secure income producing investments.
Fin, this is Jim. At a high level and to the specifics, obviously we are seeing the pace of deployment start to pick up as we've been reducing that legacy book. And it's now done around [16%] concentrated in those three positions and the junior parts of those positions tend to be the ones that have the most volatility on a quarter-to-quarter basis from a valuation standpoint. So, with that, is our current leverage is now operating seven times and that's kind of our comfort level at this point, as we continue to reduce and focus that reduction of that legacy book, obviously, I think we'll take that that leverage up. And we expect, as mentioned earlier to go to the -- for the two to one leverage vote in May of this year. And, those who -- I would say the deployments would be very similar with regards to the style over the last several quarters, and we will increase that leverage as we reduce that legacy volatility.
Okay, thanks so much. That's all from me.
And with that, let us conclude today's question and answer session. I'd like to turn the conference back to our presenters for closing comments.
Great, and thank you, everyone for the continued support as we continue to transition this portfolio. We look forward to the continued progress that we see here. And hopefully everyone stays healthy. And speak to you next quarter. Thank you.
And with that, ladies and gentlemen, that does conclude today's call. We'd like to thank you again for your participation. You may now disconnect.