BlackRock TCP Capital Corp. (NASDAQ:TCPC) Q3 2021 Earnings Conference Call November 3, 2021 1:00 PM ET
Katie McGlynn - Director IR
Raj Vig - Chairman & CEO
Phil Tseng - COO
Erik Cuellar - CFO
Conference Call Participants
Kevin Fultz - JMP Securities
Ryan Lynch - KBW
Robert Dodd - Raymond James
Christopher Nolan - Ladenburg Thalmann
Ladies and gentlemen, good afternoon. Welcome everyone to the BlackRock TCP Capital Corporation's Third Quarter 2021 Earnings Conference Call. Today's conference call is being recorded for replay purposes. During the presentation, all participants will be in a listen-only mode. A question-and-answer session will follow the Company's formal remarks. [Operator instructions].
And now, I would like to turn the call over to Katie McGlynn, Director of the BlackRock TCP Capital Corporation’s Investor Relations team. Katie, please proceed.
Thank you, Jason. Before we begin, I'll note that this conference call may contain forward-looking statements based on the estimates and assumptions of management at the time of such statements and are not guarantees of future performance.
Forward-looking statements involve risks and uncertainties and actual results could differ materially from those projected. Any forward-looking statements made on this call are made as of today, and are subject to change without notice. Earlier today, we issued our earnings release for the third quarter ended September 30, 2021. We also posted a supplemental earnings presentation to our website at tcpcapital.com. To view the slide presentation, which we will refer to on today's call, please click on the Investor Relations link and select Events and Presentations. These documents should be reviewed in conjunction with the Company's Form 10-Q which was filed with the SEC earlier today.
I will now turn the call over to our Chairman and CEO, Raj Vig.
Thank you, Katie. And thank you all for joining us today for TCP's third quarter earnings calls. Before we begin, I wanted to take a moment to thank our team for all of their hard work and dedication through this challenging period. As many of you know, I have served as TCPC's President and COO since our IPO almost 10 years ago. And I have been a senior member of the investment team for over 15 years. It has been very rewarding to be a part of a group that has consistently delivered for our investors, and I look forward to serving as TCPC's Chairman and CEO going forward. Also, I'm excited to formally welcome my longtime partner, Phil Tseng as President and COO and reiterate my congratulations to our CFO, Erik Cuellar for his new role.
As part of my commentary, I will be continuing our quarterly tradition and begin with a few comments on the market environment, as well as highlights from our third quarter. I will then turn the call over to Phil, who will provide an update on our portfolio and investment activity. Erik will then review our financial results and our capital and liquidity positioning in greater detail. After our prepared remarks, we will all be available to take your questions.
Now, turning to the current market environment. Overall activity levels in the middle market remained very robust, direct lending and broader private capital markets have clearly emerged from the global pandemic as a reliable and well-positioned source of financing for a broad spectrum of businesses. As has typically been the case at times, other avenues of financing have been less accessible, but appears now to be an even more systemic shift as a wider array of companies are looking to private credit as a primary source of capital. We continue to work with a broad range of businesses as they seek to finance growth, make acquisitions or simply refinance existing debt. We also believe that our investors benefit from these efforts as our direct lending investments continue to deliver a reliable and resilient source of income.
I'd now like to review our third quarter earnings and discuss some highlights from the quarter. In summary, TCPC delivered another solid quarter of results. First, net investment income in the quarter was $18.7 million or $0.32 per share, which again exceeded our dividend of $0.30 per share. Second, portfolio credit quality remained strong, while we added one additional portfolio company to our non-accruals during the quarter, non-accruals remain low at just 1% of the portfolio at fair value. Third, and as Phil will discuss in more detail, investment activity continues to be robust. We deployed more than $150 million in capital during the quarter and continue to identify attractive opportunities across our target sectors. Direct lending remains a relationship business, and we continue to benefit from the more than two decades of developing and cultivating strong relationships. We also continue to benefit from the extensive resources with the broader BlackRock’s platform.
In the third quarter, we also experienced an elevated level of refinancing activity with approximately $227 million of repayments, resulting in prepayment and exits that outpaced deployment and slightly reduced our total portfolio size quarter-over-quarter.
Fourth, we continue to manage our balance sheet and liability profile. In August we issued $150 million add-on to our existing February 2026 notes at a yield to maturity of 2.475%, bringing the total issuance to $325 million. In conjunction with this financing, we redeemed $175 million of outstanding notes that were due next August which had a much higher coupon of 4.125%. We will continue to seek ways to diversify and enhance our strong balance sheet and liquidity positioning given overall market conditions.
And finally, we have maintained NAV stability. Although our NAV declined 80 basis points during the quarter, this is primarily a result of a $6.2 million loss associated with prepayment charges on the early redemption of the August 2022 notes. Excluding the impact of this charge, NAV was essentially flat quarter-over-quarter and year-over-year is i[ approximately 11%.
It's also worth noting that we continue to exceed our total return hurdle. As a reminder, TCPC maintains a 7% hurdle rate with a cumulative look back based on a -- based on total returns, including realized and unrealized gains and losses. Since 2012, we have generated a 10.7% annualized return on invested assets, and a total annualized cash return of 9.7%, consistently outperforming the Wells Fargo BDC index, and in the last 12 months alone, TCPC has delivered a 19% ROA.
Outside of performance and financial results and as an indication of our commitment to strong corporate governance, TCPC's Board of Directors recently elected Eric Draut to serve in the newly created role of Lead Independent Director effective October 28th. Eric’s outstanding commitment to serving TCPC shareholders throughout his more than 10 years of service on the Board has been invaluable and we look forward to his continued contributions as Lead Independent Director. In conjunction with this appointment, the Board also appointed existing Board members Peter Schwab as Chair of the Governance and Compensation Committee and Freddie Reiss as Chair of the Audit Committee.
Now, I will turn it over to Phil to discuss our investment activity and portfolio positioning.
Thanks, Raj. As a member of the TCP announced BlackRock U.S. private capital team for more than 16 years, I've had the benefit of getting to know many of you and look forward to getting to work with you more closely. As Raj noted earlier, we're capitalizing on the scale of our platform and breadth of our team's experience to capture an increasing share of this expanding market.
At quarter end our portfolio at a fair market value of approximately $1.8 billion, 90% of our investments are senior secured debt and are spread across a wide range of industries, providing portfolio diversity and minimizing concentration risk. Our portfolio is also weighted towards companies established business models in less cyclical industries. The portfolio at quarter end was made up of investments in 106 companies. As the chart on the left side of Slide 6 of the presentation illustrates, our recurring income is distributed broadly across our portfolio and is not reliant on income from any one company. In fact, over half of our portfolio companies each contribute less than 1% to our recurring income.
Additionally, 86% of our debt investments are first lien providing substantial downside protection. And 94% of our debt investments are floating rate, positioning us well for when rates eventually rise.
Now moving on to our investment activity, in our view, many of the competitive market dynamics that existed prior to the pandemic have resurfaced. However, we remain one of the small group of reputable lenders that are able to provide complete and customized financing solutions. As such, we act as a lead or co-lead lender in the majority of our transactions. Also note, while the environment is competitive, our team continues to find attractive opportunities to invest in higher spreads than the average market transaction. We continue to source a wide range of investment opportunities. And while we have been actively deploying capital in this market, we maintain a very disciplined approach to investing. We regularly review a substantial number of opportunities but we end up investing in only a small percentage of them.
Investment activity in the third quarter was robust for both new deployments and repayments. We invested $157 million primarily in 16 investments, including loans to 7 new portfolio companies, and 9 existing companies. Follow on investments in existing holdings continue to be an important source of opportunity for us, accounting for more than 40% of our total investments over the last 12 months alone.
Incumbency clearly has become a differentiator. And from a risk management perspective, these are companies we already know and we understand it very well and therefore we're comfortable making these follow on investments. As we analyze new investment opportunities, we continue to emphasize seniority in the capital structure, portfolio diversity, and transactions where we can act as lead or co-lead. Our largest new investment during the third quarter was a first lien loan to James Perse, a founder owned luxury fashion apparel brand with a strong long-term operating history and a growing e-commerce presence. BlackRock acted as a sole lender and our loan was structured with a low leverage profile and strong collateral protection. Our second largest investment in the quarter was a first lien term loan to Infobip. Infobip offers a mobile-first omni-channel customer engagement platform that leverages direct connections to a global network of over 650 telecom operators. The company has a diversified customer base with strong blue-chip representation. And the investment represents a new loan -- sorry, a low loan to value with structured downside protection and the proceeds will support the company's growth initiatives.
New investments in the third quarter were offset by dispositions and repayments totaling $227 million. These included the partial sale of our equity investment in Edmentum and the payoffs of our loans to Sphera, Paula’s Choice, GlobalTranz, as well as Apex. Our investment in Sphera is a great example of how our team leverages our industry expertise to identify opportunities in situations that may not be widely understood. Sphera Software helps energy companies ensure that they're compliant with environmental regulations. Despite serving some of the largest global energy companies, we did not believe Sphera's business is directly impacted by energy price volatility, which was a perceived market concern actually at the time of our investment in 2016. As a result of our team’s software expertise, we identified this unique opportunity to invest in a strong company that performed well throughout our 5-year investment period, and will just ultimately acquired at an attractive valuation in September of this year.
The overall effective yield on our portfolio was 9.4% as of September 30th. Investments in new portfolio companies during the quarter had a weighted-average effective yield of 8.5%, in line with the 8.6% weighted-average yield on exited positions. Since December 31, 2018 LIBOR has declined by 268 basis points or by 95%, which has pressured our overall portfolio yield. However, 94% of our loans are floating rate, with approximately 90% of them operating with LIBOR floors. Therefore, we believe that we are well-positioned to benefit when rates eventually rise.
So, we continue to invest selectively as I noted, by maintaining our discipline and focusing on companies with established business models that are well-positioned in the current economic environment.
Our investment activity in the fourth quarter to date totals approximately $32 million, primarily in two senior secured loans with a combined effective yield of approximately 10%. While it is still early in the quarter, we remain encouraged by the opportunities in our pipeline and continue to source from a broad range of industry sectors. The yields on investments in our pipeline are generally in line with our current portfolio. And to-date, we have had limited prepayment income in the fourth quarter.
I'll now turn it over to Erik to walk through our financial results as well as our capital and liquidity positioning.
Thanks, Phil. Turning to our financial results for the third quarter. We generated net investment income of $0.32 per share, which exceeded our dividend of $0.30 per share. We continue to be committed to paying a sustainable dividend that is fully covered by net investment income, as we have done every quarter since our IPO in 2012. Today, we declared a third quarter dividend of $0.30 per share. Investment income for the third quarter was $0.74 per share. This included recurring cash interest of $0.60, recurring discount and fee amortization of $0.03 and PIK income of $0.02. Notably, our PIK income continues to be at the lowest level in more than three years.
As a reminder, our recognition follows our conservative policy of generally amortizing upfront economics over the life of an investment, rather than recognizing all of it at the time the investment is made. Investment income included $0.03 of dividend income and $0.06 from accelerated OID and exit fees. Dividend income in the third quarter included $1.2 million or $0.02 per share of dividend income from our equity investment in Edmentum, including $600,000 from the portion of our investment that was sold during the quarter.
Operating expenses for the third quarter were $0.33 per share and included interest and other debt expenses of $0.18 per share. Incentive fees in the quarter, which included $600,000 of previously deferred fees, totaled $4.7 million or $0.08 per share. As we have previously noted, we voluntarily deferred incentive fees related to our income from 2020 over a period of six quarters, amounting to $0.01 per share per quarter, with the final catch up amounts having been recognized this quarter. Our net increase in net assets for the quarter was $10.9 million, or $0.19 per share, which included in net realized gains of $7.9 million or $0.14 per share, unrealized losses of $9.5 million or $0.16 per share, and a $6.2 million realized loss associated with the early redemption of the August 2022 notes.
Unrealized losses during the third quarter primarily reflected a $6.8 million reversal of previously unrealized gains in Edmentum and a $3.7 million unrealized loss on our investment in Hylan, partially offset by a $5.1 million unrealized gain on our investment in Razor Group. Realized gains of $7.9 million were primarily due to the partial sale of our equity investment in Edmentum.
Substantially all of our investments are valued every quarter, using prices provided by independent third-party sources. These include quotation services and independent valuation services. And our process is also subject to rigorous oversight, including back-testing of every disposition against our valuations. We placed two of our loans to Hylan on non-accrual during the third quarter. Hylan is an engineering and construction company that provides electrical, telecom and utility services in New York City.
Hylan operates in a strong sector, but has faced operational challenges and our team is working closely with the sponsor to navigate these challenges. As Raj noted earlier, our overall credit quality remains strong with non-accrual loans limited to 30 portfolio companies that represent just 1% of the portfolio in fair value, and 1.8% at cost at September 30th.
Turning to our liquidity position, we ended the quarter with total liquidity of $396 million relative to our total investments of $1.8 billion. This included available leverage of $379 million and cash of $37 million, net of trades pending settlements of $20 million. Unfunded loan amendments to portfolio companies at quarter end equaled 3.8% of total investments, or approximately $67 million, of which $32 million were revolver commitments.
We continue to opportunistically take advantage of the favorable bond market environment to refinance higher cost debt. In August, we successfully issued an additional $150 million of our notes due February 2026 at a yield to maturity of 2.475% bringing the total issuance of the 2026 notes to $325 million. Additionally, we regained $175 million of outstanding 4.125% notes due August 2022 as we continue to reduce our overall cost of capital.
Our diverse and flexible leverage program now includes two low cost credit facilities, a convertible note issuance, two unsecured note issuances and an SBA program. Our unsecured debt continues to be investment grade rated by both Moody's and Fitch. Additionally, given the modest size of each of our debt issuances, we are not overly reliant on any single source of financing. And our maturities are well laddered. Our nearest maturity is March of 2022. And given the success of our latest bond issuance, we are very well positioned to redeem or refinance those notes. Combined, the weighted average interest rate on our outstanding liabilities decreased to 3.22% from 3.54% at the beginning of the year.
Now, I'll turn the call back over to Raj.
Thanks, Erik. I'll conclude now with a few comments on the market environment. We are pleased with our strong third quarter results and remain confident in our team's ability to deliver strong risk adjusted returns for our shareholders. We also remain cautiously optimistic on the investment environment. On the one hand, transaction volumes remain at historically high levels and revenue and EBITDA growth trends are strong across the middle market. However, we remain cognizant of the broader market risks and are closely monitoring inflation trends, supply chain disruptions, and energy market volatility as we analyze our pipeline of investment opportunities.
In this environment, we are leveraging our team's competitive advantages, including over two decades of experience lending to middle market companies. Our industry specialization makes us a unique and valuable partner to our borrowers and deal sponsors, as well as our special situations experienced to structure loans that are downside protected. These advantages enable TCPC to deliver a 19% ROE over the last 12 months to a 16.4% ROE since the start of the pandemic in March of last year. Additionally, excluding the impact of the early redemption of the August 2022 notes, our NAV is up 7.5% since the start of 2020.
And with that operator, please let's open the call for questions.
[Operator Instructions]. Our first question comes from Devin Ryan from JMP Securities.
This is Kevin on for Devin. Touching on the quarter-to-date investment activity, can you give us a sense how originations are tracking so far, as well as your expectation for portfolio growth in the fourth quarter?
Yes, maybe I'll turn it over to Phil to just touch on just originations activity in the process, and then I'll touch on expectations for the portfolio and growth.
Yes, thanks for the questions. So our originations activity continues to be quite robust. And the pipeline, as we've seen in past quarters, continues to be -- show substantial growth year-over-year. And we're tracking that very closely. We think we've made great progress and in a number of industries in terms of our mindshare with private equity sponsors, with advisors, with other lenders and management team. So, our origination pipeline continues to be robust, and we think it bodes well for our Q4 deployment.
Yes. And just in terms of overall growth, Kevin, I think, we said numerous times in the past, we really are credit-focused on making the right decision and being disciplined versus being oriented for growth for growth's sake. We obviously have grown successfully. I expect that we will continue to -- just given the overall market dynamics, just the number of companies that are looking for private credit solutions and our -- to use Phil’s phrase, mindshare within that dynamic. But we will not be compromising the credit view or the credit decision to do that, as a mandate. But I do expect that we'll continue to grow, just given the overall secular story.
Okay. That's helpful. I appreciate the color there. And then just on that competitive environment, obviously deal pricing has been a prominent conversation over the past quarters. Are you still seeing continued downward pressure or has that begun to normalize a bit recently?
Yes. Let me take that one and just provide a little context. We obviously had a little bit lower effective yield in the portfolio this quarter. I would highlight though that, it was around flat if not slightly below the yields on the exits for the same quarter. So, I think, when you look at the overall portfolio yield, it hasn't really changed. That's also not taking into account the benefit on the right side of the balance sheet that we've been able to create through the debt refinancing. And I think what that does is, it lets us be very strategic in our pipeline, where we want to spend time, who we want to work with, and making strategic decisions without compromising the portfolio yield. And it is more competitive. But to highlight or reiterate a point Phil made earlier, 40% of our volume is from existing deals. So, while it is competitive, incumbency and the ability to stay relevant with your deal sources is absolutely imperative and what we can do with the portfolio I think allows us to have some flexibility there.
Overall, things do seem to be settling out, but no one quarter makes a trend as we say. But the quarter-to-date activity has been encouraging with a roughly 10% effective yields on deployments, although it's still early.
The next question comes from Ryan Lynch from KBW. Please go ahead.
I just had a follow up on the last question. You talked about a robust pipeline, which I believe you guys also had -- you were talking about last quarter, and obviously there is a lot of market activity, which increased repayments and prepayments in the third quarter. You also talked about kind of some caution out there in what you guys are looking to deploy, and you see an opportunity, seen pretty positive environment. So trying to kind of squirrel that away, with a robust environment and robust pipeline this quarter versus what I think you guys said was kind of the same thing last, that resulted in pretty meaningful net repayments this quarter. Is there your expectation that, that should flip going into the fourth quarter?
Yes. Let me try to start and add a little context. Keep in mind that part of -- a decent part of our repayment was actually a exit from the Edmentum position, which you got, it's kind of a one-off. It's a good one to exit because we've got a lot of value, picked up a lot of gain and redeployed equity into credits. But that being said, repayments were high through the quarter. In any one quarter, it's hard to tell. So far, they're low. And so I think if you took that as an indication, maybe they level off. But really, it's just hard to predict. And the nice thing is when we do get the repayments, we pick up -- typically pick up some fees and unamortized discount, which shows up as we did this quarter as a benefit.
But I just -- I don't want to predict anything that to make it a sort of forward-looking statements and then have a reverse on us. But thus far, it has the potential to low we benefit from, when we get them, but I would also adjust our current quarter’s repayment level for the one-off item, which was the Edmentum exit.
The only other question I had was the $6 million loss -- prepayment penalty loss from, calling, the August 2022 notes. That was very high and that's a 3.5% loss on those notes or acceleration of fees. I mean those notes in total have just over 4% coupon. So why was that number so high? And why did you choose to repay those early to incur that loss when the cost actually wasn't that much higher just have it sit on your balance sheet, so use that as a source of funding for the next nine months?
Thanks, Ryan. I will take that question. Yes. The prepayment fee really was a function of the make-whole provision within the indenture itself. But it was a decision that we did make both to take advantage of the current rate environment. And to lock in the rate longer term, as you saw the execution on our new deal was -- we're very happy with it. And so overall, we think it's a good trade-off on a long term basis.
And I would just add, I think Erik highlights, we can't predict where rates go, it feels like they're more inclined to go up and down. And we were able to lock in the lowest level we've seen for our business. I’d also highlight that the benefit of that aside from the one-time 6.2 million that's incurred, the run rate benefit of that new financing does not show up, really given the timing of it in the quarter. So on a go forward basis, we do anticipate that to be a benefit to just NII.
What was the nature of the $6.2 million make-whole? Was that new paying out the remaining interest that would have indigenously held to maturity or what was the composition of that just 6.2 million?
Yes. It's basically the remaining interest payments discount that -- yes, standard make-whole.
The next question comes from Robert Dodd from Raymond James.
Sticking with the capital structure for a second. I mean, on the converse, which I mean, it matures in March next year. I mean, based on where you stand today, would you expect to just refi that into your revolvers or kind of I mean on a blended basis you have fixed plus convert plus SBA, I mean your fixed rate funding, unsecured funding so to speak is a pretty high proportionately mix. Would you like to keep it that high or should we expect that the convert, most likely scenario is for that to rotate into, or get paid down with the revolvers, and increase your floating rate liability mix a little bit?
Yes. This is Erik. I'll take that and the latest deals that we did really put us in that very good position to do either one. We certainly have plenty of liquidity and room under our credit facilities to just pay those off in March when they come due. However, we're comfortable with where we are in terms of secured versus unsecured debt. So we're planning on exploring both options and we have the ability to do either one.
I appreciate that. Thank you. You certainly have the flexibility. On -- if I can, I know you didn't like to answer questions about specific assets, but one Hylan. Can you give us any kind of -- did you say operate -- I think it was operational challenges. I mean, are those challenges related to supply chain issues, which I can imagine there are a lot choices around easier to rectify, or personnel challenges or any color you can give us on how we should think of that in terms of how fixable that is let’s say?
Yes, thank you for the question, I'll try to take that and I will be -- on Hylan, I will be a little -- obviously, given the stage -- early stage of what's going on there, we have to be a little careful, not to just be sensitive to the discussions and the nature of them. But overall, I would say this is a very isolated incident, it is not a supply chain issue, as their work is really more implementing and installing, it’s an E&C business essentially, with good growth trends in the market, and a market in the Northeast that is experiencing the need and dollars flowing towards their services.
So we believe it's a good business in a good sector and that's a good place to start. And we've had -- obviously, based on prior experience, we have done this before, we've done it effectively, an extreme example is Edmentum for instance. But it's -- operationally I would say is just the nature of implementing and carrying out their service wasn't run as well as it could have been. And in the meantime, the impact of that is, with the level of depth they've had for challenges on them in terms of liquidity.
So those seem to be resolvable issues. Obviously, it's going to be a longer tail process to get the right outcome. We feel like we know we're doing there and we have a good asset which to start with. But I think we'll just provide updates as we can quarter-over-quarter. I would just emphasize that this is kind of a one-off versus anything systemic or characteristic of the broader portfolio including supply chain exposure. Just given our sectors, we just really don't have a lot of traditional supply chain exposure on working capital or tangible assets, when you look at our end market -- end industry that we focus on. And that also is the case for Hylan.
[Operator Instructions]. Our next question comes from Christopher Nolan from Ladenburg Thalmann.
Raj, by the way, guys, congrats on your first quarter as senior management team. Can you share with us your perspective in terms of where you think interest rates will be? How they'll change in 2022?
Boy, if I could do that effectively, I might be in a different role. But, I think I said it earlier, it feels like the trend is to be higher. I don't know that we can predict that or I think all we can do is really position the portfolio to benefit from it, and between the level of fixed rate debt on the right side of the balance sheet that we reduce the cost of and the positioning of floating rate assets on the left side of the balance sheet even with floors that protect us, I feel like we are well-positioned for rising rates. We just can't predict how quickly or how much. But it feels like that's more likely than not -- but it's just not our business to make explicit rate predictions versus being positioned for something that we can benefit from.
Raj, given that, it seems like a possibility the federal tightens and also the long end of the curve could go up just from the Fed starting to taper, would that impact your book value and so far that your value -- your core evaluation of your investment portfolios are done on a discounted cash flow and the discount rate used, would necessarily go up as well?
I think it's possible, I guess, but when we look at how our evaluations are done, it's not only discounted cash flow. There is a lot of a fair bit of market comp data being incorporated. And obviously those multiples have benefited both portfolio and loan-to-value coverage on a market value basis. There are transaction comps. And again, those have all been moving up into the right. And then there is discounted cash flow as sort of -- and they triangulate. So, at the end of the day -- and then there is always back-testing know which we do frequently, that shows our book I think has marked quite well and accurately unrealized exits. So, I think the providers, make sure probably answer for themselves, do try to take a more balanced approach and triangulate it around the nature of the asset and the fundamental business value. So, I don't anticipate that anyone is going to disproportionately impact us, even if there is, as you say, a mechanical change in DCF.
And with that, mostly floating rate portfolio, that should have for most of the impact from rates as far as evaluation goes.
There are no more questions in the queue. This concludes our question-and-answer session. I'd like to turn the conference back over to Raj Vig for any closing remarks.
Thank you. We appreciate your participation on today's call. I would like to thank our team for all the continued hard work and dedication. I would also like to thank our shareholders and capital partners for your confidence and your continued support. Thanks for joining us. This concludes today's call.
The conference has now concluded. Thanks for attending today's presentation. You may now disconnect.