BlackRock TCP Capital Corp. Q2 FY2020 Earnings Call

Ladies and gentlemen, good afternoon. Welcome everyone to BlackRock TCP Capital Corp.'s Second Quarter 2020 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. Now I would like to turn the call over to Katie McGlynn, Director of BlackRock TCP Capital Corp. Global Investor Relations team. Katie, please proceed.

Thank you, Victor. 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. This morning, we issued our earnings release for the second quarter ended June 30, 2020. 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 & Presentations. These documents should be reviewed in conjunction with the Company's Form 10-Q, which was filed with the SEC this morning. I will now turn the call over to our Chairman and CEO, Howard Levkowitz.

Thanks, Katie. First, we hope everyone is doing well and staying safe. We appreciate you joining us today. I have several members of the TCPC team on the call with me, including our president and COO Raj Vig, and our CFO Paul Davis. I will begin with some highlights and updates since our last earnings call, followed by an update on our portfolio and activities during the quarter. Paul will then go over our financial results and our capital and liquidity situation. After Paul's comments, I will offer some closing remarks before we open the floor to your questions. Starting on slide 4, let's look at our portfolio performance. Following the significant market disruption and volatility in March, the second quarter experienced a considerable recovery in both credit and equity markets. The broadly syndicated loan market, which had been more volatile than our portfolio, recovered significantly, and overall yield spreads in private markets also narrowed. Our portfolio continued to perform well despite the considerable challenges posed by the pandemic, and our second quarter results reflected this broader market recovery. Our net asset value rose by 3.8% in the second quarter, demonstrating a 1.6% net market value gain on our investments. The credit quality of our portfolio remains strong, with total non-accruals at just 0.6% of the portfolio's fair value as of June 30. As Paul will elaborate on, we further bolstered our capital and liquidity position during the second quarter by extending the maturity and increasing the capacity of one of our credit facilities. We also replaced another credit facility with a new one on more favorable terms and a longer maturity, and both facilities now offer expansion features totaling $150 million. We are grateful for the strong relationships we have cultivated with both our lender groups. Additionally, this morning we issued a press release sharing updates to our board of directors. Brian Wruble announced his retirement from the TCPC board effective August 4. We thank Brian for his 16 years of exemplary service as a director to funds managed by TCPC's advisor, including five years on the TCPC board. We also welcome Andrea Petro to our board. Andrea has extensive experience in credit and specialty finance, having led a significant lending business at Wells Fargo for many years, and we look forward to leveraging her nearly 30 years of experience in commercial finance. Her addition continues our commitment to diversity; we are pleased to report that now half of our independent directors are women. As for our dividend policy, as previously mentioned, we have had ongoing discussions with our board regarding the current environment, particularly the substantial decrease in LIBOR over the last six quarters, which has reduced our quarterly recurring net investment income before incentives by about $0.09. As a result, the board has decided to lower the quarterly dividend to $0.30 per share due to the significant drop in interest rates and the uncertainties surrounding the current operating environment, while also maintaining our commitment to sustainably cover our dividend. This marks the first time we have reduced the dividend, and we believe this proactive move is wise given the earnings potential of our portfolio. The third quarter dividend of $0.30 per share will be paid on September 30 to shareholders of record on September 16. Now, moving to slide 6 for an update on our portfolio. At the end of the quarter, our portfolio had a fair market value of approximately $1.6 billion, remaining largely unchanged from the previous quarter. Ninety-two percent of our investments are in senior secured debt diversified across various industries. Even though the global pandemic has had widespread effects, our direct exposure to sectors severely impacted by the shutdown is limited. Moreover, our loans to companies in the hardest-hit industries, including retail and airlines, are supported by strong collateral protections, and most of our investments in these sectors continue to perform well. Middle-market companies play a crucial role in our economy, employing about a third of the U.S. workforce. Our team is diligently collaborating with our borrowers, focusing on their long-term success. For those borrowers facing challenges, our team has been assisting management in adapting to the current operating landscape. For a small number of borrowers, this has involved making specific amendments to help them navigate the initial shutdown, resulting in amendment fees of $0.07 during the quarter. In some instances, we are already observing signs of stabilization as these businesses recover from the initial impact of the pandemic and adjust to the present environment. By the end of the second quarter, our diverse portfolio included 101 companies; our largest position accounted for only 4.5% of the portfolio, while our five largest positions together represented 17.8%. The chart on the left side of slide 11 shows that our recurring income is not dependent on any single portfolio company. In fact, over half of our individual portfolio companies each contribute less than 1% to our recurring income. As of June 30, 92% of our debt investments carried floating rates. Seventy-nine percent of these are subject to interest rate floors, all of which have been triggered by the decline in LIBOR. Additionally, eighty-two percent of our debt investments are secured by first liens, as outlined on slide 8. In the second quarter, we continued to carefully deploy capital, investing $56 million, which included five new loans, three of which were to existing borrowers. Dispositions amounted to $102 million, leading to net dispositions of $46 million for the quarter. As previously stated, follow-on investments in established portfolio companies remain a key source of opportunities due to our familiarity and understanding of these businesses. Our largest investment during the quarter—a loan to Cole Haan—was new for TCPC, but this is a borrower we have known for a long time and have financed repeatedly. Cole Haan has performed well in recent years, gaining popularity for its products and maintaining a strong online presence along with a limited physical footprint. When the company sought to enhance liquidity during the quarter, we were able to provide that assistance due to our longstanding relationship with the company and its owners. As we consider new investment opportunities, we remain focused on seniority, industry diversity, and transactions in which we lead or co-lead negotiations on terms. Our investment activity thus far in the third quarter has included select new investments and a small number of draws on unfunded commitments. We are particularly interested in companies that have either faced minimal impact from COVID or those that have benefited from the pandemic-driven operating conditions. This quarter’s positions also involved the payoff of our loan to [discover report]. We have also taken the opportunity to reduce our exposure in several loans. The weighted average effective yield for new investments during the quarter was 10.6%, while investments we exited had a weighted average effective yield of 9.3%. Consequently, the overall effective yield on our debt portfolio decreased to 9.8%, primarily due to the significant decline in LIBOR since the start of the year; this has been partially offset by the triggering of interest rate floors and rate increases from amendments on a few loans. From December 31, 2018, to June 30, 2020, LIBOR declined by 250 basis points, or 89%, placing pressure on our portfolio yield and causing a $0.09 per share quarterly reduction in recurring net investment income before incentives during this timeframe. However, our exposure to any further declines in interest rates is limited since over three-quarters of our floating-rate loans are structured with LIBOR floors, as illustrated on slide 9. As highlighted on slide 14, while we are aware of the influence the current environment has had on BDC stock price performance recently, over the last eight-plus years, TCPC has delivered more than $12 per share in dividends, resulting in an annualized cash return to investors of 9.9% and an annualized economic return on NAV of 7.8%. I will now hand the call over to Paul, who will discuss our financial results in greater detail.

Thanks, Howard, and hello everyone. During the second quarter, as Howard noted, we continued to enhance our strong capital and liquidity position despite the current market disruption. First, we extended our SVCP operating facility by another year to May 2024 and increased its capacity by an additional $30 million while maintaining our low rate of L plus 200 basis points. At June 30, we had available leverage of $328 million and a regulatory leverage ratio of 1.10 times debt to equity net of cash and pending trades, well within our 2:1 regulatory leverage limit. Following the end of the quarter, we secured a $100 million accordion feature on the SVCP operating facility to facilitate future expansion. We also replaced our TCPC funding facility with a new $200 million facility with improved terms, a two-year maturity extension to 2025, and a $50 million accordion feature while again maintaining our low rate of L plus 200 basis points. Combined, we added accordions totaling $150 million since our last call; together these developments further strengthened our diversified and low-cost leverage program. Turning to slide 17, we generated net investment income in the second quarter of $0.36 per share, which again fully covered our second quarter dividend of $0.36 per share paid on June 30. This continues our long contiguous history of covering our dividend with net investment income each quarter. Investment income for the second quarter was $0.78 per share, substantially all of which was interest income. This includes recurring cash interest of $0.59, recurring discount and fee amortization of $0.04, and pick income of $0.06. We had modest prepayments in the quarter that contributed a penny per share, including both prepayment fees and unamortized OID. Investment income also included $0.08 of amendment fees and other income and a penny of dividend income. Our income 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. Operating expenses for the second quarter were $0.33 per share and included interest and other debt expenses of $0.18 per share. Incentive fees for the second quarter totaled $5.2 million or $0.09 per share for total net investment income of $0.36 per share. As you may recall, because our annualized cumulative total return fell below 7% at the end of the first quarter, the incentive fee on first quarter income was indefinitely deferred. However, the strong recovery during the second quarter brought our cumulative total return back above the 7% hurdle. As a result, we incurred incentive fees attributable to both our second quarter earnings and the catch-up for the first quarter. However, although our advisor earned the full catch-up amount from the first quarter, we are voluntarily further deferring five-sixths of the catch-up amount to subsequent quarters such that one-sixth of the catch-up amount will be payable each quarter, provided and only to the extent that our performance remains above our cumulative total return hurdle in each such quarter. We believe this demonstrates our advisors’ confidence in our future performance and further aligns our advisors' interests with those of our shareholders. Accordingly, incentives payable for the second quarter included only $600,000 or $0.01 per share of catch-up incentive fees. Our net increase in net assets for the quarter was $46 million or $0.80 per share, which included net realized and unrealized gains of $25.3 million or $0.44 per share driven primarily by the market recovery in the second quarter following the COVID-related volatility earlier in the year. Substantially, all of our investments are valued every quarter using prices provided by third-party sources including quotation services and independent valuation services and our process is subject to rigorous oversight including backtesting of every disposition against our valuations. Our highly diversified portfolio continues to perform well in this challenging market environment and we believe our overall credit quality is sound. We placed our investment in one additional portfolio company, Glasspoint Solar, on non-accrual during the quarter. Glasspoint had been in the late stages of obtaining equity financing, but the process was pulled as a result of COVID. Our team is working with the equity owner to find an alternative solution which may include a monetization of the business assets in IP. We now have loans to just three portfolio companies including AGY and Avanti on non-accrual, which together represented 0.6% of the portfolio's fair value and 1.6% of cost. Turning to slide 15, we had total liquidity of $348 million at quarter end. This included available leverage of $328 million and cash of $21 million, less net pending settlements of $1 million. Additionally, our investments in unfunded credit facilities and delayed draw term loans to portfolio companies totaled just $46 million at quarter end, or less than 3% of total investments. With the extension and expansion of the SVCP operating facility and the replacement of our TCPC funding facility with the new lower-cost facility, our diverse and flexible leverage program is even stronger. As of June 30, this program included two low-cost credit facilities, one convertible note issuance, two straight unsecured note issuances and an SBA program. Our unsecured debt continues to be investment grade rated by both Moody's and Fitch. Given the modest size of each of our debt issuances, we are not overly reliant on any single source of financing and our leverage program is well-laddered with no near-term maturities. Our nearest maturity is March of 2022, and this represented less than 15% of outstanding liabilities as of June 30. Combined, our outstanding liabilities had a weighted average interest rate of 3.53%, down from 3.84% at the end of 2019. I'll now turn the call back over to Howard.

Thanks, Paul. There continues to be significant uncertainty about what the remainder of 2020 will look like. However, the pace of new deals entering the market has picked up modestly and the deals in our pipeline are generally on more favorable terms than what we saw leading up to this period. We are cautious in our deployment but in a solid position to opportunistically invest. In addition, we remain focused on the long-term health of our existing portfolio companies with an emphasis on preserving capital for our shareholders. We seek to invest in companies with strong management teams that are relatively well situated to perform throughout economic cycles, including periods of dislocation. Our portfolio companies collectively employ thousands of individuals and provide necessary goods and services to their customers. We are committed to helping our portfolio companies successfully navigate this period of dislocation while continuing to deliver attractive returns to our shareholders. Our performance to date and our confidence in our ability to succeed in this environment are driven by our team's two decades of experience in both performing and distressed credit. The strength of our underwriting platform, as well as the depth and breadth of the firm-wide resources of BlackRock. In closing, while these are challenging times for everyone, our entire team is focused on generating strong risk-adjusted returns for our shareholders. And with that operator, please open the call for questions.

Thank you. Our first question will come from Finian O'Shea from Wells Fargo Securities. You may begin.

Hi good afternoon. Hope everyone's hanging in there. Howard, first question on the five new loans you outlined, I suppose the two-part question. I think there were three existing and two new. To start with the existing loans, can you describe the nature of these portfolio add-ons, acquisitions to support acquisitions and/or similar, like a dividend recap? And then second question on the new loans that you took on this quarter assuming that you began looking at them or underwriting after COVID started, how would you describe the change in the level of competition in terms of both financial capital and number of firms that are at the table? Thank you.

Sure. Fin, thanks for joining us. We're doing well here. I'm going to address your questions first specifically and then turn it over to Raj for a little bit more market color since I think you asked some important questions about both the environment and what we're doing. With respect to our portfolio, the loans that we made fall into a couple of categories. One of the more interesting ones was an existing portfolio company that had been pursuing for an extended period of time a strategic acquisition that was accretive to the business. The sponsors and owners of the business put in a significant multiple in equity versus the amount of incremental debt that we advanced and we were very pleased because we think it enhanced both the business and the strength of our existing debt investment. We're able to do it on new terms, but we talked about the loan to Cole Haan, which was another interesting example; great company, big online business, navigating this environment well, relatively low leverage, and that company actually has traded debt that they were looking to put on incremental liquidity and do it with a single source that they knew well. We were able to provide that financing at a 50% spread over where their existing traded debt is because they wanted certainty of execution. So we've been focused on doing things that we think are value-added, that we can diligence well and that are appropriate opportunities for us in this dislocated environment. I'll turn it over to Raj to maybe talk about the environment a little bit more generally.

Yes. Thanks, Fin. Hopefully you can hear all of us through these face masks that are now a standard part of our earnings call. In terms of the post-COVID environment activities, clearly post the start of the spike in March, the volume has been lower. It's clear through our Q2 activities and into Q3. I think also there are a few, maybe not a lot fewer, but certainly fewer active participants on the lending side based on people working on their portfolios, capital constraints if you will and at the margin but there's also still good dry powder from a number of active participants. I think at the margin what we're seeing is for those companies that are attractive in this environment, those that are neutral to COVID or even in some cases beneficiaries, which does characterize a lot of our portfolio, there is active ability for people to pursue those names. And I think on the margin, things like covenant structures and things that were normally more discussion and negotiating items are a little bit more standard as part of the structure, but there is still competition for those companies that are attractive in this environment and I think it sort of nets out being an attractive environment. But I think time will tell as we move forward through COVID and how far COVID extends, whether that's good for the lender or good for the borrower. But right at the moment, we are active. We are seeing a pipeline rebuild. We are focusing on companies that in many cases are so much of what we focus on pre-COVID; those that are less cyclical and very sustainable and predictable earnings. But there is still competition particularly for those companies that stand well in this environment at a lower volume overall that's recovering but still lower than the pre-COVID environment.

Okay, that's helpful. Thank you. Just next question, final question on the amendment discussion. I think you said there were $0.08 of fees, which seems pretty heavy on a per share and dollar basis. I think heavier than probably most of your competitors. So any color you'd provide there? Is that a function of tighter covenants or being more proactive or anything on the portfolio performance side? How would you guide us on the amendment piece?

Yes. Thanks for focusing on that. It's actually $0.07. It does come from several portfolio companies, and I think you highlighted in your question the explanation which is when we do our underwriting and draft our loans and set our covenants, it's based on expectations and as a result of the COVID disruption, some companies, fortunately a small proportion of our overall portfolio, but some companies missed their numbers and had covenant issues. In connection with those, our goal is to work with the management teams and portfolio companies to ensure that they have a good path to recover, but also gives us the ability to enhance our economics as we're working with those companies. In some cases, there are also improvements to the loan documents in connection with them. In particular, in March, we saw some real disruption in a couple of businesses and fortunately, the one that was most impacted by this started to see recovery in April, and it has continued since then as its primary customer base has adjusted to the new environment.

Okay, that's helpful and thanks for taking my question.

Thank you for your questions.

Thank you. Our next question will come from the line of Chris Kotowski from Oppenheimer. You may begin.

Yes. Good afternoon. Just following up on Fin's question. I mean is that amendment activity continuing into the third quarter and is that something we should expect for the next couple of quarters given the stressed environment or do you see the second quarter as just really an exceptional, that we are through most of that for now?

So let me take that, Chris. I think and I guess what I would just want to do is reiterate the point Howard made is just operationally when we set our loans up at the front end, we are believers that having covenants and having real covenants is a good thing and sometimes if the covenant is tripped or even in advance of it being tripped, you'll have the discussion. It really is the protection, almost a circuit breaker to allow you to get back to the table and do a whole host of things. It may be tightening up the docs as Howard said. It may be enhancing economics. It may be in advance of a real problem having the owner of the business or the sponsor address the problem in advance whether it's through capital or other actions. So I don't think we take the view that covenants or covenant-based discussions are necessarily a bad thing. It's actually meant to prevent bad things in the portfolio. So to your question, however, the activity has certainly abated, I think in Q2 the broader reset around COVID was more extensive for every company, even those that are still growing and then as we come into Q3, I wouldn't say it's zero activity. There are some additional dialogues. Again, we're going to use those discussions to ensure we are well protected and in certain cases enhance our economics which is the case with one of our portfolio companies that's ongoing today, a public company, but it certainly has come off a little bit. How it proceeds through the rest of the year is I think a question of how COVID extends, which we really can't answer, but we do feel good about the state of the portfolio. We do feel good about having real protections across most of the majority of the portfolio with covenants and real loan docs, and when we need to use those as we did in Q2 to our protection, our advantage, we will continue to do so.

Okay, and then I guess you delevered slightly this quarter. I mean it was obviously you had the appreciation in NAV and investments came down slightly. Should we expect the overall portfolio to remain roughly flattish assuming that we're sort of in this half open, half closed kind of limbo for another quarter or two at least?

Chris, you've been following us since we went public, and I think as you know and as many of our other long-time shareholders know, we don't set firm targets for leverage. We're very cognizant about the way we approach risk. We've got a balance sheet that's well diversified with a half dozen sources of financing. We're very pleased with the new facility we just brought on together with $150 million of incremental aggregate accordion capacity from our two facilities, but we don't like to set sort of artificial targets because as we saw in Q1, you can get movements in NAV, although that was certainly an outlier and an exception. And you can also be in a position particularly in this more disruptive environment where you think you're going to close things that don't close or things that are supposed to get paid off, get pushed. In fact, that happened to us both at the beginning of the year and in Q2 where things were supposed to close slip. And so we don't target a hard level. We're very comfortable with our current leverage. We did think it was important coming out of Q1 particularly with the disruption to take it down some, and so that's why we controlled both our new investments and we also did some selective sales to position the portfolio. We think in a good place where it is today where we have significant liquidity. We're comfortable with our leverage and we're in a position to do good deals as they come in but don't have any artificial pressure to do things.

Okay, and then the one thing I was wondering about is on the, can you remind us where you stand on the SBA? I noticed that like the facility you haven't drawn on it since I think the middle of last year sometime and can you just remind us where you are? I think you had applied for an additional license and gotten a green light letter or?

Yes. Right now we've got $138 million drawn on the SBA debenture out of 150 and currently recycling. We had one investment come off in the quarter, one come back on as we still have a little bit of room; we invest as we see opportunities that are appropriate for the portfolio, not necessarily keeping not necessarily to put into the SVCP but specifically, but as that fills up, yes we will examine an additional certificate.

Yes, and Chris, the SBA isn't large enough to have a statistically meaningful portfolio, but what we have found, and this may be more coincidental just because of the size, is that the investments we've had in there tend to repay more quickly probably than on average. So there's a lot of recycling activity. When you look at the aggregate, the draw, you're not seeing necessarily what's going on in the underlying portfolio which is a lot of paybacks and payoffs along with replacement assets.

Okay. Interesting. Thank you. That's it for me.

Thank you.

Thank you. Our next question will come from the line of an analyst from Raymond James. You may begin.

Hi everyone. Just to start off to follow up on the amendment questions. Would you be willing to give any commentary on the number of portfolio companies that took amendments over the quarter?

Sure. Happy to do so and thanks for joining us. We had 11 portfolio companies that had amendments during the quarter, out of 101 at the end of the quarter. So we had a few more than that going into the quarter. So you can think of it as being between 10% and 11%.

Okay, and then I guess secondly any update you can give on the airline book especially kind of how collateral values against the loans are holding up given some pressure in the industry?

Sure. Happy to do that. We have two primary loans. Our long-time lease with United was repaid in full. That's something that we've actually been financing United planes since 2009. We're pleased to have those all paid off. We have loans to Mesa and to OneSky. In the case of Mesa, they're a regional operator. They connect jet service to American and United feeding into their hubs. They've obviously been impacted dramatically. They have gotten federal money under the CARES Act. The loans continue to perform fully on amortization and interest. Of course, we all know that the sector has been impacted. We do think our approach to underwriting focusing typically on somewhat older equipment, these are all backed by assets and engines has proved highly effective since we started in this business of financing planes and plane parts since 2003. But clearly there's some disruption there. With respect to OneSky, which is the second largest operator of private aviation in the country, their business has picked up considerably. If you look at data that's publicly available, flight data, you can see that there is a significant increase in private aviation particularly coming out of the beginning of the last quarter.

Okay, that's helpful. Then just the last one for me. From our end it kind of seems the board elected to set the dividend at a level, earnable with little to no prepayment or amendment fees. I guess first question is that fair to kind of think about from our end? And then the second question being if that's correct, what are the expectations for prepayment and amendment activity in the near to midterm?

Sure. Yes, our prepayment activity has averaged $0.04 to $0.05 a quarter over quite an extended period of time. There is clearly variance there. We had record low activity in Q1, which was unusual. I would note that there's probably some historic seasonality to Q1. It tends to be a slower quarter for us generally, and this particular quarter was obviously heavily impacted as some things that we expected to happen and get repaid didn't happen. But repayments and fees are lumpy and we give data on what they've been historically but don't try and project them in the future. The board gave significant thought to setting the dividend level. We recognize it's very important to all of our investors and we know that investors have taken comfort from the fact that in the eight-plus years since we've been public, we've always earned our dividend and we wanted to set it at a level that we believed would be sustainable based on our information about the current operating environment.

Matt, I would also add to that just as we noted in the script, LIBOR has come down quite a bit over the last six quarters and our run rate has had an impact of about $0.09 before incentives on the run rate. So I think that's important to keep in mind and that was the primary factor to consider in resetting the dividend.

Great. That's it for me. I appreciate the help.

Thank you. And our next question will come from the line of George Bahamondes from Deutsche Bank. You may begin.

Hi, good afternoon. Most of my questions have been asked and answered, just two more here for you. I'm sorry if I missed this, but are you able to disclose pricing for the loan sold in 2Q relative to par value?

That's not a disclosure we provide but we were pleased with the prices that we achieved on those loans.

Yes. This is Paul. You will probably notice, we had for the second quarter we had $415,000 – $416,000 of realized losses. There were some, up some down. It was kind of a mix but roughly flat.

Great. Thank you for that. And my other one's on the LIBOR floors. Do you disclose your kind of weighted average LIBOR floors across the portfolio? You provide a range here in the deck but wondering if you do disclose the kind of weighted average?

Yes. This is Paul. Our weighted average is 1.1%.

Okay. Great. That's it from me today. I appreciate you taking those.

Thanks.

Thank you for your questions.

Thank you. And I'm not showing any further questions at this time. I would like to turn the call back over to Howard Levkowitz for any closing remarks.

We appreciate your questions and our dialogue today. I'd like to thank all of our shareholders for your confidence and your continued support and our experienced and talented team of professionals at BlackRock TPCC Capital Corp for your continued hard work and dedication in these challenging times. Thanks again for joining us. This concludes today's call.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.