BlackRock TCP Capital Corp. Q4 FY2020 Earnings Call

Ladies and gentlemen, good afternoon. Welcome, everyone, to BlackRock TCP Capital Corp.'s Fourth 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. And now I would like to turn the call over to Katie McGlynn, Director of BlackRock TCP Capital Corp. Global Investor Relations team. Katy, you may begin.

Thank you, Towanda. 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 fourth quarter and fiscal year ended December 31, 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 and presentations. These documents should be reviewed in conjunction with the company's Form 10-K, which was filed with the SEC earlier today. I will now turn the call over to our Chairman and CEO, Howard Levkowitz.

Thanks, Katie. And thank you for joining us today. First and foremost, we hope everyone is staying healthy and safe. There are several members of the TCPC team on the call with me, including our President and Chief Operating Officer, Raj Vig, and our Chief Financial Officer, Paul Davis. I will start with a few comments on our performance in 2020, and then I'll provide an update on our portfolio and key highlights from the fourth quarter. Next, Paul will review our financial results as well as a robust liquidity position. After that, I'll provide some closing comments before opening the call to your questions. On last year's fourth quarter earnings call, we noted several risks to the economic environment, including the coronavirus. The magnitude of the impact that the pandemic has had on our day-to-day lives and across the world exceeded almost everyone's expectations. We would like to thank our entire team for their flexibility and hard work together with the management teams and employees at our portfolio companies, which enabled us to deliver strong results for the year. Our ability to navigate the unique and evolving conditions in 2020 and deliver for our shareholders is a testament to our dedicated and skilled team and the strength of our carefully constructed, highly diversified portfolio. Despite the significant disruption in Q1, our net asset value increased year-over-year, and the credit quality of our portfolio remains strong through an outlook that proved to be a challenging year. The strong performance was due in part to our focus on less cyclical industries and middle market businesses that are more likely to withstand the downturn.

Thanks, Howard, and hello, everyone. Net investment income for the fourth quarter of $0.35 per share again exceeded our dividend of $0.30 per share. And today, we declared a first-quarter dividend of $0.30 per share. We remain 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. Net investment income for the full year was $1.44 per share. Investment income for the fourth 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 $0.04. This was our lowest level of PIK income in three years. As a reminder, 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 timing the investment is made. Investment income also included $0.03 of other income, $0.01 from dividend income, and $0.04 from prepayment income. While prepayment income is always lumpy, it's been historically lower in the first quarter of each year and has been particularly minimal so far in 2021. Operating expenses for the fourth quarter were $0.31 per share and included interest and other debt expenses of $0.17 per share. Incentive fees in the fourth quarter, including $0.6 million of previously deferred fees, totaled $5.0 million or $0.09 per share for total net investment income of $0.35 per share. As noted in our second quarter earnings call, incentive fees related to our income for the first quarter of 2020 were deferred. While the full amount was earned in the second quarter when our performance again surpassed our total return hurdle, we voluntarily further deferred the amount over six quarters, subject to our cumulative performance remaining above the hurdle.

Thanks, Paul. The past year emphasized the key role that BDCs play in providing capital to middle market businesses that account for roughly one-third of private sector GDP. These businesses have again proved to be resilient, demonstrating the collective appeal for investment. Middle market companies, for example, reported significantly fewer job declines last year than larger companies and smaller businesses. BDCs like TCPC helped to ensure that these companies have consistent access to financing solutions. Our team has been lending to middle market companies for more than two decades through multiple cycles, including the dot-com bubble, global financial crisis, the energy bust of 2015-2016, and now the COVID-19 pandemic. We have drawn upon this experience to inform our investment decisions and performance throughout this most recent market dislocation. Since our IPO in 2012, TCPC has returned more than $12 per share in dividends, which translates to an annualized cash return to investors of 9.8%, and is reflective of our return on invested assets of 10.5%. TCPC has also consistently outperformed the Wells Fargo BDC index. The overall market environment continues to improve, and we're seeing a pickup in activity. That said, we remain extremely selective, executing on only a small number of opportunities we review, and focusing on companies we believe have minimal COVID exposure or those that are positioned to outperform in this environment. Overall, as we navigate the persistent uncertainty in the market, we are guided by our experience managing through prior downturns and periods of market volatility, and we will continue to seek to: one, maintain a diversified portfolio that is not under highly cyclical industries; two, take advantage of unique and not widely understood industry dynamics; three, take structurally senior secured positions in the capital stack; and four, structure transactions to include specific collateral and assets for downside risk mitigation. 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 firm-wide resources of BlackRock. In closing, we would like to thank our entire team for their dedication and focus on generating strong risk-adjusted returns for our shareholders even in these challenging times. And with that, operator, please open the call for questions.

Our first question will come from Devin Ryan from JMP Securities. Your line is open.

First question, I appreciate all the detail that you guys provided, but I would love to think about the potential to expand or grow the portfolio in 2021. Obviously, the portfolio size has been fairly steady for the past couple of years. And just given the strong capital markets backdrop and what you're seeing more broadly, just expectations and kind of the opportunity to expand the absolute size here?

Sure. Thanks for the question. Our primary focus is on generating long-term consistent returns for our shareholders. We're very proud of the fact that we have covered the dividend for 35 consecutive quarters. We've been able to generate, as we noted before, 10.5% gross returns on assets. And as we think about the vehicle, that is our primary focus. We have grown over time. Like any business, we like to grow. And if we see opportunities that are appropriate that would enable us to do the right thing for shareholders over the long term, we would certainly look at doing that, but we are not focused on growth for the sake of growth. And we're happy to have the portfolio maintain a consistent size or, to the extent appropriate, shrink a little bit if we're not seeing appropriate deal flow.

I appreciate that. So my follow-up is regarding the current market conditions. You've mentioned that there are strong conditions for borrowers, which is positive. However, this can also present challenges when it comes to deploying capital. I would like to hear your thoughts on where you believe the most attractive risk-reward opportunities exist in the market. More generally, how do you assess risk evaluation at this moment, considering we appear to be in a very favorable or, as some might say, overheated market? I would appreciate more detailed insights on your observations.

Yes, to add to that, our main challenge hasn't been deployment. Looking at the last quarter, we deployed a solid amount, not a record, but a good number. We faced many repayments and experienced a lot of unusual activity in 2020, particularly in a very active fourth quarter. The team worked hard, and we had numerous opportunistic refinancings, which ties into your second question about risk and opportunity. We're discovering opportunities in many of the same sectors we have consistently focused on, even before COVID: defensive industries, well-positioned companies, and sectors with cyclical but predictable revenues and earnings. I see 2020 as a validation of our approach, demonstrating the business model's resilience during difficult times and the early recovery stages, allowing us to identify reliable and repeatable sources for investment with strong downside protection. There has been significant activity in areas like health care, ongoing interest in software and services, and a rise in financial services across our portfolio, though not in high-risk financial assets. These are the key areas we are concentrating on, and our pipeline remains robust, as reflected in Q4's deployment. Since the COVID spike in March, there has been a tightening of rates and pricing. Our strategy has always been selective; we seek opportunities from various sources and aim to choose the best. We continue to prioritize defensive structures, mainly secured first lien. We are grateful for the real covenants in our portfolio, which have provided support during challenging times in 2020. In summary, we will maintain our focus on the areas that have worked for us, the performance has been strong, and the pipeline looks promising. However, we are seeing requests in some areas that may be excessive, which we will decline, and that’s acceptable.

Yes. No, I really appreciate the color. I'll leave it there, but congrats on a really nice end of the year and all the progress you guys have made on the liability side as well.

Our next question comes from Robert Dodd from Raymond James. Your line is open.

Congratulations on the impressive NAV earnings in such a challenging year. In relation to Devin's question about prepaid, the Q4 prepayment figure of $0.04 has been quite typical. The low numbers in 2020 were expected due to the environment. Paul mentioned that activity has remained relatively subdued so far this February. While I understand it’s difficult to predict from quarter to quarter, do you anticipate this year will see normal prepayment activity concerning fee income and portfolio rotation? Or do you think it will be higher due to the current attractiveness of the market for borrowers, or perhaps remain low this year? Any insights on that would be helpful.

Yes, Robert, thank you for the question, it's good to hear from you. I'm not sure how to define what normal is anymore given everything we've experienced. There have been many changes, especially since 2020, but there seems to be a stabilization in the market and the flow of deals. While there may be more activity in liquid markets, we've observed a wave of businesses seizing the opportunity to finance amidst real advancements and transformations in their models, both positive and negative. This trend has persisted for two to three quarters into Q1. So perhaps we're returning to some level of normalcy, but I still think there are uncertainties surrounding what normal looks like for some time to come, and we remain optimistic about that. However, I don't expect things to be as hectic as they were in 2020, particularly in Q3 and Q4. There might be some lasting effects that we will need to address as best as possible.

And Robert, it's Howard. I'll just add one thing to what Raj said. As we look back at our prepayment history over the last two decades, it's been quite consistent. For instance, in 2007, 2008, and 2009, borrowers tended to repay at an annual rate of 25% to 35%, though there are significant differences. Last year, we saw Q1 at about 5%, Q2 at about 6%, Q3 at 5%, and Q4 at 13%. Typically, Q1 is seasonally light. Additionally, it's not only about the volume of prepayments; certain instruments have higher prepayment premiums and may also be repaid earlier in their life cycle, which results in more prepayment income. Paul's comment was just meant to inform you that we have not yet received those amounts. I wanted to provide a bit more information.

I appreciate that. On the other side of the balance sheet, you have a maturity coming up in March of next year and another one in August. It may be callable six months in advance or prepayable, but I'm not certain. Considering the current environment, especially with low-cost bonds for BDCs, should we anticipate that you will replace those maturities with more unsecured options? Or might you consider increasing the size of your revolver a bit? I'm interested in how you're approaching the balance there.

We're very pleased with the right side of the balance sheet. We have great relationships long-term with our revolver lenders, and they provided us with more capacity and extensions during the worst period last year during the early spring. And we're also deeply appreciative of our relationships in the bond market and having been able to issue, what we believe is a record low-cost sub-index and for those who aren't familiar with that, below $300 million is less liquid for bond issues. We're uncertain at the moment. Operator, please ensure that all other lines are unmuted. Currently, we have seven ways to finance our balance sheet, and we appreciate the combination of revolvers and unsecured debt. The ability to use our revolver to pay down any of the bond issues provides us with significant flexibility. We currently have ample credit capacity and are satisfied with the considerable liquidity we possess. Naturally, we can repay bonds at maturity, and if there's an opportunity to do so earlier, that is also something we can consider.

Our next question comes from Finian O'Shea from Wells Fargo Securities. Your line is open.

First question on a portfolio company. Mesa Air looks like it was grouped together, and maybe one entity is just a small question there. Is it as simple as that? Or was there some sort of business change in Mesa for you?

We had several exposures to Mesa, one of which was repaid. And so that may be what you're referring to; it's broken out into a number of items on the balance sheet because there's distinct pools of collateral that are cross-collateralized. But we're pleased. Obviously, it's been a difficult environment for commercial airlines. They've continued to have access to liquidity through government programs and their major airline counterparts. And in connection with that, they paid down one of our two primary exposures. The other one continues to amortize regularly, and that’s why that balance is being reduced.

And then Howard, for the ones you are making today. How do you structure and document the loan to account for the transition away from LIBOR?

Thanks for the question. What we do is provide provisions in there that account for successor instruments and a default to the extent that there isn't an appropriate one. And I think this is pretty standard in documents where they'll refer to the reference rate or prime rate if there isn't anything else, but you default to the replacement rate as a first choice. So we spent a lot of time analyzing this issue, going back several years now and believe that we're appropriately positioned to deal with.

Our next question comes from David Miyazaki from Confluence Investment. Your line is open.

And I appreciate the way that you guys have navigated 2020. You've gotten your shareholders through a pretty surprising and volatile time frame. If I could, just to kind of extend a little bit on Fin's question with regard to the airline industry, Howard, do you have a long history investing in the credit markets? And it's been my observation that you're pretty defensive in your exposure to airlines going back 20 years and really making some pretty notable loans back when the industry was disrupted around the 911 time frame. And then also kind of noteworthy in avoiding aircraft leasing at the wrong time in more recent years. So can you kind of provide a little bit of insight as to how you look at that industry and other industries that have experienced kind of a sea change with regard to the pandemic?

Sure. Thank you for the question. It's an interesting one. And I think the way we've looked at the airline industry is probably emblematic of the way we look at the whole portfolio, which is we have deep expertise there. And we've been financing companies, as you pointed out, since 911, but we're very opportunistic. And so when other people aren't financing it or we see good risk-adjusted rewards, we have great relationships. We've done financings for most of the major U.S. carriers as well as some smaller ones. We haven't added any exposure recently because we haven't seen what we deemed to be good risk rewards. We've seen lots of deals. But one of the advantages of our structure, which is focused on industries, and we've got 19 industry teams, is that we can go where the best deals are, and Raj was talking about earlier, some of the things we're focusing on. There's a lot of robust activity in a lot of less cyclical areas. And we're still doing things in cyclical industries. But the bar is high. And in the case of aircraft financing, which is really the way we look at it, we're financing metal, hard collateral. We haven't seen pricing come to where we think it needs to be, and that's why we haven't put out new money. I'm frankly surprised if you would have asked us in the spring, are you likely to do some things in this sector? We would have said probably. But having the discipline to avoid going into something just because you're seeing deals is, I think, really an important part of managing this business. And so we're going to where we see good risk-adjusted rewards, and we've got a broad enough pipeline, but that gives us the ability to choose. But we're continuing to look at things across a broad variety of sectors, and I suspect you'll see that evolution in the portfolio going through the rest of the year.

I was surprised that you didn't encounter more opportunities, considering the industry is experiencing significant disruption in this cycle. It's interesting to note that pricing hasn't really adjusted. I'd like to ask about your recent situation as part of the broader BlackRock platform. Have any general or specific resources from BlackRock been helpful during the pandemic? Additionally, I'm curious if BlackRock has provided any insights or resources related to regulation and legislation affecting the BDC industry.

David, it's Raj. I'll address the first part regarding the platform and the advantages we've seen during this time. Even prior to COVID, and particularly during it, I want to emphasize three key areas that significantly enhanced our ability to navigate 2020 positively, and I appreciate your comment on that. First, BlackRock has a strong presence in nearly all capital markets across sectors including liquid, private, infrastructure, and real estate, along with significant industry insights available in the platform. This was effectively utilized as we held daily discussions on cross-asset pricing, trends related to the virus, and industry implications, supported by our internal expertise in various sectors and health care. This approach allowed us to contextually assess our own private capital portfolio, focus on necessary defensive areas, and identify potential opportunities. This cross-asset perspective greatly assisted us in understanding risks and pricing in ways that we couldn’t have achieved independently. Additionally, BlackRock fundamentally relies on a risk management approach. As we've previously mentioned, especially in light of COVID and our integration efforts, we have a dedicated risk and quantitative analysis team that has contributed substantial rigor to our portfolio management and underwriting processes. This ongoing effort is something we truly value as portfolio managers. Lastly, on the liability front, you've noticed some shifts and adjustments on the balance sheet's right side. BlackRock's prominence with intermediaries, both for sourcing and issuing liabilities and debt, has been advantageous. I hope this isn't merely a response to COVID but a sustainable practice. In the latter part of 2020, we leveraged those relationships for successful issuance completions. I'm not sure if Howard has comments on the regulatory aspect, but if he does, we can direct it over to him.

Yes. It's something that we obviously continue to monitor and be advocates of the fact that BDCs continue to be penalized in effect by having a more limited group of investors as a result of the AFFE restrictions or rules is something that everybody, I think, who's involved in the sector is cognizant of. And we continue to do our part to be advocates to do what we think is in the interest of everybody in the sector and shareholders more broadly, which is to expand the sector on a more institutional basis so that it's easier for mutual funds, other 40 act vehicles, and hopefully, once again, index funds to more broadly on the sector without having the penalty associated with the way the AFFE rules are applied. And we remain hopeful, but we'll see what happens.

Our next question comes from Ryan Lynch from KBW. Your line is open.

Congrats, first off, on a good quarter and maybe more importantly, a good year. And that's where I really want to start my first question. In 2020, you guys were able to actually grow your net asset value throughout the year in the midst of a downturn and generate very strong results. In fact, the results in 2020 that we generated were stronger than the results that you've generated in the last couple of years despite 2020 having a pandemic and a significant downturn. So can you reconcile why your results were so strong in 2020? And what does that say about your business? And then how did it outperform previous years?

Sure. Look, I think we are wired to analyze difficult situations. If you think about the heritage of our business, it really comes out of special situations investing and understanding difficult times. And I think in tougher times, we tend to shine. Ultimately, the performance of TCPC during 2020 was a function of, first and foremost, a robust portfolio and not having significant causes, in fact, taking down our nonaccrual. It was also effective deployment of capital on an incremental basis, although there wasn't a huge amount of that, what we did was effective. And it was also balance sheet management. We went into it well prepared. We had a small proportion of our assets in delayed draws and revolvers. We had ample liquidity. We had good financing partners who gave us more flexibility and more room. And that also put us in a position when the industry sold off to buy in stock, which we thought was an appropriate use of capital at the time. And so I think it's really a combination of factors. In 2019, we did take a hit on one particular position which we talked about, which we thought was an anomalous result. The larger position that we've dealt with has de-leveraged. But I think if you look at the over two-decade track record that we have and even the nine-year track record as a public company, where our return on assets has been about 10.5%. 2020 is, I think, more emblematic of our history and the way we've been able to perform over a long period of time.

Okay, that's helpful information. One of the things we've heard from several BDCs before 2020 was the idea of late cycle investing. Now that we have experienced a downturn and are in a recovery phase instead of worrying about another downturn, do you plan to adjust your investment strategy at all? I understand there won't be any significant changes to how you assess credit and underwriting, but do you foresee any moderate shifts in the specific industries you target or in how you structure capital following a major downturn?

Sure, I'll address that. The short answer is no. What we have been doing has been effective for us. I consider 2020 to be an unusual period, and the performance, along with what Howard mentioned previously, supports that it is working. This has been further confirmed by some of the activities in 2020. My focus has been on defensive sectors and areas where we have expertise, whether that be in specific assets or industries. We aim for structures that provide downside protection and allow us to safeguard our capital or improve our positions, which we accomplished in 2020. This approach is preferable to taking on excessive risks in pursuit of higher returns without adequate protections in place. While we continually reassess our industry focus and investment strategies, I believe in maintaining consistency and discipline with our methods, which I hope will yield positive results.

Okay. Understood. And maybe to kind of take it to the opposite end of that versus more risk, which was kind of my previous question in the portfolio, being able to issue sub-3% unsecured debt on the right side of your balance sheet, does that change your guys' investment approach or the types of deals that you guys would be now willing to put on the left side of your balance sheet and in your portfolio, given that low cost of unsecured debt?

It really doesn't, Ryan. Obviously, having a lower cost of funding is helpful. But we've been doing this a long time. We don't move around our investment philosophy or our assets based on small changes in our cost of financing or on short-term changes in the capital markets or the economy. Ultimately, what we try and do is build a robust portfolio that we think can withstand a lot of different scenarios. And as you just pointed out, we just went through another downturn, a very different kind than the last downturn during the great financial crisis. So we've got another set of criteria to use in our stress cases, which is great. But if something doesn't work in the portfolio, we don't just put it in because we can borrow against it a little bit more cheaply.

Our next question comes from Christopher Nolan from Ladenburg Tallman. Your line is open.

Howard, following up on Ryan's question. Since the stock price remains below NAV and your debt costs are quite favorable, what is the capital strategy regarding the 2022 notes? You mentioned earlier that you might wait until they mature, but you could redeem them at any time with a make-whole premium, given their 4.125% coupon. Do you have any thoughts on redeeming them in 2021?

Yes. We will see what happens. Ultimately, one of the nice things about having the flexibility that we do in our capital structure. Significant undrawn capacity under both of our revolvers and significant headroom in regulatory capital means that we have a lot of flexibility there. And so obviously, the interest rate environment has changed fairly significantly in the last couple of weeks that may affect people's views of what price they want to hold bonds. And so we will look at what makes most sense as we get further into the year.

Great. And I guess a follow-up question. Given that revolving facilities have a lot of non-direct costs, legal and so forth associated with them, do you consider this new unsecured debt you guys just issued to be your cheapest form of capital?

Well, you can look at the math on it, and it's a good question. Ultimately, the all-in cost of the revolvers, if you really want to look at it analytically, you probably need to wait until the end to see what happens with them, how they're extended, how much gets utilized. The bonds are easier to analyze. We'd also like to call your attention, and I think you're aware of this to our SBA financing or SBIC facilities, which also have very attractive long-term financing costs. And there's some additional costs, but the overall coupon rate on those for the long-term is really quite cost-effective also.

Our next question comes from Chris Kotowski from Oppenheimer & Company. Your line is open.

I understand that you prefer to approach changes in a steady manner, and considering you recently reduced your dividend from 36 to 30 last year for understandable reasons during the lockdowns. However, since your NAV has returned to pre-COVID levels without any decrease, theoretically, there shouldn't be any decline in your earnings capacity. I'm curious, not regarding the next quarter or two, but more generally, what your plans are for getting back to the previous dividend distribution and what criteria you would look for to achieve that.

Yes, I want to remind you that we previously mentioned a decrease in LIBOR, which resulted in a cost of $0.09 per share. This adjustment was made during the lockdown, but it was primarily in response to the significant change in LIBOR rather than to events in our portfolio. We take pride in earning our dividend every quarter, and we believe investors appreciate the stability of the dividend, knowing it is well-earned and adequately covered. Regarding our earnings, we've benefited from prepayment fees, which can be inconsistent. We've seen significant prepayment fees in recent quarters, whereas in the first quarter of last year, we had very few, and that quarter is often seasonally slower. As Paul mentioned, we haven't received any significant prepayment fees this quarter either. We take comfort in our solid dividend coverage, but we understand that the additional earnings from fees, dividends, and prepayments can be irregular.

Thank you, and that does conclude our question-and-answer session for today's conference. I'd now like to turn the conference back over to Howard Levkowitz for any closing remarks.

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

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a wonderful day.