BlackRock TCP Capital Corp. Q2 FY2022 Earnings Call

Ladies and gentlemen, good afternoon. Welcome everyone to BlackRock TCP Capital Corp’s Second Quarter 2022 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 the BlackRock TCP Capital Corp. Investor Relations team. Katie, please proceed.

Thank you, Bethany. 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. Additionally, certain information discussed and presented may have been derived from third-party sources and has not been independently verified. Accordingly, we make no representation of warranty with respect to such information. Earlier today, we issued our earnings release for the second quarter ended June 30, 2022. 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.

Thanks, Katie, and thank you all for joining us today for TCPC’s second quarter 2022 earnings call. As usual, I will begin today's call with a few comments on the market environment, as well as highlights from our second quarter results. I will then turn the call over to our President and Chief Operating Officer, Phil Tseng, who will provide an update on our portfolio and investment activity. Our CFO, Erik Cuellar, will then review our financial results, as well as our capital and liquidity positioning in greater detail. I will then conclude with a few closing remarks, before we take your questions. As many of you are aware, the current economic environment is characterized by negative GDP growth, the highest inflation rate in generations, and aggressive Fed tightening. Within this environment, direct lending continues to be a reliable source of financing for a wide spectrum of middle-market companies and a reliable source of returns for investors. We have often noted that direct lending has outperformed other segments of the market during periods of instability, and we believe that remains the case in the current environment. As a reminder, the assets we invest in are typically senior in the capital structure and underwritten with meaningful lender protections. These often include significant collateral packages and contain real covenants, specifically tailored to each borrower's business and industry. Our strategy has always focused on core middle-market businesses in diverse, resilient, and less cyclical industries. These companies have historically outperformed their larger corporate counterparts during economic downturns. For example, during 2007 to 2009, the middle market added 2.2 million jobs while larger businesses actually shed 3.7 million jobs. It seems like we have been living in unprecedented times for some time now. Prior to 2020, none of us considered a global pandemic and an economic shutdown in our base case underwriting. Since the initial COVID shock, the pandemic and supply chain pressures have contributed to an inflationary environment that many haven't experienced in quite some time or ever for that matter. However, our team's proven ability to identify and invest in businesses that successfully managed periods of economic stress gives us confidence in the resiliency of our approach to direct lending. Regardless of the market environment, we have always been disciplined on our underwriting standards and evaluated the borrower's ability to manage in times of stress through both a forward-looking view and a historical lens of performance. We remain confident in the strength of our diverse portfolio to continue to withstand periods of economic volatility. So what does this all mean for the existing portfolio? I'm very glad to report that the portfolio remains in excellent shape. Clearly, in many sectors, growth is slowing, inflationary pressures, especially for wages, have resulted in a degree of margin erosion, and where applicable, supply chain issues have further pressured earnings. However, we have been pleased with our borrowers’ proactive actions to these pressures, including curbing spending and their ability to find cost savings in other parts of the organizations. We have also been able to further validate relatively inelastic demand for their products or services and have observed an ability to pass along cost increases to their end customers. Furthermore, given the floating rate nature of our strategy, interest rate increases are actually a benefit to our portfolio. And of course, we continue to closely monitor our borrowers' ability to service debt in a rising rate environment. Let's now turn to our second quarter performance and a few highlights from the quarter. First, we delivered solid net investment income of $0.37 per share, which exceeded our second quarter dividend of $0.30 per share. This extends our record of continuous dividend coverage throughout our more than 10 years as a public company. And today, our Board of Directors declared a third quarter 2022 dividend of $0.30 per share, payable on September 30, to shareholders of record on September 16. Second, our portfolio credit quality remains strong. As of June 30, non-accruals were just 0.3% of the portfolio at fair value. Our excellent asset quality is a function of our disciplined and consistent underwriting practices. And third, as Phil will discuss in more detail, the strength of our underwriting platform continued to drive solid investment opportunities that resulted in a total of $103 million deployed, with a total of nine investments during the second quarter. This is a testament to the strength of the relationships we've developed with a variety of deal sources over our more than two decades in direct lending, as well as the extensive resources and relationships of the broader BlackRock platform. Sales and repayments during the second quarter totaled $82 million, resulting in net acquisitions of $21 million. During the quarter, we continued to exceed our cumulative total return hurdle. As a reminder, TCPC maintains a 7% hurdle rate based on total returns, including realized and unrealized gains and losses with a cumulative look-back. Since 2012, when we took TCPC public, we have generated a 10.7% annualized return on invested assets and a total annualized cash return of 9.4%. We believe that this is at the high end of our peer group, demonstrating our ability to consistently identify attractive opportunities at premium yields and deliver exceptional returns to our shareholders. NAV did decline 2.1% during the second quarter, primarily as a result of widening market credit spreads, which resulted in net unrealized losses on our existing portfolio. These unrealized losses were partially offset by net investment income in excess of the dividend. Now, I’ll turn it over to Phil to discuss our investment activity and portfolio positioning.

Thanks, Raj. Despite the public market volatility, we continue to capitalize on the scale of our platform, and the rest of our team experienced in identifying attractive investment opportunities. At quarter end, our portfolio had a fair market value of approximately $1.8 billion; 89% of our investments were senior secured debt spread across a wide range of industries, providing portfolio diversity and minimizing concentration risk. As we've previously noted, our portfolio is weighted towards companies with established business models in less cyclical industries. The portfolio at quarter end consisted of investments in 122 companies. As the chart on the left side of slide 6 of the presentation illustrates, our recurring revenue income is distributed broadly across our portfolio and is not reliant on income from any one company. In fact, more than 90% of our portfolio companies each contribute less than 2% of our recurring income. 84% of our debt investments are first lien, providing significant downside protection, and 95% of our debt investments are floating rate, positioning us well for the current rising rate environment. Moving on to our investment activity, as one of a small group of reliable lenders capable of providing complete and customized financing solutions, we focus on transactions where our US private capital team acts as lead or part of a small club of lenders. This enables us to negotiate deal terms and conditions that we believe provide meaningful downside protection on our investments. Robust lender protections, including substantial collateral and tailored covenant packages, are particularly important in periods of economic volatility. We have delivered for borrowers and deal sources on over 1,000 transactions across the US private capital platform. Our extensive long-standing relationships provide us an advantage in identifying and assessing investment opportunities in this current environment. In addition, our industry specialization, which our borrowers truly value, bolsters our ability to assess and underwrite risk. We source an increasingly large set of investment opportunities from multiple channels – and while we've been actively deploying capital in this market, we maintain a very disciplined approach to investing. We regularly review a substantial number of opportunities but only invest in a small fraction of them. General market activity was slower in the first half of 2022, relative to the record levels we saw in 2021 based on M&A and refinancing. However, we actually continue to see strong new deal activity, which allowed us to be highly selective. TCPC invested $103 million in the second quarter, primarily in nine investments, including loans to six new portfolio companies and three existing ones. Follow-on investments in existing holdings continue to be important sources of opportunity, accounting for 50% of total dollars invested over the last 12 months; incumbency is an important factor in sourcing investment opportunities, and we believe that advantage will only increase if economic conditions continue to deteriorate. These are companies we already know and understand well, and therefore, are very comfortable in making follow-on investments. As we analyze new investment opportunities, we emphasize seniority in the capital structure, portfolio diversity, and transactions where our US private capital team acts as leader or part of the club. TCPC's largest investment during the second quarter was an incremental first lien term loan to Altice. The company provides AI-based market intelligence to financial services and corporate clients. Our team was selected to provide the financing given our reputation and scale despite offers from other lenders at lower pricing. BlackRock's US Private Capital team acted as the sole lender to refinance Alpha's existing debt and subsequently to provide acquisition financing. We saw this as an attractive opportunity to invest in a company with robust growth and a highly visible revenue stream from an entrenched blue-chip customer base. Our second largest investment in the quarter was our first lien term loan and revolver to Beqom, a global provider of compensation management software. The sponsor reached out to us directly to provide the acquisition financing, and we've served as the sole lender. We view this as an opportunity to lend to an industry leader with a strong value proposition, high-quality retention rates that provide high revenue visibility and a diverse existing client base. As Raj mentioned, new investments in the first quarter were partially offset by dispositions and repayments totaling $82 million as we had several successful exits and paydowns. The overall effective yield on our portfolio was 9.8% as of June 30, reflecting the benefit of higher interest rates now that substantially all of our loans are above the floors. Investments in new portfolio companies during the quarter had a weighted average yield of 8.9%, exceeding the 8.8 weighted average effective yield on exit conditions. Given that 95% of our debt portfolio is floating rate and the majority of our outstanding liabilities are fixed rate, we are well-positioned for further rate increases. We continue to invest selectively, maintaining our underwriting discipline and being mindful of the inflationary environment. We focus on companies with established business models that are well-positioned to succeed throughout economic cycles. And our pipeline currently is healthy, and we're sourcing attractive opportunities across multiple 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 third quarter. Let me now turn it over to Erik to walk through our financial results as well as our capital and liquidity positioning.

Thank you, Phil. I'll start by turning to our financial results for the second quarter. We generated strong net investment income of $0.37 per share, which exceeded our dividend of $0.30 per share. Investment income benefited in part from the increase in base rates, and given the majority of our loans reset quarterly, we expect to see further benefits from the rate increases in our third quarter net investment income. We are committed to paying a sustainable dividend that is fully covered by net investment income, as we have done consistently over the last 10 years. And today, as Raj noted, we declared a third quarter dividend of $0.30 per share. Investment income for the second quarter was $0.76 per share. This included recurring cash interest of $0.61 and recurring discount and fee amortization of $0.04 and pick income of $0.03. Notably, our pick income remains near its lowest level in the last three years. Investment income also included $0.05 of dividend income and $0.03 from accelerated OID and exit fees. As a reminder, our income recognition follows our conservative policy of generally amortizing upfront economics related to the investment rather than recognizing all of it at the time the investment is made. Operating expenses for the second quarter were $0.32 per share and included interest and other debt expenses of $0.16 per share. Incentive fees in the quarter totaled $4.5 million or $0.08 per share. Net realized losses in the second quarter totaled $18.4 million or $0.32 per share and included $13.8 million from the realization of previous unrealized losses on our investment in Fishbowl as a result of the company's restructuring, and $13.3 million from the realization of previous unrealized losses on our investment in Avanti. These were partially offset by an $11 million gain from the exit of our investment in CORE Entertainment. Net unrealized losses totaled $3 million and were primarily driven by widening market spreads, which had a negative impact on the mark-to-market of our existing portfolio. The impact of wider spreads was partially offset by a $6.7 million unrealized gain on our investment in Edmentum as well as the reversal of the previously recognized unrealized losses on Fishbowl and Avanti. The net increase in net assets for the quarter was $128,000 or less than $0.01 per share. 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. Our process is also subject to oversight, including back testing of every disposition against our valuations. Our credit quality remains strong with non-accrual loans at quarter end limited to only two portfolio companies that represent just 30 basis points of the portfolio at fair value and 50 basis points at cost. Now turning to our liquidity. We ended the quarter with total liquidity of $237 million relative to our total investments of $1.8 billion. This included available leverage of $187 million and cash of $49 million. Unfunded loan commitments to portfolio companies at quarter end equal 8% of total investments, or approximately $142 million, of which only $25 million were revolver commitments. Our diverse and flexible leverage program includes two low-cost credit facilities, two 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 maturities remain well-laddered. Additionally, due in part to the opportunistic add-on bond issuance that we executed in August of last year, when we took advantage of an attractive financing environment at the time, we are comfortable with our current mix of secured and unsecured financing and do not have any immediate financing needs. Combined, the weighted average interest rate on our outstanding borrowings decreased to 3.19% from 3.26% at the end of 2021. Now I'll turn the call back over to Raj.

Thanks, Erik. To conclude, we delivered another strong quarter of results and are confident in our team's ability to generate attractive ongoing risk-adjusted returns for our shareholders in this complex and evolving environment. Volatility and uncertainty in the public markets this year has been driven by inflation concerns and geopolitical instability. In periods of economic uncertainty, we are reminded of the benefits of private credit, which has historically performed well throughout economic cycles. To reiterate, our loans are typically at the top of the capital stack, often with collateral protections and with significant equity and/or subordinated capital structured below our investments. Additionally, we structure our loans with meaningful financial and maintenance covenants, and our portfolio remains well diversified by issuer and industry. It is in periods of market volatility that the strength of our diversified strategy and depth of our team's experience is a particular advantage. Our investment team's expertise consists of performing direct lending and special situations investing. This combination of investing experience, in addition to our focus on transactions where BlackRock either leads or co-leads negotiations on deal terms, ensures that we structure loans that are priced appropriately and include adequate downside protection, which has contributed to our team's exceptional long-term performance. And with that, operator, please open the call for questions.

Certainly. Our first question is from the line of Kevin Fultz with JMP Securities. Please go ahead.

Hi. Good morning and thank you for taking my questions.

Good morning.

I'd like to start by asking about your thoughts around maintaining the level of the dividend at $0.30 per share. Obviously, over the past two quarters, you've easily covered the dividend and with an outlook for rising base rates driving further net investment income acceleration, it would appear that a dividend increase could be supported. Just curious if you could share some high-level thoughts about how you're thinking about things there.

Yes. Kevin, thank you for the question. By no means is that a surprise, I think, in the current environment. I would say, as we said in the past calls, our focus is to maintain a well-covered and stable dividend, one that has a lot of protection and visibility. I think the environment certainly, for the marginal dollar has more return to it. But when you bifurcate that, a lot of that return is coming through rates, increase in rates that we've seen benefit from and just operating leverage in the portfolio. If you kind of make your way through the one-time benefits and just the run rate of the portfolio, it's higher; it's roughly $0.32. But when we think about any change to the dividend, we really need to make sure that the components that are driving that higher dividend and coverage of it are more visible and stable. And I think for the current quarter, it was just too early to determine if that was the case. And we're continuing to assess it, as we do every quarter with the Board and just kind of making our way through the portfolio and just environmental components. So, it's certainly a timely and relevant question. I think it doesn't change our operating philosophy of what we think is valued in a dividend, which is a stable, uncovered dividend. And as we kind of get our hands around the components that drive the stable uncovered dividend, I think we're going to continue to assess it within the context of the environment and our outlook. Hopefully, that helps give you some clarity.

Okay. That all makes sense. And then just one follow-up if I can. Originations were understandably on the later side in the second quarter given the slowdown in M&A activity and macro uncertainty. But it appears you're able to find some attractive opportunities still. Can you provide some commentary around expectations for the deal environment and then also net origination activity levels for the back half of the year?

Yes, we still expect healthy origination volumes. While we are not a reflection of the overall private credit market, we recognize a general slowdown in M&A, particularly in refinancing activities. However, our trend remains different; we are continuing to be selective and heavily involved in the industries we prefer, and we anticipate this will persist in the next two quarters. We have established strong relationships in many of the sectors we operate in, and we are frequently approached to engage early in these processes as buyers seek financing certainty to present strong bids. Additionally, BlackRock's broader sourcing platform enhances our capabilities further.

Okay. Got it. And that's it for me. Congratulations on a solid quarter.

Thank you.

Thank you. Next question.

Our next question comes from the line of Ryan Lynch with KBW. Please, go ahead.

Good morning. My first question is about the benefits from rising rates. There was a significant increase in the second quarter, but we won't see its full effect on loans until the third quarter. Could you clarify whether you expect the benefits from rising rates in the third quarter to be greater than in the second quarter? It would be helpful to understand the potential impact.

Yes, Ryan, this is Erik. Thanks for the question. And we do expect to see that flow through even more so in Q3. And as you mentioned, not completely all of the rate increases because of the lag when they do reset. The table that we put forth in the Q and in the presentation gives you a rough idea. If we were to see the full benefit run through in any single quarter, it could be up to $0.05 per quarter. Again, we expect to see a partial benefit from that, so probably more in the range of $0.02 to $0.03 of incremental income for the quarter.

That's helpful. I would like to know more about your investment in Juul. Recently, there's been news that Altria has significantly written down their investment, by over 95 percent from the original amount. They recently reduced that investment further. The FDA had initially banned the product, but then reopened the application for review. I'm curious about your position in the capital structure, knowing you're in a first lien position. However, as the equity approaches zero, I wonder if there's any capital that ranks below your first lien, such as sub-debt or second lien, or if the capital structure consists only of the equity and your first lien position.

Yes, I can address that. This situation certainly has garnered a lot of attention, and we are being a bit cautious as a result. We anticipate discussions occurring outside of our current perspective. To clarify, we first noticed the FDA's actions in July when they publicly announced the shutdown. Overall, in response to your question, there is senior capital beneath our first lien. Even with the write-down in the convertible bond, the equity still retains some value. While it’s not as valuable as it once was, we believe we remain secure at this level despite the headlines and the associated volatility. We feel confident in our position as first lien holders. There is senior capital under us, and the public narrative may continue to have its headline impact, but we are comfortable with where we stand.

Okay. I appreciate the commentary. I understand the sensitivity around not saying too much. That's all for me. I appreciate the time today.

Thank you.

Thank you, Mr. Lynch. Our next question comes from the line of Robert Dodd with Raymond James. Please go ahead.

Hi everyone. Congratulations on the quarter. First, I have a quick question. Regarding the strong dividend income this quarter, is this a regular amount, or was there any special one-time dividend income this quarter?

Hi Robert, this is Erik. We do have a level of recurring dividend income, which has been approximately $0.03 per quarter. And we do view that as recurring. This quarter, we did get approximately a little over $0.02 of what we would consider non-recurring dividend income from 36th Street, which has continued to perform very well and just made an incremental distribution this quarter.

I appreciate that. Thank you. There was a comment earlier about the pipeline; I can't recall your specific discussion on it. The yields appear to be generally consistent with the portfolio. What does this indicate? Is the pipeline mostly aligned, suggesting that in the existing positions you're in, there are no signs of spread widening on opportunities currently? Is that correct, or do you anticipate any spread widening in this environment?

Certainly. From a total return perspective, there are various ways to achieve returns. We observe that spreads are at least stable and, in some cases, widening for new investments as our target returns and hurdle rates have increased. A significant portion of the return increase has been due to the rise in the reference rate, primarily SOFR instead of LIBOR, which is impacting the portfolio. Additionally, elements that might not be immediately visible in the current yield include OID widening, which we amortize rather than take upfront. We now have more leverage regarding prepayment structures, allowing for potentially more favorable terms in the future. Overall, the opportunity set and pricing environment are positive, with the majority of the increase in returns linked to the reference rate. Discussions with borrowers are ongoing, facilitating the ability to maintain or even widen spreads to meet higher return targets. These factors will manifest at different stages throughout the deal life, confirming that the environment is indeed improving.

I appreciate that. Sorry, go ahead.

I appreciate your input, Robert. I would like to add that our focus is on assessing risk and reward, and it's not just about seeking higher returns. In this environment, we are not necessarily pushing prices higher; rather, we are concentrating on managing risk. This includes negotiations aimed at obtaining better structures, such as lower leverage, tighter covenants, and enhancements to credit documentation. Our goal is to ensure we are not only enhancing yields but also protecting against potential downsides to manage risk effectively.

Got it. Yes, it's definitely a risk-reward business. It's not just a reward business. On last one, if I can. I saw in the press release, I think the manager has been when it comes to valuation, does it mean? Can you tell us what that means in a practical sense?

Sure, Robert. What it doesn’t mean is that there’s any change in the valuation process at all. Really, historically, the Board has been the one approving the valuation and with the adviser performing substantially all of the valuation procedures. Now, this just formalizes the process by which the adviser continues to fulfill the valuation policies and procedures. So, no real change in any of the valuation processes.

Okay. Got it. Thank you.

Thank you, Robert.

Thank you, Robert.

Our next question comes from the line of Christopher Nolan with Ladenburg Thalmann. Please go ahead.

Hey, guys. That's a controlled company. And what sort of business? Is it a restaurant business or a hotel? I mean, a little color around where it is?

Fishbowl, now renamed Personica, is a software platform designed for restaurants that enhances marketing solutions for the quick-service segment of the industry. As we've mentioned previously, the business was significantly affected by COVID-19 shutdowns and experienced management changes. We have recently completed the recapitalization of this business, and we now co-own it with the sponsor. This process helped us to bolster the balance sheet with additional capital while also allowing us to pay down debt at par. There are still challenges with this credit, but we're feeling optimistic with the appointment of a new CEO who brings expertise in restaurant technology. We believe we are now better positioned, particularly in terms of capital structure, to meet our growth targets.

Great. That's it for me. Thank you.

Thank you.

Thank you, Mr. Nolan. There are no additional questions at this time. I would like to pass the conference back to Raj Vig for any closing remarks.

Thank you, operator. 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 their confidence and their continued support. Thanks for joining us. This concludes today's call.

That concludes the BlackRock TCP Capital Corp.'s Second Quarter 2022 Earnings Conference Call. I hope you all enjoy the rest of your day.