BlackRock TCP Capital Corp. Q2 FY2023 Earnings Call

Ladies and gentlemen, good afternoon. Welcome to BlackRock TCP Capital Corp.’s Second Quarter 2023 Earnings Conference Call. This 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. I would now like to turn the call over to Katie McGlynn, Director of the BlackRock TCP Capital Corp. Investor Relations team. Katie, please proceed.

Thank you, everyone. 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 or warranty with respect to such information. Earlier today, we issued our earnings release for the second quarter ended June 30, 2023. We also posted a supplemental earnings presentation to our website. 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 for TCP’s second quarter 2023 earnings call. I will begin with an overview of 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; and our CFO, Erik Cuellar, will then review our financial results as well as our capital and liquidity positioning in greater detail. I will conclude with a few closing remarks before we take your questions. Turning now to the highlights from the quarter. For the second quarter, TCPC delivered net investment income of $0.48 per share representing a 30% increase year-over-year and an approximate 15% annualized net investment income return on equity. Given the floating rate nature of our portfolio and a higher proportion of our liabilities at our fixed rate, our net investment income continues to benefit from strong underwriting in an environment of higher base rates as well as marginally wider spreads. Our run rate NII as of the end of the second quarter is among the highest in TCP's history as a public company. Our Board of Directors today reaffirmed a third quarter dividend of $0.34 per share, which is reflective of the $0.02 dividend increase the Board has announced since the third quarter of last year. The third quarter dividend is payable on September 29 to shareholders of record on September 15. In addition, and as an acknowledgement of TCP’s strong earnings year-to-date, our Board also announced a $0.10 special dividend payable on September 29 to shareholders of record on September 15. This announcement is consistent with our disciplined approach to the dividend and our emphasis on stability and strong coverage from our recurring net investment income. As a reminder, throughout TCPC’s history, we have consistently and comfortably covered our dividends with recurring net investment income. Phil will discuss our second quarter investment activity in more detail, but in summary, transaction volumes remain muted in this uncertain environment, increasing the importance of our disciplined approach to deploying new capital. Consistent with our historical activity, we’ve reviewed a substantial number of transactions during the quarter and invested in only a small percentage of those opportunities. Given the slowdown in private equity deal volumes, we continue to be reminded of the benefits of our channel agnostic approach to deal sourcing. Because of our direct relationships with management teams and other industry participants, as well as our team’s deep experience investing across cycles and our ability to draw upon the power of the BlackRock platform, our pipeline continues to build and we are encouraged by the compelling opportunities we are identifying. Our underwriting continues to prove very effective with NAV declining a de minimis 0.5% during the quarter, but the unrealized losses being driven primarily by mark-to-market impact on quoted names. The credit quality of our portfolio remains solid, with loans suggesting two portfolio companies are non-accrual as of the end of the second quarter totaling just 0.3% of total investments at fair value, a level that continues to be among the lowest non-accruing levels in TCPC’s history. Finally, while we do not have an explicit forward view on rates, we do believe we’ll be in a slower growth and elevated rate environment for the foreseeable future with a range of macroeconomic uncertainties. It is in complex periods like this that our historical experience and deep industry knowledge are an advantage and have resulted in strong results throughout various market cycles. Looking back at our historical performance as a public company since 2012, we have generated a 10.3% annualized return on invested assets in a total annualized cash return of 9.5%, much of which we delivered while base rates were much lower than they are today. We believe this performance remains at the high end of our peer group and reflects our ability to consistently identify attractive opportunities at premium yields and deliver exceptional returns for our shareholders across market cycles. Now, I will turn it over to Phil to discuss our investment activity and portfolio position.

Thanks, Raj. I’ll start with a few comments on the investment environment before providing an update on our portfolio and highlights from our investment activity during the second quarter. As Raj noted, economic uncertainty has driven a slowdown in market transaction volumes. Institutional leverage loan issuance and U.S. M&A volumes were both down more than 30% year-over-year in the second quarter. Despite the slowdown in market activity, our industry focused deal teams continue to proactively identify unique investment opportunities from a wide range of sources, including directly through industry contacts and management teams, as well as through our traditional sponsor relationships. However, we’re not immune to the year-to-date slowdown in market volumes. We remain disciplined and are passing on more opportunities, particularly when pricing does not appropriately reflect the current market conditions or when terms do not provide adequate lender protections. In the second quarter, TCPC invested $17 million, with deployment of the quarter including loans to two new and two existing companies primarily in senior secured loans. In reviewing new opportunities, we emphasized transactions where we are positioned as a lender of influence, which enables us to leverage our two decades of experience in negotiating deal terms and conditions that we believe provide meaningful downside protection. We believe this has been a key factor in our low realized loss rates over our long-term track record. In addition, our industry specialization, which our borrowers value, provides two key benefits. First, it bolsters our ability to assess and effectively mitigate risk in our underwriting and when negotiating terms in credit documentation. And second, it expands our deal sourcing capabilities and sponsors who value our industry experience, which lends itself to more reliable execution and also with non-sponsors like corporates and family-owned businesses who value an informed balance sheet partner. Follow on investments in existing holdings continue to be important sources of opportunity, with 45% of total dollars deployed over the last 12 months being with existing portfolio companies. TCPC’s largest new investment during the second quarter was a senior secured first lien term loan to support the acquisition and carve out of Global Payments Gaming Solutions division, which has since been rebranded as a standalone business called Pavilion Payments. Pavilion is a payment services provider to the gaming sector, providing a full suite of on-premise and online gaming payment solutions. We view this as an attractive business given strong positioning in an industry with high barriers to entry because of regulatory oversight and unique industry requirements. BlackRock participated as lead lender among a small group of lenders. New investments in the second quarter were offset by total dispositions of $32 million. We also continue to closely monitor our existing portfolio companies. Our team members are continuously engaged in dialogue with owners and operators to assess both current and projected performance relative to our original underwriting assumptions. Given the rate environment, higher input costs, and the general uncertainty in the economy, a few of our portfolio companies are navigating slower revenue growth and/or margin pressure. We’re working closely with the management teams and owners of these handful of companies in this position. However, we recently completed our quarterly review process and are pleased to report that our portfolio generally remains in good shape. Our emphasis is on companies with established business models and proven core customer bases that make them more resilient in times like this. At quarter end, our portfolio had a fair market value of approximately $1.6 billion. 88% of our investments were senior secured debt spread across a wide range of industries, providing portfolio diversity and minimizing concentration risk. We also continue to emphasize companies in less cyclical industries. The portfolio at quarter end consisted of investments in 143 companies, and our average portfolio company investment was $11.5 million. As the chart on Slide 6 of the presentation illustrates, our recurring income is distributed broadly across our portfolio and is not reliant on income from any one company. In fact, more than 90% of our portfolio companies each contribute less than 2% to our recurring income. 86% of our debt investments are first lien providing substantial downside protection, and 94% of our investments are floating rate, clearly an important benefit in this higher rate environment. The overall effective yield in our portfolio increased to 13.8% compared with 9.8% one year ago, reflecting the benefit of higher base rates and wider spreads on new investments. Investments in new portfolio companies during the quarter had a weighted average effective yield of 14.1%, exceeding the 12.2% weighted average effective yield on exited positions. Given further pullback in commercial banks' ability and willingness to lend in this environment, we continue to benefit from a more lender-friendly investment environment with improvements in both pricing and terms relative to 12 months ago. Post quarter end, we’ve seen a modest pickup in activity and have been investing selectively, maintaining our underwriting discipline while being mindful of the inflationary environment. We emphasize companies that have significant pricing power to pass on higher input costs, including increases in their cost of capital. It’s also important to note that we did not underwrite to perfection. We seek to build in sufficient buffers to ensure companies can withstand changes in the macro environment, including higher costs without impairing their ability to service our loan. Our pipeline is building and the yields on investments in our pipeline are generally in line with our current portfolio. To date, we have had no 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. As Raj noted, our net investment income in the second quarter benefited from the increase in base rates over the last 15 months. Net investment income of $27.6 million or $0.48 per share was up 30% versus the second quarter of 2022 and exceeded the second quarter dividend of $0.34 per share, following the $0.02 per share dividend increase announced last quarter. Today, we declared a third quarter dividend of $0.34 per share and a supplemental dividend of $0.10 per share. We remain committed to paying a sustainable dividend that is fully covered by net investment income regardless of the base rate environment, as we have done consistently over the last 11 plus years. Investment income for the second quarter was $0.93 per share. This included cash interest of $0.83, recurring discount and fee amortization of $0.01 and pick income of $0.07. While we did see an uptick in pick income in the second quarter, including $0.02 of one-time pick income, our recurring pick income remains in line with the average over our history. Investment income also included $0.02 of dividend income. As a reminder, we amortized upfront economics over the lack of an investment rather than recognizing all of it at the time the investment is made. Operating expenses for the second quarter were $0.35 per share and included interest and other debt expenses of $0.21 per share. Incentive fees in the quarter totaled $5.9 million, or $0.10 per share. Net realized losses for the quarter were $395,000 or $0.01 per share. Net unrealized losses in the second quarter totaled $11 million, or $0.19 per share, primarily reflecting mark-to-market impact on market quoted names. These included unrealized losses of $3.9 million in our investment in Astra Acquisition, a $3.4 million unrealized loss in Thras.io, and $2.2 million on our investment in Magenta, as well as a $3.4 million unrealized loss on our investment in Hylan. Unrealized losses were partially offset by a $6.3 million unrealized gain on our investment in Secure. The net increase in net assets for the quarter was $16.3 million or $0.28 per share. As a reminder, we have a robust validation process and 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. This process is also subject to rigorous oversight, including back testing of every disposition against our valuations. As Raj noted, the credit quality of our overall portfolio remains strong. Only two portfolio companies were of non-accrual status at the end of the second quarter, representing 0.3% of the portfolio at fair value and 0.5% on cost. Now turning to our liquidity. Our balance sheet positioning remains very strong, and we ended the quarter with total liquidity of $333 million relative to our total investments of $1.6 billion. This included available leverage of $210 million and cash of $123 million. Unfunded loan commitments to portfolio companies at quarter end equaled 5% of total investments for approximately $90 million, of which only $35 million were revolver commitments. Our diverse and flexible leverage program includes two low-cost credit facilities, two unsecured notes issuances, and an SBA program. In April, Fitch reaffirmed TCPC’s investment-grade rating with a stable outlook. Our unsecured debt continues to be investment-grade rated by both Fitch and Luis. 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, we’re 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 increased modestly to 4.28%. This compares with 3.26% at the end of 2021, representing an increase of only 102 basis points over the last 18 months, while base rates increased approximately 504 basis points during that same period. This is the result of having over 70% of our borrowings from fixed rate sources. Now, I’ll turn the call back over to Raj.

Thanks, Erik. Even as market volatility persists, we are confident in our proven strategy and approach to investing that has delivered stronger risk-adjusted returns for our shareholders throughout different economic environments. We believe we have demonstrated a consistent ability to execute in both periods of economic growth and contraction. This also makes us a reliable partner for our borrowers and further helps us to attract appealing investment opportunities. With that operator, please open the call to questions.

Thank you. Our first question today comes from Christopher Nolan from Ladenburg Thalmann. Please go ahead, Christopher. Your line is now open.

Hey guys. Raj, discussing the deals that you guys walk away from, you made a comment that they’re not able to meet their terms and conditions. Has TCPC basically made their terms and conditions tougher than before? Or is the company’s performance just weaker than just not making it?

Thanks for the question, Chris. I wouldn’t say that we’ve made them tougher. I think categorically, we are focused on many of the same things. Unfortunately, that’s been a focus coming into this environment. I would highlight those as real financial covenants. The documentation particularly reflects areas of leakage, payments out in front of us and similar concerns. I would say in some cases, the levels of those items have tightened up, like loan-to-value multiples percentage or buffer off of our targeted covenants. Certainly, we’ve tightened up, and in some cases it’s just a little more murkiness of the credit, where what we want and our targeting may not match up with what is available. So, and all of this is in a context of, as Phil mentioned, just a lower deal environment overall. For us, it’s never been about just growing for the sake of growth. You’ve seen us have lower deployment quarters even in front of more active environments, and I think that’s just one of the things that results from how we approach the market. But I wouldn’t call it tougher or new items. I think it’s probably marginally tighter, in an environment of more uncertainty, needing more buffer. And I think the outcomes are good credit performance, holding assets for longer, and, in some cases, occasionally lower deployment, which is fine in this context.

My follow up question is on value, please.

Sorry, Chris. I’ll just add that our pass rate has always been quite high. We pass on over 90% of our deals, so we’ve always been very selective and continue to be in this market environment. A lot of companies seeking financing often come from M&A; if you don’t need to be a seller in this environment and you can wait, you should to get perhaps a higher valuation later on, given the uncertainty in the environment and the impact on valuation multiples. The highest quality assets are still on the sidelines, waiting to transact. What we’re seeing in the market are firms needing refinancing or financing, and they may have a more complex story. We remain selective, but that gives context to the type of flow we’re witnessing.

Great. And as a follow-up question concerning valuations. I was surprised to see the number of unrealized appreciation in the quarter, and it raises the question, since most investments in the BDC land tend to be some variation on discounted cash flow, what is the risk-free rate that your valuers use given that we have an inverted yield curve where short-term rates are higher than long-term rates? Because if you’re keying off short-term rates, which is what your investments key off of, the valuations for many of these things should go down. I just want to get clarification.

Yes, I’ll try to add some color. Ultimately, I think you’re highlighting the key point, which is this book is valued almost completely by third parties or in the case of market quotes, where the market quotes are available, which has been more the driver of some of the unrealized losses. As far as the valuation providers go, they typically take a triangulation of approaches. It’s not just a discounted market rate. There will be precedents in transactions particularly around M&A, and there will be some applicability to public market comps. There is typically a reference rate and then a spread is adjusted above that. They do try to take a longer-term view on the discounted cash flows, and whether they’re using three months SOFR or a forward curve adjustment in the forecasted rates will depend on the provider. From a high-level perspective, we have taken some marks in earlier quarters, but there was more volatility and a recovery in equity markets this year, which has resulted in taking more mark downs. Part of this market is more of what’s happening in the public market equity that has a knock-on effect on their approach.

Okay, thanks, Raj.

And Chris, I’ll add, as Raj noted, where we are doing fundamental valuations by the valuation providers, they are using market spreads. The spreads they are observing in the public markets are typically what they use to discount cash flows as needed on a one-off basis. The markdowns we saw were primarily on the more traded loans we hold, which tend to have more volatility in markets like this.

Thank you.

Thank you. Our next question today comes from the line of Robert Dodd from Raymond James. Please go ahead, Robert. Your line is now open.

Hi guys. A couple of questions. First I got to ask about the dividend of $0.10, and I realize again, it’s a board decision, but the $0.10 special, would it be reasonable to assume, I mean, if we look at the forward curve, which is, as it stands today, projected to come down slowly, your earnings could stay elevated for some time and generate earnings well in excess of the base dividend. So, should investors expect or anticipate maybe that the $0.10 special this quarter continues in future so long as earnings exceed the base dividend by a sizable margin? Or can you give us any color on how that’s being thought about?

Yes. Thanks for the question, Robert. I’m glad you’re here. Let me provide a little color. As you know, we are focused on being prudent and disciplined around the dividend. I wouldn’t call us a fast mover in this regard, but rather methodical and deliberate. We are focused on a sustainable dividend. The special dividend is an effective way to provide more cash back than an increase on an annualized basis. It does not compel us to project forward, and as we’ve done that, we are cautious because a lot of our historical benefit has been linked to reference rates, which could come down, even if they seem elevated for a while. Our board will continue to assess and look to reward our shareholders, determining the best way to do it. We have several options, which could be more immediate or more on a run-rate basis. I would not forecast one over the other, but if we maintain our elevated return and credit quality, then our board will explore this with a focus on sustainability and ensuring comfortable dividend coverage. This is a continuous and quarterly assessment, resulting in rewards for shareholders through dividend increases and special dividends.

I appreciate that. Very helpful. Thank you. Then secondly, you mentioned a couple of portfolio companies experiencing slower growth. One of your traded names was called out by S&P as having some deterioration and may not have a sustainable capital structure without additional equity from sponsors. So in general across that, I mean, what are the conversations with sponsors looking like? Are they willing to step up and put the equity in to tie these businesses over? Or how’s the negotiation front cover?

Yes, Robert, thanks for the question. This is Phil. So that’s a great question because it touches on the nature of where private equity sponsors are today with their portfolio and their willingness to protect their positions. We’re seeing an increase in amendment activity primarily due to the covenants in place, which reflects the benefits of how we’ve structured our deals. Without these covenants, the only opportunity for us to engage sponsors typically arises during a payment default. Structuring covenants that imply meaningful equity value allows us to connect stakeholders in engaging discussions. Each of these amendment negotiations serves as opportunities for us to de-risk our loans. Restructuring, as you know, does not occur in a vacuum but through ongoing events, and these discussions provide a chance to mitigate risk.

I appreciate that. Thank you.

Thank you. Our next question today comes from Ryan Lynch from KBW. Please go ahead, Ryan. Your line is now open.

Hey, good morning. First question, I had is in your comments here, you talked about conducting a thorough review of your entire portfolio every quarter to stay ahead of any potential issues. I would just love to get some more details on what that portfolio review entails from your end.

Yes, thanks for the question. Our investment teams are organized by industry for specialization. We monitor ongoing performance continuously, but the quarterly review process includes discussions with management, stakeholders, financial assessments, and broader industry reviews. This results in a formal memorandum for our investment committee. This ongoing vigilance enriches our understanding of the borrowers' positions and market dynamics, leveraging the broader BlackRock platform for insights.

Okay. That’s helpful. Following up on one of Robert’s questions regarding the dividend, I understand that’s a board decision, but Raj, you’re the Chairman of the Board, so I’d love to hear what is either your opinion or the board’s, if you can speak for the board’s opinion on what is the hesitancy for increasing the dividend closer to the core earnings power of TCPC's businesses today, given where current base rates are, and then if base rates end up changing and going down, which they will of course at some point, reducing the dividend to match the current environment of base rates. What’s the hesitancy to not pay out near to the earnings power of the business and then adjust depending on base rates over long periods?

That’s a good question. I wouldn’t call it a hesitancy. Our intent is to reward shareholders as much as we can sustainably. Part of the reason is that earnings have moved positively and rapidly, and we’re discussing a 30% year-over-year increase in our NII. That pace furthers a cautious approach toward immediate action. The frequency of changes can undermine our credibility. We aim for stability in our dividend, and we’ve maintained that. We are proud that we maintain dividends every quarter since going public, a feat not many can claim. We want to balance rewarding shareholders while maintaining the capacity to pay dividends. Continuous reassessment will lead us to sustainable increases and ensure shareholder confidence is upheld.

Yep. No, that’s helpful. I understand the reasoning behind it. That’s all from me. I appreciate the time today.

Thank you.

Thank you. We appreciate your participation in today’s call. I would like to thank our team for their continued hard work and dedication. I would also like to thank our shareholders and our capital partners for your confidence and support. Thanks for joining us. This concludes today’s call.