BlackRock TCP Capital Corp. Q4 FY2023 Earnings Call

Ladies and gentlemen, good afternoon. Welcome to BlackRock TCP Capital Corp's Fourth Quarter and Full Year 2023 Earnings Conference Call. This conference call is being recorded for replay purposes. 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, Emily. 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 fourth quarter and full year ended December 31, 2023. We also posted a supplemental earnings presentation to our website at www.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, Raj Vig.

Thanks, Katie, and thank you all for joining us for TCPC's Fourth Quarter and Year-End 2023 Earnings Call. I will begin the call with an overview of our fourth quarter and full year results and then provide an update on our proposed merger with our affiliate BDC BlackRock Capital Investment Corporation or BCIC. Phill Tseng, our President and Chief Operating Officer, will then review the investment environment and our portfolio activity. Erik Cuellar, our Chief Financial Officer, will review our financial results as well as our capital and liquidity in detail. Finally, I will wrap up with a few comments on the outlook and opportunities we see ahead before taking your questions. Let's begin with a review of highlights of our fourth quarter and full year results. I am pleased to report that for the full year 2023, TCPC delivered net investment income of $1.84 per share, an increase of 20% over 2022. Our annualized net investment income return on equity for the year was 14.5%. Given our predominantly floating rate portfolio and higher proportion of fixed rate liabilities, our net investment income for the period benefited from strong credit performance, higher base rates, and marginally wider spreads. Net investment income for the fourth quarter was $0.44 per share, and our run rate NII at the end of the quarter again remained among the highest in TCPC's history as a public company. During the fourth quarter, our NAV declined 6.4%, reflecting in part the special dividend of $0.25 we paid on December 31, in addition to our regular dividend. Excluding this special dividend, NAV declined 4.5%, primarily due to net unrealized losses on three portfolio companies, Edmentum, Thrasio, and Securus. We will discuss each of these companies in more detail, but I would like to emphasize that the write-downs in the fourth quarter are mostly the result of unique circumstances impacting the aforementioned portfolio companies, and in the case of Thrasio, the subsector in which it operates, versus any indication of broader credit or macroeconomic-related challenges to our portfolio. Despite concerns in the market about how higher interest rates and the recession might be pressuring middle-market borrowers, we believe that, in general, our portfolio companies are successfully navigating the current environment given the proven resiliency of the sectors and companies we focus on. In fact, as of the most recent quarter, the majority of our portfolio companies continue to report revenue and margin growth in their businesses. Now turning back to the three primary contributors to net unrealized losses in the quarter. I'll begin with Edmentum, which has been a long-term beneficiary of the shift to online learning, which accelerated during COVID, but is now experiencing a reversion to a more normalized but still positive demand environment. As a reminder, our current investment in Edmentum is a residual equity position after receiving full repayment of our original debt investment. While we remain confident in the process for this well-positioned business, given overall positive secular trends, we reversed a portion of the unrealized gains we had previously recognized on our investment to reflect current demand and performance expectations. Second is Thrasio, an Amazon aggregator that along with much of the sector had initially been impacted by COVID-related supply chain issues and then by slowing growth in online consumer spending. The combination has generally left industry participants, including Thrasio with temporary excess inventories and many with overly leveraged balance sheets relative to their current operations. While we placed this loan on non-accrual during the beginning of the most recent quarter, we have actually been working closely for some time now with the management team and other lenders to improve liquidity and position the company for long-term success. As of yesterday, this involved the company formally filed for bankruptcy to accelerate the achievement of a number of these objectives as well as to incorporate a protected lender-led financing. I'd like to highlight that our team began reviewing and ultimately investing in the aggregator space relatively early, and we believe we have selected the ultimate winners in this growing space. Generally, these will be scaled players that have management teams with the experience, funding, and ability to navigate these temporary industry challenges. Third, Securus has faced mark-to-market volatility over the last several quarters, reflecting broad market conditions as well as some company-specific issues. While 2023 performance has tracked ahead of prior years, Securus has faced liquidity tightness due to an elevated cost structure and CapEx requirements as part of a large 2022 product tablet rollout and upcoming debt maturities. We are in active discussions with key stakeholders regarding next steps and the path forward. As a reminder, our team has unique expertise and a proven track record of success, working through challenging credits such as these. We are leveraging this expertise and proactively working with the management teams, owners, and lenders of these businesses to drive performance improvements and ultimately a positive outcome for our investments. Importantly, outside of these idiosyncratic situations, the credit quality of our portfolio remains solid. Now turning to our dividend. Today, our Board of Directors declared a first quarter dividend of $0.34 per share, which is consistent with our fourth quarter regular dividend. This first quarter dividend is payable on March 29 to shareholders of record of March 14. We have always taken a disciplined approach to the dividend with an emphasis on stability and strong coverage from our recurring net investment income. Throughout TCPC's history, we have consistently covered our dividends with recurring NII and have also paid several special dividends, including in recent quarters. Before handing it over to Phil, I'd also like to give a quick update on the proposed merger of TCPC with BCIC. As we approach the shareholder vote, we look forward to closing the transaction as promptly as possible following the successful vote of each BDC. We remain excited about the potential for the transaction which will combine two very similar portfolios that we know well with substantial overlap, and we expect to create meaningful value for all shareholders. We hope that any of our shareholders who have not yet voted on the transaction will vote today or in the near future. Now I will turn it over to Phil to discuss our investment activity and portfolio.

Thanks, Raj. I'll start with a few comments on the investment environment before providing an update on the portfolio and highlights from our investment activity during the fourth quarter. Starting with the investment environment. While economic uncertainty resulted in a slowdown in private credit transactions in the first half of 2023, we saw a modest pickup in the fourth quarter. This was driven by pockets of activity in both sponsor and non-sponsor opportunities, refinancing, and follow-on financings to support existing portfolio companies. Over the past nine months or so, we've seen an increased bifurcation within the direct lending market. Many have observed more borrower-friendly trends such as tightening pricing and covenant light deal structures. These are especially prevalent in the upper middle market, given the robust return of banks. However, the core middle market where we focus has been less impacted by this trend, but we continue to leverage our industry expertise to opportunistically source and invest in the scope of deals that present attractive risk-reward opportunities. We remain disciplined and continue to pass on a substantial number of less attractive opportunities, particularly when we believe that pricing does not adequately reflect the corresponding risk or terms that don't provide adequate lender protections. In the fourth quarter of 2023, we invested $40 million primarily in first lien loans, with deployment in the quarter including five new and one existing portfolio company. Consistent with our strategy, our emphasis remains on companies with established business models and proven core customer bases that make them more resilient. In reviewing the opportunities, we emphasized transactions where we are positioned as a lender of influence. That is where we have a direct relationship with the borrower and the ability to leverage our more than two decades of experience in negotiating deal terms and conditions that we believe provide meaningful downside protection. We believe this has been a key driver of the low realized loss rates we've experienced over our history. Our industry specialization continues to be an advantage, as it provides two key advantages for us in this environment. First, it enhances our ability to assess and effectively mitigate risk in our underwriting when we negotiate terms in credit arrangements. And two, it expands our deal sourcing capabilities with sponsors and non-sponsors who value that industry expertise, which lends itself to more reliable execution in their eyes. Follow-on investments in existing holdings continue to be an important source of opportunity for us. About half of the dollars we deployed over the last 12 months were with existing portfolios. Our largest new investment during the fourth quarter was a $25 million secured first lien term loan we led to support the acquisition of Mesquite Gaming. Mesquite owns and operates two of the three casinos and hotels in the Mesquite, Nevada market, the Casablanca Resort and the Virgin River Hotel and Casino. We view Mesquite as an attractive investment opportunity as the company stands to benefit from strong ongoing customer demand, given its position in a growing market, as well as favorable competitive dynamics in high barriers to entry. New investments in the fourth quarter were offset by dispositions and payoffs of $42 million. As part of our ongoing portfolio management, we closely monitor and directly engage with our existing portfolio companies, proactively assessing both current and projected performance relative to our original underwriting assumptions. In the limited situations where performance is below our expectations, we are engaged with the management teams and owners to proactively drive performance improvements and ensure our capital remains well-protected. Managing situations where our capital may be at risk is a key priority for us. We believe our 20-plus years of experience in managing portfolios through various challenging periods positions us well. The majority of our portfolio companies are successfully navigating the higher rate environment, inflation, and the general uncertainty in this economy, and continue to deliver revenue growth and margin expansion. This reflects the durability of companies in the middle market as well as our ability to focus on the right industry and the right companies. Now turning to our portfolio. At quarter end, our portfolio had a fair market value of approximately $1.6 billion. Eighty-nine percent of our investments were in secured debt spread across a wide range of industries, providing for full diversity and minimizing concentration risk. We continue to emphasize companies in less cyclical industries. At quarter end, the portfolio consisted of investments in 142 companies, and our average portfolio company investment was $11 million. As the chart on Slide 7 of the presentation illustrates, our recurring income is distributed broadly across our portfolio and is not reliant on any one company. In fact, more than 90% of our portfolio companies each contribute less than 2% to our recurring income. Eighty-three percent of our debt investments are first lien, providing significant downside protection, and ninety-six percent of our debt investments are floating rate. The overall effective yield on our debt portfolio increased to 14.1% from 12.7% at the end of 2022, reflecting the benefit of both higher base rates and wider spreads on new investments. Investments in new portfolio companies during the quarter had a weighted average effective yield of 13.4%, exceeding the 12.5% weighted average effective yield on the existing portfolio. Post quarter end, we've seen a pickup in activity driven by pent-up demand as borrowers and private sponsors adjust to the current rate environment. Our pipeline is growing, and the projected yields in our pipeline are generally in line with our current portfolio. To date, we have had no prepayment income in the first quarter. We continue to invest selectively, maintaining our underwriting discipline while being mindful of the ongoing macroeconomic uncertainty. We emphasize companies that provide necessary services or products to their customers such that they are more resilient across cycles. It's also important to note that we've not underwritten to perfection. Instead, we seek to build in sufficient buffers to ensure companies can withstand changes in the macro environment without impairing their ability to service our loans. Looking forward, we believe we are well positioned to continue to deliver attractive returns, given that our team has one of the longest track records in direct lending in any of the publicly traded BDCs. While we do not have an explicit forward view on rates, we do believe we will be in a slower growth and elevated rate environment for the foreseeable future and could see a range of macroeconomic scenarios. In periods like these, our experience, combined with our deep industry knowledge provides an advantage that has resulted in strong results through various cycles. Now let me 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 fourth quarter benefited from the increase in base rates over the last 18 months as well as wider spreads on new investments. Net investment income of $0.44 was up 10% versus the fourth quarter of 2022. On an annual basis, net investment income was $1.84 per share, an increase of approximately 20% over 2022. Today, we declared a first quarter dividend of $0.34 per share. We remain committed to paying a sustainable dividend that is fully covered by our net investment income regardless of the interest rate environment, as we have done consistently over the last 12 years. Investment income for the fourth quarter was $0.88 per share. This included recurring cash interest of $0.76, recurring discount and fee amortization of $0.03, and pick income of $0.06. Pick income remains in line with the average of our history. Investment income also included $0.02 per share of dividend income. Operating expenses for the fourth quarter were $0.35 per share and included $0.20 of interest and other debt expenses. Incentive fees in the quarter totaled $5.3 million or $0.09 per share. Net realized losses for the quarter were $16,000 or less than $0.01 per share. Net unrealized losses in the fourth quarter totaled $38 million or $0.66 per share, primarily reflecting unrealized markdowns on three investments, which Raj discussed earlier. The net decrease in net assets for the quarter was $13.3 million or $0.23 per share. As Raj noted, the credit quality of our overall portfolio remains strong. As of December 31, we had four portfolio companies on non-accrual, representing 2.0% of the portfolio at fair value and 3.7% at cost. Turning to our liquidity. Our balance sheet positioning remains solid, and our total liquidity increased to $349 million at the end of the quarter. Relative to our total investments of $1.6 billion, this included available leverage of $247 million and cash of $112 million. Unfunded loan commitments to portfolio companies at year-end equaled 4% of total investments, approximately $55 million, of which only $35 million were revolver commitments. Our diverse and flexible leverage program includes two low-cost credit facilities, two unsecured issuances, and an SBA program. Our unsecured debt continues to be investment-grade rated by both Fitch and other rating agencies. Given the modest size of each of our debt issuances, we are not overly reliant on any single source of financing, and our debt maturities remain well-laddered. Additionally, 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 modestly increased during the quarter to 4.29% and is up only 138 basis points since March of 2022, while base rates have increased more than 500 basis points during this period. This is the result of having over 73% of our borrowings from fixed rate sources. Now I'll turn the call back over to Raj.

Thanks, Erin. Reflecting on our historical performance since we took TCPC public in 2012, we've delivered a 10.1% annualized return on invested assets and an annualized cash return of 9.7%. We are very proud of these results, which include performance during periods when base rates were substantially lower than they are today. We believe this performance remains at the high end of our peer group and speaks to our ability to consistently identify attractive middle-market opportunities, have premium yields, and to deliver exceptional returns to our shareholders across market and economic cycles. Looking ahead, we see significant opportunity to continue to build upon our track record of success. Traditional lenders continue to retreat from lending to the middle market. At the same time, more borrowers view private credit as an attractive and stable source of long-term capital. Middle-market borrowers are increasingly turning to private credit for their financing needs, given the certainty of execution, flexibility, and close partnerships that can provide value beyond what bank financing has historically offered. As a pioneer in direct lending, we believe TCPC is uniquely positioned to benefit from growing demand for private credit. Additionally, we are excited about our combination with BCIC and the opportunity we see ahead to deliver solutions to our borrowers and to structure transactions to deliver attractive returns to our shareholders. And with that, operator, please open the call for questions.

Our first question today comes from Christopher Nolan with Ladenburg Thalman.

I guess turning on to new investments in the quarter. Was most of these investments for sponsors who are investing in new companies or just to support a sponsor's existing portfolio company?

Yes. Thanks, Chris. This is Phil. It's both. It's about, I'd say, close to about half and half. We did support some new platforms. I mentioned with the gain is, but there are a number of add-ons to existing portfolio companies.

Okay. And then are you seeing a decrease in dividend income from portfolio companies in general?

Sorry, you mean, in terms of our NII, Chris?

Yes, the dividend income that you guys would receive from a portfolio company, are you seeing that decrease?

No, we've seen it go the other direction. If I'm understanding the question correctly, keep in mind our spreads are fixed and the base rate has generally been quite positive throughout '23. We have enough results to support a couple of special dividend increases. The only investment that stands out with a different experience is our joint venture at 36th Street, as they are doing fixed rate leases with some duration and have been higher on average in terms of return on assets. They also have the ability to secure good advance rates at the joint venture level, but I wouldn't consider it material. That said, as a results highlight, there have been significant improvements in sustained dividends, and we've worked hard to communicate that to shareholders responsibly.

All right. I'll follow that offline. Last question. The 2024 notes, how are you guys thinking about refinancing that, given your comments on higher for longer? Is your inclination to finance that with bank borrowings or to do another fixed-rate issue?

Thanks, Chris. I'll take that question. We're definitely keeping a close eye on the market. We're very happy with the way the market has opened up for the BDC sector, and we like what we're seeing. We also are happy that we have flexibility in our credit facilities. But certainly, we're going to be looking to address that need in the next couple of quarters.

Our next question comes from Paul Johnson with KBW.

On the new non-accrual ratio, I understand it's related to a non-accrual and it resembles a few other BDC portfolios. Can you provide some insight into the situation there? Additionally, how much of your portfolio consists of these e-retailer or e-commerce roll-ups, especially considering you mentioned having other successes in that area?

Thank you for the question. I'll address several points. Firstly, our exposure to the e-retailer sector in the portfolio is around 1%, which is not significant, but every company matters. We'll get back to you regarding the broader exposure, which will be considerably higher. The trends seen here are somewhat typical in high-growth areas; we've observed certain industries, particularly those driven by increased online spending, similar to the shift seen with Amazon, where consumers have transitioned from in-store purchases to online shopping. This shift has resulted in considerable spending and opportunities for scalability. However, as with other fast-growing sectors, valuations have likely outpaced the companies themselves. We also experienced a number of companies facing supply chain challenges due to COVID, as many ordered extra stock in anticipation of increased spending, yet demand has recently softened due to economic downturns. Therefore, while I see good businesses, their balance sheets are strained. This situation can actually support several companies and emerging leaders that will succeed in the long run. As we do with other industries, we dedicate a lot of time to analyzing industry dynamics and selecting the players we want to invest in. I view the current situation as a bit of temporary disruption caused by these issues, but still within the framework of successful businesses that can thrive here. Some may require assistance, such as refinancing or consolidation, which is already underway. We are fortunate to be positioned to help address these needs thanks to our expertise and past experiences in managing portfolios. So to summarize, our aggregate exposure across the sector is around 1%.

Got you. That's 7% you said for sort of that retail roll-up strategy? Across the participants in that sector.

And there are other activities aimed at addressing those issues. I believe more specifics will be released by other companies possibly this week or earlier. Stay tuned.

Got it. Okay. That's very good color. And then if you kind of take out the non-accrual, Securus or rise sort of decline, you take those three out, what were the marks on the rest of the portfolio? Was there any sort of broad markdown elsewhere in the portfolio?

Yes. I would say I would characterize it as generally stable. There are a lot of companies that have movement. I don't want to put any numbers about it being accurate. But I think you can see from the general performance that it's pretty stable. And to put the NAV movement in context, 75% of it is tied to these three businesses. Some of it is tied to the dividends going out the door, and then the remainder of it is tied to a very stable and low-performing portfolio.

And then last question just on the pipeline bigger picture, activity picking up, curious on your thoughts where the pipeline sort of stands today versus maybe six months ago? And high-quality deals? Or is the market still sort of looking on this return of the M&A market?

Yes, that's a great question, Paul. I would say the pipeline is experiencing an increase, and we noticed a rise in activity last quarter in Q4 of last year. This increase is gradual rather than a sudden jump. There is still more to come regarding buyers and sellers willing to engage in transactions, along with more refinancing activity. We are still in the early stages of that research aspect. However, based on our conversations with market participants, including intermediaries, business owners, and sponsors, we anticipate that activity will be higher this year compared to last year. It remains to be seen if this will be more concentrated in the latter half of the year, but we are optimistic.

Our next question comes from Robert Dodd with Raymond James.

Going back to Christopher's question first, the company filed for bankruptcy, lender-led financing, can we presume that there will be incremental capital deployed to it maybe Q1, Q2, but in kind of the first half of the year that there will be additional financial support provided to that business to work it to success?

Correct. To be specific, when we encounter challenged credits, we have various tools available to facilitate a solution. If it's a solid business facing balance sheet struggles in a favorable sector, that's something we can work with. Then you determine the best approach to implement changes or funding on the lending side. In the case of a bankruptcy, specifically a lender-led bankruptcy, there are benefits that need to be balanced against any actions taken regarding the company. The advantages of this process are believed to outweigh the challenges posed by bankruptcy, and it can be executed efficiently, especially in terms of protecting the nature and terms of the financing provided, particularly with ongoing discussions and interest in the company and sector. This situation is something we believe we ultimately benefit from. To answer your question, yes, we will provide additional funding support as the bankruptcy filing will indicate, which is now documented.

Got it. And I mean, Perch, I believe, is another one of these where the fair value deteriorated over a few quarters. Is it looking likely to be following the same kind of path for Thrasio? Or is that one being handled differently by you and the sponsor?

I wish I could provide specific details, but I might be able to do so in a year. The focus will be on scaling, consolidating, and addressing balance sheet challenges stemming from macroeconomic factors. Ultimately, we will consider employing a variety of strategies, such as funding, cleaning up balance sheets, and potentially consolidating. Perch falls into that discussion as well. Stay tuned for updates later this year on these topics. In summary, my answer is yes.

We have no further questions registered. I will now turn it over to the management team for any closing comments.

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

Thank you, everyone, for joining us today. This concludes our call, and you may now disconnect your lines.