BlackRock TCP Capital Corp. Q1 FY2024 Earnings Call

Ladies and gentlemen, good afternoon. Welcome to BlackRock TCP Capital Corp.'s First Quarter 2024 Earnings Conference Call. Today's 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 first quarter ended March 31, 2024. 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-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 for joining us for TCPC's Q1 2024 Earnings Call, which is also officially the first earnings call for TCPC as a combined entity, post our successful combination with our former affiliate BlackRock Capital Investment Corp, BCIC. Today, I'm joined by our President, Phil Tseng; and our CFO, Erik Cuellar. We are also joined today by Michaela Murray, who will be taking over the Investor Relations role from Katie McGlynn, who is leaving the firm to pursue other opportunities. I'd like to officially welcome Michaela to the show. As a reminder, Katie has been a valued member of the TCPC team and private net platform since 2018, who was instrumental in structuring and closing the recent merger. She's been a great partner and friend and will be sorely missed. We, of course, wish her well in her future endeavors. For today, I will begin with a few comments on the successful completion of our merger with BCIC. I'll then provide an overview of our first quarter results. Phil will follow with an overview of the investment environment and our portfolio and investment activity, and Erik will then review our financial results as well as our capital and liquidity in greater detail. Finally, I will wrap up with a few comments on the opportunities we see ahead before taking your questions. As I mentioned earlier, during the first quarter on March 18, we closed our affiliate merger with BCIC. As a reminder, since BlackRock's acquisition of TCP's platform in 2018, the investment activities of both TCPC and BCIC were managed by one team under the current leadership. The merger simply formalizes the combination of these two materially overlapping portfolios and delivers meaningful value for our shareholders through the greater scale and targeted operating efficiencies. This includes a lower overall fee structure from the larger combined entity, the likelihood of more efficient access to capital and income accretion for the company and ultimately for our shareholders. From this point forward, we will be discussing financial results for the entity on a combined basis. Now let's give a review of the highlights of our first quarter results. I am pleased to report that for the first quarter of 2024, TCPC delivered adjusted net income of $0.45 per share, an increase from $0.44 per share in the prior quarter. Our run rate net investment income remains among the highest in TCP's history as a public company. And our annualized net investment income return on equity for the quarter was 14.7%. Net investment income continues to benefit from relatively higher base rates and spreads. During the first quarter, our net asset value declined 6.4%, primarily due to net unrealized losses on portfolio companies previously discussed, including our investments in two Amazon aggregators, Thrasio and Razor, along with our equity investment in invention. The write-downs in the first quarter are mostly the result of circumstances specific to a handful of companies. And as we have stated before, we do not believe these situations are any indication of broader credit challenges in our portfolio. The majority of our portfolio of companies continue to report revenue and margin expansion with many generating sustained performance improvements. That said, I again want to provide commentary on a few of the names that contributed to the portfolio markdowns. Thrasio and Razor both operate in the Amazon aggregator space. And as we have discussed on previous calls, the aggregators consolidate small to medium-sized brands that sell through Amazon's market-leading third-party platform. This sector was initially impacted by supply chain issues and then by slowing growth in online consumer spending, as supply chain issues alleviated, resulting in excess inventories and overleveraged balance sheets. Given the persistent operating and liquidity challenges that resulted, Thrasio, one of the largest annual aggregators opted for a balance sheet restructuring via a Chapter 11 filing in February 2024, which we supported given the net benefits from that process. Although a fair bit of work remains ahead of us, we expect ultimately Thrasio to emerge with a lower and more manageable debt structure, as well as a leaner and more efficient operating profile. This should allow the company to remain a leader in the sector and to focus on our return to profitability post-emergence and what we continue to believe is a long-term viable and attractive industry. By contrast, Razor Group also addressed challenges via consolidation and acquired Perch in March, solidifying the combined entity's position as a global leader in the space. Similar to Thrasio's stand-alone restructuring effort, we expect the strategic combination to drive a more efficient operating structure than either company could have achieved in the near-term stand-alone. We also believe that further consolidation and cost optimization are likely to continue in this space and ultimately, there will be fewer, larger scale, and better-capitalized vendors serving it. We will continue to update you on the progress of each of these as we are able to. Next, I'll discuss Edmentum, an online learning provider, which, as we noted last quarter, is navigating a reversion to a more normalized but still positive demand environment. Demand for its tools and services spiked during the pandemic but that has since corrected following the successful return to in-person attendance in many schools. Relative to pre-pandemic levels, digital education and remote learning services continue to grow in popularity, and Edmentum remains well positioned in an industry with positive secular trends. As a reminder, our current investment in Edmentum is a residual equity position after we received full repayment on our loan to the company. As a long-standing player in the direct lending space, our team has experienced lending across market cycles and has developed unique expertise and a proven track record of success, working through challenging credit situations. We are leveraging this expertise, believe we have the right teams in place, and are proactively working with management teams, equity owners, and other lenders to improve performance and achieve positive outcomes for our investments. Most importantly, outside of these situations, the credit quality of our portfolio remains strong. As of March 31, 2024, our internal risk rating was relatively unchanged from December 31, 2023, and reflects the fact that the majority of our portfolio companies are substantially in line or ahead of base case expectations. Our Board of Directors declared a second quarter dividend of $0.34 per share, which implies a 132% NII coverage based on our first quarter adjusted NII. The second quarter dividend is payable on June 28, to shareholders of record of June 14. We have always taken a disciplined approach to our dividend with an emphasis on stability and strong coverage from our recurring net investment income. Throughout TCPC's 12-year history, we have consistently covered our dividend with recurring net investment income and have also paid several special dividends, including in the most recent quarters. Now I will turn it over to Phil to discuss our investment activity and portfolio.

Thanks, Raj. I'll start with providing an update on our portfolio and highlights from our investment activity during the first quarter and then provide a few comments on the investment environment. In the first quarter of 2024, we invested $20 million, primarily in senior secured loans. Deployments in the quarter included loans to four new and three existing portfolio companies. Consistent with our strategy, our emphasis remains on companies and established business models and proven core customer bases that make them more resilient across economic cycles. In reviewing the opportunities, we emphasize transactions where we are positioned as a lender influencer, 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 our low realized loss rates over our history. We also see emerging opportunities on the horizon, as pent-up M&A transactions come to market. As the bid-ask spread and valuations for higher-quality assets narrow, we expect market participants who have been sitting on the sidelines to be more active. Actual interest rate cuts should help to catalyze a pickup in M&A due to the lower debt service costs for prospective borrowers. And based on our conversations with market participants, we're optimistic about activity in the near to medium term. In this environment, our industry specialization continues to be an advantage, as it provides two key benefits for us. First, it enhances our ability to assess and effectively mitigate risk in our underwriting when we negotiate terms and credit documentation. And second, it expands our deal sourcing capabilities with sponsors and nonsponsors, who value our industry experience, which lends itself to more reliable execution for borrowers. Follow-on investments in existing companies continue to be an important source of opportunity for us. About half of the capital we deployed over the last 12 months was to existing portfolio companies. One of the recent investments made during the first quarter was an investment in PMA Asset Management. PMA is a leading money market asset manager serving local government, K-12 education, and other public sector entities. The company provides its public sector clients with a comprehensive suite of investment advisory, fund administration, and capital markets advisory services. BlackRock provided capital to support the sponsor's acquisition of PMA. We believe this investment offers an attractive risk-adjusted return and provides a unique opportunity to invest in a scaled money market asset manager that has exhibited strong growth over its history. New investments in the first quarter were offset by dispositions and payoffs of $24 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're engaged with the management teams and the owners to proactively drive performance improvements and ensure our capital remains well protected. Managing situations where capital may be at risk is a top priority for our team. And we believe our 20-plus years of experience in managing portfolios through cycles is a significant competitive advantage for TCPC. We are pleased to report that the majority of our portfolio companies continue to deliver revenue growth and margin expansion as they successfully navigate the higher rate environment, lingering inflation, and general uncertainty in the economy. We believe this reflects the durability of companies in the middle market, as well as our ability to pick the right industries and the right companies and to structure transactions that are good for our borrowers and for our investors. Now I'll turn to our portfolio. As a reminder, these figures relate to our consolidated portfolio following the merger with BCIC. At quarter end, our portfolio had a fair market value of approximately $2.1 billion. Ninety-one percent of our investments were senior secured debt, spread across a wide range of industries providing portfolio diversity and minimizing concentration risk. At quarter end, our diversified portfolio consists of investments in 157 companies. And our average portfolio company investment was $13.5 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 income from any one company. In fact, more than 75% of our portfolio companies each contribute less than 1% to our recurring income. Eighty percent of the portfolio are first lien, providing significant downside protection and 97% of our debt investments are floating rate. The overall effective yield on our debt portfolio was 14.1%, reflecting the benefit of higher base rates and wider spread on new investments. Investments in new portfolio companies during the quarter had a weighted average effective yield of 14.7%, exceeding the 14% weighted average effective yield on exited positions. To date, we have had no prepayment income in the second quarter. And looking forward, we believe we're well positioned to continue to deliver attractive returns, given that our team has one of the longest track records in direct lending of any of the publicly traded BDCs. Irrespective of when the Fed rate cuts commence, we believe we will be in a slower growth and an elevated rate environment for the foreseeable future and could see a range of macroeconomic scenarios. But in periods like this, we believe our experience and our deep industry knowledge provide us advantages and result in strong results throughout various market cycles. The market environment that persisted over the past year is changing. For a large part of 2023, we saw wider spreads. We saw more conservative leverage profiles and generally stronger structural protections. However, for much of this year so far, we've seen a broader repricing, and we expect this to continue. This means managers have to work harder to identify deals with favorable economics and favorable structures. As we noted last quarter, there's been an increased bifurcation of the direct lending market, which continues to persist today. 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 or large-cap direct lending market, given the robust return of banks to that segment. However, in the core middle market, where we focus, there's been less impact from this trend. We continue to benefit from lower leverage overall in the presence of maintenance covenants, all of which lead to generally stronger documentation. We continue to see a durable yield premium for our transaction flow relative to the broadly syndicated market. Now I'll 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 first quarter benefited from the increase in base rates over the last 21 months and was $0.45 on an adjusted basis for the quarter. As detailed in the earnings press release, adjusted NII excludes amortization of the purchase accounting discount resulting from the merger with BCIC and is calculated in accordance with GAAP. The full reconciliation of adjusted NII to GAAP NII, as well as other non-GAAP financial metrics is included in the earnings press release and 10-Q. Today, we declared a second 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 consistently done over the last 12 years. Investment income for the first quarter was $0.90 per share. This included recurring cash interest of $0.78, nonrecurring interest of $0.02, recurring discount and fee amortization of $0.03, and PIK income of $0.05. PIK income remains in line with the average over our history. Investment income also included $0.02 of dividend income. Operating expenses for the first quarter were $0.35 per share, including $0.21 of interest and other debt expenses. Incentive fees in the quarter totaled $5.8 million or $0.09 per share. Operating expenses for the quarter reflected the impact of the lower management fee rate since the closing of the transaction on March 18. We expect other synergies and expense savings to materialize over the next few quarters. Net realized losses for the quarter were $168,000 or less than $0.01 per share. Net unrealized losses in this first quarter totaled $23 million or $0.37 per share, primarily reflecting unrealized markdowns on previously discussed investments as Raj described earlier. The net increase in net assets for the quarter was $5.1 million or $0.08 per share. As of March 31, we have five portfolio companies on nonaccrual, representing 1.7% of the portfolio at fair value and 3.6% at cost. During the quarter, we added two portfolio companies to nonaccrual status, including Aventiv, previously known as Securus, as well as Gordon Brothers, a preexisting nonaccrual portfolio company from the acquired BCIC portfolio. Turning to our liquidity. Our balance sheet positioning remains solid, and our total liquidity increased to $409 million at the end of the quarter relative to our total investments of $2.1 billion. This included available leverage of $286 million and cash of $121 million. Unfunded loan commitments to portfolio companies at quarter end equaled 4% of total investments or approximately $91 million, of which only $57 million were revolver commitments. Net leverage, excluding SBIC debt for the quarter, is 1.08 times well within our target range of 0.9 to 1.2 times leverage. Our diverse and flexible leverage program includes three low-cost credit facilities; three unsecured note issuances, and an SBA program. 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 distributed. Additionally, we are comfortable with our current mix of secured and unsecured financing, and we expect to address the upcoming maturity of our 2024 notes in the near future. Combined, the weighted average interest rate on our outstanding borrowings, including debt assumed as a result of the merger, increased modestly during the quarter to 5.08%. That average interest rate is up only 217 basis points since March of 2022, while base rates increased more than 500 basis points during this period. This is the result of our lower overall cost of capital. Now I'll turn the call back over to Raj.

Thanks, Erik. Since we took TCPC public in 2012, we've delivered a 10% annualized return on invested assets and an annualized cash return of 9.7% to our shareholders. 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 investment opportunities at premium yields and to deliver exceptional returns to our shareholders across market and economic cycles. Following our successful merger with BCIC, we look forward to continuing to deliver financing solutions to our borrowers and structuring transactions to deliver attractive returns to our shareholders. And with that, operator, please open the call for questions.

Our first question today comes from Robert Dodd with Raymond James.

On Thrasio, et cetera, the aggregator space. I mean on Thrasio particularly, I mean, the bankruptcy got resolved, I think, after quarter end. And I just want to clarify, I think in the docs in the discussion was in 5 recovery below the mark that you currently have, it carry that. Is that factored in or because you disagree about the valuation of the business long-term potentially? Or is it because it happened after the quarter end, that was not fully known at the time you were evaluating some of these positions?

Robert, I think I got most of that question, but I think the question was, is the bankruptcy after quarter end? Is that correct?

It was resolved at the quarter end, right? I mean it was finalized. And what I read was implied value to senior lenders 20%, which obviously is lower than the current market value that you have to carry that. So is that a disagreement with the valuation, which is fine? Or is it that it wasn't factored in yet because it hasn't been resolved yet?

Yes. I believe I understand the question. Our valuation procedures rely on third-party sources, which consider all relevant circumstances at the time of valuation. The bankruptcy process is distinct, as the valuations presented may vary based on one's position in the capital structure. So, will there be differences? Yes. Are people evaluating it for the same reasons? Not necessarily. I want to emphasize that we uphold a valuation process and policies that are suitable for portfolio marking. The bankruptcy was essentially a collective decision viewed as a strategic tool to facilitate additional financing and to reorganize the capital structure and other liabilities. However, I must point out that for any company undergoing restructuring, including not just Thrasio but generally, you're likely to see more volatility and possibly variation in marks until the final realization occurs. This is likely to happen in our case, with other aggregators and with Edmentum as well, where we are fully committed to the process, providing all available information, including the filing. But ultimately, realization is cash-based. In Edmentum's case, despite fluctuations in equity, we've managed to take all our cash and the original debt at par plus. Moving forward, our focus will be on maintaining strict standards regarding valuation, while concentrating on recovery on a realized basis, which will likely take a couple of years of effort during the restructuring. The valuations may indeed differ. Our team will incorporate operating results into their assessments, and I don't think they will take the bankruptcy valuation at face value compared to the information we provide regarding forecasts, projections, and similar data. I hope this addresses your question.

Absolutely.

And Robert, as it relates to the 3/31 mark, this loan actually has had some trading activity even through the bankruptcy process. So it's quoted, and that's what drove the mark at 3/31.

Got it. I understand there's a lot of moving parts in there. The next question is, Phil, you mentioned that you expect market activity to pick up as rates decline. Looking at the current curve, which is quite variable, rates are not really projected to decline significantly this year according to today's curve, and that could change. Can you provide any additional insights? Are you anticipating that the activity level will stay quite moderate as long as rates remain at this level, or are there other factors we should take into account?

Yes, that's a good observation. You're correct that the forward yield curve has changed significantly compared to a few quarters ago when people anticipated rates would stabilize in the mid to high 3s within about 18 months. Now, it seems we are likely looking at rates closer to the mid-4s, which indicates that rates are not expected to drop as sharply. Therefore, we are adjusting our expectations since real rate changes will lead to higher equity valuations and more transactions are likely to occur. While rates appear to have normalized, it's uncertain if people are expecting rates to rise based on recent market discussions. Nonetheless, we continue to hear from market participants, including investment bankers and private sponsors, that many processes are currently in progress. There is also significant pre-marketing activity for deals, which suggests there is some momentum. Additionally, institutional investors are actively seeking distributions from their general partners, which increases pressure for more returns on future vintages. This has prompted general partners to test the market. If they are not outright selling businesses, they are exploring other methods to return capital to clients, such as through dividend recapitalizations or similar vehicles. We have successfully funded dividend recaps over the last few quarters for solid assets that have been deleveraging over time, and we are willing to continue investing in these scenarios. So, while we are cautiously optimistic, I agree that we should closely monitor the lack of a more significant reduction in the yield curve.

I understand, and I appreciate your response. I would like to explore a slightly different angle. You mentioned that it's becoming more difficult to find favorable deals, and I would certainly look into LBO financing and similar options. Over the past decade, it seems your firm has demonstrated significantly more flexibility than some others regarding willingness to pursue various types of deals, such as ABL financing for retail and leasing, among others. Should we expect to see an increase in these other areas over the next few years if the LBO market remains somewhat subdued? How do you plan to operate in a scenario where LBO activity stays moderate for an extended time?

Yes, that's a great question, Robert. You have an insight that extends beyond our public vehicle to the platform itself, which has been in place since before the BDC became public. As you've pointed out, we've consistently managed to pivot towards areas that may not be heavily saturated, like leasing, and possibly aviation as well. One of the advantages of the merger, which we don't often talk about, is that our increased scale gives us the opportunity to explore these areas, and we may be capitalizing on that now. Even if new LBO activity decreases, it's important to remember that our existing portfolio has consistently provided a strong source of deals and add-on investments. As those companies in our portfolio remain healthy, they are adept at seizing opportunities elsewhere, whether through mergers and acquisitions or other forms of consolidation. To address your question directly, whenever we identify promising areas where we can conduct thorough credit assessments and feel confident in the industry or asset, we will pursue those opportunities. Leasing is one strong example of this approach. Additionally, we've engaged in more ABL structures, where our focus shifts from being exposed to an entity to being secured by specific assets. As the market presents such opportunities, our team is well-prepared to act on them, but our strategy will always prioritize credit-first and downside protection.

Our next question comes from Christopher Nolan with Ladenburg Thalmann.

Katie, congratulations. Michaela, welcome. Regarding the maturing debt you mentioned earlier, what are your plans for refinancing it? Will you be pursuing bond issuance, and do you believe you can leverage your investment-grade rating for that? Alternatively, will you consider bank financing?

Yes, Chris, good question. We're certainly looking to address those maturities in the near future. We're very happy with what we've seen in the capital markets within our sector. So definitely, that will be a factor. We also like our current mix of secured versus unsecured. So all of that will come into play. We really, the only reason we hadn't addressed it to this point was the pending transaction, and we just wanted to wait until that was done to be able to address the maturity. But we plan to do so in the near term.

I read an article indicating that Moody's has a more negative outlook on private credit overall. Does your funding cost depend solely on having an investment-grade rating?

I mean I think any credit issuance is correlated to a rating, ours is no different. I would just clarify that the article was more broad-based than honing in on our issues specifically. And it wasn't a downgrade; it was an outlook change, which we have seen them do before in the past in the sector. So whether that actually really impacts the pricing, I think, is to be determined as we're exploring that. I also think the net movement in pricing has been favorable over the last 12 to 18 months. And you can see that in issues and issuances that have hit the market with some very directly comparable deals. So stay tuned. I think we're going to do the responsible thing and sort of explore the options. Obviously, the write-up is not irrelevant, but how relevant it is, is sort of to be determined. And I think, fortunately, we've had a very long-established investment-grade rating in the market. So I think, hopefully, our bond investors and others looking at it will keep that in line.

The next question comes from Paul Johnson with KBW.

I'm just curious, what was the driver of the higher other income this quarter? Was there anything in particular driving that amendments or dividends or anything like that?

Yes, we did have $0.02 of nonrecurring income, just amendments in general and a couple of prepayments that we received. Any time that we have any prepayments that tends to accelerate any advertised discount or exit fee that might be linked to that investment.

And then just kind of higher level with the portfolio. There's a decent amount of software businesses in the portfolio. I know it's not something you've disclosed historically. But I'm just curious, are any of those ARR loans? And are you able to give any kind of sense of what percent of the portfolio is ARR?

Yes. Thank you, Paul. We have shared the percentage of software related to ARR deals. However, when we examine our portfolio more closely, we see that software and ARR are closely related, with ARR being a part of our overall software exposure. Generally speaking, software has been one of the strongest sectors for us. We view software not merely as a broad industry but as horizontally spread across various end markets. For instance, this includes a risk management software provider or an insurance company using insurance in the services market. Alternatively, it also includes a software provider that facilitates e-commerce transactions for retailers in the retail consumer market. Therefore, we perceive software exposure as being less correlated as a whole, while being more sensitive to risks within the end markets. When we analyze it this way, we find it to be quite diversified.

We do not have any further questions. So I'll turn the call back to the management team.

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.