Earnings Call Transcript - TCPC Q3 2020

Operator, Operator

Good afternoon, everyone. Welcome to BlackRock TCP Capital Corp.'s Third Quarter 2020 Earnings Conference Call. This call is being recorded for future reference. I will now hand the call over to Katie McGlynn, Director of the Global Investor Relations team at BlackRock TCP Capital Corp. Katie, please go ahead.

Kathleen McGlynn, Director, Global Investor Relations

Thank you, Grace. Before we begin, I'll note that this conference call may contain forward-looking statements based on the estimates and assumptions of management at the time of such statements and are not guarantees of future performance. Forward-looking statements involve risks and uncertainties, and actual results could differ materially from those projected. Any forward-looking statements made on this call are made as of today and are subject to change without notice. Earlier today, we issued our earnings release for the third quarter ended September 30, 2020. We also posted a supplemental earnings presentation to our website at tcpcapital.com. To view the slide presentation, which we will refer to on today's call, please click on the Investor Relations link and select events and presentations. These documents should be reviewed in conjunction with the company's Form 10-Q, which was filed with the SEC earlier today. I will now turn the call over to our Chairman and CEO, Howard Levkowitz.

Howard Levkowitz, Chairman and CEO

Thanks, Katie. And thank you for joining us today. First and foremost, we hope everyone is healthy and safe. There are several members of the TCPC team on the call with us, including our President and COO, Raj Vig; and our CFO, Paul Davis. I will start with an update on our portfolio and key highlights from the third quarter. Paul will then review our financial results as well as our liquidity position. After that, I will provide some closing comments before opening the call to your questions. Starting on Slide 4. Our portfolio continues to perform well despite the significant headwinds caused by the pandemic. Our third-quarter results reflect further improvement in credit markets and spreads following the significant dislocation that occurred in the spring. Our net asset value increased 4.1% from the prior quarter reflecting a 1.8% net market value gain on our investments, driven by spread narrowing on middle-market private credit transactions as well as improved financial results for several portfolio companies. Importantly, the overall credit quality of our portfolio remains strong. As of September 30, total non-accruals were only 0.6% of the portfolio at fair value, this is a testament to our disciplined approach to underwriting, our more than 20 years of experience lending to middle-market companies, and the strength and breadth of the BlackRock platform. Also during the quarter, we further strengthened our capital and liquidity position by opportunistically issuing a $50 million add-on offering to our outstanding 3.9% notes due in 2024. This complements the actions we took earlier in the quarter to enhance our credit facilities by replacing our funding facility one with a new facility on more favorable terms as well as adding $150 million in aggregate accordion commitments. We truly value and appreciate the strong long-standing relationships we have with our lenders. Today, we declared a fourth-quarter dividend of $0.30 per share payable on December 31, 2020, to shareholders of record as of December 17 and in line with the third-quarter dividend of $0.30 per share paid on September 30. We are committed to paying sustainable dividends and continuing our track record of having covered our dividend every quarter as a public company. In the third quarter, our dividend coverage ratio was 117%. Turning to Slide 6 and an update on our portfolio positioning. At quarter end, our portfolio had a fair market value of approximately $1.6 billion, substantially unchanged from the prior quarter. 91% of our investments are senior secured debt and are spread across a wide variety of industries. We have a diverse portfolio of companies with an emphasis on less cyclical businesses with limited direct exposure to sectors that have been more severely affected by the pandemic. Furthermore, our loans to companies in more impacted industries, including retail and airlines, are generally supported by strong collateral protections, and most of our investments in these industries continue to perform well. As an example, the value of our investment in OneSky, the second-largest provider of private jet aviation services in the country, appreciated during the quarter based on strong performance resulting from increased charter flight activity. At the end of the third quarter, our diverse portfolio included 101 companies. Our largest position, which represented only 4.5% of the portfolio, is an equipment leasing company that itself has a highly diversified underlying portfolio of lease assets. As the chart on the left side of Slide 7 illustrates, our recurring income is not reliant on income from any one portfolio company. In fact, over half of our individual portfolio companies contribute less than 1% to our recurring income. As of September 30, 92% of our debt investments were floating rate. 82% of these were subject to interest rate floors, all of which are now in effect. Additionally, 82% of our debt investments are first lien, as demonstrated on Slide 8. Moving on to our investment activity. We continue to prudently deploy capital in the third quarter. We invested $79 million, including investments in 8 new loans, half of which were with existing borrowers. Follow-on investments in existing portfolio companies continue to be an important source of opportunities. From a risk management perspective, these are companies we know and understand well. Dispositions in the quarter were $89 million for net dispositions of $10 million. As we analyze new investment opportunities, we continue to emphasize seniority in the capital structure industry diversity and transactions where we act as a lead or co-lead. Our largest investment during the third quarter, a senior secured first lien term loan to Metricstream demonstrates this emphasis on transactions where BlackRock teams act as a lead lender as well as our team's deep industry knowledge and experience investing in software companies. Metricstream is a leading software provider of integrated governance, risk management, and compliance solutions. The company has a strong equity sponsorship and is benefiting from the increased awareness and emphasis on managing risk in response to the global pandemic. Metricstream reached out to BlackRock directly based on our reputation in the market and experience investing in similar companies. As a result, our team acted as the sole lender in the transaction. Our investment activity in the fourth quarter-to-date has been selective and focused on companies that are minimally impacted by the pandemic or beneficiaries of the COVID-impacted operating environment. Dispositions in the third quarter included payoffs of our $29 million loan to InMobi, our $16 million loan to American Broadband, and the refinancing of our $11 million loan to Pulse Secure. We also restructured our investment in AGY, which monetized a portion of our loans while maintaining ongoing upside potential through a small preferred equity position. Investments in new portfolio companies during the quarter had a weighted average effective yield of 9.5%. Investments we exited had a weighted average effective yield of 8.8%. And the overall effective yield on our debt portfolio increased to 10%, primarily reflecting amendments made on several loans, coupled with the higher yield on originations versus exits. Since the end of 2018, LIBOR declined 257 basis points or by 92%, which put pressure on our portfolio yield over this period. However, our portfolio is largely protected from any further declines in interest rates as over 80% of our floating rate loans are currently operating with LIBOR floors as demonstrated on Slide 9. Finally, while we are cognizant of the impact that the current environment has had on industry-wide BDC stock price performance, our focus has always been on delivering consistent returns to TCPC shareholders across market cycles and over the long term. As you can see on Slide 14, TCPC has returned in excess of $12 per share in dividends over the last 8.5 years, which translates to an annualized cash return to investors of 9.9% and is reflective of our return on invested assets of 10.3%. Since our IPO, TCPC has consistently outperformed the Wells Fargo BDC in the index.

Paul Davis, CFO

Thanks, Howard, and hello, everyone. During the third quarter, as Howard noted, we continue to enhance our strong capital liquidity position. First, in August, we replaced our funding facility with a new $200 million facility with improved terms. A 2-year maturity extension to 2025 and a $15 million accordion commitment, while again, maintaining our low rate of LIBOR plus 200 basis points. Combined, we now have accordion commitments totaling $150 million. Additionally, in September, we opportunistically raised an additional $50 million of our 3.9% notes due 2024, bringing the total issuance to $250 million. With the new unsecured notes, 82% of our assets were supported by unsecured debt, equity, and our SBA debentures, which are excluded from regulatory leverage calculations. This allows our secured credit facilities to be significantly over-collateralized, which helps ensure that we have ample liquidity in a broad range of market conditions. At September 30, we had available liquidity of $253 million and a regulatory leverage ratio of 1.05x debt-to-equity net of cash of $35 million and pending trades, which was down from 1.10x at times at June 30 and is well within our 2:1 regulatory limit. Our unsecured debt continues to be investment-grade rated by both Fitch and Moody's. Turning to Slide 18. We generated net investment income in the third quarter of $0.35 per share, which exceeded our third-quarter dividend of $0.30 per share paid on September 30. This extends our continuous track record of covering our regular dividend every quarter. Investment income for the third quarter was $0.74 per share, this included recurring cash interest of $0.54, recurring discount and fee amortization of $0.06, and PIK income of $0.06. We had modest prepayments in the quarter that contributed $0.03 per share, including both prepayment fees and unamortized OID. Investment income also included $0.03 of other income and $0.02 of dividend income. Our income recognition follows our conservative policy of generally amortizing upfront economics over the life of an investment rather than recognizing all of it at the time the investment is made. Operating expenses for the third quarter were $0.31 per share and included interest and other debt expenses of $0.17 per share. Incentive fees in the third quarter included $600,000 of catch-up fees and totaled $5 million or $0.09 per share for total net investment income of $0.35 per share. As noted in last quarter's earnings call, 5/6th of the catch-up portion of incentive fees earned in the second quarter were deferred over the subsequent 5 quarters. Subject to our performance remaining over our total return hurdle. We believe this further aligns our interest with our shareholders and demonstrates our confidence in the strength of our portfolio and its earnings capacity over time. Our net increase in net assets for the quarter was $49 million or $0.85 per share, which included net unrealized gains of $48.6 million and net realized losses of $18 million. Net realized losses during the quarter were comprised primarily of the restructuring of our investment in AGY, as Howard noted earlier. Unrealized gains in the quarter included spread tightening during the quarter following the dramatic spread widening and volatility that occurred during the spring as well as improved performance at several portfolio companies. Unrealized gains included $6.9 million of appreciation in the value of our investment in Edmentum and $4.4 million of appreciation on our investment in OneSky. Howard discussed the strong performance at OneSky as charter flight activity has outpaced expectations. And Edmentum continues to benefit from a shift toward online learning that is accelerated in the current environment. Substantially all of our investments are valued every quarter using prices provided by independent third-party sources, including quotation services and independent valuation services. And our process is subject to rigorous oversight, including back testing of every position against our valuations. Our highly diversified portfolio continued to perform well even in this challenging market environment, and our overall credit quality is sound. We have loans to just 3 portfolio companies on nonaccrual: GlassPoint, CIBT, and Avanti, which together represented only 0.6% of the portfolio fair value and 1.2% of cost. CIBT, which is new this quarter, is a leading global provider of immigration and visa services for corporations and individuals, and the company has been challenged given the current slowdown in international travel. Turning to Slide 15. We had total liquidity of $253 million at quarter end. This included available leverage of $224 million and cash of $35 million, less net pending settlements of $6 million. Additionally, our investments in delayed draw term loans and unfunded credit facilities to portfolio companies totaled just $51 million at quarter end or 3% of total investments, of which only $19.8 million was revolver commitments. With our new lower-cost funding facility, increased accordion commitments, and additional unsecured notes, our diverse and flexible leverage program is stronger than ever. As of September 30, this program included 2 low-cost credit facilities, a convertible note issuance, 2 straight 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 leverage program is well-laddered with no near-term maturities. Our nearest maturity is March of 2022, and this represents less than 15% of outstanding liabilities as of September 30. Combined, our outstanding liabilities had a weighted average interest rate of 3.3%, down from 3.8% or 51 basis points since the end of '19.

Howard Levkowitz, Chairman and CEO

Thanks, Paul. While the economic outlook is uncertain, our team is focused on delivering the results our shareholders have come to expect from TCPC. The overall market environment has continued to improve following the significant dislocation that occurred in March, and middle-market companies overall have performed better than market expectations. While deal volumes remain below pre-COVID levels, we are seeing a pickup in activity, and the deals in our pipeline are generally on more attractive terms. We remain extremely selective in this environment executing on only a small number of opportunities we review and focusing on companies we believe have minimal COVID exposure or those that are positioned to outperform in this environment. We also remain focused on companies and industries we know well and on transactions where our team leads or co-leads negotiations to ensure deal teams and structures include appropriate creditor protections. Our performance to date and our confidence in our ability to succeed in this environment are driven by our team's 2 decades of experience in both performing and distressed credit. The strength of our underwriting platform as well as the depth and breadth of the firm-wide resources of BlackRock. In closing, while these are challenging times for everyone, our entire team is focused on generating strong risk-adjusted returns for shareholders.

Operator, Operator

Our first question comes from Chris Kotowski at Oppenheimer.

Christopher Kotowski, Analyst

Good. First of all, I guess, I was wondering on the kind of the relatively outsized levels of dividends and other income, is there any story there? Or should we just expect that to kind of normalize next quarter?

Howard Levkowitz, Chairman and CEO

Yes. Chris, thanks for the question. As I think you and others who have followed us for a long time are aware, our other income is lumpy; it comes from different sources. We do have income in connection with some amendments of relationships with portfolio companies. In this case, the biggest contributor was from a company that's performing well and requested an extension of the credit agreement. We also have dividend income that we get from portfolio companies as well.

Christopher Kotowski, Analyst

Okay. And then I know you've had the slide in there. I just wanted to make sure I'm interpreting it correctly, but Slide 9 on your interest rate sensitivity, where you say that the cumulative decline in LIBOR amounts to $0.09 per share before incentive fees. So I mean, just to kind of get the bottom line NII impact, I would just take that number and multiply by 0.8, right? So it'd be like $0.07?

Howard Levkowitz, Chairman and CEO

Yes, that's correct. $0.07, $0.08.

Christopher Kotowski, Analyst

Yes, around $0.07 to $0.08. Regarding the new nonaccrual, CIBT, I'm not sure what details you have, but it was significantly marked last time. Was there an event that contributed to its decline? On the other hand, you mentioned taking a preferred holding for AGY. Does that investment have potential for appreciation? Is it a convertible feature, or is it just a standard preferred?

Howard Levkowitz, Chairman and CEO

Sure. In reverse order with respect to AGY, there is upside in our remaining position in AGY. It is a small position, though, for clarity. With respect to CIBT, it's a very good business, but it is dependent on global travel. And in connection with the company's performance, which is significantly dependent on the level of global travel, particularly in and out of Asia and China, more specifically. We reached the conclusion that it was appropriate for it to go on nonaccrual.

Christopher Kotowski, Analyst

Okay. And then just in general, any thoughts on significant deal activity coming back and driving volumes. I mean, kind of we can see geologic numbers for announced M&A. They seem to have picked up in the last couple of weeks or months. Are you seeing that in your market as well?

Rajneesh Vig, President and COO

Chris, it's Raj. I'll take that one. We are seeing a pickup in deal activity. I think we also are, as a comment over the last call, seeing good competition out there. The private capital asset class has generally navigated this environment well. I think it's a testament to the business model. But we are also saying no a lot. I think terms are competitive. And for certain companies, people are, whether it's pricing or structures, doing things that we're not ready to sign up for. So while the inbound activity has certainly picked up as well as the deployment, I don't know that they're necessarily one-for-one correlation. And that's not a bad thing. We're just maintaining discipline. And we're doing what we feel comfortable with. And hopefully, as we make it through the election cycle and to the end of this year, we'll see that continuing. But to answer your question, yes, there has been a pickup in deal activity from our perspective.

Operator, Operator

And our next question comes from the line of Finian O'Shea from Wells Fargo Securities.

Finian O'Shea, Analyst

Just a first follow on. For the AGY re-org or restructuring, was there any money in or money out there, did that probably receive another investor? Or did you just re-org your debt into equity? Or any color you can provide there?

Rajneesh Vig, President and COO

Sure. AGY is a fundamentally good business, but it has struggled with the cost of one of its major inputs, Rhodium. And we reached the conclusion that it was more appropriate to let a third party come into the business and pay down our position and sell down a significant part of our economics. And retain a small preferred upside.

Finian O'Shea, Analyst

Okay. That's helpful. And then just for Howard or Paul on the unsecured issue, I think you closed the first quarter. Any comment on this being an opportunistic availability for you? How much more unsecured financing might you pursue given this availability, considering it represents a large portion of your capital structure? Should we expect more to come if the market remains favorable?

Howard Levkowitz, Chairman and CEO

Yes. Fin, thanks for the question. We have been very careful in how we think about building out the liability side of our balance sheet. As I think you're aware, we added to the note issue you just referenced. We have 2 other unsecured note issues. We have a long-term SBA facility and we have 2 distinct credit facilities, one of which we increased in the spring, the other of which we replaced. They both have accordion features; it is by intent that we fund the balance sheet with 6 different sources, no one of them very large in relationship to our asset base. We think it's important to have staggered funding by maturity and sources as a way of managing our balance sheet and positioning us so that we can be opportunistic as we invest in to deploy capital without having to be overly concerned about any given test from particular lenders.

Operator, Operator

Our next question comes from the line of Christopher Nolan from Ladenburg Thalmann.

Christopher Nolan, Analyst

Kawa Solar Holdings, it matured on 9/30/'20. Were those loans paid off?

Rajneesh Vig, President and COO

Kawa Solar Holdings is part of a broader series of securities, including Conergy. The answer is complex because certain loans in specific regions have been paid off, including the commentary loans. I believe the Kawa loans were also settled. What remains is some equity that was converted in the APAC region, which represents the outstanding position. The loans that were paid off are no longer reflected on the balance sheet, and several were successfully completed. What is left is solely the equity position resulting from a conversion in Asia. This is in a runoff mode, which we've mentioned before, where the main asset is an operating facility that we plan to exit in the near future as we proceed with the process.

Christopher Nolan, Analyst

And Raj, is that Asian affiliate Conergy Energy, Asia...

Rajneesh Vig, President and COO

Correct.

Christopher Nolan, Analyst

Last quarter, that particular credit has spread of 10% total coupon of zero. Now the spread is zero, the total coupon is zero, and there's $2 million on a cost basis. But why have a jet with a zero coupon?

Rajneesh Vig, President and COO

The collateral of that business is the asset. We consider ourselves to have a preferred position in the remaining business, as we are the sole lender with the asset currently being marketed for sale. In some respects, it is more about appearance than essence, as we are the only capital provider involved. The zero interest should be viewed as an indication that this asset is essentially held for sale in that form of the security.

Operator, Operator

Our next question comes from the line of Ryan Lynch from KBW.

Ryan Lynch, Analyst

You mentioned having 8 new loans this quarter, with about half going to new borrowers. You brought up Metricstream, which is a software provider. As you look for deals with new companies in this environment, where deal activity is beginning to increase, are you more focused on businesses that are well-positioned and resilient to COVID, or are you considering taking on additional risk at this stage of the cycle? There is still a lot of uncertainty, but there seems to be a bit more clarity about the current state of the economy.

Paul Davis, CFO

Yes. I'll take that one, and others may add on to the comment. But so we are generally even pre-COVID, have always viewed our efforts as being focused on companies that are more defensive, less cyclical or acyclical and sometimes, we'll focus on really an asset collateralized business or loan. For instance, in the aircraft financings or some of the asset backlogs have done in the retail area, if there is, in fact, a more cyclical, broader business. That has not changed through COVID. If anything, the approach, as we've taken it historically, I think in many ways, it's validated through COVID. You have seen a very stable portfolio quarter-over-quarter. I think the lens perhaps tightens because some businesses at the margin are performing better or benefiting from COVID, some are more neutral. But overall, our approach has always been to be focusing on defensive businesses where we have good revenue and earnings visibility. Those happen to be businesses that I would say necessarily benefit, but are more defensive in COVID as well. So that approach and that philosophy will continue. We also agree that things are relatively uncertain in various ways. And we're more inclined to be defensive, both in structure and where we want to be in a capital structure versus venturing out on the risk curve. And I think that has done well for us through this point in time, and we're going to continue that approach until such time we feel that stretching out on the risk curve makes sense, but that given the uncertainty, we're generally the same inset as your comment about the environment.

Ryan Lynch, Analyst

Given the level of uncertainty in the economic environment, taking on additional unsecured debt could help strengthen and diversify your liability structure as a defensive measure. You've mentioned an increase in deal activity, similar to what other BDCs have reported, driven by pent-up demand and potential influences from the upcoming election. If you have a strong pipeline of deals, are you looking to further grow the portfolio and increase leverage if the right opportunities arise, or are you aiming for a more conservative balance sheet and planning to maintain or even lower leverage levels despite the deal volume?

Howard Levkowitz, Chairman and CEO

Thank you for the question. Our conservatism begins with the assets themselves. As Raj mentioned, while we do leave some room for adjustments that might be slightly more affected, our focus is on building our portfolio with durable businesses and structures. We have a liability structure that offers us significant flexibility, allowing us to adjust leverage as needed. Our approach prioritizes making sound loans as they come to us rather than aiming for a specific leverage target in our portfolio, while always ensuring we maintain substantial cushions. TCPC has been publicly traded for 8.5 years, but we have managed leveraged funds for over two decades. We understand the advantages of leverage and are committed to using it responsibly. We have the capacity to add more assets and do so occasionally, but we evaluate opportunities on a deal-by-deal basis first.

Ryan Lynch, Analyst

Sure. Okay. Fair enough. One last one for me. You gave some good commentary on OneSky, the increased demand for charter flight is making that business a more favorable business to be in. I was wondering if you can just get a quick update on Mesa Air. I believe that's in a different business subset of the airline space. It looks like the valuation held up pretty well this quarter. But just given the backdrop of that industry, any update on that?

Howard Levkowitz, Chairman and CEO

Yes, thank you for the question. We remain confident in Mesa. The airline sector has certainly faced significant challenges, but we assessed that loan by concentrating on what we consider to be resilient assets and at advantageous points. They have received substantial government support. We believe they play a crucial role in the operations of major carriers' hubs. While the entire industry is experiencing considerable pressure on valuations, our loans are designed to amortize, and we are satisfied with the company's performance in this exceptionally challenging environment.

Operator, Operator

Our next question comes from the line of Matt Jaden from Raymond James.

Unknown Analyst, Analyst

Howard, I appreciate the commentary on deal flow towards the end of the call. Just to clarify, when you say terms are more attractive than kind of pre-COVID levels, is that on all fronts, say, if we look at covenant quality, underlying leverage and spreads. Are all of those improved versus pre-COVID levels? Or is it just kind of one or another?

Howard Levkowitz, Chairman and CEO

Yes. Look, there's variability. Generally speaking, we're finding terms more attractive and more ability to drive stronger documents and better protective packages. With respect to pricing, in general, deals are a bit wider. You can see from our additions versus exits last quarter. There's a bit of a pickup. We always caution don't read too much into 1 quarter or a fairly small number of investments that are coming on or off the balance sheet. At the same time, there are some deals in the market that are remarkably competitive and tight pricing, and I think you can see that in both the public markets and our markets, where you've got some tightening on some companies that people are really chasing after. And at the same time, you're starting to see some deals get pulled and lender push back in the public markets. And that same dynamic is going on in the private markets. Where we believe we have the ability to continue to push back on things and drive some overall better terms than we were seeing before going into the crisis.

Unknown Analyst, Analyst

Great. I guess, second one for me then. So kind of the second quarter that prepayment fees have been lower than that historic $0.04 to $0.05 range. Any visibility you can provide on kind of when we might expect prepayment activity to pick up more in line with that historic range?

Howard Levkowitz, Chairman and CEO

We appreciate the interest in projecting and modeling these figures. The process can be unpredictable. For instance, InMobi, which had a payout this past quarter, was actually expected to pay off in the two quarters prior. Although March 31 posed some disruptions, it ultimately paid out in the first week of July instead of by June 30. This example illustrates that we were aware of InMobi's refinancing situation, and it took three quarters to report this outcome. This unpredictability is a common occurrence across our portfolio. In previous years, we have had multiple repayments occur on the last business day of the year, including some cases where we were uncertain about their timing in relation to the current or following year. This is just part of the nature of our business; these transactions are bespoke and involve individual borrowers, not straightforward capital market transactions. When borrowers are refinancing, there may be others involved who do not align with the expected timeline, and they are not necessarily planning to meet a specific quarterly target. Over the long term, we believe this provides a fair indication of trends. While there is a slight seasonality, especially in a COVID environment, external factors also influence decision-making.

Unknown Analyst, Analyst

Okay. And then just a quick one, lastly for me. Howard, I know you said last quarter there were about 11 portfolio companies that took loan amendments over the quarter. Would you be willing to say what it was for 3Q?

Howard Levkowitz, Chairman and CEO

Yes. It was remarkably similar this quarter by coincidence.

Operator, Operator

I'm showing no further questions at this time. I would now like to turn the conference back to Mr. Howard Levkowitz for any closing remarks.

Howard Levkowitz, Chairman and CEO

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

Operator, Operator

Thank you, ladies and gentlemen, this concludes today's conference call. Thank you all for joining. You may all disconnect.