Earnings Call Transcript - TCPC Q3 2023

Operator, Operator

Ladies and gentlemen, good afternoon. Welcome to BlackRock TCP Capital Corp.'s Third Quarter 2023 Earnings Conference Call. This call is being recorded for replay. During the presentation, all participants will be in listen-only mode. A question-and-answer session will follow the formal remarks. Now I would like to turn the call over to Katie McGlynn, Director of the BlackRock TCP Capital Corp. Investor Relations team. Katie, please proceed.

Katie McGlynn, Director, Investor Relations

Thank you, Alex. 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 third quarter ended September 30, 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 & 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.

Rajneesh Vig, Chairman and CEO

Thanks, Katie, and thank you all for joining us for TCPC's third quarter 2023 earnings call. I will begin the call with a review and reminder of our post-merger with our affiliate BDC, BlackRock Capital Investment Corporation, that was recently announced in September. I will then cover the overview of our third quarter results before turning the call over to our President and Chief Operating Officer, Phil Tseng, who will provide an update on our portfolio and investment activity. Our CFO, Erik Cuellar, will then review our financial results as well as our capital and liquidity positioning in greater detail. I will then close out our prepared remarks with a few final comments before we take your questions. On September 6, 2023, we announced a proposed merger of TCPC with BlackRock Capital Investment Corp. or BCIC. As highlighted at the time of the announcement, the proposed transaction is a very logical and natural strategic next step in the growth and evolution of BlackRock's BDC platform and the broader $81 billion global private debt business at BlackRock. What's especially compelling about the merger is that it combines two very similar portfolios that we know well, as our collective investment team has been managing both portfolios for many years now. We believe the proposed merger positions a combined company for sustained growth and will create meaningful value for TCPC shareholders. As a reminder, the transaction is expected to result in a combined company that benefits from operational cost efficiencies, enhanced scale, and better access to capital on improved terms. We also anticipate that the transaction will be accretive to net investment income. Importantly, our proven investment strategy and overall approach to investing will not change, and the Officers of TCPC will remain Officers of the combined company following the close of the transaction. The transaction will be a NAV for NAV exchange, resulting in an ownership split of the combined company that is proportional to each of TCPC's and BCIC's respective net asset values, subject to each company's shareholder approvals, customary regulatory approvals, and any other necessary closing conditions. BCIC shareholders will receive newly issued shares of TCPC common stock based on the ratio of BCIC's net asset value per share, divided by the TCPC net asset value per share, each determined shortly before closing. As an added reminder, TCPC's Advisor, BlackRock, is supporting the transaction with several shareholder-friendly measures, including a reduction in the management fee from 1.5% to 1.25% for assets equal to or below 200% of net assets. Net investment income coverage via a waiver of advisory fees for any of the first four quarters ending following the merger closing, in the event net investment income in any such quarter is less than $0.32 per share, up to a maximum of the advisory fees earned during such quarter. Finally, BlackRock has agreed to cover 50% of the merger costs for both companies, up to a combined capital of $6 million, assuming shareholder approval for the transaction. We expect the transaction to close in the first quarter of 2024, subject to shareholder and regulatory approvals and customary closing conditions. Now let's get back to the normal programming in a review of highlights from the current quarter. For the third quarter of 2023, TCPC delivered net investment income of $0.49 per share, representing a 17% increase year-over-year and an approximate 15.3% annualized net investment income return on equity. Given the floating rate nature of our portfolio and the higher proportion of our liabilities being fixed rate, our net investment income continues to benefit from higher base rates as well as marginally wider spreads. Our run rate net investment income at the end of the third quarter was again among the highest in TCPC's history as a public company. Our Board of Directors today declared a fourth quarter dividend of $0.34 per share, which is consistent with the third quarter and inclusive of the two dividend increases declared by the board over the last four quarters. The fourth quarter dividend is payable on December 29 to shareholders of record on December 15. In addition, as an acknowledgment of TCPC's strong earnings to date, the board announced an additional $0.25 per share of special dividend, also payable on December 29 to shareholders of record on December 15. We have always taken a disciplined approach to the dividend, with an emphasis on stability and strong coverage from our recurring investment income. As a reminder, throughout TCPC's history, we have consistently covered our dividends with recurring net investment income. In a few minutes, Phil will discuss our third quarter investment activity in more detail, but in summary, we saw a modest pick-up in transactions towards the end of the quarter, although volumes remain muted in this uncertain environment. We remain disciplined and consistent with our historical activity, investing in only a small percentage of the opportunities we reviewed in the quarter. Given the slowdown in private equity deal volumes, we are reminded of the benefits of our channel-agnostic approach to deal sourcing. Our pipeline benefits from our direct relationships with management teams and other industry participants developed over our more than 23 years of lending to the middle market across various cycles and our ability to draw upon the power of the BlackRock platform. Our NAV declined 1.7% during the quarter, primarily reflecting unrealized markdowns on six positions, which Erik will discuss in more detail. The majority of these unrealized marks in this quarter reflect general market volatility and some isolated performance challenges. Importantly, we remain confident in the long-term performance of these investments and our portfolio in general. The credit quality of our portfolio remains solid, with loans to just three portfolio companies on non-accrual at the end of the third quarter, totaling 1.1% of total investments at fair value. We believe we are well positioned to continue to deliver solid results given that our team has one of the longest track records in direct lending of any of the publicly traded BDCs. While we do not have an explicit forward guidance on rates, we do believe we will be in a slower growth and elevated rate environment for the foreseeable future, with a range of macroeconomic uncertainties persisting. It's in periods like this that our historical experience and deep industry knowledge continue to provide us an advantage and have resulted in strong results throughout various market cycles. As a reminder, our team also has had direct experience in special situations investing which we believe positions us well to navigate more complex market environments as we have demonstrated in prior periods of market volatility. Looking back at our historical performance as a public company, since 2012, we have generated a 10.3% annualized return on invested assets and a total annualized return of 9.6%, much of which we have delivered while base rates were substantially lower than they are today. We believe this performance remains at the high end of our peer group and reflects our ability to consistently identify attractive opportunities at premium yields and deliver exceptional returns to our shareholders across market cycles. Now, let me turn it over to Phil to discuss our investment activity and portfolio positioning.

Philip Tseng, President and COO

Thanks, Raj. I'll start with a few comments on the investment environment before providing an update on our portfolio and highlights from our investment activity during the third quarter. As Raj noted, economic uncertainty has driven a slowdown in market transaction volumes this year. However, we saw a modest pickup in transaction volumes towards the end of the third quarter, which has continued into the fourth quarter to date. We are seeing pockets of activity including in non-sponsor opportunities and refinancing to support existing portfolio companies. However, we remain disciplined and continue to pass on a substantial number of less attractive opportunities coming to market, particularly when we believe that pricing does not appropriately reflect the current market conditions or does not provide adequate lender protections. In the third quarter, TCPC invested $92 million, a significant increase from the $17 million invested in the second quarter. The deployment of capital during the quarter included loans to four new and four existing companies, primarily in senior secured loans. In reviewing new opportunities, we emphasize transactions where we are positioned as a lender of influence, which enables us to leverage our two decades of experience in negotiating favorable terms and conditions that we believe provide meaningful downside protection. We believe this has been a key factor in the low realized loss rates over our long-term track record. In addition, our industry specialization is valued by our borrowers, providing two key benefits. First, it bolsters our ability to assess and effectively mitigate risks in our underwriting and when negotiating terms in credit documentation. Second, it expands our deal sourcing capabilities with sponsors and non-sponsors who value our industry experience, which lends itself to more reliable execution. Follow-on investments in existing holdings continue to be an important source of opportunity for us. About half of the dollars deployed over the last 12 months, including in the third quarter, were with existing portfolio companies. TCPC's largest new investment during the third quarter was a senior secured first lien term loan to Nephron Pharmaceuticals to support the company's future growth initiatives. Nephron developed safe, affordable, generic inhalation solutions and suspension products. We view this investment as aligned with our overall approach to healthcare lending, focusing on companies that are lowering the overall cost of healthcare or building efficiencies in the system. New investments in the third quarter were offset by total dispositions of $126 million. Our emphasis is on companies with established business models and proven core customer bases that make them more resilient. We continue to closely monitor and engage in dialogue with our existing portfolio companies. As a result, we assess both current and projected performance relative to our original underwriting assumptions, enabling us to get ahead of any potential credit issues. The majority of our portfolio companies are successfully navigating the higher rate environment, inflation, and the general uncertainty in the economy, and they continue to deliver revenue growth and margin expansion. We are working closely with the management team and owners of the handful of companies that are facing slower revenue growth for margin pressure. However, we recently completed our quarterly review process and are pleased to report that our portfolio remains in good shape. At quarter end, our portfolio has fair market values of approximately $1.6 billion. 89% of our investments were senior secured debt spread across a wide range of industries, providing portfolio diversity and minimizing concentration risk. We also continue to emphasize companies in less cyclical industries. The portfolio at quarter end consisted of investments in 143 companies, and our average portfolio company investment was $11 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 90% of our portfolio companies each contribute less than 2% to our recurring income. 86% of our debt investments are first liens, providing significant downside protection. And 95% of our debt investments are floating rate, which offers important benefits in this higher rate environment. The overall effective yield in our debt portfolio increased to 14.1% compared with 11.3% one year ago, reflecting the benefit of higher base rates and wider spreads on new investments. Investments in new portfolio companies during the quarter had a weighted average effective yield of 14.8%, exceeding the 12.7% weighted average effective yield on exited positions. While we observed some contraction in market spreads in the third quarter relative to earlier in the year, we continue to benefit from a more lender-friendly investment environment overall, with improvements in both pricing and terms relative to 12 months ago. Post-quarter end, we have seen a modest takeoff in activity and have been investing selectively, maintaining our underwriting discipline, while being mindful of the lingering inflationary environment. We emphasize companies that provide a necessary service or product to their customers, ensuring they are more resilient across market cycles. It's also important to note that we do not take on excessive risk. We seek to build sufficient buffers to ensure companies can withstand changes in the macro environment, including higher costs, without impairing their ability to service our loans. Our pipeline is building and the yields on investments in our pipeline are generally aligned with our current portfolio. To date, we have had no prepayment income in the fourth quarter. Let me now turn it over to Erik to walk through our financial results as well as our capital and liquidity position.

Erik Cuellar, CFO

Thank you, Phil. As Raj noted earlier, our net investment income in the third quarter benefited from the increase in base rates over the last 18 months. Net investment income of $0.49 was up 17% versus the third quarter of 2022 and exceeded the third quarter dividend of $0.34 per share. Today, we declared our fourth quarter dividend of $0.34 per share and a supplemental dividend of $0.25 per share. We remain committed to being a sustainable dividend that is fully covered by net investment income, regardless of the interest rate environment, as we have done consistently over the last 11.5 years. Investment income for the third quarter was $0.94 per share. This included recurring cash interest of $0.82 per share, recurring discount and fee amortization of $0.30, and fixed income of $0.02. Fixed income remains in line with the average over our history. Investment income also included $0.02 of dividend income. Operating expenses for the third quarter were $0.34 per share and included interest and other debt expenses of $0.21 per share. Incentive fees in the quarter totaled $6.0 million or $0.10 per share. Net realized losses for the quarter were $129,000, less than a penny per share. Net unrealized losses in the third quarter totaled $15 million or $0.27 per share, primarily reflecting unrealized markdowns on our investments in Edmentum, Khoros, McAfee, 36th Street Capital, Highland, and CIBT. As Raj noted earlier, unrealized losses in the quarter were primarily driven by overall market volatility, coupled with a few isolated company-specific performance challenges. Unrealized losses were partially offset by $3.2 million of unrealized gains on our investment in Astra acquisition. The net increase in net assets for the quarter was $12.8 million or $0.22 per share. As a reminder, we have a robust valuation process, and substantially all of our investments are valued every quarter using prices provided by independent third-party sources. These include quotation services and independent valuation services. This process is also subject to rigorous oversight, including back testing on every disposition against our valuation. As Raj noted, the credit quality of our overall portfolio remains strong. Only three portfolio companies were on non-accrual at the end of the third quarter, representing 1.1% of the portfolio at fair value and 1.7% at cost. Turning now to our liquidity, our balance sheet positioning remains solid, and our total liquidity increased to $353 million at the end of the quarter, relative to our total investments of $1.6 billion. This included available leverage of $261 million and cash of $92 million. Unfunded loan commitments to portfolio companies at quarter end equaled 4% of total investments, for approximately $57 million, of which only $35 million were involved with commitments. Our diverse and flexible leverage program includes two low-cost credit facilities, two unsecured debt issuances, and an SBA program. Earlier this month, Moody's reaffirmed TCPC's investment-grade rating with a stable outlook. Our unsecured debt continues to be investment-grade rated by both Fitch and Moody's. Given the modest size of each of our debt issuances, we are not overly reliant on any single source of financing. Our maturity remains well managed. 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 decreased during the quarter to 4.24%. That is an increase of only 98 basis points over the last 21 months, while base rates increased more than 525 basis points during that same period. This is the result of having over 70% of our borrowings from fixed-rate sources. Now, I'll turn the call back over to Raj.

Rajneesh Vig, Chairman and CEO

Thanks, Erik. Even as market volatility persists, we are confident in our proven strategy and approach to investing. We believe we have demonstrated a consistent ability to execute in both periods of economic growth and contraction, which has enabled us to deliver outstanding long-term returns to our shareholders and also makes us a reliable partner for our borrowers. Furthermore, we are excited about the merger with BCIC and believe the transaction will further amplify our strengths and provide numerous benefits. And with that, operator, please open the call to questions.

Operator, Operator

Thank you. Our first question for today comes from Robert Dodd of Raymond James. Robert, your line is now open. Please go ahead.

Robert Dodd, Analyst

Hi, guys. On the pipeline question, I mean, you talked about a little bit of pickup activity after quarter-end, but that's actual investing. What about the more preliminary stages of the pipeline? Are you seeing that build towards maybe closing in Q4, or are you seeing any evidence of an increase in activity at the moment?

Philip Tseng, President and COO

Yes, thanks, Robert. This is Phil. So, I'd say in the earlier stages of the pipeline, we are definitely seeing that more robust than in the prior quarters. Whether that means deals will close in Q4 or if we're still in the early parts of '24 is still to be determined. But I think what it does pose is a good, solid pipeline for '24. I think that you can assume, and that's something that we've been thinking more about as we see the rate certainty be a little bit more visible given what the Fed just communicated yesterday and has been alluding to in terms of starting to really hit the ceiling. Whether rates come up once or twice more obviously depends, but I think the certainty over the near-term horizon probably will lead to more transactions happening, whether it's M&A or opportunities to start investing in growth again, but I think that should be encouraging for our pipeline going into '24.

Robert Dodd, Analyst

Got it. Thank you. And then on the credit and maybe sponsored discussions, etc., I mean Perch, a new non-accrual this quarter, markdown a bit. You've talked about Highland in the past, but then on the flip side, Astra, which was marked up a decent chunk this quarter. So could you give us any color on where things are struggling and, to your point, where a handful of companies are seeing slow revenue growth? Are the sponsors responding as normal or is there any change in the dynamics in your discussions with sponsors where they exist for the companies that might be having a little bit more of a difficult time?

Rajneesh Vig, Chairman and CEO

Yes, Robert, it's Raj. I'm going to try to take that as one question because there's a lot in there, but we'll try to cover a bunch of those. So, big picture, there's no thematic issue—the names you mentioned are all very individual stories, and we can cover them. There's no sort of thematic, portfolio-wide issue that is a general theme, even though there are obviously thematic issues in the macro economy. The sponsor question is a good one. I will tell you that we've mentioned this in the past couple of times, and I think we continue to see this. For the most part, the sponsors have been doing a good job, and there has been a good collective and constructive dialogue. Again, I think the steps from everyone really looking at the environment with some uniform view, which is higher rates and lower growth. In that environment, it's all about promoting liquidity and longevity, either organically or supplementing it where needed. There has been a good general observation of sponsors doing the right things by their companies, whether that's cost-cutting more aggressively or reducing discretionary items on the investment side if the ROI and growth aren't meeting expectations. It has met in numerous cases with infusions of liquidity. I think broadly speaking, we've had a good dialogue with the sponsors we work with, but keep in mind we're not a broad sponsor shop; it's more with those who we’ve done a lot of deals with over the years. For the names you mentioned, there are very idiosyncratic stories—there are no thematic portfolio-wide issues. I would say Perch and the Amazon aggregators represent more of a general industry weakness in the consumer discretionary realm. It doesn't change our long-term view on those companies; it just means that certain companies that had certain expectations of growth are not meeting those, leading them to have to take different actions, individually or collectively, and we're going to keep an eye on that. Highland, we’ve spoken about several times. Astra, just for your information, is a publicly traded name, so that valuation move is really just a quote. Other names like Edmentum, 36th Street, and others can be discussed, but I think there’s very much a similar story that’s company-specific, not portfolio-wide.

Robert Dodd, Analyst

Got it, thank you.

Operator, Operator

Thank you. Our next question comes from Christopher Nolan of Ladenburg Thalmann. Christopher, your line is now open. Please go ahead.

Christopher Nolan, Analyst

Hey guys. For the acquisition in the deck, the pro forma net leverage was, following the deals, 0.96. Given the changes in the market, do you expect that to continue? Are you saying by that projection, or have market conditions changed that?

Philip Tseng, President and COO

Chris, your question on the disclosures on the pro forma numbers is based on 6/30 leverage levels for both TCPC and BCIC. If you notice, TCPC's leverage level came down at 9/30, right about what that pro forma number was. So, on a pro forma level, right now it would be a little bit lower. Our leverage range at which we plan to leverage for the combined company doesn't change. It will fluctuate quarter-over-quarter, but likely to stay within the range that it's been for TCPC over time.

Christopher Nolan, Analyst

Great. I mean, then I guess a follow-up question. How is solar? That's an unusual holding; it's sort of been zero-coupon for a long time. I noticed that it's maturing, and these pieces of it are maturing in the fourth quarter. Is the plan simply to extend that investment? And if so, it's zero-coupon. So what's the status there, please?

Rajneesh Vig, Chairman and CEO

Yes, that's quite an old one, and it's a residual position on something that we generally exited, but has a longer tail of liability participation, and it'll just have to run its course. There's no plan to extend it. There's no entity there other than these obligations that are going to run their course in a staggered fashion, running through, I want to say 2024, but you should see that exposure continue to whittle down. It's pretty minimal now, but it will continue to decline, and we will not re-open or extend it at all.

Christopher Nolan, Analyst

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

Rajneesh Vig, Chairman and CEO

Thank you.

Operator, Operator

Thank you. At this time, we currently have no further questions. My apologies, we do have a question from Ryan Lynch of KBW. Your line is now open. Please go ahead.

Ryan Lynch, Analyst

Hey, thanks for taking my questions. First one I just had was, was there any material amendment made in the quarter that were performance-related for any? If there were, can you just talk about what was the nature of those amendments? Was there any support in conjunction with those amendments from the private equity sponsor?

Rajneesh Vig, Chairman and CEO

Yes, I'm going to try to answer that in a general way, because a lot of these tend to be confidential items. Keep in mind for us, covenants are really built to be kind of risk-mitigating circuit breakers. When things are a little weaker or growth is slower, whatever the case may be, we expect them to get close to our breach. That doesn't mean that we view the credit as challenged at those levels; it’s just a structure to give us a chance to get back in and discuss and review the situation. In numerous cases, that’s happening as it's supposed to. In some cases, that has led to not doing very much because it's not an issue; it's just a reset, and we’re comfortable with it. In some cases, that has led to infusions where we think that’s appropriate and discussions with the owner, whether it's a sponsor or not. In some cases, we may reset the covenants and take an economic view, as long as the credit is considered not compromised. It ranges quite a bit, including cash infusions. But our main and most important job in this type of business is protecting principal through effective structuring and leveraging covenants.

Ryan Lynch, Analyst

Okay, understood. And then in your prepared comments, you mentioned about approximately half of the dollars deployed over the last 12 months, which also included in the third quarter, were for existing portfolio companies. Could you kind of just give a ballpark of generally what those proceeds are being used for? Are they just refinancing existing debt packages you have in these borrowers? Are they for new growth or dividend recaps? Just love to kind of get a good framework of, when you're investing in the existing borrowers over the last 12 months, what the use of those proceeds has been.

Philip Tseng, President and COO

Yes, thanks, Ryan. This is Phil. So in every single one of those cases where we do provide additional financing for public companies, there are always healthy situations, obviously, because we're willing to do so, based on the performance we've observed over the years. We feel very comfortable extending additional credit. In large part, it's for add-on acquisitions primarily. There are some situations where they're continuing to grow their business and investing in organic growth rather than inorganic acquisitions. There's a very small sense, probably some dividend recapacity, but again, these are all for well-performing situations where we feel like they have additional capacity. A good example of that is our companies that have de-levered substantially over the time they’ve been in our portfolio. Based on our analysis, we view them as having additional capacity that we're very willing to participate in and help facilitate.

Ryan Lynch, Analyst

Okay. My final question I had was a sizable special dividend made in the third quarter, a very large spend in the fourth quarter. I'd love to hear if dividend coverage remains really strong over your core dividend next year, as far as estimates and consensus.

Rajneesh Vig, Chairman and CEO

So let me try to take that one. Certainly, we don't want people to take the special as a forecast of a repeating special, because then it's not a special anymore. We do think of this as one way to give value back to the shareholders in a more concentrated fashion. Obviously, we've not only done the special; we’ve also done some dividend raises to be viewed as recurring. We are more frequently and periodically assessing the dividend and other tools to return value to the shareholders. The merger is another form of that as well. Our Board conducts thorough reviews around the business, its current prospects, and maintaining a healthy dividend that’s well covered, so we don't find ourselves in a position where we have to take it up and then take it down, which would not be received well. It’s a long way of saying we’re going to continue to assess the conditions, which are very good. You can tell by the NII over the last few quarters. The portfolio looks in good shape, and the market is fairly attractive. We are looking to close the transaction. We'll revisit all of this under the new dynamic versus just TCPC standalone. As we do that, we will come back and share our thoughts with the market about where we can give more to shareholders. We'll continue to focus on that. I would just encourage you not to consider any one-time item as a recurring item; it’s categorized as a one-time for a reason; there is a year-end dynamic that ties into our over-earning of the dividend throughout the year.

Ryan Lynch, Analyst

Okay. Understood. I appreciate the time today.

Rajneesh Vig, Chairman and CEO

Thanks, Ryan.

Operator, Operator

Thank you. At this time, we currently have no further questions. So I'll hand back to Raj Vig for any further remarks.

Rajneesh Vig, Chairman and CEO

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

Operator, Operator

Thank you for joining today's call. You may now disconnect your lines.