Trinity Capital Inc. Q1 FY2024 Earnings Call

Good afternoon. My name is Jamie, and I will be your conference operator today. At this time, I would like to welcome everyone to Trinity Capital's First Quarter 2024 Earnings Conference Call. This call is being recorded and will be available for replay beginning at approximately 3 p.m. Eastern Time. The replay dial number is 1-800-839-2389, and no conference ID is required for access. It is now my pleasure to turn the call over to Ben Malcolmson, Head of Investor Relations for Trinity Capital. Please go ahead.

Thank you, Jamie, and welcome to Trinity Capital's Earnings Conference Call for the first quarter 2024. Today, we are joined by Kyle Brown, Chief Executive Officer; Michael Testa, Chief Financial Officer; and Gerry Harder, Chief Operating Officer. Also joining us for the Q&A portion of the call are Ron Kundich, Chief Credit Officer; and Sarah Stanton, Chief Compliance Officer and General Counsel. Trinity's financial results were released earlier today and can be accessed from our Investor Relations website at ir.trinitycap.com. A replay of the call will be available on our website or by using the telephone number provided in today's earnings release. Before we begin, I would like to remind everyone that certain statements that are not based on historical facts made during this call, including any statements relating to financial guidance, may be deemed forward-looking statements under federal securities laws. Because these forward-looking statements involve known and unknown risks and uncertainties, there are important factors that could cause actual results to differ materially from those expressed or implied by these forward-looking statements. We encourage you to refer to our most recent SEC filings for information on some of these risk factors. Trinity Capital assumes no obligation or responsibility to update any forward-looking statements. Please note that the information reported on this call speaks only as of today, May 1, 2024. Therefore, you are advised that time-sensitive information may no longer be accurate at the time of any replay listening or transcript reading. Now please allow me to turn the call over to Trinity Capital's CEO, Kyle Brown.

Thank you, Ben. Thanks, everyone, for joining us today. First quarter was a strong start to the year for Trinity. We remain opportunistic in the current market by investing in our platform as we continue to scale and deliver value to our shareholders. Notable highlights during the quarter include $243 million of gross fundings across 8 new portfolio companies and 12 existing portfolio companies. Platform AUM growth of 38% year-over-year, pushing our assets under management to $1.6 billion. Record net investment income of $25.2 million, a 30% increase versus Q1 of last year and a return on equity of 16.1%. Our performance allowed us to increase our quarterly dividend to $0.51 per share in the first quarter, making this the 13th consecutive quarter. We’ve increased our dividend. Credit underwriting and portfolio management continue to remain fundamental to our success. We maintain regular standards and origination diligence and portfolio management to position us to effectively navigate a dynamic market. Our team of nearly 80 professionals is the cornerstone of Trinity's track record and is a key to our trajectory going forward. We're committed to creating a unique culture of excellence built around six pillars: humility, integrity, trust, uncommon care, continuous learning, and an entrepreneurial spirit, all of which create a differentiated lending platform that we built here at Trinity. We strive to provide value above and beyond expectations to every part of the Trinity platform, whether that's employees, clients, or investors. As an internally managed BDC, our employees and management own the same shares as our investors. Shareholders own a pool of assets as well as a management company, which maximizes returns and maintains a strong alignment of interest with our shareholders. Our commitment to expanding the platform is highlighted by our investments in strategic growth initiatives across the platform. In the first quarter, Trinity solidified its position as a diversified lender by further growing our four distinct business verticals: equipment financing, life sciences, warehouse lending, and tech lending, each with their own origination, credit, and portfolio management teams. Our exceptional relationships with portfolio companies and industry partners have also been pivotal in achieving our strong performance. In the first quarter, an aggregate of $1.2 billion of equity was raised by 21 of our portfolio companies, demonstrating that our portfolio companies are able to secure the funding they seek. We ended the quarter with a strong investment pipeline, including $405 million of unfunded commitments, leaving us well positioned for continued growth in 2024. As a reminder, all of Trinity's unfunded commitments are subject to ongoing diligence and approval by our investment committee. Turning to the macro environment, activity is picking up in the bench capital and private equity worlds. Exceptional levels of dry powder remain in BDCs, and nonbank lenders continue to be vehicles of choice for sponsor-backed companies. With this high demand for capital, we maintain our selective approach with new opportunities. As a direct lender, we own our pipeline and have originators strategically located in major markets around the country to further build deep relationships with sponsors, banks, and operators. We pride ourselves on three core principles here at Trinity: exhibiting uncommon care for our employees and our partners, serving our clients by being partners rather than just money, and providing outsized returns for our shareholders. We're bullish about the future. We plan to continue to invest in our teams and systems, diversifying our investments to mold the best-in-class direct lending platform. We're just getting started. We look forward to extending this momentum in the quarters to come as we continue to grow and maximize value for our shareholders. And with that, I'll turn the call over to Michael Testa, our CFO, to discuss financial results in more detail. Mike?

Thank you, Kyle. In Q1, we achieved record total investment income of $50.5 million, a 21.5% increase over the same period in 2023. Our effective yield on the portfolio for Q1 was once again strong at 15.8%. Our core yield, which excludes fee and prepayment income, was 15.3%, mostly consistent with the prior quarter. Net investment income for the first quarter was $25.2 million or $0.54 per basic share, an increase of 30% compared to $19.3 million or $0.55 per basic share in the same period of the prior year. Our net investment income represents 106% coverage of our quarterly distribution, and our undistributed income is approximately $55 million or $1.33 per share. Our platform continues to generate strong returns for our shareholders with ROAE based on net investment income over average equity of 16.1%, and ROAA based on net investment income over average total assets of 7.5%. As of March 31, 2024, our NAV was $626 million, which increased from $611 million as of December 31, 2023. Our corresponding NAV per share was $12.88 per share at the end of Q1, which decreased from $13.19 per share as of December 31, 2023. The decrease in NAV per share this quarter was primarily attributed to the issuance of restricted stock awards that enable us to continue to grow our platform as well as net unrealized depreciation that Gerry will discuss in more detail later in the call. Under our ATM program in Q1, we raised approximately $24.3 million in proceeds, all at an accretive premium to NAV to fund our ongoing portfolio growth. As of March 31, 2024, we had total liquidity of $172 million, comprised of $160 million of undrawn capacity under our credit facility and $12 million in unrestricted cash and cash flow. We continue to realize the benefits of our co-investment joint venture, which in Q1 provided $1.3 million or $0.03 per share of interest, dividend, and fee income to the BDC. During the quarter, the joint venture also expanded its revolving credit facility. And as of March 31, 2024, we have more than $200 million of assets under management. This off-balance sheet vehicle provides incremental capital for growth and accretive returns to our shareholders. At the end of the quarter, we raised $115 million of unsecured notes that mature in 2029, further enhancing our balance sheet and liquidity position and extending our maturity ladder. We believe our current debt funding mix, which is currently 74% unsecured debt, is appropriate, and we remain consistent with managing the right side of the balance sheet. We intend to repay $30 million over $182.5 million in May. Our weighted average cost of debt was in line with the prior quarter at 7.4%, and we continue to benefit from low-fixed-rate debt, having access to the unsecured market during a period of lower interest rates. Our net leverage ratio, which represents principal debt outstanding less cash on hand, was 1.16x as of March 31. Both our strong liquidity position and the fact that we are operating within our targeted leverage range provides Trinity with the flexibility to manage a strong pipeline and be opportunistic in the marketplace.

Thank you, Michael. At the end of Q1, on a cost basis, our total portfolio consisted of 74.3% secured loans, 19.7% equipment financing, 3.7% equity, and 2.3% warrants. The composition of our portfolio remained consistent with prior quarters with diversification across investment type, transaction size, industry, and geography. Our portfolio is segmented across 21 industry categories, with our largest industry exposure, finance and insurance, representing 13.3% of the portfolio at cost. Growth in this industry sector was driven by investments in three new portfolio companies in the quarter. Our next largest industry concentrations, our green technology and space technology, representing 10.5% and 8.7% of the portfolio at cost, respectively. Life sciences-related industries, including health care tech, medical devices, biotechnology, and diagnostics and tools collectively made up 18.2% of our total portfolio on a cost basis. As of the end of Q1, our largest debt financing is to Rocket Lab, USA, Inc. and represents 3.9% of our debt portfolio and 3.6% of our total portfolio on a cost basis. Our 10 largest debt investments collectively represent 25.8% of our total portfolio on a cost basis. Moving on to credit. The credit quality of our portfolio companies remained stable with approximately 97.6% of our portfolio performing on a fair value basis. Our average internal credit rating for the first quarter stood at 2.7 based on our 1 to 5 rating system with 5 indicating very strong performance. This rating is in line with our average credit rating in each of the last four quarters and reinforces Trinity's track record of low loss rates. The total number of credits in our lowest two credit tiers did not change from Q4 to Q1, but was reduced on both a cost and a fair value basis. Quarter-over-quarter, we remain consistent with five portfolio companies on nonaccrual. Core Scientific was removed from nonaccrual in Q1 following its emergence from bankruptcy and our election to receive shares of its common stock in lieu of our debt investment. However, one additional credit was added to nonaccrual status. As Michael mentioned earlier in his prepared remarks, our decrease in net asset value per share in Q1 was a function of expenses related to growth of the platform as well as unrealized depreciation in the portfolio. Out of approximately $12 million in unrealized depreciation within the portfolio, approximately $9 million is due to the single credit mentioned above. Additionally, approximately $5 million of unrealized depreciation was due to a decrease in the publicly traded share price for our common shareholdings in Core Scientific. Outside of these two positions, the fair value of the balance of our debt and equity portfolio was slightly up for the quarter. At the end of Q1, our nonaccrual credits had a total fair value of approximately $30.4 million, representing 2.4% of the total debt portfolio. At quarter end, 75% of our total principal outstanding was backed by first position liens on enterprise, equipment, or both. The weighted average loan-to-value of our entire portfolio sits at just under 19%, demonstrating that our portfolio companies are generally not over-levered and are in a healthy position to service the debt, even if our loan is not in first position. In closing, I'd like to remind our investors that our team is made up of dozens of veteran investment professionals who are solely focused on portfolio management and asset quality. They continue to take a vigilant approach to the overall health of our portfolio companies and when necessary, work tirelessly to find resolutions that benefit both the portfolio company and Trinity shareholders. At this time, we'd like to open the line for questions. Operator?

We'll take our first question from Bryce Rowe with B. Riley.

Maybe I wanted to start with just from the comments you made about activity picking up, you've seen your unfunded levels kind of go up as well as we've progressed here over the last, I don't know, a couple of years or so. Is that a function of just again, the market picking up? Or the I guess, the broader capabilities that you've been working on there at Trinity over the last year or so?

Yes. So I just got back last night from an off-site with our sales team in our San Diego office, 25 professionals covering four different business verticals: life science, equipment financing, tech lending, warehouse lending. And these are people that we've recruited over multiple years. The seasoned veterans, 20-plus years of experience, most of them, they're fired up. I wouldn't want to be competing against them. They're out there building the business, very excited, tons of opportunities. And yes, it is exactly what you said. It's a lot of great people who are very good at what they do. And then it also speaks to the diversification of our business. We have continued to grow above and beyond just doing technology venture loans. We have multiple businesses, multiple products, and we are seeing growth in those different business verticals. So yes, it's very active right now. This is the most robust pipeline we've ever had, and it's looking really exciting going forward.

And Kyle, considering the current situation, there is significant planning required for managing the right side of the balance sheet. You've made some moves by raising equity, setting up joint ventures, and increasing debt. How do you approach managing that part of the balance sheet, especially with interest rates being somewhat elevated? Given that markets seem to be somewhat open now, are you planning to take advantage of that to secure some debt financing for the right side of the balance sheet?

We're not focused on just expanding our market presence. Instead, we're taking advantage of opportunities to raise debt and equity in the most efficient manner possible. You can see this in our recent bond deal and through our ATM program, which are both effective ways to gather capital. Each of these efforts begins with a crucial question: will this growth benefit our investors? It should be clear what our intentions are at this stage. We have consistently delivered steady and increasing returns for our shareholders over 17 quarters as a publicly reporting company, including raising the dividend for 13 consecutive periods. I don't need to forecast the future; we've clarified our strategy and goals. Our capital-raising isn't aimed at merely increasing assets under management, which makes no sense for an internally managed BDC. I aim to avoid diluting my shares, which are the same ones held by your investors. Thus, we're focused on strengthening the balance sheet in ways that are beneficial to our investors. We will seek to raise equity and debt when it makes sense. If our team can continue to grow, build, and capture market share, we'll utilize that capital effectively to enhance returns for our investors. We'll keep pursuing this approach.

Just given where we are in the year, if we're thinking back to where we were last year at this point and given your expertise in venture, but just give us kind of an update on the competitive environment now that we're kind of year out from, call it, the regional bank fallout?

I believe there has been reduced competition, especially in our venture business. We're seeing returns and an influx of equity dollars from venture firms, returning to levels we witnessed in 2019, which were historic at the time in terms of deployment. We're at the beginning of the process and are experiencing increased deal flow. However, the percentage of deals from the top of the funnel has decreased, reflecting our careful underwriting to ensure we fund the right investments. The longevity of these venture-backed companies is rising, and we're stricter about ensuring they have sufficient equity support. The current investments we're making are in companies that are thriving despite challenges and are being valued much lower than they were a couple of years ago. Therefore, we are observing growth, and while there's some competition, it seems to be slightly less, particularly from banks, which are pulling back. This shift is creating more opportunities for us to pursue higher quality credits that previously would have secured bank financing but are now considering alternative options like Trinity.

Got it. Very helpful. And then just shifting to credit, all the metrics you highlighted seems like things are relatively stable companies have adapted to the rate environment. But just give us a sense for kind of the growth rates you guys track and where those are trending versus, I don't know, call it, 6 months ago versus a year ago?

I think you're talking about our core yields, is that you were talking about?

I apologize for any confusion. I was speaking generally. You mentioned stability, but I would like to understand the growth rates at your portfolio companies and how they compare to six months or a year ago.

Okay. Sorry, Kyle. Yes. Ron, do you want to touch on that?

Sure. Kyle, Ron Kundich here. As Kyle mentioned in his answer just now, I mean, the top of the funnel is very active. We're seeing companies of all shapes and sizes. We're focused on the companies that are growing; they are growth-stage companies. The companies that we're lending to are growing at a relatively healthy clip. We're not focused on flat-to-nongrowth companies. So broadly speaking, the industry is mixed, but we're laser-focused on the growth stage.

Yes. The majority of our portfolio is now made up of investments made post that banking volatility. So you're looking at companies that have figured out a way to grow and perform well, and those are the investments in the companies we're putting capital into. So things haven't changed really for a lot of those investments since we made them.

Just in terms of the pipeline you mentioned, I was just wondering on mix. We look at Q1, it looks like about $38 million venture loans, $50 million equipment finance. Is that the kind of mix we should think about throughout this year? Or is it going to be kind of more opportunistic quarter by quarter?

I'll let Gerry provide more details, but I'll start with a high-level overview. We have an Annual Operating Plan that we are committed to. We planned this well in advance and are very strategic about each vertical, determining their annual and quarterly deployment and what the pipeline should look like to achieve our goals. We believe we are on track for the year, and our approach is not merely opportunistic. Each business vertical has its own contribution margin that they focus on, so they know precisely what their deployment needs to be and what their spending limits are. We are not improvising or acting purely based on opportunity. Gerry, would you like to add anything?

Yes. I mean, at a high level, Vilas, we're looking at somewhere between 40% to 45% of the deployment across the year ought to be in tech lending and then 25% to 30% in life sciences and equipment, and maybe 10% or so in asset-based or warehouse. So this is on the annual level. It is blocky, right? And so in a given quarter, you can get the wrong signal of percentages based on what we happen to close just within that quarter versus what pushes. But at a high level annually, you will see tech lending be our largest deployments, but life sciences and equipment also posting very strong.

Okay. And then on the venture lending side, do you have a line of sight into healthy companies that may or may not have come to the market over the last couple of years that you may be eyeing later on in this year as potential opportunities? Like is there anything there that kind of gives you a sense of optimism as to the quality of investment on that side of your deployment that you'll be able to do?

Yes. Well, I think particularly because we do a lot on the venture debt side, we're doing mostly later-stage companies, right? And so I think what you're seeing there is a lot of companies who have remained private, hoping for that IPO or exit-type opportunity. They're seeing that window start to open up. We're having different conversations with companies internally, externally about financings kind of leading up to it. So I think that what you're seeing is a new exit opportunity, which is creating new investment opportunities kind of leading towards that, which is new for 2024.

Okay. Makes sense. And just one more on credit in your prepared remarks, you mentioned a new nonaccrual, I think you were alluding to NextCar. I was just wondering if there was any kind of commentary you could give there on what you're seeing, given it seems like the market you have there about 50% of cost is a bit more cautious than one of your peers that's looking at the same company. So is there any color you can provide there on how to think about that?

Yes, we strive to maintain a rigorous and process-oriented approach in our valuation methodology. We apply this consistently each quarter. Our methodology relies on third-party collaboration, and we recently had third-party input on NextCar's valuation. In situations like this, we often conduct a profitability-weighted outcome analysis and rely heavily on the expertise of our portfolio management team. The account is overseen by our most seasoned portfolio manager, who has 25 to 30 years of experience in the banking sector. He will provide his honest assessment. We will continue to seek third-party collaboration and remain consistent in following our process from quarter to quarter.

We'll go next to Paul Johnson with KBW.

In terms of making loans on the platform across any of your verticals, such as warehousing or equipment leasing, can you share if there is any limit on the hold sizes you are willing to take for any particular loan in the BDC? Additionally, how much credit are you generally prepared to extend to a single borrower?

Historically, we've aimed to keep our total assets under 4%. On average, we are well below that. We want to ensure that no single deal creates excessive volatility for Trinity. Therefore, we will maintain a very diversified portfolio across various sectors and within those sectors, ensuring that no single company has the potential to jeopardize us. Gerry, feel free to add to that.

Yes. I'd further add, as we look to grow and expand the platform at Trinity, we're going to do this very thoughtfully, but by providing additional value products to our growth-stage companies and not by increasing our hold sizes, right? That's not the approach we intend to take. So Kyle mentioned that 4% line. I think over time, you can see that drop, right, as our platform continues to expand. And that's at the BDC level when we talk about that 4%, not at the total aggregated holdings across the balance sheet.

I believe you summarized our goal, which is to build and scale effectively. The internally managed BDC has not yet achieved optimal efficiency, but we are committed to reaching that scale. As we progress, you will begin to see improvements in our cost and expense ratios. We still have significant potential to deliver value to shareholders through the internally managed BDC alone, not accounting for our off-balance sheet activities. It's essential to understand our strategy and how we plan to execute it. We now have a registered investment advisor and manage off-balance sheet funds, generating fee income for several quarters, and we aim to increase this income in addition to the interest from our loans and equipment financing. Our potential for growth is much greater than our current position. We want to gauge what our team can achieve, but our growth will be purposeful. We are focused on a five-year plan that we believe can result in meaningful, accretive growth for investors, while also diversifying beyond just return metrics. The model of generating fee income in addition to our loans is beneficial, and we can further diversify our portfolio across various sectors, which helps mitigate risk. While I can't provide specific numbers right now, we are strategically focused on our growth as a public company, and we intend to pursue it in a manner that benefits investors.

We'll go next to Casey Alexander with Compass Point.

Just wondering any update on the launch and funding of the RIA?

So we've been talking about deploying capital in Q2, and that is still the target, Casey.

There's been a lot of discussion about scaling and growth for the business. Can you provide insights on your expected loss rate for the portfolio, especially considering you're lending at 10% over SOFR? However, net income has consistently been below net interest income. What are your updated thoughts on the current market, and how should we view the portfolio loss rate moving forward?

Well, I think Mike can provide the exact loss rate. The loss rate has been very consistent for 16 years, four of which have been as a publicly reporting company, at 32 basis points. I mean the loss rate in our world is...

26 basis points.

Okay. Sorry. It's less than what I thought. We have consistently been able to keep that loss rate low. The upside that we get in our investments via warrants and those realized gains, they offset those losses and deliver a little upside for investors. We've seen that play out for 16 years. We intend to just keep doing what we've been doing. So I do not see for any reason why that loss rate should increase. Our underwriting and our thesis on how we invest has not evolved or changed. And so I think that should stay steady, Fin. And over time, and particularly with this season right now with valuations dramatically increasing, that creates some really interesting upside potential on our warrants. And so I think there's some upside that we're starting to see and hopefully baking into the long-term plan here with the investments we're making today.

I appreciate the comments on mitigating risks. I'd like to shift the focus a bit and understand how you are managing risks in your funding base, especially regarding your debt funding. You have several maturities coming up in 2025 and 2026, and your credit facility makes up 26% of total borrowings by my calculations. You are working with a single bank, which I estimate has about 70% of its loans invested in commercial-related projects. This presents a particular risk profile for the company that hasn't been widely discussed. I'd like to hear your thoughts on this.

Michael here. I just wanted to talk a bit about why we went into the unsecured market. I think in the past quarter, we were pleased with the execution on that deal and that size. And that again, it was really a consistent approach of laddering out our maturities. We're going to continue to tap the market, whether it's secured or unsecured. And in our revolver with KeyBanc, we have 10 other banks in there. So we're happy having that diversified across that. Also, the liquidity through a joint venture and we upsized the facility across two additional banks in the JV facility. So we look at that as a risk-mitigant to diversify our funding sources. And then long-term, vehicles under the RIA adding to that flexibility of multiple funding sources, debt and equity.

Great. Is the plan to replace these maturing notes with secured borrowings kind of mature?

Sorry, can you repeat the question?

Yes. Are you going to use more secured funding as these unsecured notes mature?

Yes, that's definitely an opportunity for us. We've been in discussions and have observed many of our peers utilizing a CLO structure for securitization and increasing leverage. I believe we have room within our current leverage range. Additionally, diversifying our borrowing sources is important. We currently work with ten different banks in our syndicate and are in talks to expand that through the current revolver or potential additional revolvers in the future.

The other key point I think Chris mentioned earlier is the importance of not relying on a single bank. We actually have 10 banks in that syndicate. It's expanding, and we maintain strong relationships with all of those banks. This was a deliberate strategy to ensure diversification across multiple banks.

And it appears that we have no additional questions at this time.

Okay. Well, listen, we're really proud of our first quarter results, and we look forward to updating you on our next call in August. We'd like to just thank everybody for participating in the call today. Appreciate your interest and investment in Trinity Capital. Have a great rest of your day.