Earnings Call Transcript - TRIN Q1 2023

Operator, Operator

Good afternoon. My name is Leo, and I will be your conference operator today. At this time, I would like to welcome everyone to Trinity Capital's First Quarter 2023 Earnings Conference Call. Our hosts for today's call are Steve Brown, Chairman and Chief Executive Officer; Kyle Brown, President and Chief Investment Officer; David Lund, Chief Financial Officer; Michael Testa, Chief Accounting Officer; and Sarah Stanton, General Counsel; Jerry Harder, Chief Operating Officer; and Ron Kundich, Chief Credit Officer, are also present. Today's call is being recorded and will be made available for replay at 8:00 p.m. Eastern Time. The replay dial-in number is 1800-839-9145, and no conference ID is required for access. At this time, all participants have been placed in a listen-only mode, and the floor will be open for your questions following the presentation. It is now my pleasure to turn the call over to Sarah Stanton. Please go ahead.

Sarah Stanton, General Counsel

Thank you, Leo, and welcome, everyone, to Trinity Capital's earnings conference call for the first quarter of 2023. Trinity's first quarter financial results were released just after today's market close and can be accessed from Trinity's Investor Relations website at ir.trinitycap.com. A replay of the call is available on Trinity's webpage 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 4, 2023. Therefore, you are advised that time-sensitive information may no longer be accurate at the time of any replay listening or transcript reading. Now allow me to introduce Trinity Capital's Chairman and CEO, Steve Brown.

Steve Brown, CEO

Thank you, Sarah, and thank you to everyone joining us today. We started the year with strong operating performance, building off the momentum of a record year in 2022. I'm going to start my remarks by addressing current market conditions and then transition to our first quarter performance. We continue to see market dynamics shift, given the uncertainty in the U.S. economy and increased concerns over the banking sector. We know that both challenges and opportunities exist in every economic environment. Our business model and platform at Trinity are built to thrive in stronger markets and perform well through difficult ones. Since our last call, we have seen the closures of Silicon Valley Bank and Signature Bank as well as the acquisition of First Republic Bank. SVB particularly hits the Trinity team close to home as we have both partnered with and, to a lesser degree, competed against them for many years. We have a great deal of respect for the business they created and the people that built it. We are disappointed to see these institutions shutter, but are pleased with the actions that the FDIC took to protect depositors and customers connected with these banks. While the absence of these banks has a short-term effect on the venture ecosystem, that impact is mostly related to banking services and receivable type financing, a void that other banks are already stepping in to fill. As secured non-bank lenders, Trinity and our industry peers will remain the primary source of term debt lending to the VC ecosystem. We are well-positioned to meet the emerging needs of strong VC and other institutional backed companies. Despite recent disruption, the VC industry is strong and able to navigate the current macro environment. While headlines will focus on recent year-over-year comparisons in venture equity funding, fundraising commitments are still at pre-pandemic levels. Strong companies are receiving equity support and funding. Trinity's portfolio companies are demonstrating this fact. Year-to-date, more than 25 of our portfolio companies have received over $1 billion of new equity. While we are seeing worthy companies get funding, we do want to note that it is typically at lower valuations. Equity support at any evaluation is an overall positive for Trinity and its loan portfolio. The funding that our portfolio companies are securing ensures that they can perform on any outstanding obligations to us. If down rounds persist, debt financing remains a crucial solution for venture-backed companies that want to continue to fund growth without dilution. At Trinity, we have made it our goal to only finance the companies that should and will continue to get support from their equity investors in any market. This means that we are highly selective. To put that into perspective, we generally fund only about 5% of the opportunities that we see. We have a rigorous due diligence process that will continue in today's operating environment. Turning to credit. Our portfolio has stabilized and strengthened. During the quarter, our overall internal risk rating remained constant at 2.8. When you look at historical loss rates, Trinity has been consistent over its 16-year history at approximately 24 basis points annually. When you factor in realized gains, loss rates are a net positive. We take a proactive approach to managing our portfolio. Trinity's dedicated portfolio management team monitors our investments on a day-to-day basis, communicates with all of our portfolio companies, and participates in our quarterly valuation process. In Q1, our NAV increased by $10 million, in part due to the stability of our portfolio. We have recently heard concerns over NAV decline in the BDC space. In 2022, similar to our BDC peers, we experienced a decline in NAV due to the unrealized losses attributed to multiple interest rate changes, market volatility, and some specific valuation adjustments. Additionally, we had an unusual event in Q1, in which we converted a prior year unrealized appreciation on two public company investments into a historic $50 million net realized gain that resulted in a decline in NAV of approximately $0.67 per share because of that flip. I also would like to remind our investors that $0.60 of the NAV decline in 2022 was related to the special dividends we paid to our shareholders. We have begun, and we believe we will continue to grow our NAV in the long term. Our loan portfolio should recover markdowns due to interest rate movements as we hold our loans to maturity. We also seek to recover losses from market volatility and valuation adjustments over time as we continue to work with our portfolio companies during market uncertainty to garner full recoveries. Since becoming a BDC in January of 2020, we have paid out over $5 per share in dividends to our shareholders, and we've generated over 5% NAV growth. We view generating strong returns for our shareholders while achieving NAV appreciation life-to-date as a BDC as a good reason to be optimistic about the future for Trinity. Now I'd like to turn to a few key highlights from our first quarter performance. Q1 net investment income was $19 million or NII per share of $0.55, providing 117% coverage on our core dividend. Meaningful undistributed NII as of Q1 will be reinvested into our business, both supporting our current portfolio companies and used to fund new commitments. We increased our quarterly dividend by over 2% to $0.47 per share, marking the ninth consecutive quarter that we have increased our dividend. I would also like to remind our shareholders that we had spillover income of approximately $1.64 per share at year-end that we'll continue to reinvest. Management is diligently evaluating our liquidity position in this market and regularly discusses the various uses of our capital with our Board, including the possibility of special dividends in 2023. However, our Board has not made any affirmative decisions on the special dividend at this time. In closing, Trinity is operating through volatile times with a measured approach and capitalizing on certain opportunities as they emerge. Our portfolio is built for times like these, and our investment criteria and underwriting process remain as rigorous as ever. Trinity's platform and capabilities are growing, and we are committed to our vision of building the world's best lending platform for growth stage companies. I will now hand the call over to Kyle to provide more detail on our portfolio composition and investment performance.

Kyle Brown, President and Chief Investment Officer

Great. Thanks, Steve. In previous quarters, we announced the creation of two unique value-driving investment vehicles, a direct lending joint venture and our registered investment adviser. These initiatives solidify our ability to continue to grow and deploy capital via off-balance sheet investments. The benefits of this off-balance sheet growth, including fee interest income, will provide incremental returns that will flow to our shareholders at the BDC. We're generating profitable growth and building a unique platform here at Trinity. Q1 was the first quarter that we started to recognize the benefits of the JV through both fee income and liquidity. Subsequent to quarter end, we closed the JV credit facility with KeyBank and intend to leverage that financing similar to the BDC. Trinity is prepared for the current environment, and our portfolio is differentiated by several key factors that put us in an advantageous position in terms of mitigating risk. First, we have deep relationships with a vast number of institutional sponsors who are active in the market and we are in regular communication with them. Additionally, we have no concentration risk with any one sponsor. Second, each of our lending verticals have highly diversified assets across investment type, both term loans and equipment financing, transaction size, industry, and geography. This distribution protects our portfolio from being reliant on any one deal structure or industry. And lastly, our senior portfolio managers are in constant communication with all of our portfolio companies, proactively monitoring their performance and finding ways to add value. As Steve mentioned, year-to-date, 25 of our portfolio companies have raised just over $1 billion. This speaks to the quality of our portfolio companies and the investors that are backing them. What we are seeing is not a liquidity crunch, but rather a repricing of past valuations; good companies continue to get funded. Fundings in Q1 were approximately $70 million, proceeds received from repayments of the company's debt investments during Q1 totaled approximately $83 million, which included $13 million from early debt repayments, $28 million from normal amortization, and $42 million from the sale of assets to the joint venture. The composition of our portfolio remains consistent with prior quarters and shows diversification across 20 different industries. We have intentionally structured our portfolio with varied industry segmentation with our largest industry exposure representing only 12% of the portfolio at cost. Additionally, we continue to build out our life science vertical. At fair value, 74% of our debt portfolio, or $808 million is comprised of secured loans, while 22%, or $239 million is invested in equipment financings. The remainder of our portfolio, $44 million at fair value, is comprised of equity and warrants. Our credit quality in the portfolio remains stable with approximately 98% of our debt investments at fair value performing. In Q1, the number of loans on nonaccrual remained unchanged with the same forward debt investments that have a cumulative investment cost and fair value of approximately $49 million and $24 million, respectively. For reference, this represents 4.5% and 2.3% as a percentage of the company's total debt portfolio at cost and fair value, respectively. The $6 million increase in fair value on the nonaccrual assets is related to our fair value market adjustment to our investment in Core Scientific. The company is benefiting from improved underlying market conditions. Looking at our pipeline, we finished the quarter with $339 million of unfunded commitments, all of which are subject to ongoing diligence and approval by our investment committee. In addition, we had signed term sheets for $312 million at the end of Q1. We are seeing significant opportunity with the volatility in the banking industry. Companies looking for alternative lenders continue to increase more now than ever. Looking ahead, Trinity will continue to be an attractive partner for prospective portfolio companies seeking capital to fund their growth. We are dedicated to capitalizing this business for the long term. We are diversifying our capital base with access to both public and private markets. We think this provides our shareholder base with significant upside potential that we've only now just begun to realize. With that, I'll pass the call to Dave to discuss our operating performance in more detail.

David Lund, CFO

Thank you, Kyle, and welcome to everyone joining us today. We entered 2023 with a flexible balance sheet and a strong first quarter operational performance. We recorded total investment income of $41.5 million, a 30.5% increase over the same period in 2022. This increase was attributable to the higher average loan balance in our investment portfolio and the benefit of increases in the prime rate since Q1 of 2022 that positively impacted our floating rate loans. Our effective yield on the portfolio for Q1 was 15.2% compared to 15.5% in the fourth quarter. Our core yield, which excludes nonrecurring fee income, increased to 14.3% from 14.2% in the prior quarter. The decrease in effective yield is attributed to lower early repayments, while the core yield benefited from the recent increase in the prime rate. This yield performance was contributed to our solid NII performance. Our debt portfolio continues to be well-positioned against the recent interest rate hikes with 70% of our debt investments at floating rates, while on the borrowing side, 30% of our outstanding debt at the end of the first quarter was at a variable SOFR rate, contributing to a solid net interest margin or NIM of 11.1% for the quarter. We incurred a total of $11.1 million in interest expense and amortization of deferred financing costs on our various debt facilities as compared to $10.3 million in Q4. The increase in interest expense was primarily due to the higher average debt outstanding during the quarter and the increase in the base rates under our KeyBank credit facility. Our other operating expenses, excluding estimated excise taxes, were approximately $10.5 million during Q1 as compared to approximately $9.2 million during Q4. The increase of approximately 14.6% was primarily driven by an increase in variable compensation, employee benefits, and professional fees. As a result of this operating activity, net investment income for the first quarter was $19.3 million or $0.55 per basic share, an increase of 23.7% compared to $15.6 million or $0.57 per basic share in the same period of the prior year. We recorded net unrealized appreciation of $3.5 million during the quarter as a result of $2.8 million of credit-specific adjustments. $1.4 million related to the impact of interest rate changes, and the flip of $318,000 to realize losses, offset by $950,000 of depreciation related to market volatility. We recognized an unrealized appreciation of $8.2 million in our debt portfolio and unrealized depreciation of $4.7 million in our equity and warrant portfolio primarily related to market volatility. Approximately $6.6 million of our unrealized appreciation in the debt portfolio is related to two portfolio companies, Core Scientific that Kyle mentioned earlier, and FemTec Health, both of which we have previously identified. FemTec was realized after quarter end and the impact is reflected in our first quarter NAV. Our operating activities generated strong returns for our shareholders with an ROAE based on NII average equity of 16.5% and our ROAA based on NII on average total assets of 6.8%. Lastly, as of March 31, 2023, NAV increased 2.2% to $469.7 million, driven by our $22.5 million of net operating income. NAV per share decreased to $13.07 compared to $13.15; the decrease in NAV per share was primarily related to the impact of additional shares issued under Trinity's restricted stock award program. I will now hand the call over to Mike Testa, our Chief Accounting Officer, who will discuss our credit performance, liquidity, and capital allocation.

Michael Testa, Chief Accounting Officer

Thanks, Dave. Starting with credit quality. Our portfolio companies continued to perform well in the first quarter of 2023, with approximately 98% of our portfolio performing at fair value. We maintain the number of nonaccruals and watchlist companies from last quarter with four debt investments on nonaccrual, representing just 2.3% of the fair value of the total debt portfolio. Our average credit rating for the first quarter stood at 2.8 based on our 1 to 5 rating system with five indicating very strong performance. This rating is in line with our average credit rating of 2.8 in Q4. Looking ahead, we see solid credit opportunities in the pipeline. As those potential investments convert, we will continue to be rigorous with our due diligence, underwriting, and portfolio management processes. Moving to liquidity. As of March 31, 2023, we had total liquidity of approximately $175 million, comprised of approximately $167 million of undrawn capacity under our credit facility and $8 million in unrestricted cash and cash equivalents. Additionally, we commenced co-investing with our joint venture that provides additional investment liquidity. Our net leverage ratio, which represents principal debt outstanding less cash on hand, decreased slightly to 1.29x this quarter as a result of net portfolio activity, including the sales of investment to our joint venture. As of March 31, 2023, total debt principal outstanding was $616 million, and had a weighted average cost of debt of 7%, up slightly from 6.8% at December 31, 2022, due to higher base rates under our credit facility. Unsecured debt represented 70% of total borrowings at quarter end, with the majority of our investment portfolio in floating rate investments and the majority of our corporate debt at fixed rates, we continue to be well positioned in a rising rate environment. To reiterate what the rest of the team has already touched on, we are confident in our capital structure and balance sheet, especially with the commencement of the JV and RIA. Both are expected to provide us with access to additional liquidity and are just two examples of how we are raising capital in ways that are accretive to our shareholders, while being opportunistic at the VC level. We also utilized our ATM offering program during the quarter, raising approximately $4.2 million, further supporting the long-term growth of Trinity. We look forward to sharing more updates on these initiatives in future earnings calls. Finally, on March 14, 2023, our Board declared a cash dividend of $0.47 per share for the first quarter of 2023, representing a 2% increase from Q4 2022. Our Board of Directors generally makes a determination of our dividend distributions on a quarterly basis. With that, I will now open the line up for questions.

Operator, Operator

We'll take a question from Casey Alexander of Compass Point. Your line is open.

Casey Alexander, Analyst

Yes. Good afternoon. Can you tell us how big you expect the joint venture to become in terms of assets under management? You reported a decline of $42 million this quarter. What is the total capacity anticipated?

Michael Testa, Chief Accounting Officer

Yes, Casey, this is Mike. We did previously report this, but the total size of the equity capital is $171 million, and we closed a debt facility with KeyBank for $75 million after Q1. We believe that will be leveraged similarly to what the BDC is at. Additionally, from that joint venture, we expect to see $400 million to $500 million over time that will be available for investment in the marketplace.

Casey Alexander, Analyst

In relation to Core Scientific, there is a healthy markup of $5.7 million. Was this markup primarily influenced by the macroeconomic conditions, or do your negotiations with Core suggest a more favorable outcome for the loan or the equipment finance facility? Additionally, do you have an estimate on when they might reemerge?