Q2 2020 Owl Rock Capital Corp Earnings Call
[music].
I would like to remind our listeners that remarks made during the call may contain forward looking statements.
We're looking statements are not guarantees of future performance or results and involve a number of risks and uncertainties that are outside the company's control.
Actual results may differ materially from those and forward looking statements as a result of a number of factors, including those described from time to time in our out capital corporations filings with the Securities and Exchange Commission.
The company assumes no obligation to update any forward looking statements.
As a reminder, this call is being recorded for replay purposes.
Yes, the company issued its earnings press release and posted an earnings presentation for the second quarter ended June Thirtyth 2020.
This presentation should be reviewed in conjunction with the company's form 10-Q filed on August 4th with the FCC.
The company were well refer to the earnings presentation throughout the call today. So please have the presentation available to you.
As a reminder, the earnings presentation is available on the company's website I when I will turn the call over to Craig Packard, Chief Executive Officer of our route Capital Corporation.
Thank you operator, good morning, everyone and thank you for joining us today for our second quarter earnings call.
This is Craig Packer and I am C O about rock capital Corporation, and a co founder about Roth capital partners. Joining me today as Alan Kirshenbaum, our CFO, and COO and Danisco funny or head of Investor Relations.
Welcome to everyone, who is joining us on the call today, we hope you in your families or safe and well.
I will start today's call by briefly discussing our financial highlights for the second quarter before providing an update on what we're seeing across our portfolio in this challenging economic environment.
Then after Allen covers our financial results I'll conclude by discussing our outlook and current market conditions.
Getting into the second quarter financial highlights net investment income per share was 34 cents.
We ended the quarter with net asset value per share of $14.52.
Which is an increase of 3% versus the prior quarter, primarily reflecting a reversal of a portion of the unrealized losses, we took last quarter as we've seen credit spreads tighten meaningfully from the end of the first quarter.
This now is in line with the estimated range that we pre released on July 13th.
Looking forward for the third quarter. Our board has declared a dividend of 31 cents per share the same amount we've paid each quarter since our IPO and which is in addition to the previously declared special dividend of eight cents per share.
We have two additional remaining eight cents per share special dividends, which had been previously declared for the third and fourth quarter of this year.
Regarding our balance sheet, we remain very well capitalized with over $2 billion in liquidity today.
That said, we continue to be cautious on capital deployment in this environment and so we continue to commit to maintain what are the lowest leverage profiles in the space.
The leverage ending I'd 0.6 this quarter.
In June we received shareholder approval to decrease or asset coverage <unk> requirement to 150%, which will allow us to achieve our revised leverage target <unk> 0.9 to 1.25 debt to equity and operate with meaningfully more cushion to our regulatory cap.
Lastly, the third and final lock up a bar stock came off on July 20th.
At this point, 100% of our pre IPO shares our freely tradable.
Although we don't feel the current stock price reflects the true value of the portfolio we have created.
We're pleased to have moved through the lockup period with limited disruption to our stock price, which we believe continues to highlight the long term orientation of our shareholder base.
Now I'd like to provide an update on our portfolio.
While the effects of the economic shutdown related to the Cobot 19 pandemic. We're just beginning to be felt at the end of the first quarter second quarter reflects a full quarters impact.
As such our top priority has remained protecting the value of our existing investments.
I spent significant time on our first quarter call detailing our enhanced portfolio management process and we've been very pleased with the outcome of this approach.
Information flow with our borrowers remains strong and we continue to receive frequent updates from our companies.
Overall, we feel very good about the quality of our portfolio and its performance despite the economic challenges.
I'd like to remind everyone why we believe our portfolio is well positioned to whether these uncertain times.
We ended the second quarter with 9.2 billion of investments at fair value across 100 to borrowers with an average investment size of less than 1% of the total portfolio.
Our investments consist primarily of first lien term loans to upper middle market businesses with an average EBITDA of $93 million.
Since inception, we aim to assemble our portfolio in a defensive minded manner by focusing on large stable recession resistant businesses.
We are well diversified across 27 industries with no industry, representing more than 9% of the portfolio and our top 10 positions representing 24% of the total.
We lend primarily to private equity backed companies, which we find attractive because private equity firms can support their companies with financial and operational resources.
In line with last quarter, our sixth largest sectors or software insurance professional services health care providers distribution, and food and beverage, which collectively comprise approximately half of our portfolio.
We continue to believe this is a solid core group of sectors that continues to perform well even in the current economic environment as many of these businesses provide essential or non discretionary services.
To date or borrowers in these segments have demonstrated resilience and by and large continue to perform well.
Looking beyond or six largest sectors. The vast majority of our borrowers continue to have reasonable performance even in this highly unusual environment.
Although it's still early in the economic disruption what we've seen so far we believe validates how we're positioned our portfolio.
As expected this quarter, we saw an increase in discussions with our borrowers and their private equity owners about covenant levels and liquidity needs.
To date. These discussions have been very constructive and in a number of cases have already lights concrete actions, which improve our borrowers balance sheets.
We have needed to negotiate amendments in a relatively modest amount number of credits in the context of the size of our portfolio.
We executed a significant amendments during the quarter in which we provided covenant modifications or liquidity runway, sometimes by allowing a borrower to pay a portion of interest in kind rather than in cash for a period of time.
In exchange the borrowers financial sponsors putting additional equity in almost all of these situations.
Most of these we also received enhanced economics, such as increased spread fees or call protection.
We amended roughly $500 million of investments this quarter, where we received additional economics, which added an average.
Added on average an additional 120 basis points of spread on those investments.
We're pleased to strength in capacity of our portfolio management, and workout resources, which have allowed us to work through these complex situations.
Overall, we did not see material change in our internal credit ratings metrics this quarter.
The percentage of our portfolio, which is a three or four on our internal rating system is 13% for the second quarter up only slightly from 12% in the first quarter.
We also saw some names continue to outperform our expectations and were upgraded to our highest rating category.
9% of the portfolio is now rated as a one versus 7% in the first quarter.
Names in our two rated category names, which are performing in line with our expectations continue to account for over 75% of the portfolio.
Further we continue to have no names in the lowest rated five category and we continue to have no loss of original principal on any investment since inception.
Another measure of our portfolio health is that less than $950 million or 10% of the portfolio is marked below 90 cents on the dollar today.
Further only one debt investment is marked below 80.
Our most cobot impacted borrowers, which make up a majority of our three and four rated investments operate across several different industries. However for the most part they have ultimate end market exposure to either have to broad segments.
Discretionary consumer spending where the travel and hospitality space.
The discretionary consumer spending and market primarily includes businesses with physical locations, which were impacted by temporary store closures and stayed home orders.
Many of seen some pickup in activity as the economy reopens, although it's still early.
The travel and hospitality sectors face a longer wrote back to historical levels. The company's most impacted here include the ones in our aerospace and defense sector as well as businesses, whose end market is driven by travel.
As a quarter and each of our 102 portfolio companies were current on their interest.
Pick interest represents less than 5% of total investment income for the year to date period.
We have one situation, where we have agreed with the borrower to delay the interest payment past quarter end, while we the borrower and the sponsor or working on a broader amendment package.
As previously disclosed at the end of the second quarter, we placed two names on nonaccrual status.
The incorporation also known as national dentists, and see I'd be to global.
Aggregate exposure of these names is approximately $165 million or less than 2% of the total fair value of the portfolio.
We're working closely with both companies and their financial sponsors to help the company's through these difficult times as well as maximize the value of our investments.
This is the first time since inception, though we've had names on non accrual. However, we have certainly always understood that there would be challenges over time, where they hopefully small number of names to our portfolio.
We believe that the focus of our portfolio management of workout experts will allow us to navigate these challenges in a proactive and holistic manner.
Turning briefly to our origination activity during the second quarter, New investment fundings were $308 million and net funded investment activity was $142 million, which was net of 166 million of cells and repayments.
As we anticipated coming into this quarter, our originations were more modest as activity in the market slowed and we remain cautious given the macroeconomic environment.
That said, we were pleased to add three new borrowers to our portfolio.
As you'll see in our earnings presentation, the weighted average spread of the new investments. This quarter was 7.4% roughly 100 basis points higher than our current portfolio spread.
I'd like to spend a moment highlighting one of these deals we provided a 300 billion dollar unitranche loan to check marks and what was one of the few transactions to take place during the height of the pandemic.
Our financial flexibility and ability to provide certainty enabled us to support the buyout of this leading software security provider by Helman, Friedman and a $1.2 billion transaction.
Acquisition will bolster check marks is already outstanding growth at a time when software security has never been more critical for modern enterprises building out their software solutions.
I'll also highlight one of the names that was repaid at this quarter.
Given go is a leading provider of frozen baked goods.
We don't disclose ratings on individual names in the portfolio, but I can say that at one point during the course of our investment this name, which were three rated on or internal rating scale.
The company was sold to a strategic buyer in early April and our loan was fully repaid.
This example is evidenced for our thesis that larger companies, even if they encounter challenges should prove to be more durable and to benefit from increased strategic value and exit opportunities.
Now I'll turn over turned over to Alan to discuss our financial results in more detail.
Thank you Craig Good morning, everyone first and foremost as Craig noted, we hope that you and your families are all safe and healthy we thank you for your continued partnership and support.
I plan to take everyone through our financial results for the quarter and then touch on some of the important topics I covered last quarter as they continue to be very relevant in the current environment.
To start off and you can follow along on slide seven of our earnings presentation. We ended the first quarter with total portfolio at second quarter with total portfolio investments of 9.2 billion outstanding debt of 3.5 billion and total net assets a 5.6 billion.
Our net asset value per share increased to $14.52 as of June thirtyth compared to $14. A nine cents as of March 30, Onest NAV increase of approximately 3.1%.
Our dividends for the first quarter was 31 cents per share plus an eight cents per share special dividends and our net investment income was 34 cents per share all of that was for our second quarter.
On the next slide slide eight you can see total investment income for the second quarter was 190 million down from 205 million last quarter I will talk about this a bit more in a moment.
Net expenses for the second quarter were 61.7 million up from 56.4 million last quarter.
This increase was driven by two items related to interest expense in the second quarter. The first item was a noncash acceleration of upfront costs related to the full pay down of SPV asset facility, one which contributed two and a half million dollars in one time interest expense. This quarter. The second item was our average debt during this.
Second quarter was higher than during the first quarter, hence increasing interest expense in the second quarter.
All of this led to net investment income or Eni for the second quarter of 129 million down from 146 million last quarter also as a result of the fair value of our portfolio, increasing from 93.5% to 95.1% we had $175 million of net.
Unrealized gains during the second quarter.
Our other operating expense ratio continues to be among the lowest in the industry at 24 basis points on a trailing 12 month basis, and we have 11 cents per share in undistributed distributions as of June thirtyth.
To drill into our income interest investment income and interest expense results a little more I think it's helpful. If we talk about our asset liability rates sensitivities for a moment.
As you can see on slide 13, our NIM analysis, our average portfolio spread is flat at 6.3% Marchthirty Onest first June thirtyth, but our yield has decreased from 8.4% at March 30, Onest to 7.9% at June Thirtyth.
This is driven by the continued decline in LIBOR the weighted average LIBOR floor on our investment portfolio is 85 basis points, we saw floors generally kick in towards the end of the second quarter.
You can also see on this slide that our cost of debt continues to come down driven also by the decline in Libra.
Our cost of debt declined from 4.2% at March 31st% to 3.6% at June Thirtyth.
So pulling the lens back from them and although the decline in LIBOR effects, both our investments in a negative way and floating rate debt in a positive way, we have over $9 billion, a floating rate investments and a little over $2 billion of outstanding floating rate debt or on a committed debt basis, a little over $4 billion on either base.
Yes, you can see why a sharp decline in LIBOR has an adverse impact to earnings and just to put into perspective, the LIBOR landscape over the past six months at December 31st three month, LIBOR was 191 basis points for the first quarter averaged three month LIBOR was 153 basis points and for the second quarter.
Averaged three month LIBOR was 59 basis points and today three month LIBOR sitting around 25 basis points, that's a pretty drastic change in a short amount of time.
Based on when LIBOR elections were made and the LIBOR decline over the past few months, we will see a little more pressure on interest income in our third quarter results before it flattens out.
To wrap up our discussion on our financial results as we look to the end of this year. We think it would be helpful to provide everyone with a reminder, about our fee waiver and special dividends as a result of the fee waiver our advisor put in place in connection with our IPO, We declared six quarterly special dividends starting in the third quarter of last year and running through.
Including the fourth quarter of this year you can all see.
All of our dividends mapped out on slide 17 of our earnings presentation.
Our fee waiver expires during October of this year and our advisor is not extending or renewing the fee waiver I mentioned earlier in my remarks that our Eni for the second quarter was 34 cents per share. If you were to impact this amount for the full effect of fees are 1.5% management fee and 17.5% performance fee.
That will be in effect starting in the fourth quarter of this year, our Eni this quarter would've been 24 cents per share I would note. This obviously it does not take into account continued growth in our portfolio between now and the fourth quarter, Greg will talk more about our dividend coverage shortly.
I also wanted to review some of the key topics I covered last quarter, including our financial philosophy and funding profile, we continue to be well positioned in the industry given the strength of our balance sheet. Our three structural pillars of low leverage significant liquidity and unsecured debt have provided comfort to our stakeholders through this.
Crisis to date and has allowed us to keep an extreme focus on the health of our portfolio. The most important aspect of our balance sheet.
We had very intentionally built a very well diversified financing landscape diversifying the number of facilities. We have the types of facilities and the number of lenders, we partner with matching duration between the left and right sides of our balance sheet is another important aspect of our landscape our weighted average debt maturity is over six years.
We do not have any debt maturities until June of 2023.
As it relates to our financing activity. We were very active this quarter you can see an overview of all of our financings on slide 16 of the earnings presentation.
To sum up our activity.
We completed our fourth CLL financing from one of our dropdown SPV facilities, we added commitments to our senior secured revolver, taking total commitments here to over $1.3 billion and last month, we completed our fourth unsecured public bond issuance. We continue to have one of the lowest leverage levels in the industry at 0.6.
Zero times debt to equity as of June Thirtyth, we had $2.4 billion up liquidity pro forma for the 500 million dollar bond issuance I just mentioned in total now we have issued $2 billion of unsecured debt, which brings us to a funding mix of 56% unsecured debt.
As of this we continue to have a meaningful amount of excess collateral for our secured facilities and we continue to have a significant cushion to our new regulatory asset coverage of 150%.
We are free as we've previously mentioned our updated target leverage ratio is 0.9 to 1.25 times debt to equity overall, our funding profile is very sound and we continue to be in a very good position.
Thank you all very much for your support and for joining us on todays call cranked back to you.
Thanks, Alan I will close with some thoughts on our dividend coverage and our investment outlook.
First I would like to pick up on Allen's comment regarding our earnings as we look ahead to the expiration of our fee waiver in the fourth quarter.
And we prepared for the IPO of course, you see about a year ago, we set our regular dividend at a level. We felt we could comfortably support from an earnings standpoint, as we continue to ramp our portfolio to our target leverage while maintaining our strong focus on credit quality.
While we remain pleased with the quality of our portfolio. The current economic climate is currently having impact on the earnings power of our portfolio and resulting ability to cover the dividend out of net investment income.
The main challenges have been lower interest rates and slower investment pace.
The time of the IPO LIBOR was approximately 200 basis points higher than it is today.
We had hoped to be at our target leverage by now, but originations have lagged our historical pace, primarily because of our cautious approach to investing.
We also continue to see a lower pace of repayments unexpected.
As a result sitting here today, we would expect net investment income to trail our regular dividend level upon the expiration of our fee waiver in the fourth quarter.
The key factor to help us addressed the shortfall is ramping our portfolio to our target leverage level, which should boost our earnings power.
Although getting to a fully ramped portfolio is the main driver, we also see opportunities to increase spread.
Including higher spreads on new investments improving spreads on existing investments.
As well as gradually changing or asset mix to favor more unitranche loans.
It will take some time for us to achieve our target leverage and have a fully ramped portfolio, but we expect by the second half of 2021, we will be operating in our target leverage range and able to cover our regular dividend from a net investment income even in todays rate environment.
Until then we expect to be able to continue to pay or regular dividend of 31 cents per share as well as our previously declared a special dividends.
These comments are forward looking and therefore inherently uncertain, we hope to achieve this goal sooner, but want to be transparent as to what our current expectations are once the fee waiver expires.
I'd like to spend the last few minutes discussing our perspective on current market conditions.
Business conditions improved in May and June as stay at home restrictions East. However, the environment remains uncertain and we remain cautious about the economic recovery, which we believe will be slow and uneven.
That said, given our significant liquidity and strong origination capabilities, where you're seeing we're seeing some very interesting opportunities to provide financing to companies seeking enhance liquidity and new capital overall, the deal flow and pipeline or picking up compared to the more muted activity in the first and second quarter.
New private equity M&A flow has increased which should lead to greater market activity from the second half of the year.
Now that we have a better sense of the effects of the economic slowdown on partner investments, we've been able to shift some attention to selectively deploying capital.
We're excited about the current opportunity set which provides higher spreads increased call protection and strong documentation.
While allowing us to continue to invest in the same types of high quality durable businesses, we have focused on since inception.
While the current environment is challenging we believe it highlights the strength of our team platform and balance sheet.
Based on our unique capabilities. We believe we are well positioned to continue to increase our market share as private equity firms turned to us for sizeable customized direct lending solutions with certainty.
More broadly we expect direct lending will continue to take share from the syndicated market as we see banks pulled back from making new commitments and increasingly large deals are being done in the private market.
In closing, we believe that our portfolio has proven so far to be resilient in the current economic environment.
The certainty of our significant capital is extremely valuable and positions us to be a financing partner of choice and these uncertain times.
Our team continues to work hard to protect our current portfolio of investments and to identify attractive opportunities to grow our asset base.
While the environment has created some near term earnings headwinds our credit performance continues to be very strong ultimately as a result, we believe we will be able to deliver strong long term returns to our investors without deviating from our strategy or sacrificing credit quality.
Thank you for joining us today and on behalf of the entire al Rock team. We help each of you and your family's remains safe and well operator. Please open the line for questions.
Thank you at this time.
Audio question I start, but the number one on your telephone keypad again mini star one for audio questions <unk>, just a moment to compiled acuity roster.
Your first question comes from the line, It's Chris York with GMP Securities.
Hey, guys good morning, and thanks for taking my questions.
It's a Craig certainly appreciate forward looking comments on earnings in the core dividends with respect to the expiration of the fee waiver now the manager has been very supportive of the vehicle. Historically, so could you just update us on the managers appetite to temporarily waived fees.
Bridge, the dividend shortfall until you grow the portfolio.
Typically offset any book value decline.
Thanks, Chris look we as you say, we've been extraordinarily supportive.
You should not expect that we're going to have additional a fee waivers, we havent as far as any fees since the inception of RCC and our shareholders and benefited from that from substantial special dividends and so you know how and made in his comment Allen made the comment I'll reiterate you should.
Not expect additional fee waivers, we do however think that there are a number of levers in our portfolio that will allow us to earn the dividend.
I'm happy to go through those but but but by getting primarily getting to our target leverage even at today's interest rate environment, we expect to be able to cover the dividend. We also see opportunities to improve spread in the portfolio at some point or repayments will pick up and so those factors, we think should be sufficient to cover the dividend.
On an ongoing basis and if there were to be any shortfall. We think it would be very modest in very short lived on but but I want to be clear and not to be repetitive you shouldn't expect us to extend the fee waiver.
A very well and apologize for missing everyone's prepared remarks about that so moving on you talked a little bit about.
The validation of your portfolio a little bit on the business model. So I'm, just the resiliency and strong enterprise value Procon had companies.
During that time.
And validation and my view, so it's important to biotech companies via gross lending to the caused you to reconsider your allocation policy of 20% and potentially increase that higher going forward.
Look you.
You're right our software businesses were extremely pleased with their performance. They have continued to grow even even during the pandemic. They may not be growing as fast as they were previously but they continue to grow they really benefit from some of the trends stay at home work a remote work of many of our businesses are.
Benefiting and the software space I'm, so it's our largest sector not by accident, we really like those deals. They have the most attractive economic features lowest loan to value best Covenant packages, we very much value the diversification of the portfolio and so I I don't have Ah I don't want to signal.
Change to that approach I think we're going to remain I'm very focused on diversification I I think that theres still we have a capacity for additional software buyouts. We obviously did did one this quarter, but I you know I think that were also sensitive to having overall industry diversification. So there's some room for increase but.
We're not anticipating a significant rethink to our approach to diversification.
Got it and then a couple of housekeeping items.
There was a meaningful change sequentially in the excise tax maybe Alan could you enlighten us on what the drivers of that change where.
Sure, that's just going to be a matter of.
Quarter over quarter, where our taxable income was versus our GAAP income.
And just just for modeling it should we expect more of a Q1 or a Q2 kind of excise tax.
Going forward.
I think going forward, it's probably more of a one Q.
Okay.
And then lastly, you know you've got to payables sizable payable on the balance sheet.
You know can you give us any update on how the pipeline look.
Of originations as well.
Oh sure its been picking up steadily over the last couple of months I won't I won't be concrete with you or give you some precise numbers, but I would say I'd stay at home orders began started to lift we saw some resumption in private equity.
He M&A sale processes, we saw deals that got put on pause as cobot broke in certain instances buyer and seller that's kind of resumed discussions back to where they were just pretty coated.
And so we are I would say meaningfully busy are certainly than than we were in the back half of the first quarter in the first half of the second quarter. Its certainly not back to where it was in last year, but we've seen a meaningful.
Pick up and I do expect deal activity to be higher in the third quarter than than first two and and my guess is higher again in the fourth quarter. So the back half of this year I think you'll see a nice pickup and deal activity, obviously dependent upon pandemic and all the other factors, but but.
Are you activity private equity firms have a lot of capital valuations.
Our I'm very high obviously, the public equity markets are.
Back to all time highs and so that that supports significant valuation for sellers of private equity assets and.
So you're seeing resumption of deal activity, which should should help us in terms of deployment.
Perfect that's great color. Thanks, Craig Thanks, Alan Thanks, Chris.
Thanks, Chris.
And your next question comes from Lance Ryan Lynch with KBW.
Hey, good morning, Thanks for taking my question.
China following up on on your commentary regarding Marty pipeline in market activity.
You know you said it was kind of picking up versus where it was kind of and it gets a downturn several months ago.
You know as we look forward what do you think has to occur before you'll volumes can return to more normalized level that we saw in 2019, you have to get or some sort of vaccine you think or you just need to have business travel Starcher unit back then you can dream you can.
I'm really happy these fee case meeting just just any thoughts or commentary and you'd have on on what is going to take you to before deal volumes from a market standpoint structures you can to more normalized levels like we saw in 2019.
Sure I mean, it's a great question, obviously tough one answer but I'll give you some some thoughts.
I might just simply start by breaking de <unk> deal volume into two separate buckets, there's new there's M&A transactions, where companies are getting sold to new buyers and then there are refinancing or liquidity driven transactions where companies just raises capital.
The refinancing and liquidity transactions can happen, but right now you know companies owned by private equity firms or not on my private equity firms may just need additional liquidity to Ah you know because of the of the environment, where they may want to refinance their balance sheet.
Those are fairly easy doesn't require a change of control, there's an existing lender group or and there's an established balance sheet. So those can happen right now and then there's M&A, where buyers new buyers and sellers, obviously the bar as much higher for a new M&A transaction, where a new equity owner was coming in I think.
The private equity firms.
Are are able to buy companies now travel is not the constraint they figure out a way to do that and in a way that's appropriate and that is not the hindrance I think the greater issue is simply.
In this given the uncertainty of the path of co bid and the economic recovery.
For certain businesses.
That their visibility and their durability are clear enough that a buyer and seller can agree on value.
There are many businesses that even though stay at home offer orders are lifted the outlook for their businesses is still cloudy and so they just case and uncertain near term future and so what would be difficult for buyers and sellers to agree on value you know the buyers going a lot of halo price and sellers going to want to wait for recovery and so.
I think as as greater confidence comes for the economy more fully reopening, which obviously vaccine would be one significant factor you'll get resumption. So there's certain sectors were like for example, we were active in the second quarter software insurance food and beverage you don't need a full throated economic rebound for.
So to get conviction around those sectors. There are other sectors business is exposed to the consumer business is exposed to travel and entertainment.
Were you know, it's gonna be a choppy wrote back and so in those sectors. You may see finished liquidity driven financing, but you're not unlikely to see M&A, where does all that lead us I think the second half a second half of this year will be greater than the first half I would assume the first half of 2021 is greater still and at some point.
When you see a real resumption of economic activity in the country them, we'll get back to where we were a pretty cobot I know that I haven't said anything precise there you know I wish I wish I had a precise answer but I think that's a framework for how to think about it.
No that's.
That's extremely helpful color and and.
Just just looking for your opinion, because nobody really knows what's going to happen.
That's helpful.
You know regarding sort of terms and structures on Neil new deals going forward I'm. Just curious to also get your thoughts on that just because you know clearly there are a lot of letters out there who are worse shape.
They were in our capital constrained during this downturn, so that restrict the amount of.
Capital you know I can comment to new deals however.
Deal flow has had has slowed down so dramatically.
Still feels like there could be a decent amount of capital still chasing after two fewer deals you know kind of the same problem that we had.
Back in 2018, 2019, although there's a much different environment, but we had a lot higher.
You know capacity to until land <unk> companies.
Do you see big changes in you deal terms and structures you know given.
You know you did not yield volumes going forward.
Oh, I do I do and we've demonstrated that this quarter spreads are wider materially wider I would say directionally <unk>, depending upon the credit and depending upon what's firstly and secondly, the unit tranche of 150 basis points water and spread additional fee additional call protection.
Good covenant packages lower leverage lower leverage points I think the deal the deals that were doing today or meaningfully better economically and a more attractive from a credit standpoint, and I think that reflects the first part of your question, which is a two things one number of the smaller lenders. They just.
They're having issues and I think they haven't they've got challenges and not just more lenders and number of lenders are having trousers in their portfolio that very few there's number of lenders that have a significant challenges you got a lot of challenged in your portfolio, you really or not in position to extend new capital. We are we have and will continue to do so but in addition, the pie is bigger we're.
Taking share from the syndicated market bigger deals are coming into the direct lending space because banks are nervous about underwriting sponsors are placing a greater premium uncertainty.
So I think the hardest part for US. It's just finding credits that we really like and that we think are going to meet our specs and and perform well, but when we find them. We are we're well positioned to get them and there are we're getting better terms and if there's always going to be some measure of competition in any part of the financial Mark.
Yes, but I I think our competitive set I'm, particularly for the larger check for the upper middle market private equity backed company with certainty and size 234 or $500 million at a clip I think we're one of a few we don't need to be the only went out there to provide those terms and good and good good deals, but by the way we're perfectly happy too.
Partner with one or two other direct lenders that are like minded with us we don't need to 200% of every deal so pick the opportunity set as attractive I think the harder the harder judgment is the economic recovery and we've had you know the ability to to originate a lot of a lot of deals over the last four years I expect we'll continue to do so it really is a question of our CFO.
Fiction around credit quality.
Okay that makes sense.
And then just one mile.
Yeah, Ryan you you cut out there.
I think right if you're still there I think most I can't hear you.
Why don't we go to next in the queue and we can pull Ryan backup.
Your next question comes from line of Robert Dodd Raymond James.
Okay.
Hi, guys actually a follow up to Ann's question. So.
You could.
Take an attempt at Viking down as we go into the second after they get you took activities going to pick up well hopefully maybe more on the M&A side as well I mean o'neil.
Pay me, a prepayment and accelerated amortization, which was obviously low this quarter.
Surprisingly in this environment, what do you think it takes deal in Bob why given your spreads are wider structures on time, so there's less incentive to refinance unless you get you not going to save any money that has to be an melted dry.
You know, maybe an M&A transaction or a a forced refinancing what does it what does it take that kind of activity to pick back up.
The the visibility if any of that happening in say the second happens.
Sure.
Sure I I and there.
Ticket will pick back up.
I think the drivers of it you're right. The this is not an environment, where your refinancing to try to save rate M&A.
Buyouts or are the biggest driver of refinancing company gets sold refinanced its balance sheet, but companies are also acquisitive buying build strategies are very prevalent for financial sponsors where they fail to buy a port a bike company in the sector and they'll grow it overtime through acquisition often times at some point in that growth the.
Company, a company gets big enough that it makes sense for them to refinance obviously maturities you know play a role and companies need to refinance their balance sheets companies don't wait until last minute to do that everyone. Everyone. I think getting nice pretty profound scare with covidien. So I think companies that we delayed refinancings for the first half of the.
This year and they're going to be companies that as the window opens up for them to to pursue them. Even if the cost is is higher they're going to have to consider that because the worlds and uncertain place and you can't just simply due to refinancing you know the last minute I'm. So I look we were in an.
Incredibly unique time, hopefully we can all agree on that refinancing repayments are going to pick up in the second half of this year barring some return to the level of of economic stress. We felt in a in March and April they're going to pick up I think it will be we're assuming a modest pick.
Quarter, and then and an additional pick up from there but.
Our debt to or debt hasn't hard maturities sponsors want to return capital to their lpds. If their companies are doing well and there were sitting on a gain they're going to be looking for ways to monetize that recap sell to company what have you and so I, it's not likely we're going to be an extended period.
Good where there's just no repayments I in my opinion.
Got it thank you and if I got one bought unrelated on on the SPV.
The extra expenses you terminated the SPP and then any any more.
Did.
Early termination somebody financing structures over the next I'll call. It the second half of this even into next year when is the the the up the existing ones going to continue to it.
This to through the life.
Are we getting get any other big onetime expenses and interest expense line.
Yeah. It's good question Robert.
Hopefully this this isn't a.
A big item. It so it is about half a penny.
But overtime, yes, you can continue to see us take down. These SPV facilities, we had a huge task early on which is we raised a tremendous amount of equity and we needed to raise a tremendous amount of debt in order to match.
And get leverage and stay Levered on so overtime you should continue to expect us to do CLL financings that its facilities and over time close the facilities as there are no longer needed. We can do with CLL financing write off our balance sheet.
So overtime, we will expect to to close a few more of these.
Got it thank you.
Of course, thank you.
And your next question comes from the line of Mickey Schleien with Ladenburg.
Yes, good morning, Craig you know and I I wanted to ask another question about the tone of the market.
Remark. So far you mentioned that spreads are currently wider versus the pre covert levels.
But when we think about the amount of private capital that's been created.
Over the years, how concerned are you that your competitors will begin at some point to chase deal flow and drive those spreads down again, you know while at the same time the forward LIBOR curve is basically flat.
Potentially develop into a lot of pressure and portfolio yield.
But.
Look I I look at this point the floors for all the lenders are really going to cover livewatch. It really isn't isn't a variable at this point I think all lenders have a certain return expectation there trying to deliver to their shareholders. Just like we are and and I think that that serves as a bit of a guide point for any lender when their lending caps.
Will we want to generate a return for our investors.
While there's been a creation work creation of private credit, it's really a fraction of the creation of private equity private equity as as the growth of private equities dwarf the growth of private credit that's what drives demand for the product. In addition, private credit has taken market share in the us from the syndicated market. So the pies growing.
It's certainly a big enough pie and a growing pie to find attractive risk adjusted returns for high quality upper middle market managers like ourselves and more than one a few a high quality ones that that are good they're still very few firms that come right the size check that weekend. Despite all.
The capital that's been created.
Thats, a a significant driver of how of who private equity firms like to work within this environment.
They want to move quickly they want to move confidentially. They want to work with firms that can write a three four or 500 million dollar check themselves. They don't want to build a club eight lenders that can each to $50 million and that serves us well. So I think we we and other high quality managers wanted to.
Active returns.
For our investors, obviously and I admit my bias and this and this extremely low interest rate environment, we think that our funding I would say other high quality bdcs offer an extremely attractive risk adjusted dividend yield and return versus other.
Investment opportunities and so you know I think that.
You know that I'm not sure that's totally realized at this point I recognize there's concern about losses I'm on the margin if spreads get chipped away by 25 or 50 basis points. It will still be the case that we can offer and others can offer an attractive risk adjusted returns obviously relative to something in the relative at this point is relative to zero right now.
That's not a concern right now we can do really the deals we want to do we just a question of our credit bar and we can get a very attractive spreads I'm right now in the environment, you're describing where spreads are getting contracted with likely an environment, where the economic news is getting better portfolio is feeling up I mean, there's these.
Things don't move in a vacuum I don't think theres, an environment, where spreads tighter and we're still and really difficult economic environment I thought that that I do not think as a high risk.
Okay.
Uh huh.
Clear on that answer and then just wanted to follow up with your you mentioned LIBOR floors have you started to see any push back.
Folio companies.
Either in terms of new deals on refinancings in terms of LIBOR floors, if I'm not mistaken they were sort of.
80, 85 basis points on the upper middle market probably.
<unk> basis points in the lower middle market, they started or cost lower floors.
We're not going to do deals without LIBOR floors, [laughter], paros or reclass off the things but.
After they get pushed back all they want we're going to assist on a LIBOR floor. We have 85 basis points I think the market. That's an average they're a few deals in there that that have zero zero percent floors. So that's why the the averages where it is but I would say market at this point as 100 basis point for the vast majority of deals were going to or get done there and and I think most lenders.
I think in almost all lenders will insist upon that at this point and the borrowers will pet.
Okay.
Lastly, I'm just curious and.
Assuming everyone still working remotely.
How do you approach underwriting without the ability to go out and kick the tires in terms of your underwriting process.
Yeah. That's a good question, it's it's a tough it's a tough one that we're all facing you know whenever you every walk of economic life in this country, our team's done extraordinary job of Ah of managing through this and the private equity firms face. The same issue look many of the businesses, we lend to are not asset intensive business.
So the tires that you're suggesting to be kicked in many businesses you know, it's as much and financial statements talking to the management team talking to the sponsors independent corroboration. We can go see companies, we have the wherewithal to do that on the sponsors are selectively visiting companies as well obviously there.
The company's our portfolio today that we you know we know intimately well and that is less of a pressure point, but but it does create a higher bar for certain businesses where to the extent we can't go see it it will it won't be a gating item that we we might not be able to do financing. We have what we are we have tremendous resources our disposal not.
Only or 60 person investment team, but we work with extremely high quality accounting consulting.
Firms around the world, but certainly around the U.S. and we can bring whatever resources to bear we need to but if there's a small business that has a single plant and we can't go see it you know that could be a reason, we turn that deal down in this environment I'm. So it's something we've worked through we're not going to sacrifice our diligence for anything.
But we think its workable and then we'll continue to be workable.
I understand and appreciate that.
Explanation those are all my questions for this morning I appreciate your time, thank but thanks, Mike.
Thanks Mickey.
And once again like you asking audio question, sorry that the number one on your telephone keypad.
Your next question comes from line of Casey Alexander with Compass point.
Yes, hi, good morning, most of my questions have been answered or maintenance questions, but I will ask Oh one.
But you mentioned software and you guys were early to the software area, but it seems as though software now it is on that you do list as every venture debt fund and almost every traditional BDC that we see have you seen any change in the competitive dynamics of software deals because there are people that do seem to be chasing.
With that particular vertical and then secondly are there any new verticals that have.
Occurred to you that maybe you might not have thought them attractive before but because of this environment. It creates a new opportunity set within a new verticals that you had approached in the past.
Oh sure you don't want software.
Well it has been a sector that we have had a lot of conviction now for several years and weve built out a substantial effort, including having a separate dedicated funds at al rock that does lending to software businesses I won't repeat the comments I made earlier about the attractiveness of the space I. It's a it is.
Probably the most active space for private equity the deal volume and deal activity continues to grow we without repeating everything I said I think we're very well position not only because of the size of the check we come right, but our team has has many years of experience underwriting businesses al rock as a platform has only been around.
And for us for four and a half years, but but the senior leadership of our tech and software team has been underwriting software investments for 15, 20 years, a piece and they've seen many of these companies multiple times they haven't intimacy around their business models, they've seen them they've seen what works what doesn't work and so I think that that is a.
Core investments skill set that we have that is very differentiated and not easily.
Replaceable, it's not it's not simply just want to do a software deal you have to understand credits what makes them different they're not all the same were lumping them all into category. It's obviously much more complicated than that and so we are we continue to find the terms the economic terms and the deals and the demand for us to do those deals is very weighted in our favor would help.
Lot of success in that space, you know I.
There is competition I I.
You know it is and there is an area that several other bdcs have been active in and there's plenty to feed feed off each of us and if there are new entrants I think there's room for that but it takes a lot of investment it's not just money you've got to have a significant team got to have our relationships with private equity firms. You have you doing you'd have to have on.
And expertise in the deals and understand the difference between them private equity firms don't like with with a light to go to lenders that are just warning about space. They want to work with lenders to understand the space. If there's problems they've got to wonder that they can work through so I don't see a big change in the competitive environment.
We can certainly withstand some additional competitors, but the price of admissions is a very large fund writing a very large check with a very large investment team.
In terms of new verticals, nothing nothing like leaps to mind.
Particularly I think you can see our six biggest sectors I think that in this environment. There are certain sectors that it's just we're more confident to underwrite and and there's certain sectors that I'm probably are changed in our view I'll use aerospace and defense as a sector that we liked a lot and.
Understood very well and picked good companies in that sector.
But obviously nobody could have envision kind of environment affecting air travel that there is today. So that's a sector that we'd like before and just the world change that we're going have to look at differently in terms of new opportunities. You know, it's just businesses that are that are that are going to hold up well in this environment I think.
Really the underlying theme I don't really have any any precise area and candidly, even if I did I probably wouldn't broadcast into the whole world.
Great. Thank you I appreciate you taking my question. Thank you.
Thank you Stacy.
And your next question comes to mind, if Kenneth Lee with RBC capital markets.
Hi, Thanks for taking my question just a follow on V originations outlook I think last quarter, you talked about expecting some origination volumes, maybe to skew towards existing borrowers versus new borrowers and there's probably added some three new borrowers this past quarter wondering.
If you would.
Sure some of your thoughts about whether you could still see.
Most of the origination volumes, leading towards existing versus new borrowers in the near term. Thanks, Oh sure.
Yeah, a quarter ago, we really were.
Focused on existing portfolio, you know for for obvious reasons, we knew the company's environments very uncertain I would say our posture has shifted now I'm, we're very open to new new situations.
You know we are.
I don't want to paint a picture that were aggressive now I think that we went to the second quarter I would say we went into a really defensive mode, where we only did from new transactions. We you know very few and the ones. We had extreme level of conviction on I think at this point were more open minded about new opportunities and you should expect us to have a more balanced approach bits.
Tween existing portfolio companies and new investments, so I I think that assuming I'm, assuming that the co bid and economic situation doesn't take a sharp turn for the worse.
I think we have Oh, we have a very good handle now and needs and our portfolio's needs needs of our portfolio in terms of dollars in situations that are going to command a lot of attention on many of them most of them will not and so it gives us the confidence to deploy capital. We've also raised more capital getting the unsecured deal done a few weeks.
To go I, just think we feel on more solid footing to to add new names to the portfolio again moderate moderate I'm going to give you a moderate sense, we're not opening the spigot up but but we're taking spigot that was pretty closed and turning on in a moderate level, you know and in light of the still choppy economic environment.
Great very helpful and just one follow up if I may.
It looks like amendment activity was still very modest this past quarter I'm, just wondering what whether it could remained at very modest levels going forward or do you expect any kind of pick up there. Thanks.
Yeah look item as I said my comments I you know we were pleased that.
While we had a significant amendments its modest in the context of 102 portfolio companies.
I don't expect sitting here right now a significant pickup from that number.
Amendment cycle tends to pick up as the quarter wears on you know for obvious reasons I'm sitting here right now, it's relatively quiet, but but I would expect some pickup as the quarter, whereas on I would have to imagine that the you know the second quarter 2020 will go down as you.
Hi, watermark for amendments among direct lenders given the magnitude of the economic shutdown, but I. So sitting here right now I don't expect a big pickup from here again nice it speaks.
In my opinion to the high quality companies, we led to that just Didnt you know we had.
A challenging situations and the rest of the companies. They are doing just fine and they didn't require amendments and maybe some additional ones in the third quarter, we'll see but I expect it will remain a modest number and overall portfolio.
Great. Thank you very much.
Thanks, Ken.
Thank you now like turn the call back over to Craig for closing remarks.
Great well, thanks, everyone for dialing into hope you and your film which are doing well. We appreciate your time and attention. We're always available to you to to answer questions about our company, we like we like having a informed investor base and hopefully your businesses and our businesses will continue to improve over the next three months and look.
Forward to talking to you at the end of the third quarter.
Thank you. This does conclude today's conference call you may now disconnect.