Q3 2020 FS KKR Capital Corp Earnings Call
[music].
Good morning, ladies and gentlemen, and welcome to <unk> first KKR capital Corp's third quarter 2020 earnings Conference call.
Your lines will be in a listen only mode during remarks by <unk> management.
At the conclusion of the company's remarks, well begin the question and answer session.
In Wisconsin.
Give you instructions on entering the queue.
Please note that this conference is being recorded.
It's Tom Rubber Pond head of Investor Relations will proceed with the introduction Mr. <unk> you may begin.
Thank you.
Good morning, and welcome to Fs KKR capital Corp's third quarter 2020 earnings Conference call. Please.
Please note that Fs KKR capital Corp may be referred to as S.K., The fund or the company throughout the call.
Today's conference call is being recorded and an audio replay of the call will be available for 30 days replay.
Replay information is included in a press release that up its K issued on November nine 2020.
Addition, advocate has posted on its website a presentation containing supplemental financial information with respect to its portfolio and financial performance for the quarter ended September Thirtyth 2020.
A link to todays webcast and the presentation is available on the Investor Relations section of the company's website under events and presentations.
Please note that this call is the property of FX K. any unauthorized rebroadcast of this call in any form is strictly prohibited.
Today's conference call includes forward looking statements and are subject to risks and uncertainties, including risks associated with the possible impact Toby 19, it could affect cabot's case for the economy generally.
We ask that you refer to Atlas case, most recent filings with the FCC for important factors and risks that could cause actual results or outcomes to differ materially from these statements.
Okay does not undertake to update its forward looking statements unless required to do so by law.
In addition, this call will include certain non-GAAP financial measures.
For such measures reconciliations to the most directly comparable GAAP measures can be found NFS Cais third quarter earnings release that was filed with the FCC on November nine 2020.
Non-GAAP information should be considered supplemental in nature and should not be considered in isolation or as a substitute for the related financial information prepared in accordance with GAAP.
In addition, these non-GAAP financial measures may not be the same similarly named measures reported by other companies.
Gene copies of the company's latest SEC filings. Please visit Apis Caes website.
Speaking on today's call will be Michael Foreman, Chairman and Chief Executive Officer, Dan.
C N Pietrzak, Chief investment Officer and co President.
Brian Gerson co president.
Thanks, Steven Lily Chief Financial Officer.
Also joining us on the phone or co chief operating officers drew tool and Ryan Wilson.
I will now turn the call over to Michael.
Thank you Robert and welcome everyone to ask KKR capital Corp's third quarter 2020 earnings Conference call.
First let me offer my continued well wishes to each of you your loved ones and your coworkers as our country continues to adapt to oppose Caldwell.
Yes, that's taking our team continues to function largely in a virtual work environment.
Thanks to the ongoing dedication of our investing operating teams the day to day cadence of our business somehow you got to see almost normal I.
I continue to be extremely proud of the job our team is doing during these extraordinary times.
In recent weeks, our country has been almost entirely consumed by events, leading up to the presidential election.
The uncertainties associated with the election combined with the effects of depends how mek and social unrest seems have permeates every aspect of our society.
Our hope is that as we move towards the Thanksgiving holiday season in just a few weeks.
And our country will begin the process of healing by recognizing we are strong in together and we are delighted.
Across our investment portfolio, we've seen management teams and sponsors continue to make well informed business decisions focused on transitioning their companies for long term value creation.
These decisions have included such things as building cash reserves streamlining operations.
Communicating practically with customers and realigning supply chains to maximizing time to market for products.
These decisions are manifesting themselves in tangible ways is the value of our investment portfolio appreciated during the third quarter, resulting in increasing our net asset value per share of 4.7% as of quarter at.
The S.K. car investment team has done an exceptional job working closely with these companies.
From an operating perspective, our net investment income was 63 cents per share during the quarter, which was three cents above our third quarter dividend of 60 cents per share and also 3% per share above our public guidance.
From a liquidity perspective, we ended the quarter with approximately $1.5 billion of available liquidity with no meaningful near term debt maturities.
Looking forward consistent with our dividend strategy of targeting a long term yield to investors of 9% of our net asset value. We currently expect our fourth quarter adjusted net investment income to approximate 64 cents per share.
As such our board has declared a distribution of 60 cents per share for the fourth quarter, which equates to an annualized yield of 9.8% and our energy energy and hazy per share of $24 to 46 cents as of September 32020.
And with that I'll turn the call over to Dan and the team to provide additional color on the market and the quarter.
Thanks, Michael.
From a macro perspective, many of the trends we highlighted in our second quarter earnings calls have continued to develop including a rebuilding of our investment pipeline alongside a reemergence of M&A activity.
And while the market is still not back to pre covered levels in terms of transaction volumes. We believe it has recovered to approximately 75 or 80% of those levels.
Another topic, we discussed in detail on our second quarter call. The disconnect between the markets and the general U.S. economy continues to raise meaningful questions and still concerns us with regard to near term economic performance and ongoing economic recovery.
The high yield market continues to experience record monthly issuance levels as illustrated by year to date 2020 cumulative issuances of 338 billion through September Thirtyth, which is only 7 billion below the full year annual issuance record of 345 billion. The market said during 2000.
12.
The high yield market continues to be fueled by a record level of refinancings not seen since the great recession.
And the leverage loan market the record low level of monthly issuances in January and February evaporate in March and remain depressed through July.
However, in both August and September the leverage loan market has returned to record levels of issuances as borrowers have access to the market with a healthy balance of elbow M&A and refinancing activity.
[noise] pricing for these leverage loans has been aggressive in many instances driven in part by the low overall yield environment and a desire by many managers to put money to work in an effort to generate current yields.
From a <unk> perspective, we continue to believe the federal Reserve's stated goal of reducing unemployment from the current level of 6.9% to the feds long term target of 4.1%.
While simultaneously targeting inflation of around 2% per year.
Clearly illustrates the feds focus on recovery of jobs first with inflation targeting a distant second.
As a result, we believe significant levels of government stimulus will continue well into 2021 and possibly beyond.
[noise] across the F.S.K. care platform, we are participating in a number of active processes relating to new investments, but we are continuing to invest with a narrow credit lines. During this unprecedented time.
Well our goal is to generate attractive risk adjusted returns given the still fragile nature of many aspects of the economy. We are exercising caution from an underwriting standpoint.
Additionally, the renewed health the financing markets, especially in the upper end of the middle market, where we focus has created strong demand for perceived high quality transactions.
In some cases, we are seeing pricing and structural terms returned to pre corporate levels.
[noise] across the Fs KKR platform, we benefit significantly from our incumbency positions with existing borrowers as well as our deep relationships with key sponsors.
These positions and relationships have allowed us to see our fair share of new opportunities, while still maintaining a selective bias, which hinges on protection of principal first and yield second.
As a result of these fundamental drivers during the third quarter, we originated $174 million and new investments, which is still below our capabilities from a processing or capacity standpoint.
Our $174 million of total investments combined with 231 million of net sales and repayments when factoring in sales to our joint ventured.
Equate it to a net portfolio reduction of approximately $57 million during the quarter.
I should mention that during the period from October Onest to November 4th Fs K closed on an additional $300 million and investments.
As a result, even though we believe we have remained disciplined from an origination perspective, we think we are well positioned from an overall portfolio standpoint, as we move into the last few months of the year.
Last quarter, we began providing detailed investment performance metrics for the Fs take care advisor this.
This information is detailed on slide 12 of our Investor presentation on our website.
The updated information is summarized as follows.
Since the Fs care advisor was formed through December 31, 2019, we made approximately $3.2 billion in new investments and we experienced 42 basis points of cumulative appreciation.
From the same starting point through September Thirtyth 2020, we have originated approximately $4.2 billion of new investments and have experienced.
1.17% of cumulative depreciation which includes the effects of Covance.
We continue to be satisfied with the Investor performance. Our team has been able to deliver over this time period and we believe these data points illustrate the manner in which we are turning the investment portfolio toward what we believe to be more conservative investment structures in companies with more defensible operating positions.
Lastly on this point as of the end of the third quarter approximately 51% of our portfolio has been originated by the Fs KKR advisor and 81% has been originated by KKR.
From a forward looking perspective, we believe the federal government and we will continue to find ways to support the economy until either an effective cobot vaccine is developed or herd immunity is achieved.
We believe the broader market, which has been.
In receipt of stimulus dollars and government support will continue to function somewhat in line with where we are today.
That is liquidity will continue to exist for both borrowers and lenders some level of corporate M&A activity will continue and the public markets will continue to function within a band of relative normalcy.
Of course, these assumptions in large part depend on investors and operators collective trusts in the future actions of the federal government.
We also believe government intervention in the economy will be increasingly difficult to unwind and a nondisruptive manner the longer the monetary support is required.
As a result, we are pleased with the performance of our investment portfolio this quarter and while we are confident that the investment decisions. We currently are making are based on thorough analysis and diligence we have to acknowledge that the operating world. We find ourselves in is still far from normal.
These observations lead us to conclude that the road back to full recovery may at times be volatile effort.
If for no other reason than the significant dependence the capital markets has placed on our federal government for the foreseeable future.
Nevertheless, we are pleased with the quarter and believe we are well positioned as we begin to look forward to 2021.
And with that I will turn the call over to Brian to discuss some investment portfolio specifics.
Thanks, Dan.
As of September Thirtyth, our investment portfolio had a fair value of $6.6 billion, consisting of 172 portfolio companies.
This compares to a fair value of $6.6 billion and 173 portfolio companies as of June 32020.
At the end of the third quarter, our top 10 largest portfolio company is represented approximately 23% of our portfolio.
Which remains in line with our results for the last several quarters we.
We continue to focus on senior secured investments as our portfolio consisted of 54% of first lien loans and 68% senior secured debt as of September thirtyth.
The weighted average yield on accruing debt investments was 8.6% at September Thirtyth 2020, as compared to 8.7% at June Thirtyth 2020.
The decline in our weighted average portfolio yield was primarily due to exit certain higher yielding assets throughout the quarter.
From a non accrual perspective as of the end of the third quarter. Our non accruals represented approximately 8% of our portfolio on a cost basis, and 2.8% of our portfolio on a fair value basis, compared to 9.9% and 3.8% as of June Thirtyth.
We do not place any new investments on non accrual in the third quarter and four previous non accrual debt positions were restructured.
From an overall valuation perspective, our investment portfolio increased by approximately 2%.
Or a $132 million during the quarter the details associated with our core with our core quarterly evaluation results are as follows.
The total amount of realized and unrealized appreciation we experienced across the portfolio during the quarter was $356 million our.
Our quarterly appreciation includes the reversal of $180 million of unrealized depreciation associated with certain portfolio company restructurings, including Borden, Gary four point and made media.
Our remaining $176 million of portfolio appreciation.
Primarily was driven by a combination of positive operating results and improved valuation inputs during the quarter for specific investments initially impacted by spread widening and general market conditions during the first and second quarters, but which continue to recover.
Our realized and unrealized depreciation totaled $224 million during the quarter.
Over 90% of our unrealized depreciation was related to certain legacy investments many continuing to be impacted by the effects of co that.
In addition, approximately $182 million of depreciation related to realized losses, primarily from the previously mentioned restructuring.
While we discussed many of the specifics of these investments on our second quarter earnings call, having a series of completed restructurings across the legacy portion of our portfolio represents a meaningful step for us from both an operating and valuation perspective.
Okay ours dedicated work our group was instrumental during these complicated and time consuming processes.
Which we believe demonstrates the value of having a dedicated internal team of investment professionals able to work seamlessly alongside our investment teams to navigate these challenging situations.
With that I will turn the call over to Steven to discuss our financial results in more detail.
Thanks, Brian.
My comments will be less focused on reporting financial match metrics already contained in our earnings press release and 10-Q.
But rather focus more on the color behind our results hopefully linking them in a more transparent and informative way to the broader comments on which Michael Dan and Brian have touched.
First the $3 million decline and our total investment income quarter over quarter was impacted by the following.
We experienced a decline of $12 million in our interest income primarily due to repayments of higher yielding assets across our investment portfolio.
Coupled to a lesser extent with continued declines in LIBOR.
Given that 98% of our floating rate investment portfolio has floors, which averaged 88 basis points.
We believe the vast majority of LIBOR based interest rate compression has now worked its way through the portfolio.
Our fee and dividend income increased by $9 million during the third quarter as compared to the second quarter.
The largest components of our fee and dividend income included 17.5 million of dividend income from our joint venture during the quarter as many of you know we typically expect to this recurring dividend income to approximate between 15 and $20 million on a quarter to quarter basis.
Other dividends, primarily from our asset based finance investments totaled approximately $12 million during the quarter and fee income totaled $3 million during the quarter.
Our interest expense declined by $2 million during the quarter as we benefited from the reduction in LIBOR floor as approximately 54% of our drawn balance sheet is floating rate.
Management fees decreased by $2 million during the quarter due to the lower amount of average gross assets during the quarter compared to the prior quarter.
The detailed bridge and our net asset value per share on a quarter over quarter basis is as follows.
Our starting Threeq you 2020, net asset value per share of $23.37 was increased by net investment income of 63 cents per share.
And was further increased by one dollar and six cents per share.
Due to an increase in the overall value of our investment portfolio.
Our net asset value per share was reduced by EUR 60 cents per share dividend. Some of these activities results in our September 30, net asset value per share of $24.46.
From a forward looking guidance perspective, we expect our fourth quarter recurring net investment income per share to approximate 64 cents.
We expect our GAAP net investment income per share to approximate 57 cents.
The bridge from our 63 cents per share of net investment income during the third quarter to our fourth quarter guidance is as follows.
Our recurring interest income is expected to be relatively flat quarter over quarter, as new investments and repayments somewhat offset each other.
And with more static yields associated with our floating rate portfolio given that most of our LIBOR floors have now been achieved.
We expect dividend income associated with our JV to approximate 20 million.
We expect other fee and dividend income to approximate $15 million during the fourth quarter.
From an expense standpoint, we expect our interest expense will remain relatively flat quarter over quarter.
We expect our quarterly management fee will increase by approximately $2 million during the fourth quarter based on the higher average value of our investment portfolio during the quarter and.
And we expect other general and administrative expenses will remain flat quarter over quarter.
Finally during the fourth quarter, we expect to pay excise taxes totaling approximately $9 million to reflect more accurately the ongoing operational nature of the business, we add back excise taxes to calculate our recurring net investment income and net investment income per share.
Nevertheless, we believe it is important to provide in the market a bridge for both calculations.
As a reminder, over the long term, we expect our dividends per share will equate to a 9% yield on our net asset value per share.
We acknowledge there will be certain quarters, where our annualized yield may be greater or less than this range.
Due to quarter to quarter fluctuations in the business from an operational standpoint.
That being said we are pleased that during the first three quarters of 2020, despite before reaching effects of coated and the resulting volatility on most companies investment portfolios, we have been able to exceed our 9% target dividend yield to investors.
Obviously.
Our dividend policy of achieving a 9% target dividend yield on our net asset value means that over time, it would be normal for our quarterly dividend to fluctuate somewhat in concert with the quarter to quarter change in our net asset value.
In terms of the right side of our balance sheet, our gross and net debt to equity levels or 131% and 120% respectively. These.
These leverage levels represent a decline from our leverage levels during the first and second quarter of this year.
Our available liquidity of $1.5 billion equates to approximately 22% of the value of our investment portfolio, which is a very comfortable percentage.
And as we said on our second quarter earnings call. We continue to be pleased with our liability structure, which is 36% unsecured and 64% secured with an overall weighted average cost of debt of 3.7%.
In terms of debt maturities, we have no maturities until the middle of 2022, our largest year maturities is 2024 on approximately 50% of our capital structure will roll forward.
Finally from an unfunded commitments perspective as of September 32020, we had approximately $311 million of unfunded commitments of which approximately 46 million represented revolver facilities and 212 million of unfunded equity commitments, primarily associated with commitments related to our asset base.
Finance portfolio.
As we said during both our first and second quarter earnings calls the majority of our unfunded debt and equity commitments are generally used for capital expenditures for acquisitions, and therefore subject to performance or other threshold tests, including in certain situations are specific consent.
As a result, while these commitments are disclosed in our 10-Q for informational purposes, we do not believe they will be drawn in any meaningful capacity on a quarter to quarter basis.
And with that I will turn the call back to Michael for a few closing comments before we open the call for questions.
Thanks, Steven as.
As we have mentioned throughout this call. There is no shortage of issues. Our wells currently faces as we believe the federal government will continue to play an active role in the economy for the foreseeable future.
That said, we continue to believe the long term benefits that we believe would accrue to investors from the establishment of the assets came through our platform are beginning to materialize in tangible ways from deep sponsor relationships to the rigor of investment committee decision, making to proactive portfolio management.
The broad based dedicated work teams to season BDC industry operators, the best of what we structured and planned for as we establish the Fs K.K., our advisor seems to be coming to fruition at a very opportune time.
We will look forward to continuing to update you on future progress and with that operator, we would like to open the call for questions.
Thank you.
As a reminder, ladies and gentlemen to ask a question. Please press star one it's a little too.
John Your question. Please press the pound key.
Please stand by Bob tuning rocks.
And our first question comes from the lumber Casey Alexander with Compass point. Your line is now.
Hi.
Good morning can you.
Put a pencil around.
Kind of a run rate for dividends being generated by the portfolio. There's been a fair amount of fluctuation and came in at a higher than normal number and I'm just trying to get to the right.
One rate going forward.
Yes. This is Dan good morning.
I think you've seen the dividend growth out of the joint venture over the last several quarters.
No I think we have started to get back to steady state, maybe there's a little bit more growth. There we did have.
Some strong performance out of the asset base finance portfolio this quarter.
Some of those mainly due to sort of common reasons had been sort of turned off and they return to sort of paying those numbers are probably.
In some ways, maybe a little bit higher because there was some sort of catch up in there and then the only other thing I'd note is if you look at our fee income for the quarter and it was $3 million in the range of the four quarters. Prior was six to 16.
But thats probably the ranges in the bounds for sort of what you are seeing and dividend and fee income.
You stole my next question, which was about fee income so.
You discussed a pro.
Rising and structured terms.
In some cases have returned to pre coded levels.
From a logical standpoint, it seems to me that the deals that got into the pipeline first we're kind of no brainers that that performed exceedingly well through covert and would have been done under any circumstances.
Is there a point in time, where we start to see some.
Somewhat co bid.
Turning to companies that are going to come to market for money because they have to for refinancing reasons, where.
Spreads may be a little bit better terms may be a little bit stronger because of their financial condition at the point in time that they are coming to market.
Yes, it's a good question I, probably break it down a couple of ways of the I think a lot of the covenant packages names could have already come sort of seeking sort of capital right and maybe those things aren't done by us, but just on by.
There are other market participants or is it a different sort of forms of the market.
Where we.
We see things today pipeline is definitely build back up but we quoted the 70, 580% number I mean, the teams are sort of very busy I think for for transactions that are more center of the fairway.
The ones that you want to be invested in for sure from a credit perspective, we are seeing them.
We'll call those pre commitment levels I do think theres more scrutiny on documentation I do think theres more scrutiny on add backs of at least from a pricing perspective, I think some of that is just a supply demand point, we're still catching up on the pipeline activity there as people who want to deploy money in this market.
I do think if you have a credit which maybe is not even covering impact of it just has a story to it a little bit harder a little bit more work that is so wide on what we would have seen in say January February buying or maybe 50 to 75 basis points.
So I think thats, the way were seeing things sort of today.
In the morning, Okay.
Okay all right. Thank you.
I'll step back in the queue and let.
Let some other folks asked some questions. Thank you.
Thanks.
Thanks.
And our next question comes from the line of Rich Shane with JP Morgan Your line is open.
Good morning to everybody and thank you for taking my questions I hope everybody as well.
Yeah.
First of all I really appreciate the effort to provide so much guidance. It's helpful. As we look.
Forward.
When we think about the overall mix of the portfolio and the combination of repayments and you highlighted the fact that they are higher yielding loans repaid disproportionately.
Disproportionately in the third quarter.
When we think about where spreads are now the opportunities, particularly that you're considering di do we think that spreads are going to stabilize strip higher drift lower and again I realize given the size of the portfolio, it's very marginal, but where do you see the marginal investment at this point.
Yes, no and good morning, where it can help your wells as well.
I think spreads are.
Let's call that.
Fairly sort of stable now and I think we would have talked about in April or may of a scenario, where we would have thought you every deal would have been 100 to 200 basis points. Why is that is that didn't last very long and there wasn't necessarily a lot of deals that are done there.
Yes, I think for that regular way, we'll call Unitranche type loans I think we're seeing.
Fairly.
Cost stable so the spread environment I think there are things that on an opportunistic basis than we can do.
Whether it be second lien or maybe back to Caseys question, something that maybe had a little bit more of a covert impact but were comfortable on the recovery that weekend.
Al earn kind of that normal type investment.
So I think those opportunities exists I think the way we've constructed the portfolio to date is a way that we will continue in terms of pork.
Portfolio construction I think the comment you made about your repayments in the quarter being sort of higher yielding investments I mean, it wasn't that many repayments in the quarter. So that was skewed really just sort of one or two names.
You've obviously, we're looking to build a portfolio in a very diversified basis with with.
Principal protection first kind of yields second, but knowing what we've got dividend sort of goals and sort of targets to me.
Got it and then.
I'll ask the same question basically in the context of covenants.
In protections in terms, our recurring annual power in the market in terms of structure.
Yes, I think we have.
While pricing has for that center of the fairway deal has sort of come back to what well call prepayment levels.
You think.
Yes. This is just a bit more discipline out there as it relates to add backs and structure and so the covenants I think you've heard US say this before we're a big believer that the first lien unitranche product is supposed to have a covenants and you're not getting paid enough to sort of not and.
I think you will continue to see us.
Employ that strategy on a go forward basis, I think a little bit more.
Weighted to the to the lender signs into now.
Hey, Dan Thank you very much.
Thanks.
Thank you and our next question comes from the line of John.
Jefferies. Your line is open.
Good morning, guys. Thanks very much.
First question, it's a little bit of a tag onto to the last question.
Characteristics of the recent pipeline in the in the recent kind of post end of Q3 investment activity, but not maybe not terms, but any any industry. Your geographical characteristics excuse me characteristics, we should be thinking about.
Yes. Good morning, I don't think any geographical per se I think you should assume that with the higher risk our underwriting more than we have today, we are focused on non cyclical.
Many ways.
Not names that we wouldn't be worried about being impacted by a.
We'll call it second wave of Covidien, hopefully the news yesterday, so the changes that dynamic a bit but.
No I think were planned.
Defense, when we think about sort of underwriting today.
Those would be the kind of industries that you should expect versus playing and obviously a lot of the deals that closed in that first month of this quarter were things that were committed to sort of last quarter, but I think thats. The way, we'd expect the pipeline to come together over the next sort of quarter two for short.
Okay, and then within the last quarter of your net deployments.
Asset based financing is a pretty big portion was that one particular deal or was that just sort of an opera <unk> an opportunity that presented itself in that quarter or is that something more of a long term.
So you have that might be a bigger mix of that how do we just think about that component of the originations in the quarter.
I know it's a good question I start on the portfolio construction sort of piece I think we've talked about.
Asset based finance.
I mean, let's call it somewhere between 10 and 15% of the portfolio were kind of there now so I think we're happy about that.
No because I think the total numbers inside of Q3, you on the origination side, where are fairly small versus kind of normal quarters, I think thats, probably skewing a little bit there was one more opportunistic transaction. It does come to mind that we sort of did but I wouldn't read too much into that I focus on the 10% to 15%.
Guidance from the portfolio construction.
Okay, and then last question Dan.
Dan you talked about a lot of parts of the markets kind of terms getting back to norm would even pre covance levels, but you also kind of referred to.
I guess other activities like elbow and in the maybe acquisition kind of financings creeping up just as you look into 2021, assuming more of the same. We're you know we have a call it a.
Slow recovery that might not be straight lined but but more or less a recovery some some levels of stimulus.
You guys have an opinion on how the kind of deal market shapes up next year in terms of the drivers of the flow.
You know it's a good question.
I think we've seen a lot of.
You add ons and recent sort of months Thats companies, just effectively going on the offensive.
As their businesses has stabilized I think it's probably been easier to buy a competitor today than than arguably do sort of a new deal. So I think for us percentage wise that is probably been higher.
We're starting to see more regular way M&A processes happen.
Happen and at current advisors are higher I mean people are not traveling as much as they used to as much as maybe what the historical norm would be but I think people are finding ways to get deals done I think a more in and around the environment. We are.
Today, so let's call that.
No single large second wave Lockdowns mehr, maybe sort of an understanding of the economy can be a bit bumpy volatile, but people have some comfort around that I think you'll just continue to see that that more traditional pipeline sort of pick up on the M&A side.
Great. Thanks, very much guys.
Thank you.
Thank you and our next question comes from the line of spinning O'shea with Wells Fargo Securities. Your line is now open.
[laughter].
Hey, good morning, Thank you.
Just a first question on the dividend again.
Appreciating that the target levels, you all laid out.
Is there a certain point, where you'll go back to a fixed dividend, perhaps when you feel NAV is stabilized.
Just like should we think of this variable policy is as a more transitory or permanent concept.
Yes, and maybe I'll start and Steven can can add to this.
I think we've we've gotten a lot of feedback from from the market.
I think it's it's it's probably a bit of a combination of of creating a sense of of stability, but.
But also I think understanding what this product is and what what's the BDC is I think that variable component does make some real sense to us, but Steven why don't you kind of add to that.
Yes so.
I think Dan is right that we think of this more as a permanent shift rather than a transitory shift and we think frankly the industry would would benefit itself.
In the same way not just just our platform yeah. There's so many variables every quarter that bdcs deal with in terms of changing interest rate environment is changing deal environments, we've talked a lot about pricing of pipeline Chris.
Credit quality, yes, it's there's just lots of inputs that you handle every quarter as an operator and to have a fixed dividend overtime as becomes very difficult for for all bdcs. So we think having more of a floating type policy that matches in HIV and creates a target yield for investors.
For a long sustained period of time.
As we think of a.
More enlightened better way to go for the industry as the industry continues to mature frankly.
Well that's helpful. What do you think of a similarly, the concept of a floating hurdle rate.
Yeah.
It's an interesting question I mean, it's it's.
You can argue it does well aligned with.
What.
The general investments of these types of vehicles are which are floating rate loans.
In the other side of that it probably puts a little bit of complexity in there as you think about how to manage your kind of asset liability. So those side.
And I think there's also some complexity because most of the deals do so to come with LIBOR floors.
So I mean, I think that the concept is probably interesting I think the complexity is going to be a challenge so to be honest.
I understand that's all for me. Thank you guys.
Thanks Ben.
Thank you.
Our next question comes from the line of Robert Dodd with Raymond James Your line is now open.
Hi, guys. Good morning back to kind of a pricing question, but but not just just about spreads obviously I mean the.
Oh with you had comments then I mean talking about.
Even a better structure is maybe lower leverage et cetera, I mean, this that might have been given given back so to speak in a very coming.
Competitive mark after the cobot Spike what about.
You can kind of talking about what's the full wouldn't risk adjusted.
Total return yield or however, you want to would it given.
Add backs, we would use if docs have bad it's not so I'd say hi, it's the spread might have been competed away, but those other companies don't seem to have been so what impact.
Those have right now in kind of the implied total return pricing rather than just but pricing.
Yes, it's an interesting question I mean I think.
I'm I'm not entirely sure those other pieces are.
So far away from pre.
Recall that items that you would give them a ton of value in a pricing sort of comp standpoint, I mean documents are are better but documents are not what they would have been in a in April or may deal.
Covenants I think are holding I think and I think the focus on add backs are sort of better for.
For sure and I think the market saw sorry.
Certain challenges was on deals were add backs for Don obviously that was inflating EBITDA, maybe that cash and it didn't come through so.
I think it's an impact I would say this for your benefit I think from our view that.
Regular way.
Traunch deal is probably live or plus six 625 is probably two points of all I'd, you probably get an assumption of some level of of call fees.
Call Pro when you think about your overall portfolio Thats, putting you maybe sort of 80% on on an unlevered basis, we've been pretty selective in the second lien space that we're prepared to do those a lot of time. So second lien credits will be locking them nothing all the time will be larger companies, but in our mind that can be some of the better credits in the portfolio.
They're probably 400 basis points back of the first lien syndicated markets and now you're talking probably 200 basis points back of what we just said on the Unitron. So.
I think theres ways to build an overall pretty attractive yield here, especially considering where overall sales rates are I think thats the way weve been thinking about.
Got it I appreciate that on.
On the asset backed I mean, obviously truck paid paid a dividend this quarter.
So are you seeing a rebound in those areas, but that's still kind of maintaining that the 10% to 15% target for that mix in the portfolio. Even obviously asset backed security has something going for it versus versus other that is the market, but what would it take.
For you the latter embedded said we need to be.
Interested in shifting that 10% to 15% the high or low.
Yes, well I mean.
It is a sector that we are.
Very fond of and you've heard us talk about it on on calls prior yes, we like the.
Sort of collateral backing of those deals, they're generally paying sort of a higher sort of overall margin I think there probably is.
Governor to why we would not take that higher obviously the strategic purpose of.
Of our sort of platform here is to focus on directly originated.
Sort of corporate loans focused on that our friends in the middle market. So I think you got wants it a natural governor and obviously a lot of this stuff can be.
Non HPC. So that's another sort of piece of that but again I think we really like what we see there as as real downside protection and very attractive returns. So I think we're comfortable with that balance today.
I think we could have some flex to take it down if if we saw other less.
Lending situations spreads just widen and maybe we didnt see the spreads widen in the asset base finance space, but.
And we are dynamic as we think about portfolio allocation, albeit we're cognizant visit a liquid asset book right. So you just can't sort of move in sort of that quickly, but I will probably stay in that 10% to 15% range.
Got it thank you.
Thank you and our next question comes on line of Bryce Rowe with National security on the sales.
Thanks, Good morning, and I appreciate you taking the questions here wanted to ask a little bit about the.
Restructuring, Stan and or Brian.
You mentioned, the reversal of $180 million a reversal assays.
Associated with with with realized losses, So curious what the what the mark might have been on those assets.
And what kind of what kind of gain was associate or loss was associated with with those exits.
Hey, Brad Brad So we had $180 million of reversal of unrealized depreciation and $182 million of realized losses associated with us in asset.
It was pretty much on top of each other.
Great.
That's that's encouraging.
And then just again on every on the restructuring you noted the you know the.
For restructuring here in the third quarter.
Maybe Dan you can talk a little bit about your thoughts on the outcome. There. The process you know within within the organization from a restructuring perspective, and then if we look at.
The current pipeline if you will of restructuring what what's your you guys provided some good detail around around that last quarter. So just curious how you think about the current portfolio of potential restructuring here over the next three to three to six months. Thanks.
Yeah, no. Thanks for that and I'll take the first part and then Brian will sort of add to that Matt and I, maybe just start off with the team right I think we've.
Kind of it.
It really getting back to the end of 2017, I'm sort of lean into the idea of wanting to have a dedicated restructuring team. We've we've added that over time, we we actually added someone there.
Sort of April or so the timeframe.
I think were.
Very happy that we have that I think we've been the team has has.
Worked tremendously hard they've been on our minds and a very effective I think it is not just value for these names when they get to the spot but adds a lot of value. When just the company is kind of on the watch list right because.
We can be thoughtful with what amendments we might make.
We're not in the business of trying to.
Takeovers sort of all of these companies, but we need to be prepared to do that people need to know we're prepared to do that.
So we think that that team adds a lot of value sort of generally I.
I think Boston was sort of one example inside the quarter.
We think that we.
We've put ourselves in a good position there we took some take back paper, we got an equity stake that equity stake is marked effectively zero, we partnered with what I would call a best in class. So the management team to do that that was a lot of I think hardworking brain damage to get to that point.
I think we were happy with where we said we're going to you know.
Work hard and support that seem to try to maximize our recovery versus our initial investment.
And price four point, probably another name worth mentioning.
We were investors in a second lien tranche and we had some equity as well in that business.
The company was certainly impacted by coded and the decline in commodity prices.
It's a gas weighted MP business.
Back in the summer in July.
We basically report we were part of a restructuring where we converted the second lien notes to equity.
So control of the business.
Significantly de Levered, the balance sheet ticket from close to six times to under one times leverage.
And also read some of their hedges so they are 89% hedged.
We think control that business is important it allows us to.
Focused on semester DNA opportunities.
As well as potentially M&A down the road.
Okay. That's helpful and just any any any any forward guidance on how to think about the current portfolio of non accruals and there yet you are closer to getting some more restructured here over the near term.
I'm not sure this things and so the guidance perspective, I mean, we're I know.
We're pretty happy Im pleased with how weve rotated the portfolio sort of where we sit today and clearly there is some some names that were focused on but I don't think we see anywhere near the we'll call restructuring pipeline I think was your words on sort of a forward basis.
Okay. All right. Thank you guys appreciate the time.
Thank you.
Thank you and our next question comes from amount of Ryan Lynch with KBW. Your line is now.
Hey, good morning, Thanks for taking my questions.
You know really credit performance has been the focus for.
Correct Thats K. investors.
Over the past several quarters and in fact over the last several years.
Q2 versus Q3's credit performance was was dramatically different. Despite you know I think a pretty similar.
Background for liquid loan prices and credit spreads and I think that was due to some specific credit issues.
And some markdowns in Q2 that that caused a pretty big declining now that nagging Q3, you saw the opposite of that a big big uptick in Bath. So what do you think change between Q2 and Q threes performance in your portfolio and you think that the portfolio has really turned the.
Corner from a credit perspective, with the restructuring that occurred markdowns at both stressed investments or you're still just too much uncertainty out there to make that call.
Yes.
Hi, Good morning, Ryan. Thank you for that I mean, it does a couple maybe sort of different pieces in there.
Yes, I don't think the quote unquote credit performance has sort of changed and over Q2 to Q3 I would go with kind of your point. It was much more certain specific names that we continued to kind of work through and I think if we take a step back you're right. We've been very focused on rotating the portfolio.
So you saw in our some earlier comments, we've got 50 plus percent originated from the Fs kicking our advisor you, 81% plus from.
From KKR sort of overall.
No I think we've had some some legitimate challenges on.
Some of these older names.
And I think we've.
Been forced to dig deep on the restructuring side and quite frankly, the recovery rates on some of those names have not been great I think thats been a driver now what I would what we do want to make sure the market understands and this was page 12 of our slide deck, that's up on the website.
We have originated since the start of this advisor so 10 quarters now you over four and a half a billion dollars of assets.
Total.
Cumulative.
Depreciation sort of $49 million right. So I think and you put that in context.
Almost four and $5 billion of investments $49 million over 10 quarters, that's well with inside the range that we've talked about us.
Probably a target of sort of 1% annual losses. So I think I think we've made some really good progress I think we're quite proud of what the team has done both on the origination side, but also on the portfolio side I think we've still got some work to do as it relates to some names in there, but I think we do believe the portfolio sort of turn the corner.
And we look forward to continuing.
With what we believe our strong originations too good and defensive companies continue to build this portfolio in an accretive manner for our investors.
Okay.
Good color.
And then I just had one other one I know there's been a lot of discussion online.
Firms in pricing in the market as well as your current pipeline.
Just as I look at your guys' leverage levels today, and I understand where you guys leverage targets are set at UTI expectation you know.
Going forward as that at this point you know you guys are just going to match repayments with originations or what's the thought from from leverage levels going forward from here.
Yes, I'm not sure that's that's a us the wrong assumption I mean, we were happy to see the leverage come down.
This quarter I mean, weve at that 1.2 times net.
With inside our.
Ours are the target range, our target range of one to one in the quarter times hasn't changed. So I think you should expect us suspect has to operate.
Within there I think we feel very good where we are from a liquidity perspective, both from available liquidity that also sort of near term debt maturities and the only time I think that we would probably take it above there what do we would be to capitalize on what we see is a market opportunity and volatility which is obviously not there today.
The way it may have been in kind of end of Q1 beginning of Q2.
Okay understood.
That's all from me I appreciate the time today and congrats on the on the next quarter.
Thank you.
Thank you and our last question and follow up question comes from the line of Casey Alexander with Compass point. Your line is now.
Yeah real quick for Steve because this is just math that I want to check you know if you level set your earnings stream going forward do you know how many quarters.
Of additional incentive fee waivers, we have in front of us before they're they're absorbed through to look back.
Hi, Casey, we gave guidance I guess.
Probably two quarters ago now that.
What we said we expected it to be kind of the five to six quarter range from that period of time.
Clearly in our guidance for the fourth quarter.
There is not an incentive fee.
Really the books moved in a positive direction too so.
Forgive me for not having the exact math, but hopefully that's maybe a bit of a book in for you.
We can also follow up offline as yeah.
If you want to follow up offline that'd be great. Thank you great. Thank so much awesome. Thanks.
Thanks for taking my question.
Okay. Thank.
Thank you.
And this does conclude today's question and answer session I would now like to turn the conference call back to Dan teaches that for closing remarks.
Thank you we.
We want to thank everyone again for taking the time today.
And we do hope that you and your family remains safe and healthy and we do look forward to talking to you again soon thanks again.
Ladies and gentlemen, this concludes today's conference call. Thank you for standing by May.
Okay.
Everybody you may now disconnect.
[music].