Q3 2021 Owl Rock Capital Corp Earnings Call

Good morning, and welcome to the Al Rock capital corporations third quarter 2021 earnings call. All wines have been placed on mute to prevent any background noise. After the speaker's remarks, there'll be a question and answer session. If you'd like to ask a question. During this time simply presti Starkey followed by the number one on your telephone key.

[noise] pad, if you'd like to withdraw your question Press Star one once again I'd like to advise all parties. At this conference is being recorded and now like to turn the call over to Dana Sclafani head of Investor Relations four O R. C C.

Thank you operator, good morning, everyone and welcome to Iraq capital corporations third quarter earnings call. Joining me this morning, or co founder and Chief Executive Officer, Craig Packer, Our Chief Financial Officer, and Chief Operating Officer, Jonathan Land and other members of our senior management team I'd like to remind our listeners that remarks made during today's call may contain forward looking statements.

Which are not a guarantee of future performance or results and involved a number of risks and uncertainties that are outside of the companies control actual results may differ materially from those and forward looking statements as a result of a number of factors, including those described in O. R. C. Six filings with the SEC. The company. It seems no obligation to update any forward looking statements.

We will also be referring to non-GAAP measures on today's call, which I reconciled to gape figures and our earnings press release and supplemental earnings presentation available on the Investor Relations section of our web site at Al Iraq Capital Corporation Dotcom, Craig will start by briefly discussing our financial results before providing an update on our portfolio in jail activity Jonathan.

Then cover our results in more detail after witchcraft will close to some stuff on our outlook before opening to call up for questions with that I'll turn the call over to Craig.

[noise]. Thanks data good morning, everyone and thank you for joining us today to discuss our third quarter earnings. We're very pleased to report strong results for the quarter hour net investment income per share. It was 33 cents up from 30 cents per share in the second quarter and in excess of our 31 cent per share dip.

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This was driven by the continued growth of our portfolio maintaining low operating expenses the cost effective imprudent use of our balance sheet and there are ongoing superior credit performance. We ended the third quarter with net asset value per share a $14.95 up five cents from the previous quarter.

Which represents our six consecutive quarter of NAV increases.

As you will recall our N I I had been previously impacted by the expiration of our fee waivers in the fourth quarter of 2020, and we had been expecting to achieve full coverage of our 31 cent per share dividend sometime in the second half of 2021.

With the strong results. We have now achieved this milestone and are well positioned to continue to fully earn our dividend going forward.

We experienced a record level of originations this quarter, which resulted in a fully ramped 12 billion dollar plus portfolio.

We also had a record level of repayments prior to this quarter, we had not yet seen the pace of repayments expected for a portfolio of our size, but this trend finally materialized in the third quarter we.

We had more than $2 billion of repayments, which generated healthy fee and amortization income.

At the same time, we're able to seamlessly replace those repaid investments with equally attractive new investments of a similar credit quality and comparable economics, which also allowed us to finish the quarter and an equally strong position and with leverage comfortably in our target range.

We are also benefiting from a terrific environment for direct lending continue.

Continuing the trend we saw in the first half of this year M&A activity remains at record levels.

Private equity firms remained flush with capital and are investing at a very fast clip.

We are also witnessing the continue continued penetration of direct lending until the overall leveraged finance space taking share from the broadly syndicated markets.

With larger pools of capital available for direct lending solutions private equity firms are using these solutions more frequently and for larger transactions.

Take your we continue to see growing demand for large privately placed unit trash loans. This.

This year, we have evaluated more than 30 opportunities over $1 billion in size and this quarter alone closed on five loans $1 billion or more in size most of which were structured as you the tranches.

We believe these trends favor large scale direct lenders, who can provide sizeable financing solutions and who have the resources relationships and expertise to partner with the private equity community.

The <unk> platform is especially well positioned for this trend do door a scale full suite of products and awards deeply experienced team with strong relationships with financial sponsors.

The broader al rock platform deployed a record amount of capital in the third quarter and we will look to further enhance our strong competitive position by investing an additional resources to remain a market leader.

Turning to our investment activity for the quarter. We were extremely pleased to originate 2.8 billion of investments with 2.3 billion of funded activity and 2.1 billion of repayments, resulting in net funded originations of 198 million.

Our investment pace was driven in part by our strong and growing base of incumbency positions, which provide a natural pipeline of differentiated deal flow.

Nearly half of our investment activity was in a handful of refinancings for existing portfolio companies, where we were able to leverage our in depth institutional knowledge and strong relationships.

Two of these companies associate and Troon golf have been in our portfolio for over three years and have delivered strong operating results over this time.

They have they have historically represented some of our largest positions and we are pleased to be able to reinvest in names, we know extremely well and have great confidence in.

Another trend, which drove the growth in our origination volume this quarter was the opportunity to make larger investments in larger companies.

When we deployed roughly 2.2 billion across 21 investments excluding add ons.

This compares to 1.2 billion across 16 investments last quarter.

So we were able to to deploy 80% more capital with only five additional investments, which allows us to be efficient with our resources and continue to devote the full attention to credit underwriting that we think is so critical.

We also continue to grow the size of the companies in our portfolio. The weighted average EBITDA of our borrowers is now $114 million, which is up from $95 million a year ago and.

In addition to allowing us to invest more efficiently. We believe larger companies are safer to lend too and that has been borne out by our results over the last five years.

As you May recall, we had been expecting to see a pick up in repayments for awhile. We finally saw this occur this quarter with 21 fully exited investments.

While this quarter may prove to be on the higher end, we do expect repayments to continue to exceed the levels. We have seen in the last couple of years.

Importantly, we were able to deploy capital from our sizeable repayments into attractive opportunities without deviating from our investment strategy.

Roughly 90% of activity. This quarter was in first lien in unit trusts loans and our average spread on new commitments was approximately 625 basis points, which was in line with the average spread on repaid investments.

As a result, the overall portfolio spread remained in line with previous quarters at roughly 650 basis points.

Credit quality levers levels and credit protections for new investments remain consistent with those of the rest of our portfolio.

So despite the high repayments and competitive market conditions, we continue to feel very good about our ability to deploy capital and maintain a high quality asset base.

Today, the portfolio stands at $12.1 billion across 130 companies and continues to deliver extremely strong credit performance.

The overwhelming majority of the portfolio continues to perform very well and the weighted average fair value remains at approximately 98, and there were no significant change to our portfolio ratings.

As we look at the performance of our borrowers I would note that we have now had it was four quarters of normalizing performance since the worst of the Covid impact was felt in the second quarter of 2020.

We are pleased to see the continued improvement in performance in each quarter since and today. Many of our borrowers are reporting record sales driven by strong consumer health and economic activity.

That said, we are carefully monitoring the current headwinds caused by the labor shortages in supply chain disruptions to date, we have not seen a material impact as many of our companies our services businesses, which have modest exposure to the manufacturing economy.

For example, some of our largest sectors, our software insurance and health care, which are not as exposed to the current economic headwinds.

In line with last quarter are Nonaccruals remain low with only two investments on non accrual status, representing 0.4% of the portfolio based on fair value one of the lowest levels and the BBC sector and our annualized loss ratio is 14 basis points.

I will now turn it over to Jonathan to discuss our financial results in more detail.

Thank you Craig.

We ended the third quarter.

With total portfolio investments is 12.1 billion outs.

Outstanding debt of 6.9 billion in total net assets of $5.9 billion.

Net asset value per share increased to $14.95 up five cents from last quarter.

This increase was primarily driven by the growth in our net investment income, which exceeded our dividend by 10 million as well as from 12 million of unrealized gains.

We ended the third quarter with net leverage of one point O six times debt to equity.

Roughly the mid point of our target leverage range and with liquidity of 2.4 billion.

Our net investment income was 33 cents per share two cents above or previously declared third quarter dividend of 31 cents per share.

For the fourth quarter, our borders again declared a 31 cent per share dividend payable on January 31st 2022 to stockholders of record on December 31 2021.

Our total investment income for the corner increased to 269 million of $20 million from the prior quarter.

This increase was primarily driven by dividend income, which increased by 8 million.

We received our first dividend from wingspan this corner as well as continued dividend income from windows entities, and our senior loan fund.

We expect dividend income from wingspan and our senior loan fund to continue to increase as are committed capital is deployed.

Craig noted we had a significant amount of repayments this corner, which drove a material increase in earnings from accelerated accretion and prepayment fees.

While this is not a contractual earnings stream, we do expect repayment related income to broadly stay around these levels and future corners, as we expect that our repayments will remain at a more normalized pace recognizing that the timing of repayment is idiosyncratic in any specific quarter.

Interest expense was $56 million up from the prior quarter as our leverage slightly increased in the quarter <unk>.

Management and incentive fees modestly increased to 73 million, reflecting the growth in the portfolio.

From a capitalization perspective, we continue to be pleased with the strength and flexibility of our balance sheet.

As a corner and 62% of our debt outstanding was in the form of unsecured bonds and we continue to execute secured and unsecured financings at attractive levels.

With that I'll turn it back to Craig for closing comments.

Oh thanks.

Thanks, Jonathan.

To close I would like to touch on our outlook for the rest of the year.

Based on our pipeline, we expect another active quarter for both originations and repayments.

In terms of repayments, we expect to see a healthy level likely lower than this quarter's record, but higher than previous quarters.

Now that the portfolio was fully ramped we will generally be targeting originations in line with repayments in order to maintain a fully levered fully invested portfolio and we have a strong backlog of attractive deals expected to close this quarter.

We do see some on see some ongoing competitive pressure on spreads, but we are focused on ways to offset this pressure while maintaining portfolio quality.

To this end we of May two strategic investments in the last few years that have generated attractive returns and we think can help us achieve this goal.

One is our investment in wingspan <unk>, an asset based lender to U S based middle market companies with roughly $350 million of assets and very strong credit performance.

We currently have approximately $195 million invested in wingspan and see opportunities to invest more capital going forward.

We expect wing spiral will will be run rating at a high single digit R. O E. By the end of this year and can generate a 10 plus percent R. O E overtime.

The other investment is in our senior loan funds.

How's your real call last quarter, we increased our equity commitment and the fun to $325 million in our economic ownership to 87.5%.

The fund has already generated an attractive average quarterly R. O E over the past three years of approximately 10% and we will look to increase our capital invested over time.

We continuously look at opportunities for additional investments such as these in situations, where we can leverage our expertise resources and relationships in ways that are accretive to or C. C shareholders.

Lastly, we continue to see an opportunity to improve our portfolio mix we.

We still have just over $1 billion of debt investments in the portfolio with a spread lower than 550 basis points are.

Our portfolio spread will benefit as these investments are repaid and we seek to redeploy this capital into higher spread investments typically unit tranches, which is an area, where we have been able to achieve attractive pricing.

We are very proud of where the portfolio stands today. It is fully scaled with leverage in our target range. We've executed on the earnings levers. We had previously laid out and are now, earning the dividend from NII, we've demonstrated our ability to originate and underwrite deals across credit cycles, and I've proven to be a lender of choice.

For sponsors all while delivering one of the strongest credit performances in the sector.

We had a record quarter for originations have now deployed nearly $18 billion of capital since inception, while delivering a very low loss rate we'd.

We look forward to continuing to build on our current progress.

I would like to close with a note of appreciation for our investment in corporate solutions teams that al rock like many of you. We have recently reopened our office and they after more than 18 months of working remotely. It is wonderful to be able to interact in person with our colleagues. After so long working apart and seeing each other only on V.

D O calls.

Our team has worked tirelessly and selflessly. During these 18 months to build a large portfolio with terrific investment results maintain very high credit standards and do it in a remote work environment that often created a unique level of stress and strain and they did it with tremendous pride teamwork and the spread.

Decor.

On behalf of the entire Al Rock leadership I, just want to thank our team for their incredible dedication to our company.

And with that thank you all for joining us today operator, please open the line for questions.

Thank you at this time I'd like to remind everyone in order to ask a question Press Star then the number one on your telephone keypad will pause for a moment to compile the Q&A roster and we will take our first question from Devon, Ryan with J M. P Securities.

Yeah.

Great Good morning, everyone.

Kevin how you doing.

Doing terrific. Thanks, maybe start with one here on the liability side of the balance sheet you guys had been obviously very active and growing and optimizing slide 13, you show, how you've managed to reduce the weighted average interest rate on that by 40 basis points over the past year, which is great. So and what were you guys sit today are there any other opportunity.

You said, maybe further optimized.

Spot falling profile and if there are kind of what type of funding it maybe most appealing right now.

Yes, sure devotee on the margin there there are opportunities we've.

We've fully <unk>.

Raised capital really across all of the various legs of the stool from a financing perspective, both an unsecured in dropdown spv's with with banks as well as yellows.

And a revolver and we're well financed and well diversified in our financing.

Really out a number of years there are things that we can continue to do on the margin incremental C. A loose and an opportunistic unsecured financings, but I wouldn't say that there's a massive amount of of of moves that we can do from a from a cost perspective in the very near term.

I mean, the unsecured bonds that we have are trading today 125 basis points tighter than than where we issued but they have call protection that makes it expensive for us to take them out over time when they when they were call bowl or repayable, we will take them out and we should experience meaningful savings, but that is.

Not an immediate opportunity, it's something that will happen over time.

Yep Okay.

I'll phone just wanted a little perspective, there maybe a follow up just on some of the conversation on.

More I guess large companies.

Something you guys have been talking about for awhile, but.

Yeah, and and and it makes sense just given you differentiate there there's there's attractive opportunities, but yeah is that a function of how the market more broadly is evolving you that there there's just more opportunities.

The large end of the spectrum, just given whether it's did you have any markets or just grunter market dynamics or.

Just more of a concerted effort it out rock I understand it is concerted effort, but like has that part of the market also grown until you just there's more opportunities out there for you to do there.

It's both it's both and it's not coincidental that it's both I mean part of the reason we started al rock as we thought that more companies would want direct lending solutions. If there were a bigger pools of capital available and we went out and raised a pretty sizeable pool of capital.

<unk> bigger pools of capital of formed we can offer the advantages of a direct funding direct lending solution to bigger companies and we're finding great receptivity.

To them the sponsors are finding more and more opportunities to come to us and other larger direct lenders and ask for direct lending solutions when they could they could find those options available on the syndicated market and they're choosing direct lending solutions. So direct lending is getting greater market share and the overall leveraged finance.

Face and and and that by the way that trend is accelerating and.

And it's doing so at a time, where the broadly syndicated markets are extremely strong so they're not coming because they can't get a deal done in the broadly syndicated markets, they're coming despite that.

What that means is if we get a period, where there's instability in the broadly syndicated markets I would expect an even greater penetration of direct lending until the overall leveraged finance space. So the trends accelerating now as is and with with I think upside from a share standpoint in the future.

Okay, great to hear all leave it there I'm back in queue. Thank you.

Thank you and next <unk> next we'll go to Robert Dot with Raymond James.

Hi, guys and congratulations on the quota I just want to go to one of those things in your prepared remarks quite I mean, you you talked obviously about we can spot.

D S L S.

The Avs way you can kind of combat.

Competitive pricing conditions, but I've been <unk> is.

Is it financial engineered similar product to the Bdcs verses wing Spa, which is a different like.

Like it it it's not sponge.

Sponsored back then they all of the all the vehicles that you're looking.

To expand into that it that it really differentiated film large scale private credit whether.

The you've got advantages, but the competitive pressures Ah Ah most elevated like now.

So there's no area that I want to highlight as an area you should expect us to go into you know obviously, if we were about to do that I would share that with you. We get approached regularly by teams that have our ends I'll call. It special T finance verticals across the spectrum that are <unk>.

Hacked into the Owl rock platform and are you know very significant capital base that we look at any evaluate from time to time and and if we find something that we think provides a really attractive risk reward and is you know opportunity that makes sense relative to the rest of our <unk>.

Platform, we would do it I don't have anything I really want a signal right yet other than to tell you I would like to find one or two more and so we're we're actively looking and you know hope to find something but we're quite picky about what will go into and so we'd want to make sure. It was something that that really made sense for us.

Understood and one one more if I can sort of sort of follow up.

You you you also talked about obviously, yeah, you you at scale now deployments it'd be targeted roughly it be payment levels to to.

To maintain uhm portfolio size should we inspect the the.

Over time, the number of assets in in the portfolio would would rise because if they if the b B C is the public VDC isn't isn't going but the platform is in the BDC represents a little bit <unk> I think 50% of the the credit kind of capital investing right now but it.

Arguably and shrinking is what we're gonna see more diversification within the BDC more asset positions and add a small average hold size so always the target to keep.

The whole size and the number of positions similar as well, while maintaining the portfolio size.

It's a good question what I would say is this quarter. We you know it's date about flat.

So where there's a number of different factors that are that are at play there so without making it too complicated with respect to <unk> see we've always been most comfortable targeting one or 2% position sizes and we've helped that we've been very consistent with that and that's about where things have wound up so.

So so I think from when we size RCC positions.

I think we're going to continue to do what we're doing as our platform has grown you're right will RCC will shrink as a as a percentage of the incremental investment dollar.

But you know it really depends on you know other portfolios needs at a time, how much we're putting into <unk>. So as we construct a portfolio. My guess is we grind higher on position sizes, but but you know not not dramatically so but over time. It wouldn't surprise me, if we grind grind to a bit higher but not dramatically. So.

Okay I appreciate it thank you.

Okay next we'll go to Orion a lynch with K B W.

Okay. Good morning, Thanks for taking my questions first one I had I would slide number six and your guys the weighted average spread.

And can they make it six 2%, which is you know down pretty measly over the last several quarters I'm just wondering you know.

Ever have all the upper middle market in Mega tranche market, which again is changing as as as it's still in formation is new players entering that you think that that's 6.2% is sort of hitting that spread is kind of getting a floor level that that folks in that market or are willing to.

<unk> or you could you still see further pressure in those numbers and is there any sort of floor level.

You guys still you know comfortable stopping avenue and not going any less lower than.

Sure. So one thing I would point out is this quarter, we were almost entirely first lien or unitranche.

Whereas in the second quarter, we had meaningful second lien and we also had a couple of really high spread tech deals in there so what you're seeing in the in the dropped from the second quarter to the third quarter is in part driven by mix as well as a couple of really really widespread deals done in the cough.

Order for example, if you went back to the first quarter. We're at six four versus 6.2, certainly lower but the not not not as not as significant.

Significant having said that there is spread pressure in the market I mentioned that in my comments I think one of the real advantages now for us that we've gotten to fully invested is we can be very disciplined about the incremental investment and we are being disciplined about the incremental investment and where it's being shown opportunities for.

High quality credits that would fit our credit characteristics, but are being offered it spreads.

That we think is or not not super attractive and so in those situations, we may do less than before or none at all so we are I think afforded the opportunity now to be disciplined and we are but there is some spread pressure I. My sense is that the spread pressure has leveled off based.

On what I've seen market activity wise in the last couple.

Couple of months a couple of other large lenders seemed to have found therefore, and maybe not kept pushing it lower than that but these things can vary and so what will just have to see I know that for all our C. C. We continue to find attractive spread opportunities I would say in excess of the market spread and compared to the piers where I'm seeing I think.

We're continuing to find deals that are attractive in part based on a growing base of Incumbencies and so we have the the ability to offset some of that spread pressure and we're not totally immune to it but but offset some of it. So hopefully that gives a little bit of color. What we're seeing what I see out there I think it's leveled off I don't think it'll go tighter but.

But it's possible I could I don't know how other people run their business.

Sure I understood. That's that's helpful in Colorado.

I wanted to get some more detail on a common you mentioned earlier because of where you are right. Now you know from a capital appointment standpoint of leverage standpoint of matters. You said you're at scale. So originations will you know roughly equate to repayments I think you said going forward.

I'm just curious you know you guys have the upper hand, your leverage target is 1.25 times.

You know from a gross standpoint, you guys are you know 118, or so but from a net standpoint, you guys are only about one O. Five so there's quite a bit of room to go if your leverage target of of the upper hand, and 1.25 of that on your next standpoint. So could you just give some clarity.

Your your leverage range is that a net bases or grow spaces and do you feel comfortable going to the upper end because.

If it is the latter that would suggest that you guys could still.

Handle a decent amount of net growth from here.

So we when we talk about it we talk about on a net basis you know obviously the cash can move around meaningfully you know at the end of a quarter is deals close so that's the gist. So we're all speaking the same language.

We're comfortable operating anywhere in that range. That's why we have the range.

I, we try to balance obviously, a great returns for shareholders, but also being terrific stewards of our balance sheet with respect to our lenders and our bondholders have been terrific supporters of our growth rating agencies. You know all of these factors come into account, we would be comfortable operating anywhere in that range and where.

Land in any one quarter.

Is dependent on deal activity for that quarter, which can be lumpy and we don't have perfect precision, where we might land at the end of a quarter. So I think folks should expect in any given quarter. We can be anywhere in that range I don't want a signal that we're gonna go out and just operated at the high end of the range was I think what you're asking me I don't think that that.

That that.

That should be your your your your your expectation, but in any quarter, we could drift towards a higher end of that range. There's a tradeoff there but for shareholders. Overall, we want a balanced getting great returns, which come from higher leverage with also maintaining very low financing costs, which come which is a countervailing force we're trying to.

To to take all that into account.

Okay understood I appreciate your time today.

Alright, Thank you Ryan.

I'd like to remind everyone if you'd like to ask a question you can press star one on your telephone keypad and next will go to Mickey.

<unk> with Ladenburg.

It's good morning, everyone. Most of my questions have been answered I just have a couple of housekeeping questions on innovative innovative water I see it's on non accrual, but it's actually marked above par. So could you just give us some guidance on its outlook and maybe for Jonathan did you reverse any.

Previous income accruals for innovative water.

Okay.

Innovative water is not is not on non accrual. So we can we can take it offline Mickey but.

It's a it's a performing investments there was no reversal of income there.

Okay, sorry that must be my mistake. That's it for me. This morning. Thank you.

Okay. Thanks Mikey.

Again, it's star one if you have a question next we'll go to Kenneth Lee with RBC capital markets.

Good morning, and thanks for taking my question it sounds like you're still expected to see a potential benefit over time in terms of pick up and portfolio yoga as you rotate towards higher spread new investments just wondering it turns out remaining $1 billion that's at lower spread.

And it sounds like a good time is dependent on prepayments is there any way to bracket the potential timeframes for for when you could expect it to to start you know rotating a meaningful amount of that remaining investment.

<unk>.

Sure.

Now with any great precision you know, there's there's a portion of that billion that I think there's a reasonable chance we'll get repaid then the next one to two quarters and then there's a portion that I think will take longer than that there's a portion in there that we might choose to sell over time and then there.

As others have probably aren't easily sold because there's not other lenders in the credit with US now for a credit reason, so I I don't want to put out it's not a predictable thing for us it depends what's going on with the companies. There's certainly some in there that probably will get repaid in the fourth quarter I talked about <unk>.

Acted repayments being meaningful in the fourth quarter, but I I don't have a number to give you to model and so if I was modeling in something I would just assume it's over over the next two years 292, and a half year or something like that.

Gotcha very helpful and just one follow up if I may wonder if you could just talk a little bit more about your current appetite for second lien loans to see that the percentage allocation within the portfolio has tried to down slightly over the last couple of quarters, but just wanted to get your lettuce latest sticking their.

Sure we.

We we have been consistent on this we were very selective on the second liens that we do we only do them and really very strong credits with meaningful equity cushions and businesses that we think are really stable and sore commiserate with taking the risk of being a junior lender, but in situations like those we lie.

Second liens and are are more than willing to do them. We haven't we oftentimes get shown opportunities that we say no too, but if they're credits that meet those characteristics.

Characteristics will be you'll be very pleased to do them. So in any given quarter can be zero could be a couple of deals you know I'd like to on the margin take that percentage up but I've been saying that very consistently probably for eight quarters in a row and and I think the fact that it's gone down a little bit is just a.

Asian of our discipline, but but I would if we find quarters, where we see.

<unk> good opportunities to do more second liens I I hope that that would not surprise anyone because we've been continuously pointing to this they obviously help helped our overall spread them returns just you have a sense of it are average EBITDA on our second liens is twice the EBITDA in our portfolio. Our average heaped on our second lien borrowers tends to be 200 million.

Plus with with all the same credit characteristics of our overall portfolio in terms of leverage on loan to value. So bigger companies stable will continue to do them, but we're very selective.

Got it very helpful. Thanks again.

Thank you.

That concludes today's question and answer session I'll now turn the call back over to Craig Packer for any additional or closing remarks.

Well terrific. Thanks for the questions. Thanks off your tuning in we're really pleased with a quarter I. Appreciate everyone's support were pretty accessible if anyone has follow up questions. Please please reach out to Dana and other than that enjoy the rest of your afternoon. Thank you.

This includes today's conference call you may now disconnect.

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