Q2 2019 Earnings Call
And at June 30 of 2019. It is my pleasure to turn the call over to Mr., Sabrina Rusnak Carlson General counsel of Th.
L. credit incorporated Ms. Rusnak Carlson you may begin.
Thank you operator good morning. Thank you for joining US with me today are Chris Flynn, our chief Executive officers and Terry Olson, our Chief operating officer, and Chief Financial Officer.
Before we begin please note that the statements made on this call may constitute forward looking statements within the meaning of the security tactic 1933 as amended.
Such statements reflect various assumptions by THL credit concerning anticipated results that are not guarantees of future performance and are subject to known and unknown uncertainties and other factors that could cause actual results to differ materially from such statements.
The uncertainties and other factors are in some ways beyond management's control and include the factors, including included in the section entitled Risk factors in our most recent annual report on Form 10-K as updated fire quarterly report on Form 10-Q , and our periodic and other filings with the Securities and Exchange Commission.
Although we believe that the assumptions on which any forward looking statements are based on are reasonable any of those assumptions could prove to be inaccurate and as a result, the forward looking statements based on those assumptions also could be incorrect.
You should not place undue reliance on these forward looking statements THL credit undertakes no duty to update any forward looking statements made herein.
All forward looking statements speak only as of the date of this call.
Our earnings announcement, and 10-Q were released yesterday afternoon copies of which can be found on our website along with the Q2 earnings presentation that we may refer to during this call.
A webcast replay of this call will be available until August 19th 2019, starting approximately two hours. After we conclude this morning.
To access the replay.
Please visit our website at Www Dot THL credit BDC Dot com.
With that I'll turn the call over to Chris.
Thank you Sabrina and good morning, everyone.
I will begin today's call with an update on our Q2 financial results and then we'll move on to the progress we've made in managing and reposition our portfolio.
Our net investment income for the quarter was 28 cents a share and included a onetime entity from the sale of daily eye of five cents per share.
That's good to see our core earnings were 23 cents per share versus our dividend of 21 cents.
The NAV declined to $8.49 per share this quarter was isolated primarily in two credits charming, Charlie and ally with some modest volatility in our Logan joint venture.
Well charming Charlie in L.A. I have been on nonaccrual and were significantly more down in Q1. So there is minimal to no impact to income.
I'd also like to point out that 90% of our NAV declined over the last three quarters have been concentrated and I used to names.
Despite the NAV volatility, we believe the fundamentals of our business in our portfolio that are moving in the right direction.
Well, let me first and restaurant and Charlie.
Despite a successful they'd be all refinancing that we mentioned in our Q1 call.
An evaluation of additional liquidity sources, because many projected an incremental liquidity need a 2020, which was not able to be filled.
And the tough headwinds that many in the retail space Center are facing the company had difficulty securing sufficient trade support which resulted in weaker inventory levels that led to softer spring sales season.
As a result charming Charlie filed for chapter 11 bankruptcy in July and is in the process of liquidating.
This process is progressing well our Q2 Mark reflects the current estimated recovery value. Once all these assets, there's a good source or successfully liquidated.
Now, let me speak to the sale of Elliot.
As we mentioned in our Q1 call we expected the sale of the largest component of the business to close quickly.
Unfortunately, the process of protracted and the sale close later in June .
Resulting in a further deterioration on the value of our non priority loan and a negative impact to NAV of approximately 4% our school I'm, sorry, four cents per share versus our mark.
Our priority loan were repaid in full plus the one and a half million dollar at city, which is recorded as income.
We continue to hold a modest receivable on our balance sheet related to the remaining assets of this business.
I want to emphasize that outside these two write downs. We are pleased with the overall stable performance in effect the transition of our portfolio.
Our objective over the last 18 months has been to reduce the risk in our portfolio by improving diversification.
We're doing this by adding smaller first lien secured positions nitric acid and concentrated names and noncore investments.
And continuing to invest in first lien senior secured loans and a little bit joint venture.
We remain confident in our plan that we've outlined and we believe it made good progress executing it.
As a result, we believe the risk in our portfolio has significantly decreased over the last 18 months and we remain well positioned to deliver solid performance in 2020.
Let me provide some more color on our progress.
First we have significantly improved our overall diversification in the portfolio by adding small acquisitions and proactively exiting more concentrated ones.
The average size of them seven new investments made in Q2 is approximately $4.6 million in this represents approximately 1% of the portfolio and is well below our target ever told.
Of 2.5%.
Since the start of 2018, the average size of our last 19 investments was 5.8 million or 1.2%.
DCR de continues to benefit from our co investment capabilities across our private funds or middle markets, Zelos, which are allowing us to take smaller positions and achieve our diversification goals, what's still originating very attractive investments.
Second since Q1, 2018, we proactively explore the opportunity to exit our larger positions and we reduced the number of lease companies with a hold size above 2.5% from 14 to seven.
This progress continued in recent months as we exited four concentrated positions park LPI and accident unfair stone, which was accident in early July .
Part was repaid at par from both an internet unfair stone repaid at par plus a prepayment penalty.
As a result of our efforts the average size of this investment and our debt portfolio at cost has decreased from $14 million in Q1, 2000 $18 million to $9 million at the end of Q2 2019.
While we are focused on our remaining concentrated positions from a risk and diversification perspective, we continue to be especially focused on tumor many positions highlight in our previous calls Holland and OEM.
Fallen due to its size sector and the recent performance and only on primarily due to its size.
Together these two positions represent 12.5% of our portfolio based on fair value at June 32019.
Paul under the first lien investment and one of our three remaining energy credits. The can business continues to make progress, albeit slower than expected pace and we've adjusted the value of our holdings this quarter to reflect this.
OEM continues to execute on its plan has performed in line with our expectations. So far this year from both a product development standpoint, and a booking standpoint.
It is our goal to position this company for sale by early 2020.
The third thing I'd like to emphasize is that we continue to make progress on our remaining noncore control equity investments.
Capital is marked up notably in Q2, and three and they continue to perform as well.
We remain optimistic about the sale prospects for both of these companies in 2019 and expect our current dividend levels to continue as long as the whole. These positions in Q2, we recorded $1.2 million of dividend income related to these positions.
Overall, we believe the portfolio substantially less risky today than it was one year ago.
The vast majority of the portfolio now 82% first lien as of June Thirtyth is invested in first lien senior secured loans, including the Logan joint venture, which is primarily comprised of first lien loans.
100% of our new investments in 2018, and 19 has been in first lien loans and we continue to grow those Logan joint venture, which now represents 18% of our portfolio as of June Thirtyth generates approximately 11% to 12% return on equity.
We continue to believe the first lien investments in sponsor back middle market companies to provide the most attractive risk adjusted return in today's environment.
For the remainder of 2018, our focus remains to substantially complete the rotation of our portfolio and the best of our ability ensure alignment with our shareholders.
We've taken a number of recent actions to further strengthen this alignment.
With the approval of our shareholders at the annual meeting in June 2019, our advisor, formerly lowered our management fee from 1.5% to 1%.
And also lowered our incentive fee from 20% to 17% with an 8% hurdle.
These changes are even more shareholder friendly and we believe are appropriate for the more diversified senior secured floating rate portfolio that we're building.
The lower base management fee of 1% went into effect on April 1st as expected to add approximately two cents per share quarterly income going forward.
Additionally, the incentive fees being weighed to the extent earn through 2019, it's worth noting that our three year look back feature takes into consideration realized and unrealized losses.
Which also may limit future incentive fees going forward.
We also continue to execute on our $15 million Tenbfive, one stock repurchase program.
Since March 2019, we have repurchased 8.4 million of our stock today or 56% of the target amount.
At a substantial discount to NAV repurchase in Q2 alone were accretive to book value by four cents a share.
As we look forward to 20 point I want to highlight several factors that we believe will position the BDC for continued progress and performance.
First our shareholders approved the reduced asset coverage requirement at our annual meeting in June .
As we've noted on previous calls our plan is to begin to use increased leverage in early 2020.
This is subject to successfully amended our credit facility and further progress in diversifying our portfolio.
What is important part of our plan to 2020, and we just started at modest leverage in the 1.05 to 1.15 range.
We do not anticipate that this will change our investment.
Strategy as we continue to target investments in companies with $5 million to $25 million of EBITDA yet.
Second we expect the BDC to continue from the growth.
The benefit from the resources of THL credit platform, which currently manages approximately $17 billion.
We continue to have success, raising private funds and middle market. So close.
Our co investment capabilities across these vehicles allow us to take smaller positions within the BDC.
Achieve our diversification goals, while still executing our strategy as a lead investor an originator of middle market private credit.
2019 has been the most prolific year to date in terms of originating attractive direct lending opportunities.
We closed on over $500 million of commitments across 18 portfolio companies. So far this year.
And over the last 18 months, we've committed over $800 million across 38, new portfolio companies.
We strongly believe we have the right team in place to complete and the execution of our plan. We believe these actions we have taken in 2018 and thus far in 2019 are the right ones as overall risk in the portfolio has continued to decrease and become increasingly isolated.
We expect continued improvement diversification will result in more stable and predictable returns to the BDC and for our shareholders and will position us well going forward.
With that I'll turn the call over to Terry to take a more.
Look into our portfolio and Q2 results in more detail.
Thanks, Chris and good morning, everyone first a few portfolio highlights as of June Thirtyth, our portfolio $464 million invested 64% in first lien senior secured debt.
At 18% the Logan JV.
As a reminder, the Logan JV of 96% of the diversity of assets.
Remained 18% or TCR do portfolios held and secondly in subordinated debt and other income producing equity holdings.
Copperweld unseen cave represent over half of the 18% or 40 million.
Please refer to slides 14, and 15 and our earnings presentation, which highlights these trends over the last two years.
The weighted average yield on the debt in income producing portfolio, including Logan was 9.8% in line with the previous quarter.
Logan continues to perform well and credit quality remained solid.
The 336 million dollar portfolio.
The par of 128 issuers continues to generate an attractive return for our shareholders.
We expect to continue to grow Logan as we cycle out of non core and concentrated positions at 18% of the portfolio today, we see the upper end of the future at 20% plus or minus at this time.
Long term yield expectation continues to be in that 11% to 12% range. We were near the lower end this quarter largely due to the portfolio running at lower leverage levels timing of equity contributions and the continued muted muted level of prepayment activity in the broader market, which has slowed the accretion auto I'd and prepayment penalties at Logan.
Local was marked down by 2.4 million or eight cents per share this quarter largely due to broader program largely due to broader credit market movements in pricing in June .
And some credit weakness in a couple of names that was one loan on non accrual status as of June 30, with a cost basis at $2.5 million, representing less than 1% below the portfolio.
Total non accruals as a percentage of TCR deep portfolio at fair value and cost decreased to 1.8% and 7.8% respectively with the sale of LCR in Q2.
Charming, Charlie Loadmaster, where the other two names on non accrual status of June thirtyth, consistent with prior quarters and no new names rather to non accrual for Q2.
Moving on to the financials for the second quarter, Chris mentioned that the net investment income of 28 cents per share included the onetime exit fee related to be.
Hi.
This is excluding this item our core earnings were 23 cents looking at some components of our 15.4 million of investment income this quarter.
Interest income of $9.6 million was primarily flat. This quarter included approximately $200000 of prepayment fees from the realization of the next.
Dividend income was also flat as expected at $3.8 million and reflects dividends from C and K copperweld and the Logan JV.
The increase in other income over the.
Quarter over quarter was related primarily to the $1.5 million exit fee, we mentioned earlier.
On the expense side total expenses for the quarter were $6.5 million compared to 7.5 million in Q1.
The decrease was primarily due to the lower management fees, reflecting motion of our management fees that became effective April one.
This has been reflected as a waiver.
Formal shareholder approval in June .
Interest and fees and borrowings were also lower versus Q on Q1. If you may recall included approximately 400000 or one time charge.
In connection with the acceleration of deferred financing costs incurred in connection with the downsizing of our revolving credit facility.
As a reminder, we expect a reduction in the facility will save approximately $425000 per year and unused fees.
Unrealized depreciation during the quarter, which drove the NAV decline as Chris mentioned was primarily isolated to.
Bug credits previously identified charming Charlie early on in the Logan JV was offset by markups and copperweld in a number of other positions in the portfolio.
The net realized loss of $24 million of Q2 was primarily related to the sale of L.A.R. and was largely offset by a corresponding change in unrealized appreciation.
From a leverage and liquidity perspective leverage levels were made to the 0.8 timeframe at June thirtyth, but fell below.
Fell below 2.75 times with the repayment affair stone in early July we anticipate maintaining leverage in the 0.75 0.8 times range in the near term.
With that I will turn the call back to Chris for closing remarks.
Thanks, Eric we appreciate this opportunity to update you on our continued progress in Q2, hopefully have a better understanding of our efforts to reduce risk and transformed the fundamentals of our portfolio.
We believe continue diligence.
Execution of our plan is a clear path way to a more stable and predictable return for our shareholders.
Thank you and we look forward to your questions with that ill turn the call back over to the operator to start with you on it.
Thank you ladies and gentlemen at this time if you have a question. Please press Star then one on your Touchtone phone. If your question has been answered or you would like to remove yourself from the queue. You May press the pound key to prevent any background noise. We ask that you. Please limit your line on mute. Once your question has been stated our first question comes from Lee Cooperman of Omega Advisors. Your line is open.
Thank you. Thank you very much good morning.
How you doing Chris.
Good luck. Thanks, good good I have three questions just put it met did handle maybe what you want.
If I take the 23 cents core earnings over your 849 book, we earned 10.8% and equity is that a number that you think is reasonable given the way we run the business do you think you can enhance upon that return et cetera. So kind of question. One is the ROI, we target likely to be achieved in the business model I'm not interested in the next quarter or two im just looking out to 12 18 months, what is a reasonable target for return on equity for the shareholders given the way you want to run the business in the future secondly.
The cost of management.
Taking a full fee.
With your new arrangement with the cost of management expressed in basis points percent whatever.
So we have a gross return on equity net return equity and third I think you gave me. The answer is the status. The repurchase program. You Board you have 50 million to authorize you spent.
8.4 to 6.6 million left is that correct and if.
What is your time frame, assuming the stock is where you want to buy it spend is the $6.6 million. Thank you very much.
Perfect. Thanks, Les appreciate the question.
I'll take them and probably inverse order.
The math that you outlined is correct the.
$50 million program, we have approximately $6.6 million left at our current line velocity, we'd anticipate that to be fully utilized in the next.
Two to three months.
Okay first question regarding the dividend I think as we sat back and said the dividend of 21 cents, we took a number of factors into consideration.
Potential stress in the portfolio.
What we think the new earnings stream should be as it relates to the types of assets that were booking and then the potential when appropriate for putting incremental leverage on on our books as I sit back and take in thinking about the highlights of the quarter, obviously disappointed on the write down of charming, Charlie but with that coupled with the fact that we're still able to cover our dividend of 110% at these lower leverage.
Levels is it something we feel we feel very good about so as I look out into the future I believe the the 21 cents is very strong.
It's something that we can support.
The other comment regarding the appropriate return on equity were in the 10 tenant tenant tenant half percent range, you think most bdcs that trade at or around book or in the nine and a half the 10.5% range. So I think thats appropriate.
Your second question I was a bit confused on is that the cost of management.
Could you specify what you're what you're looking for a bit more detail. Please.
Basically I guess the cost of management is the 1% management fee plus 75% of the profits above 8% hurdle, that's the way to look at it I guess right.
Yes, I think you're saying, you're saying you have to all costs. You think you get around about 10 tenant have percent.
Correct on a fully loaded basis Lee we think we can earn that tend to tenant at percent, yes, right got you.
Okay. That's that's the question very good.
I have other questions about do those offline. Thank you thankfully I appreciate it.
Thank you.
And our next question comes from Kyle Joseph of Jefferies. Your line is open.
Hey, good morning, guys and thanks for taking my questions.
I thought you guys did it did a good job of outlining the strategy shift, but I just wanted to go back over any sort of incremental Rick.
Any be from here.
Thank you outlined to.
Potential.
That said I don't know were causing you to lose sleep or just that you are you are focused on but beyond those two and given the.
Concentration reduction as well as the portfolio rotation are you pretty confident in that room remaining any.
Yes, Hey, Kyle Thanks, I appreciate the comment as it relates to the portfolio.
Kind of regardless of the performance of the business anything that's concentrated as a heightened sense of focus for us. It's been a core comment sense. The last 18 months, we want to reduce any exposure.
Thats over 2.5% regardless of the of the company being performed we highlighted OEM in Holland OEM, just because it's our single largest investment with that said the business itself is performing fine.
We highlighted Holland as as another example.
Given that we took a small markdown in that this quarter, given some industry headwinds, but our focus as as I've said all along is too.
Diversify some of the risks associated.
With our historic portfolio construction by exiting these names and replacing them with substantially more diversified pools of assets and I think thats the critical component of.
And why the fundamentals part of our business is working so well, we let a lot of transactions over the last.
Six months and the Bdcs been able to participate.
Given the overall size of the broader platform, but do so on a much more diversified basis, which once that rotation is complete it will substantially reduce the overall risk in the portfolio.
No that makes sense and thanks.
Next question you guys talked about.
Potentially increasing leverage on the balance sheet.
Yes, just interested on your thoughts given that given sort of the an evolving rate environment would it be primarily focused on increasing the bank line would you seek.
Alternative.
Debt financing options.
I kind of hysteria.
Look I think we've got some we've got capacity under our existing facility too.
Achieved the leverage levels is that Chris outlined under it under a new construct of 1.05 to 1.15, So I don't think.
We don't change the size of our facility, obviously risks that would still we still need to go through the process of amending that so.
Given the amount of folks that have gone through that process.
Uh huh.
Confident that.
That level of leverage can be achieved I think more importantly.
Before we go go down that path as Chris highlighted.
I think it's important to us to have moved on from these concentrated positions.
And further diversified as we outlined so we kind of expect the two things to happen in tandem with though and as a result be able to just utilize more of our existing facility.
Got it that's helpful and one last question from me I appreciate the color you guys provided.
On term, Charlie La Vie Holland et cetera.
But in terms of the rest of your portfolio that you have the majority of the portfolio just want it.
Get a sense of what sort of trends, you're seeing from top and bottom line perspective.
Particularly over the last few months as we've seen a little bit of more macro volatility out there.
Thanks, Yes, no I appreciate the question I think the good news is that we step back and think about.
Our historic our legacy portfolio and our new portfolio.
Since 2014 over 90% of the loans Weve originated are performing at or above expectations. So I think the team has done a very good job in not only selecting credit better, but also underwriting and structuring credit better. So the overwriting portfolio, what I call. The new the new strategy New assets is is performing in line.
Or above expectation so that feels good.
There are some select pressure as we highlighted on Holland, It's one of our remaining energy credits and it's obviously facing some volatility and some headwinds the good news there is a first lien investment so.
We have a lot to say and how that plays out, but we do see some industry pressure there on holiday, but the rest of the portfolio itself, especially the new things that we've underwritten are up very well.
Got it thanks very much for answering my questions, yes. Thanks Scott.
Thank you and our next question comes from Robert Dodd of Raymond James Your line is open.
Hi, guys own.
I appreciate the color on the LPI.
Charlie as well I mean, obviously the.
The comment on NII that the.
That delay resulted the deterioration of value.
Any potential this of that kind of thing a charming Charlie obviously in liquidation.
A is is though and your comment Mark reflects what you anticipate the liquidation value to be but how sensitive could that be to two potential delays in that process.
Sure.
Thanks for your are your question. Robert This is Terry charming, Charlie only has about six or 700000 dollar value ascribed to it at June Thirtyth. So.
That would be the maximum exposure that being said that reflects our estimate of recovery through the through the process as or as it relates to the assets at June 30.
<unk>, Okay, Okay, and then on the non core controlled I mean, you said, making progress and then also the common dividend should.
We continue I mean, obviously, if we look at a couple of wells.
And see NK they produce.
A pretty attractive dividend yield on on a combined equity fair value.
So can you give us any more on on the timing of that or whether that.
As an incentive to basically keep those.
A little long obviously this concentration risk I don't necessarily think I think you should but does it create incentives since they produce such an attractive dividend yield while everything else is going on.
Yes, Hey, Robert This is Chris Brathwaite the question.
We played that game before we're not we're not going to hold what we believe to be concentrated or IRS positions in an effort to support or chase a dividend, we're not going to do that.
If you look at those today, we don't disagree that businesses had been restructured that performed well they are paying us a nice dividend and when we anticipate those being sold our expectation is that de risks.
It provides further diversification to our balance sheet, we can continue to enhance and support the dividend.
By taking lower risk positions and utilizing slightly higher leverage and maybe that's a much more appropriate way to play this market as opposed to taking outsize concentrated equity positions and plan the dividends. So don't disagree with your math, we see it but we do believe as we get those proceeds in and that balance sheet affords us to take leverage up slightly that's the way will offset the pressure there and maintain the 21 cents.
Got it got it good. Thank you I appreciate the comment I agree with you.
But those get around the same pace.
Thank you.
And our next question comes from Ryan Lynch of Seaweed W. Your line is open.
Hey, good morning, guys.
Wanted to talk about.
You guys had a really good slide slide number 15 of decreasing non core assets.
You know obviously the top left.
Thought get you know non income producing investments those are probably don't have a lot of credit risk, but those are the three buckets, you've done a pretty good job of reducing you know subordinated debt.
The 2%, but you still have about 5% secondly, and about 9%.
Unsponsored investments I was just wondering as you look at maybe those three debt categories on that slide.
How do you guys kind of view that from a risk standpoint is it is it more urgency to get rid of the subordinated debt would you guys have done a better job at doing versus the second lien versus the on sponsors.
Yes.
I appreciate the question I think as we sit and look at the portfolio from a security mix.
The second lien or Mezz.
I'd say, we're more focused on the individual asset as opposed to the type of security.
Anything that second lien or Mezz, we want to reduce but what will be driving our.
Our decision is going to be more of the underlying portfolio company itself versus versus the related versus the related securities that that makes sense again.
When you originate some of these loans.
In an effort to drive a higher yield it to support the dividend just give or take it on that incremental risk and we're just we're not going to do that any longer.
So we want to exit all of these assets.
It's a unique situation in a portfolio like this when the business is performing your ability to exit or reduce isn't always apparent takes time there needs to be some some catalysts to that that enables us to raise their hand to try to reduce or or exit and I can assure you when given the opportunity. We're we're doing those across both mezzanine and secondly.
Sure I guess.
You talked about the big write downs this quarter were now and charming, Charlie which were identified problem credits in the past and we're hoping to move past those and look forward.
But as I look at again slide number 15, 9% of your portfolio still non sponsored me as an outside.
You know analysts looking in.
It's tough for me to decide does that non sponsor the 9% non sponsor does that still hold a significant amount of risk that could potentially further downside to NAV in the future. So how confident are you with those remaining for.
Portfolio companies that represent about 9% your portfolio that are on sponsored investments.
Yes, no. It's a great question. It is an area of focus if you think about it that 9% is approximately four names there are some small stub pieces. Unlike the wheels up that's that's very small that is performing.
OEM as the vast majority of that.
Because the vast majority of that box. So it's our single largest investment we control the debt Eylea control the equity of that investment. So we we control that business.
If you go back over time, if you watched our the capital structure, we had a change in management going back almost 18 months, we've injected capital under the business to stabilize it.
The business has now stabilized has got a very good team running it. We believe we are positioning the business for sale.
But so from the confidence of segment, we feel good about the businesses that we control. These are those businesses.
Copperweld. Another example, that's that's a business that you know that that had very similar history. Its just running its course faster than I am but.
We've had a few markups and that over a over the last two quarters. So.
OEM has lifted as an area of focus not based on performance again, it's just based on size, it's an outside physician.
I wish it was more diversified we're working as hard as we can to take that risk off the table and and redeploy that capital, but it's a.
It's going to take time are bit more time to out to finish that transition.
Okay. That's helpful commentary surrounding those thank you for that.
The time students on all my questions.
Thanks, Ron Thank you and currently I'm showing no further questions in the queue I'd like to turn the call back over to Mr., Chris Flynn for closing remarks.
Thanks, operator, we want to thank everyone for joining us on this Q2 call to the extent folks have additional follow up questions feel free to reach out.
We look forward to give you an update of our Q3 results and in the coming months. Thank you.
Ladies and gentlemen, thank you for your participation in today's conference you May now disconnect everyone have a wonderful day.