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BlackRock Capital Investment Corp (NASDAQ:BKCC)
Q3 2019 Earnings Call
Oct 31, 2019, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning. My name is Anna and I will be your conference facilitator today for the BlackRock Capital Investment Corporation Third Quarter 2019 Earnings Call. Hosting the call will be Chairman and Interim Chief Executive Officer James Keenan; Interim Chief Financial Officer and Treasurer Michael Pungello; General Counsel and Corporate Secretary of the company Laurence Dean Paredes; Marshall Merriman Head of Portfolio Management for BlackRock's U.S. Private Capital Group; Jason Mehring Chairman of the U.S. Private Capital Group's Investment Relations and Business Strategy -- I'm sorry Investment Committee; and Nik Singhal Head of Investor Relations and Business Strategy. [Operator Instructions] Thank you. Mr. Paredes you may begin the conference call.

Laurence D. Paredes -- General Counsel and Corporate Secretary

Good morning and welcome to BlackRock Capital Investment Corporation's Third Quarter 2019 Earnings Conference Call. Before we begin our remarks today I would like to point out that certain comments made during this conference call and within corresponding documents contain forward-looking statements subject to risks and uncertainties. Many of these forward-looking statements can be identified by the use of words such as anticipates believes expects intends will should may and similar expressions. We call to your attention the fact that BlackRock Capital Investment Corporation's actual results may differ from these statements.

As you know BlackRock Capital Investment Corporation has filed with the SEC reports which lists some of the factors which may cause BlackRock Capital Investment Corporation's results to differ materially from these statements. BlackRock Capital Investment Corporation assumes no duty to and does not undertake to update any forward-looking statements. Additionally certain information discussed and presented may have been derived from third-parties sources and has not been independently verified. Accordingly BlackRock Capital Investment Corporation makes no representation or warranty with respect to such information. Please note we've posted to our website an investor presentation that complements this call.

Shortly Jim will highlight some of the information contained in the presentation. Presentation can be accessed by going to our website at www.blackrockbkcc.com and clicking the October 2019 Investor Presentations link in the Presentations section of the Investors page. I would now like to turn the call over to Jim.

James E. Keenan -- Chief Executive Officer

Thank you Larry. Good morning and thank you for joining our third quarter earnings call. I will provide you with business and performance highlights an update on investment activity during the third quarter and the summary of underlying portfolio performance. I will then turn it over to Mike Pungello our Interim CFO to discuss the financial results in more detail before opening the call to questions. For the third quarter net investment income was $0.14 per share. We deployed $67 million during the quarter which was offset by repayments and other exits totaling $37 million for an approximately $30 million net increase in the portfolio due to investment activity. Over the last year the company's advisor has continued to make significant investments across our platform and sourcing channel including Tennenbaum

Capital Partners integration and other resources within BlackRock that bolster origination. The advisor has approximately 50 investment professionals dedicated to our U.S. middle-market direct lending strategy. The company is seeing the benefits of these investments made by the advisor via increased deal flow and broader underwriting capabilities. Additionally our ability to co-invest with certain affiliates under our co-investment order is helping the company to construct a diversified portfolio with reduced idiosyncratic risk. To focus on this quarter we added a total of 5 new names to the portfolio this quarter which are detailed along with repayments in our earnings press release. Since the beginning of 2019 key portfolio highlights include: gross deployments of $230 million including first or second lien

loans to 20 new portfolio companies; number of portfolio companies increased from 27 to 43; first lien investments increased from 24% of the portfolio by fair market value to 33%; and secured investments increased from 47% of the portfolio by fair market value to 57%. With the net deployment activity this quarter the portfolio now has a fair market value of $726 million across 43 companies. The weighted average yield of income-producing securities at fair market value was 11% as of September 30 down to 72 basis points since last quarter. Quarter end leverage was 0.61x increased from 0.53x prior quarter. We have ample liquidity of $206 million to support new investment activity and we have no debt maturing until 2022. Net asset value decreased 4.8% from $6.82 per share last quarter to $6.49 per share as of September 30 driven by net unrealized and realized losses of $22 million. 85% of these losses or $19 million were related to non-core legacy investments in the portfolio including $11 million related to the company's legacy investment in U.S. Well Services a publicly traded company. A substantial portion of this equity investment is subject to certain lockup provisions which expire in November of 2019. Although there can be no assurances we anticipate that the valuation of this investment will continue to shift in line with the quarter end closing prices of USWS common stock.

Now I will talk about the progress on rotating out of the legacy non-core portfolio which as of September 30 is reduced to 18% of the portfolio by fair market value down from 28% last quarter. This part of the book is comprised of: First performing debt and income-producing securities at 13% by fair value with AGY first lien Sur La Table and Red Apple stores being the 3 largest holdings. Second nonearning equities at approximately 1% by fair value primarily consisting of U.S. Well equity. And third investments on nonaccrual at 4% by fair value including AGY second lien and preferred stock Advantage Insurance preferred stock and Advanced Lighting second lien. During the third quarter $32 million of proceeds were realized from the sale of certain investments in Vertellus Holdings and related issuers which was previously the largest non-core position. The entire equity and second lien positions were exited at levels which in aggregate were $2.2 million lower than the prior quarter mark.

Additionally $5 million of Vertellus' first lien investment was sold at a price of [1 0 1.] With these transactions $17.5 million of Vertellus' first lien remains in the portfolio which we do not view as non-core on a go-forward basis. We remain dedicated to completing the restructuring of the current portfolio and creating shareholder value through a more stable income-oriented book. We are focused on: one prudently exiting the nonearning and non-core legacy assets to bring stability to book value; two redeploying on to a broader more diverse portfolio with a greater mix of first lien assets; and three increasing NII through a better mix of portfolio and optimizing leverage. We believe that all of this will result in improved return on equity bringing the earnings power of the company in line with the sector and drive enhanced shareholder value. After careful consideration of the progress in achieving our strategic goals of exiting non-core assets and improving portfolio mix the company's

Board of Directors approved a reduction of the company's minimum asset coverage requirement from 200% to 150% which will become effective on October 29 2020 or earlier if stockholder approval is obtained. We believe that the added flexibility will allow the company to pursue its goal of improving return on equity while creating a more diversified portfolio of secure income-producing investment. As we achieve further progress with non-core exits we will endeavor to prudently increase leverage from current levels with a steady state leverage target of 1 to 1.25x. Additionally at the time that the reduced asset coverage ratio becomes effective which will be October 29 2020 or earlier if stockholder approvals obtained we intend to lower the base management fee for the company from 1.75% to 1.5% with an additional reduction to 1% on assets that exceed 200% of NAV. Additionally at the same time we intend to reduce the rates of incentive fees based on income and capital gain from 20% to 17.5%.

Since BlackRock began managing the company in March of 2015 our team has deployed approximately $1.2 billion into new investments $414 million of which has been exited with a realized IRR of 14.1%. As of June 30 over 80% of the company's investments portfolio by fair market value constitutes investments made by BlackRock. Before I turn the call over to Mike Pungello I'd like to emphasize the company's continued transformation as a result of BlackRock's expanded direct lending platform as evidenced by strength in deployment in 2019. As we continue to rotate out of legacy assets the company's conservative leverage and ample liquidity puts it in a position to take further advantage of these benefits and grow its earnings power. Over to you Mike.

Michael L. Pungello -- Chief Financial Officer

Thank you Jimmy. I will take a few minutes to review additional financial and portfolio information for the third quarter of 2019. GAAP net investment income NII was $9.6 million or approximately $0.14 per share for the three months ended September 30 2019. Relative to distributions declared a $0.14 per share our NII coverage was 100% for the quarter. Total investment income decreased $1.1 million or 5% as compared to the third quarter a year ago. Excluding fee income and other income total investment income decreased by approximately 4.4% primarily attributable to an increase in nonaccrual and amortized cost from 1.4% at September 30 2018 to 5.9% of total portfolio at September 30 2019 partially offset by an increase of 4% in average investment portfolio and amortized cost for the comparative period.

At quarter end there were 4 nonaccrual investments representing 4.3% and 7.6% of total debt preferred stock investments at fair value and cost respectively. This compares to nonaccrual investments of approximately 1.6% and 7.1% of total debt and preferred stock investments at fair value and cost respectively at December 31 2018. Our average internal investment rating at fair market value at September 30 2019 was 1.38 as compared to 1.43 as of the prior quarter end. Total expenses increased $1.8 million or 21.1% for the three months ended September 30 2019 from the comparable period in 2018 primarily due to the increase in net incentive fees based on income professional fees and interest and credit facility fee.

For the quarter ended September 30 2019 we incurred incentive management fees based on income of $2.1 million of which our advisor had voluntarily and partially waived incentive fees of $1.2 million resulting in net incentive fees of $0.9 million for the period. Including this voluntary partial waiver $22.2 million of incentive management fees have been waived on a cumulative basis. During the quarter there was no accrual for incentive management fees based on gains. In the third quarter net realized and unrealized losses were $22.3 million primarily due to depreciation and portfolio valuations during the quarter. During the third quarter of 2019 no shares were repurchased. As of September 30 2019 3320309 shares remains available for repurchase under the current program which has since expired. The Board has authorized a repurchase of up to 5 million shares through November 3 2020. We closed the quarter with a strong liquidity position to fund our robust pipeline of new investment opportunities including approximately $205.5 million of availability under our credit facility and in cash and cash equivalents. With that I would like to turn the call back to Jimmy.

James E. Keenan -- Chief Executive Officer

Thank you Mike. In closing I would like to take a moment to thank our shareholders for their continued support as we make progress on the restructuring of the company's book and recognize our team for their continued hard work toward achieving our portfolio objectives. This concludes our prepared remarks. Operator we would like to now open the call for questions.

Questions and Answers:

Operator

[Operator Instructions] And we'll now take a question from Fin O'Shea with Wells Fargo Securities.

Finian Patrick O'Shea -- Wells Fargo Securities -- Analyst

Good morning. Thanks for taking my question. Congratulations on some moves in the legacy book this quarter. I have a question on fees that it's also appreciating your fee waiver. It seems like you're modernizing the fee structure to market at this point. First question is why is that tied to the management pursuing higher leverage for one? And then just big picture how do you view the management fee? Because optically you guys say all the right things every quarter you're moving out of the legacy book you want to shore up a market dividend and so forth but your actions show you in the camp of those BDCs that sort of seemingly begrudgingly chase the market structure like a year after everyone else goes 1 50 and 17.5. You're in that camp that finally follows along. And it's tied to you getting a large benefit. So can you just kind of touch on those points why you're doing what you're doing on the fee side?

James E. Keenan -- Chief Executive Officer

Thanks Ben. It's Jim Keenan. I appreciate the question. I would say a couple of things there. As you highlighted before we work very closely with our Board of Directors with regards to optimizing our -- and setting the appropriate fee structure for the vehicle. And as you mentioned before I think we've now on a cumulative basis waived $22 million plus dollars' worth of fees back on the benefit of the shareholder base. So along the strategic initiative of the portfolio company we've had a process in place that has taken a long time based on the liquidity of some of these assets and the minority position in these assets to ultimately liquidate a variety of stressed positions and restructure that and deploy that into a far more diversified pool of capital. So the liquidity nature of that obviously has taken time.

We worked with our Board throughout that time with the appropriate fee structure. And that was basically a combination of management fee as well as the performance fees that were waived. I think on a go-forward basis I think we are happy with where we are on the progress and have more conviction with regards to some of the exits that you highlighted Vertellus for the quarter. But we're happy with the progress that we're seeing on the rest which has led us to work with our Board on moving toward the 2:1 leverage ratio and ultimately optimizing that into the new assets that we're deploying into. I would say over the course of the last couple of years when some of our peers may have done that we did not view it as appropriate for this vehicle based on the stressed more equity-oriented assets that come from that legacy book. So I think we've talked in the past when you look at our leverage ratio that has come up the reason why that we have increased our leverage and deployed further is because we've gotten either realizations of exits of some of those legacy books or we've gotten more conviction on some of the sales.

So this quarter as we started to see Vertellus exit we were willing to kind of increase that leverage. I think as you look forward into the next year and I think what we highlighted is that we're -- the progress that we're seeing we're getting more conviction so we worked with our Board to increase that leverage that we'd be willing from a portfolio discipline standpoint to increase leverage when we start to exit that equity portion. So when you think about why it's ultimately tied I would say it's been a combination of a progress over time with our Board to set the appropriate fee structure our willingness to increase leverage at the portfolio level and start to move that above the 0.6 to 0.7 to the 1 to 1.25 ratio that we talked about before is because we believe we'll be able to exit the remaining portion of that book. And as we do that I think relative to others in the market when we think about that fee is when we're starting to lever and increase that leverage we should start to see benefits of economy of scale for the portfolio and the shareholders.

And that leverage on balance sheet we should be able to potentially find other assets that may have a lower return on assets or ROA associated to that and still be able to be NII accretive. And so I would say it's a combination of all of those factors that ultimately we and the Board got comfortable with regards to how we wanted to set the fee on a go-forward basis. But why now versus a year ago was really based on our construct and the legacy -- the volatility and drawdown risk of the legacy book.

Finian Patrick O'Shea -- Wells Fargo Securities -- Analyst

Makes sense. And can you talk about AGY. It looks like that was a new nonaccrual this quarter still probably your legacy position of focus at this juncture. Anything we can expect on an outcome perspective now that that's on nonaccrual? How much does that set you back in terms of moving that position?

R. Marshall Merriman -- BlackRock Capital Investment -- Analyst

Fin this is Marsh Merriman. Thanks for your question. The nonaccrual there at AGY reflects the investor base concluding that it is better to leave capital in the business to fund various initiatives at the business at this time. And so it does reflect sort of things going on in the business that are generally operational things that we wanted to do. I don't think it has any impact one way or the other as to timing of exit. AGY like all the other legacy portfolio positions is one of those that we are interested in exiting at the appropriate time and at an appropriate value.

Finian Patrick O'Shea -- Wells Fargo Securities -- Analyst

Forgive me just -- I didn't word that perfectly. What I was sort of asking is is that sort of some covenant breach that gives you more control over the situation?

R. Marshall Merriman -- BlackRock Capital Investment -- Analyst

It is not Fin. That is a situation where we are in both the debt and the equity. So we have flexibility to do things across the capital structure in the absence of a covenant breach.

Finian Patrick O'Shea -- Wells Fargo Securities -- Analyst

Got it. Thank you so much for the color.

Operator

We'll now take our next question from Melissa Wedel with JPMorgan.

Melissa Marie Wedel -- JP Morgan Chase -- Analyst

Melissa on for Rick today. I wanted to follow up on your commentary from your prepared comments about the expiration of a lockup on U.S. Well Services. I'd love to understand better how you guys are weighing the trade-off between wanting to stabilize now but also understanding that that has traded off tremendously in the last quarter. How do you guys think about that trade-off? And what's the strategy around rotating

R. Marshall Merriman -- BlackRock Capital Investment -- Analyst

Well the existence of the lockup -- this is Marsh again. The existence of the lockup that you referenced meant that we had extremely limited opportunity to exit the shares during the existence of the lockup period which is a lockup that extends to a vast majority of the shareholders of the company. The lockup expires here in a couple of weeks and a large number of holders will be free to trade. It's difficult to predict how that will play out when that happens. We of course are monitoring and we'll continue to monitor the situation but we have no hard and fast parameters for timing or price of exit at this point.

James E. Keenan -- Chief Executive Officer

And I'll add -- Melissa it's Jim Keenan again and thanks for the question. I'd say at a high level just to take us back from U.S. Well because I think it's an important area with the balance of rotating the book but also maximizing the recovery on NAV. I would say all -- some of the reasons why this is taking a very long period of time is that each one of these individual assets within the legacy book have its own level of complexity associated to it. And that illiquidity can come from a variety of different ways whether it's the lockup agreement for the shares or whether it was a restructuring the minority nature of some of our positions relative to other constituents in those debts. And I think the balance of why this has taken a very long time is because there's been a lot of effort to work of trying to really recover to get the best recovery in order to rotate that into new deployments over time. And I think we've stated that this in itself that legacy non-core book it was a very challenged book of stressed assets. And so that I think we've been able to protect on some of that but we certainly have seen a lot of write-offs and writedowns based on operational losses each one of those assets have come. But thank you for the question on U.S. Well but that is -- that nature has been specific to each asset that we've been trying to sell.

Melissa Marie Wedel -- JP Morgan Chase -- Analyst

Understood. And I think my follow-up question on the asset coverage ratio change. I'm wondering if you -- and I'm sorry if I missed this earlier. Are you guys going to pursue shareholder approval for a single effective date?

James E. Keenan -- Chief Executive Officer

Yes we would plan to pursue shareholder approval. And again probably consistent with -- as we continue to see movement of exit then our willingness to manage the portfolio with a higher degree of leverage I would expect you to see us -- those two things to be coinciding.

Melissa Marie Wedel -- JP Morgan Chase -- Analyst

Great, thank you.

Operator

And it appears there are no further telephone questions at this time. I'd like to turn the conference back over to our presenters for any additional or closing remarks.

James E. Keenan -- Chief Executive Officer

Great. Thank you. And again I would like to thank everybody for their continued support as we continue to make progress on our strategic goals. We're very happy with some of the movement that we saw on some of the legacy noncore assets in the quarter. I'm very happy with regards to the pace and scale of the deployments that we're seeing on a forward basis. So thanks again for all the support and we'll continue to progress on the strategic goals of the portfolio. Thank you.

Operator

[Operator Closing Remarks].

Duration: 28 minutes

Call participants:

Laurence D. Paredes -- General Counsel and Corporate Secretary

James E. Keenan -- Chief Executive Officer

Michael L. Pungello -- Chief Financial Officer

Finian Patrick O'Shea -- Wells Fargo Securities -- Analyst

R. Marshall Merriman -- BlackRock Capital Investment -- Analyst

Melissa Marie Wedel -- JP Morgan Chase -- Analyst

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