Blackrock Kelso Capital (BKCC) Q3 2020 Earnings Call Transcript

Blackrock Kelso Capital (BKCC 0.27%)
Q3 2020 Earnings Call
Nov 05, 2020, 10:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Please standby. Good morning, everyone. My name is Lisa, and I will be your conference facilitator for the BlackRock Capital Investment Corporation third-quarter 2020 earnings call. Hosting the call will be James Keenan, chairman and interim chief executive officer; Michael Pungello, interim chief financial officer and treasurer; Nik Singhal, president; Laurence Paredes, general counsel and corporate secretary of the company; Abby Miller, director of finance; Marshall Merriman, head of portfolio management; and Jason Mehring, managing director and member of the company's investment committee.

[Operator instructions] Thank you. Mr. Paredes, you may begin the conference.

Laurence Paredes -- General Counsel and Corporate Secretary of the Company

Good morning, and welcome to BlackRock Capital Investment Corporation's third-quarter 2020 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, intend, will, should, may, and similar expressions. We call to your attention the fact that actual results of BlackRock Capital Investment Corporation or BCIC, may differ from these statements.

As you know, BCIC has filed with the SEC reports, which list some of the factors, which may cause BCIC results to differ materially from these statements. BCIC 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-party sources and has not been independently verified. Accordingly, BCIC 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. The presentation can be accessed by going to our website at www.blackrockbkcc.com and clicking the November 2020 Investor Presentations link in the Presentations section of the Investors page. I would now like to turn the call over to Jim.

Jim Keenan -- CFA, Managing Director, Chief Investment Officer, and Co-Head of Global Credit

Thank you, Laurence. Good morning and thank you for joining our third-quarter earnings call. Today, I'm going to highlight the significant progress made toward our strategic goals, during and subsequent to the third quarter. I will also provide an overview of other third-quarter updates in our remaining near-term priorities.

I will then turn it over to Mike Pungello to discuss the financial results in more detail before providing some closing remarks and opening the call to questions. As announced in yesterday's press release. Mike Pungello, our interim CFO and treasurer, plan to retire from BlackRock, and he will be stepping down as BCIC's interim CFO and Treasurer effective November 9, 2020. Mike would be available to BCIC in an advisory role until his retirement from BlackRock in March 2021.

Mike has had a distinguished career spanning over 40 years, including the last 22 years at BlackRock. We are truly thankful to Mike for his service at BCIC and BlackRock. We'd like to congratulate him on his retirement and wish him the very best. I'm also excited to announce that Abby Miller has been appointed by our board to serve as BCIC's CFO and treasurer effective November 9, 2020.

Abby has served as BCIC's financial controller and as a BlackRock director of finance since September 2017. She has been an integral part of the BCIC finance team, and we look forward to her leadership in her new role. Also, as announced yesterday, BCIC's board appointed Nik Singhal to serve as BCIC's president effective November 3, 2020. I would like to congratulate Nik as this accomplishment is a reflection of the important role Nik played for BCIC as we continue to progress toward our strategic goals and priorities.

Our primary strategic priority has and continues to be rotating out of legacy and other junior investments and redeployment of capital to further build a portfolio of senior secured loans that will generate stable income. During and subsequent to the third quarter, we made great progress toward these objectives as we significantly reduced our exposure to both Gordon Brothers Finance Company and the AGY. On November 3, GBFC, which had been our largest portfolio holding transferred a majority of its assets to Callodine Commercial Finance, a new entity controlled by a third party. As a result, we received $78 million in principal repayment on the unsecured notes.

BCIC will retain a $5 million investment via GBFC's senior secured bank facility, which has rolled over to Callodine. Additionally, BCIC will retain its pro rata of share of GBFC's remaining assets. Additional details of which are provided in our earnings release. Simultaneous with this transaction, BCIC provided $25 million of new financing to Callodine.

Pro forma for these transactions are combined exposure to GBFC, and now, Callodine is reduced from 24% of the portfolio at the end of the second quarter to approximately 12% of the portfolio of Gordon. In addition to reducing junior capital concentration, this brings in new capital partners via Callodine, it should benefit our remaining investment. As this transaction occurred subsequent to the third quarter, it will be reflected in our year-end financials. Definitely, during the third quarter, we substantially exited our legacy investment in AGY, which underwent a recapitalization.

The transaction resulted in cash recoveries of $9 million against the prior AGY Holdings, which were valued at $18 million in the June quarter. The only remaining AGY exposure in the portfolio is preferred stock valued at approximately $1 million. Our GBFC and AGY contributed $0.68 per share to NAV decline in the third quarter. We believe that these transactions lead to a meaningful improvement in our portfolio composition and reduce future NAV volatility by freeing up $62 million of capital that we intend to locate in our core senior secured deployment strategy.

Our near-term priorities just substantially complete the non-core exits are focused on two areas of the portfolio. First, the seven companies that make up the remaining legacy investment, which has already been reduced to 9% of the total portfolio at fair value. Of this, only 1% at fair value is non-income generating. And second, the equity and unsecured debt exposure in the portfolio, which is approximately 30% of the total portfolio by fair value, pro forma for the GBFC reduction.

The largest of these is BCIC Senior Loan Partners, our senior loan JV with Windward Investments LLC. We have initiated a process to explore viable opportunities to reduce or exit our investment in the JV. However, there can be no assurance as to the degree and the timing of such dispositions, which would also be subject to obtaining required consents from our JV partner. Historically, we have managed our leverage in a conservative manner, the reduction of the non-core and junior investments in our portfolio and associated deleveraging will further improve our credit profile.

As these near-term priorities are accomplished, we intend to address the 2022 to 2023 maturities of our unsecured and secured debt in the early part of 2021. Another prong of our portfolio optimization strategy is the ongoing capital deployment into diversified senior secured assets that generate a stable stream of income with limited volatility. To that end, we added four new portfolio companies in the third quarter, each of which was a first lien loan. The details of these new investments can be found in the earnings release.

We continue to emphasize transactions where we lead or co-lead negotiations on deal terms. Over the last few quarters, we were cautious in sizing our new investments, given our leverage ratio in the potential for additional capital needs of existing portfolio competence. However, with these strategic portfolio exits accomplished to date, we are resuming our more normalized approach to sizing new investments, which were the case with our $9.5 million investment in MetricStream, a new portfolio company this quarter. As a reminder, our current portfolio composition target includes at least 50% of first-lien loans, compared with 37% at quarter-end.

We are also targeting 65 to 75 portfolio companies translating to 1% to 2% position sizing as a percentage of the portfolio. Lastly, our goal for unsecured debt or equity positions is 5% or less, down from approximately 30% pro forma the reduction in GBFC. Our core portfolio with an increasing percentage of first-lien loans has continued to perform well, despite the pandemic. At the end of the third quarter, there were only three investments on non-accrual totaling less than 1% of the portfolio at fair value.

Excluding the NAV decline associated with GBFC and AGY, the rest of the portfolio increased in value are approximately $12 million or $0.17 per share during the quarter, reflecting further improvement in credit markets and spreads. Turning to our financial results. Net investment income for the quarter was $0.12 per share, down from $0.13 in the previous quarter and due primarily to the GBFC preferred stock non-accrual. In terms of investment activity, we deployed $25 million during the quarter, which was offset by a similar amount of repayments and other items.

The deployments and repayments are detailed in our earnings press release. The weighted average yield of income-producing securities at fair market value was 9.8% as of September 30, down 8 basis points since the last quarter, primarily driven by portfolio movements. Quarter-end leverage was 0.98 times, up from 0.95 times in the June quarter. While the NII covered our dividend by 122%, we elected to pay a portion of our dividend in stock this quarter.

The primary reason for this was to bolster NAV by offsetting some of the decline created by the two exits. Our goal remains to transition back to an all-cash dividend in the coming quarter. Our liquidity remains strong and unfunded commitments are relatively minimal at $5.3 million. To further support NAV, the company's advisor waved its full incentive fee for the quarter, which totaled $1.5 million.

Inclusive of this waiver BlackRock has permanently waived $28.4 million of incentive fee on a cumulative basis. Before I turn the call over to Michael Pungello, I'd like to emphasize that while the economy gradually recovers from the impact of the pandemic, we've made significant progress in our strategy of exiting non-core assets. Recognizing that these exits have been accompanied with NAV declines, we believe that much of the work is now behind us, as we remain optimistic about completing the portfolio allocation in the coming quarters. Over to you, Mike.

Mike Pungello -- Interim Chief Financial Officer and Treasure

Thank you, Jimmy. Before I get started, I'd like to thank Jimmy and the team for their support during the three years, I have served as interim CFO and treasurer. I am confident that Abby is ready to provide the financial support necessary as the company continuing to implement a good strategic approach. Now, I will take a few minutes to review additional financial and portfolio information for the third quarter of 2020.

GAAP net investment income NII was $8.5 million or $0.12 per share for the three months ended September 30, 2020. Relative to distributions of $7 million with $0.10 per share, our NII distribution coverage was 122% for the quarter. Total investment income decreased $3.7 million or 18.3% as compared to the third quarter a year ago. Excluding fee income and other income, total investment income decreased by approximately 16.5%, primarily due to a lower rate environment to create some dividend income period over period and a 3.7% decrease in the average investment portfolio and amortized cost for the comparative period.

At quarter-end, there were three nonaccrual investments, representing 1% and 7.7% of total debt and preferred stock investments at fair value and cost respectably. This compares to non-accrual investments of approximately 2.7% and 10.7% of total debt and preferred stock investments at fair value and cost respectively at June 30, 2020. Our average internal investment rating at fair market value at September 30, 2020, improved to 1.78 from 1.93 as of the prior quarter-end. Total expenses net of incentive management fee waiver decreased $2.5 million or 24.7% for the three months ended September 30, 2020, from the top-row period in 2019 primarily due to decreases in net incentive fee based on income, base management fees, interest and credit facility fees, and professional fees period-over-period.

In the third quarter, we voluntarily waived the entire incentive fee based on income of $1.5 million, bringing our cumulative incentive fees waived since March 2017 to $28.4 million. Additionally, there was no accrual for incentive management fees based on gains. During the third quarter, net realized and unrealized losses were $35.7 million, primarily driven by realized losses in AGY and unrealized depreciation in GBFC. As of September 30, 2020, we had approximately $134 million of availability under our credit facility, as well as in cash and cash equivalents.

Our net asset value benefited by $11.1 million during the third quarter as a result of a portion of our dividends paid in stock on July 7, 2020, and September 29, 2020. During the third quarter of 2020, no shares were purchased under our existing share repurchase program and 4,013,446 shares remained available for repurchase under the program as of September 30, 2020. On November 3, 2020, the company's board of directors renewed the authorization for the company to purchase up to a total of 7.5 million shares effective until the earlier of November 2, 2021, or such time that all the authorized shares have been repurchased. This new authorization replaced the previous authorization and the remaining approximately 4 million unpurchased shares on that authorization expired on November 3, 2020.

With that, I would like to turn the call back to Jimmy.

Jim Keenan -- CFA, Managing Director, Chief Investment Officer, and Co-Head of Global Credit

Thank you, Mike. In closing, I would like to take a moment to thank our stockholders for their continued patience and support as we work through the restructuring of the portfolio and recognize our team for their hard work. Most of all, I hope everyone remains safe and healthy. This concludes our prepared remarks.

Operator, we would like to open up the call for questions.

Questions & Answers:

Operator

Thank you. [Operator instructions] We'll take a question from Finian O'Shea with Wells Fargo Securities.

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

Hi everyone. Thanks for having me on. Congratulations on the strategic moves you've pulled off this in passing first quarter. I guess first question on that, to my recollection, I don't think Gordon Brothers was -- didn't seem core, didn't seem non-core, right? And it looks like you're just lumping this new category of junior and equity as things to get out of, which is understandable.

But I guess sort of two-part question and I guess to spend less time on Gordon Brothers because that's already done. But when did that become non-core? And then, more importantly, the SLF that's always seemed to be part of your pride and joy as new management with BlackRock took over. So it's a bit of a surprise to see you all view the SLF as something you need to get out of. I guess for the sake of not asking too many questions in one, I'll stop there and just ask what's the sort of – has there been a revision on these strategies?

Jim Keenan -- CFA, Managing Director, Chief Investment Officer, and Co-Head of Global Credit

Thanks. Appreciate the question, Jimmy here. A couple of things I think is obviously GBFC, it's been a good-performing asset with regards to -- it's not been part of our legacy book, and it's been a portion of which has been supportive from an NII perspective. But that being said with regards to our strategic plan of trying to reduce concentration, remove kind of equity risk or junior capital risk on the portfolio and move to a kind of more diversified first-lien portfolio on balance sheet, both GBFC and the joint venture would play into that.

I think from GBFC standpoint, obviously, it was a more concentrated position. The company itself obviously lends to an asset-backed lending facility which had got impacted this year from the COVID environment. But from a BDC perspective, it's really in the sense of core to our strategy to try to reduce that volatility or try to reduce that concentration on our balance sheet and continue to shift that into kind of direct first lien assets on balance sheet. Specific to the JV, that falls into that as well, prior to the shareholders and the board approving the ability for the increased leverage on balance sheet.

The Joint Venture was a way it means for the company to increase or improve its NII by getting that exposure to the diversification of first liens that approval and as we look at right now, as for us to kind of put those now on balance sheet and continue to reduce the kind of stated equity on balance sheet and ship that to direct first liens, which we think will help both of the high-quality side and ability.

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

Yes, that helps. This is just a small follow-on for that matter. Is there a structural impediment to just -- I mean, most of your peers that have moved out of these have just very simply brought them on balance sheet. Is there something with yours that prevents the ease of that facilitation?

Jim Keenan -- CFA, Managing Director, Chief Investment Officer, and Co-Head of Global Credit

So from a status standpoint of looking to exit or look at all options to maximize the value of that which can include both a sale, taking assets on balance sheet, there are variety of factors that come into that and inclusive of looking at the leverage ratios on balance sheet, as well as potential new deployments and other options that come into place. But, yes, that is an option. That is part of that exit strategy.

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

Sure. That helps. Just one more. The partial stock dividends still being declared.

I would say that was more understandable last quarter. But I think your reason now is growing NAV, doesn't seem as compelling against the contrasts of the cases against being a stock dividend. Would you expand on why growing in NAV is the reason for that?

Jim Keenan -- CFA, Managing Director, Chief Investment Officer, and Co-Head of Global Credit

Yeah, absolutely. I mean, to be clear, we stated is we want to move back to 100% cash dividend in the upcoming quarters. And working with the board in setting the cash and then stock splits for this quarter, of multiple factors obviously, went into that as you know we are, I think, in the final stages of finally being able to restructure and exit some of the legacy assets, as well as transitioning out of some of those junior securities. So with that, we recognize that there was some NAV decline associated to that that has an impact, obviously, with our liability side and our leverage covenants.

I think now, as we move forward and we're able to accomplish some of these sales and having a lower leveraged book with less exposure to the volatility associated or downside risk to some of the equity and junior side, it's really working to extend the liabilities that we have, we have 2022 and 2023 maturities, and reset and solidify the liability side of the balance sheet. And then post that beyond just the stock dividend is really working with the board in all options then to try to look at ways and means to examine high shareholder value. And certainly, we are aware of the price to bulk discount that exists today.

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

Sure. That's helpful. That's all for me. Thank you.

Jim Keenan -- CFA, Managing Director, Chief Investment Officer, and Co-Head of Global Credit

Thanks.

Operator

We'll take our next question from Rick Shane with JP Morgan. Please go ahead.

Rick Shane -- J.P. Morgan -- Analyst

Thank you, everybody, and congratulations to Mike, Abby, and Nik. I'm not sure who is the luckiest on that list, but I think Mike probably is the happiest at this point. So best wishes to all you guys. I wanted to talk about the incentive fee waivers.

You guys have cited that you waived about $28 million in fees since 2017. At the same time, that's been coincident with about $275 million of decline in equity. And what I think is interesting here is that you guys have made an effort to be fair to your investors, made an effort to support the dividend by flexing down. But inherently, do you think there is an incentive problem here in that, because the book value continues to decline, it generates that incentive scheme, and so you have this construct where we've sort of optionally waived it as opposed to give shareholders in mechanism that they will rely upon for dividend protection?

Jim Keenan -- CFA, Managing Director, Chief Investment Officer, and Co-Head of Global Credit

Thank you, Rick. I would say I did take a step back there. Obviously, when looking at the book and restructuring this, obviously, these are illiquid complex securities, many of which are minority stakes in restructuring and reorganization. So it has certainly taken a significant amount of time to try to exit or monetize.

And as you say, alongside that has come some fairly significant NAV declines. I think we're on a very good path and again, highlighted in this quarter to be able to try to exit the majority of those and kind of reposition this portfolio. I think alongside that over the last several years, we've continued to work with the board. And as you know, they have their annual process to kind of review that is, working with the board and understanding that a lot of this, although understand that we are managing this has been us trying to work out of complex legacy securities.

And we recognized and understand the paying net debt from some of the NAV declines associated to that. So I think from BlackRock standpoint of working with our board, that is not something, even though it had generated an incentive fee, which is in line, our fee structure was approved recently. And it's in line with the fee structures associated to the market. That being said, with regards to the experience that the restructuring of that book and the losses associated to the NAV declines, that's still the realization of our shareholders and the partners of this book.

So we've worked with our board. We have not looked and tried to take performance fees out associated to that. So when we waived that, we're generally putting those back into the BDC itself. And we'll work forward.

I mean, our goals are mainly to completely 100% restructure this portfolio, completely to shift this back into a more stable first-lien portfolio, and to have a BDC that can deliver a stable income stream. And that, I would say, we'd hope to take a few years. It's taken a little bit longer associated to that because of the exits on some of these assets. So we continue to work through our board with regards to both the fee structure and what the experiences for the shareholder base.

Rick Shane -- J.P. Morgan -- Analyst

Understood. And look, I realize that some of these are inherited challenges, but having followed the company for a decade, it's been in transition for 10 years, from my perspective, and that's, I'm sure, frustrating for shareholders. My concern is that to the extent that income grows, that NII grows as you turn off the incentive fee waiver, none of that benefit will actually accrue to shareholders. And I think that that's one of the things that potentially weighs upon the stock because investors need to see even greater growth to actually get earnings and dividend growth.

Jim Keenan -- CFA, Managing Director, Chief Investment Officer, and Co-Head of Global Credit

I mean, a lot of the things that we're realizing losses on right now are some of the 2014 and 2015 investments, and again, I think we're largely through that. From our perspective, obviously, we hope to stabilize NAV by exiting those. And then the market environment, depending on where spreads are, where LIBOR will be, all of those will factor into what the potential NII of the underlying portfolio is. That being said, we are keen to try to get this where, as outlined, that these are going to be first-lien changes occurred to reducing that potential NAV decline.

We're going to try to shift this into having more diversification so that one or two names can't -- we wouldn't have the potential experience like we've had in the past where several names just can take severe NAV declines. And then ultimately, continue to shift that. And the market environment will also help determine where the full NII is, but ultimately, that experience, I think, will be level set with what that NII generation will be based on a stable first-lien book. So that's basically our focus in order to kind of reposition that aggregate book.

And it has certainly taken time, but I think we are more in the final stages of that just based on the legacy book is now less than 9% of the portfolio.

Rick Shane -- J.P. Morgan -- Analyst

Got it. I appreciate that. Thank you, guys.

Jim Keenan -- CFA, Managing Director, Chief Investment Officer, and Co-Head of Global Credit

Thanks, Rick.

Operator

And that does conclude the question-and-answer session. I would like to turn the call over to the management for any additional or closing remarks.

Jim Keenan -- CFA, Managing Director, Chief Investment Officer, and Co-Head of Global Credit

Thank you, operator, and thank you all again for your patience and support as we finalize and continue to restructure this portfolio. Also, again, I'd just like to thank Michael Pungello on his retirement and welcome Abby to the roles. Thanks again, and hopefully, everyone stays healthy in this environment.

Operator

[Operator signoff]

Duration: 40 minutes

Call participants:

Laurence Paredes -- General Counsel and Corporate Secretary of the Company

Jim Keenan -- CFA, Managing Director, Chief Investment Officer, and Co-Head of Global Credit

Mike Pungello -- Interim Chief Financial Officer and Treasure

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

Finian OShea -- Wells Fargo Securities -- Analyst

Rick Shane -- J.P. Morgan -- Analyst

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