Blackrock Kelso Capital (BKCC) Q2 2022 Earnings Call Transcript

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Blackrock Kelso Capital (BKCC 0.27%)
Q2 2022 Earnings Call
Aug 04, 2022, 10:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning. My name is Justin and I will be your conference facilitator today for the BlackRock Capital Investment Corporation second quarter 2022 earnings call. Hosting the call will be James Keenan, chairman and interim chief executive officer; Nik Singhal, president; Chip Holladay, interim chief financial officer and treasurer; Laurence D. Paredes, general counsel and corporate secretary; Marshall Merriman, managing director and member of the company's investment committee; and Jason Mehring, managing director and member of the company's investment committee.

Lines have been placed on mute. Ater the speakers complete their update, they will open the line for a question-and-answer session. [Operator instructions] Thank you. Mr.

Paredes, you may begin the conference call.

Laurence Paredes -- General Counsel and Corporate Secretary

Earnings conference call of BlackRock Capital Investment Corporation, or BCIC. 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 BCIC's actual results may differ from these statements.

As you know, BCIC has filed with the SEC reports, which list some of the factors which may cause BC's 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 August 2022 Investor Presentation link in the Presentations section of the Investors page. I would now like to turn the call over to Jim.

James Keenan -- Chairman and Interim Chief Executive Officer

Thank you, Larry. Good morning and thanks to all of you for joining our second quarter earnings call. I'll provide an overview and highlights from the quarter. Nik will then give an update on our portfolio activity and status and Chip will then discuss our financial results in more detail.

We will then open the call to questions. We delivered another quarter of strong results highlighted by our ongoing deployment momentum and solid progress in building a diversified portfolio that generates favorable risk adjusted returns for our shareholders. Our net leverage increased to 0.64 times, up from 0.46 times at prior quarter, driven by $73 million of deployments in the second quarter. We added 11 new portfolio companies during the quarter with the portfolio reaching a milestone of 100 portfolio companies, up from 86 at the end of 2021 and 47 at the end of 2019.

We are also pleased to report metrics that demonstrate significant advancement toward our portfolio construction goals. Approximately 74% of our investment portfolio consists of first lien investments, a high point for BCIC, and up substantially from 34% at the end of 2019. Junior capital investments now comprise of only 6% of our portfolio, down from 43% at the end of 2019. Let's turn now to our portfolio positioning amid the current backdrop of the economy and markets.

While some measures indicate the U.S. economy remains on sound footing, including a robust job market and increased consumer spending year over year, we are mindful of the concerns about an impending slowdown or a possible recession, driven by rising inflation and interest rates, and potentially increasing unemployment levels. Our underwriting emphasis on less cyclical companies that are better able to withstand inflationary pressures, rising rates, and broader economic slowdowns, along with a focus on seniority in the capital structure, positions us well in the current macroeconomic scenario. We remain committed to selective investing based on our time-tested and prudent underwriting approach that focuses on credit analysis through the cycle.

We're engaged in regular dialog with our portfolio companies to understand and evaluate how the evolving macro landscape is impacting their business. While we are seeing signs of a slowdown in revenue growth and/or margin contraction in some names, we have not seen an evidence of a broad-based credit deterioration. Notably, we had no new nonaccrual loans in the quarter and no amendments resulting in deferral of payment terms. In the third quarter, so far, we are seeing a continuation of the level of deployment activity that we saw during the first half of the year.

We are also seeing pricing and structures more favorable to lenders in the private credit market. Additionally, 99% of the yield and debt investments in our portfolio have a floating rate coupon, substantially all which are above their LIBOR or SOFR floors in the current market. We expect the rising rate environment to be accretive to portfolio income. As we proceed, we will pursue compelling new opportunities while remaining true to our underwriting discipline.

We believe this will be accretive to NII and provide increased dividend coverage for our stockholders as we progress through the coming quarters. I'll now turn the call over to Nik to discuss our portfolio activity in further detail.

Nik Singhal -- President

Thanks, Jim. We're seeing good momentum toward our goal of relevering the portfolio by building a diversified book of primarily first lien investments. During the second quarter, 85% of our new deployments were in first lien investments, consistent with the strategy. Gross deployments in the quarter were primarily across 11 new and six existing portfolio companies.

62% of the investment dollars went into new portfolio companies, and the remaining 38% into existing relationships. Follow-on investments in existing portfolio companies continue to be an important source of opportunity for us. And these are businesses we already know and understand well. Repayments during the quarter were $25 million.

This was driven by four realized investments with an average realized IRR of 10.1%, along with a 4.2 million paydown on the legacy Gordon Brothers Finance Company investment. We continue to have a healthy pipeline of opportunities across a wide range of industries. So far, in the third quarter, we're seeing a steady deployment pace. While there can be no assurances that all transactions will close, our investment committee has approved transactions over $50 million that either close subsequent to the second quarter or are pending close.

Our three largest new portfolio company investments included the following an $11.4 million, SOFR, plus 7.5% first lien term loan to Inmoment Inc., a provider of customer experience management software and analytical solutions; $7.4 million, SOFR, plus 5.75% first lien terminal and $1 million of unfunded commitments to Kaseya Inc., a provider of cloud-based I.T. management solutions; a $5.5 million, SOFR, plus 6% first lien term loan and $0.6 million of unfunded revolver to beqom, a global provider of compensation management software. Importantly, the company and other BlackRock funds were the sole terminal lenders in two of these investments, highlighting the benefits to the company of proprietary access to deals from BlackRock's scale platform. Our NAV per share declined by 2.8% in the second quarter, largely driven by the valuation impact of wider credit spreads in the market.

As previously mentioned, we had no new nonaccruals or payment modifications during the second quarter. Our core deployment focus remains consistent with our objective of stable income and low NAV volatility. We're seeing the opportunities that become more attractive in this market as we deploy capital to relever the portfolio. As a result, we expect to gradually increase leverage to more normalized levels over time.

We believe that this will enable us to grow NII with the goal of eventually having our core earnings fully power our dividend, which we declared $0.10 per share in cash. I'll now turn the call over to Chip to further discuss our financial results for the quarter.

Chip Holladay -- Interim Chief Financial Officer and Treasurer

Thank you, Nik. I will now take a few minutes to review some additional BCIC financial results for the second quarter. GAAP net investment income was $7.1 million or approximately $0.10 per share, up 10% from the prior quarter. GAAP NII covered 97% of the $7.4 million distribution we declared to our stockholders this quarter, an increase from 88% coverage in the prior quarter.

Included in the second quarter results was a reversal of $1.1 million in capital gains incentive fee previously accrued under a hypothetical liquidation basis required by GAAP. With such reversal, the balance of accrued incentive fee on capital gains was zero for the annual measurement period ending June 30, 2022, and no incentive fee on gains was payable to the advisor. Excluding this reversal, adjusted NII was approximately $6 million for the second quarter or $0.08 per share, in line with our adjusted NII results for the prior quarter. Total gross investment income was $12.3 million, a slight increase from $12.2 million earned in the prior quarter.

During the quarter, the company had one time fees and other income of approximately $0.4 million against $0.7 million in the prior quarter. Excluding one time fees, our gross investment income grew approximately 3% quarter over quarter. The company's weighted average portfolio yield based on fair value increased to 9.1% as of June 30th, up from 8.4% as of the prior quarter end. This increase was driven by a rise in LIBOR and SOFR rates, as well as slightly wider spreads on new originations we made during the quarter.

Total net expenses decreased by $0.5 million for the first quarter, driven largely by the reversal of capital gains incentive fee accrual. Excluding the impact of such reversal, expenses were roughly unchanged. Net unrealized losses on the portfolio were $9.7 million for the quarter, primarily attributable to spread widening and general market declines. The company had no realized gains or losses during the quarter.

At the end of the quarter, the portfolio had three nonaccrual investments, representing 3.5% of our portfolio's total fair value, an improvement from 4.4% as of the March quarter end. This reduction was due to the partial repayment of $4.2 million of our unsecured debt position in Gordon Brothers Finance Company. There were no new nonaccrual investments during the second quarter. Our weighted average internal portfolio rating at fair value declined slightly to 1.27, compared to 1.25 at the prior quarter end, and improved from 1.37 compared to the June 2021 quarter end.

At quarter end, total available liquidity for deployment was approximately $141 million, including cash on hand and subject to leverage and borrowing base restrictions. Our net leverage ratio was 0.64 times, up from 0.46 times at the end of the prior quarter due to strong net deployments during the quarter. As previously announced, we issued $92 million of senior unsecured notes in a private placement on June 9, 2022. We used the notes proceeds as well as availability under the credit facility to repay our $143.7 million of outstanding unsecured convertible notes on our June 15, 2022 maturity date.

During the second quarter, we repurchased approximately 420,000 shares of our stock for $1.6 billion at an average price of $3.78 per share, including brokerage commissions. As of June 30th, approximately 7.4 million shares remained available for repurchase under our current buyback program. As announced yesterday, we declared a third quarter distribution of $0.10 per share to be paid on October 6, 2022 to stockholders of record at the close of business on September 15, 2022. With that, I would like to turn the call back to Jim.

James Keenan -- Chairman and Interim Chief Executive Officer

Thank you, Chip. In summary, we continue to emphasize prudent underwriting, portfolio diversity, and disciplined growth to produce reliable income, NAV stability, and solid results for our shareholders. We thank our shareholders for their continued support. With that, we would now like to open the call for questions.

Questions & Answers:

Operator

[Operator instructions] And we'll go to Melissa Wedel with J.P. Morgan.

Melissa Wedel -- J.P. Morgan -- Analyst

Thanks for taking my questions this morning. I think first to start, I'd like to follow up on what was an active quarter and a little bit of releveraging in the portfolio. It sounds like you're seeing that pace sort of continue into the back half of the year, at least to start. I was hoping to get your thoughts on net originations, what that could mean for the trajectory of leverage in the -- at the portfolio level and how that will drive some incremental earnings.

How do you think about that driving some incremental earnings power and potential progress on dividend coverage?

Nik Singhal -- President

Yeah. Hi, Melissa. This is Nik. Look, that's a great and very relevant question.

And just to take a step back, we've spent the last several quarters in repositioning the book as we had mentioned that we would. And as a result, our portfolio construction is really starting to look like what we set out to be. The unsecured and equity portion is now just 6% of the portfolio, non-core is 4%, and first lien and second lien combined are 94% of the book, of which 74% is first lien rate. So really accomplishing everything that we set out to do.

And we've seen some good deployment momentum in the first half of the year. Recall that we had $45 million of repayments from St. George in Q1. We were able to redeploy that and really grow our leverage from 0.46 to 0.64 times, which still gives us plenty of room to grow the portfolio.

We're also fortunate to do so at a time when the market conditions are becoming more lender friendly. We're seeing improved pricing in the market. I think if you take OID and yield, the main basis, we're seeing 50 to 100 basis points of incremental return on new investments, and that's before any benefit of LIBOR and SOFR increase. In restructures, we're seeing fewer interest rate step downs, more lender friendly documents.

So really a good environment to be deploying into. And BKCC really benefits from the scale of the BlackRock platform. We have a very broad funnel, deep industry expertise, which allows us to be very selective and not abandon our prudent credit underwriting discipline. So I would say we -- as also mentioned in the prepared remarks that we have about $50 million of deals, which either close toward the end of the quarter or approved pending close.

Not all of them might necessarily come to close but I guess directionally, I can point out that we are trending to a very similar deployment pace that we did in the second quarter. And when it comes to yields, I mean LIBOR and SOFR they've gone up even -- since the end of June quarter. I will say SOFR is up about 60 to 65 basis point and yields, as I mentioned, are on the margin better than, say, the last 12 to 15 months that we've seen in the market. So hopefully that's sort of addresses your question.

We're happy to hit up on any other aspects of the question as well.

Melissa Wedel -- J.P. Morgan -- Analyst

Thanks, Nik. That is helpful. I'd actually like to pick up on a comment that was made earlier in the call in your prepared remarks, actually, around existing portfolio companies being an attractive and likely fruitful source of new investment opportunities going forward. Can you elaborate on that? What might be driving -- I assume you distinguish between sort of incremental needs for capital versus maybe more bridge financing through a tough environment and how you'll make that distinction and think about allocating between new and existing investments? Could you expand on that a little bit?

Nik Singhal -- President

Yeah, absolutely. And again, to provide more context here, historically, roughly two-thirds, maybe actually more than two-thirds, more like 70% of our portfolio companies don't tend to be sponsor-backed businesses. We work with a lot of sponsors, very reputable sponsors that often they will buy one or two businesses to start a platform and then make subsequent acquisitions to grow that platform. That's been a proven strategy for private equity, and so it's really been a very good risk and sort of leverage strategy for the private credit book also.

Most of our incremental opportunities come from places like that, where we have sponsor relationships, we finance the initial investments, and then the sponsors piece is to grow that platform by making incremental acquisitions. And that's really been -- when we look at percentages, we mentioned this quarter it was 38%. That was in follow-on investments. I think typically it varies from 25% to 50%, and that's really a good sort of source of additional deployment opportunities for us.

We have the advantage of incumbency in these situations. And then we've also had a chance to look at these investment businesses up close, having invested in them. So that's how I would contextualize the follow-on investments here.

Melissa Wedel -- J.P. Morgan -- Analyst

OK. So Nik, if I could just recap what I heard there. What you're talking about is perhaps portfolio companies taking advantage of some volatility in the environment and doing some sort of bolt-on M&A type deals that need financing rather than sort of more of a stress scenario where companies might need some amendment and some bridge financing?

Nik Singhal -- President

Yeah. So, Melissa, I think this works not necessarily in a local market. Actually, it works in most markets, right. So if you're a private equity sponsor you want to you want to consolidate a certain subsector or niche place where there are many smaller players, they'll start off with maybe one or two acquisitions and then keep making additional acquisitions to sort of create sort of a role of play.

It actually works very well in all cycles, not just down cycles. In fact, it could tend to slow down a little bit in down cycles as maybe sellers are not willing to sell, even though buying opportunities become more attractive. So we really view this as an ongoing benefit the platform has and not necessarily a feature of the current volatility in the marketplace.

Melissa Wedel -- J.P. Morgan -- Analyst

OK. Thanks.

Operator

[Operator instructions] And that does conclude the question-and-answer session. I'll now turn the conference back over to you for any additional or closing remarks.

James Keenan -- Chairman and Interim Chief Executive Officer

Thank you, operator. If there are no further questions, I'd just like to thank our shareholders for their continued support. And we can end the call.

Operator

[Operator signoff]

Duration: 0 minutes

Call participants:

Laurence Paredes -- General Counsel and Corporate Secretary

James Keenan -- Chairman and Interim Chief Executive Officer

Nik Singhal -- President

Chip Holladay -- Interim Chief Financial Officer and Treasurer

Melissa Wedel -- J.P. Morgan -- Analyst

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