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Edited Transcript of ABDC earnings conference call or presentation 7-Aug-18 1:30pm GMT

Q2 2018 Alcentra Capital Corp Earnings Call

NEW YORK Aug 18, 2018 (Thomson StreetEvents) -- Edited Transcript of Alcentra Capital Corp earnings conference call or presentation Tuesday, August 7, 2018 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Ellida McMillan

Alcentra Capital Corporation - CFO, COO & CAO

* Peter Glaser

Alcentra NY LLC - MD

* Suhail A. Shaikh

Alcentra Limited - Co-Head of U.S. Direct Lending

* Vijay P. Rajguru

Alcentra Capital Corporation - Chairman, CEO & Global Co-CIO

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Conference Call Participants

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* Laura Allison Taylor Rudary

Oppenheimer & Co. Inc., Research Division - Associate

* Leslie Shea Vandegrift

Raymond James & Associates, Inc., Research Division - Senior Research Associate

* Lisa R. Thompson

Zacks Investment Research, Inc. - Senior Technology Analyst

* Paul Conrad Johnson

Keefe, Bruyette, & Woods, Inc., Research Division - Associate

* Robert James Dodd

Raymond James & Associates, Inc., Research Division - Research Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Alcentra Capital Corporation Quarter 2 2018 Earnings Conference Call. (Operator Instructions)

I would now like to introduce your host for today's conference, Ellida McMillan. Please go ahead.

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Ellida McMillan, Alcentra Capital Corporation - CFO, COO & CAO [2]

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Thank you, Chris. Good morning, and welcome, everyone to Alcentra Capital Corporation's Second Quarter 2018 Earnings Call. I'm joined this morning by Vijay Rajguru, Chief Executive of Alcentra Capital Corporation and Chief Investment Officer who manager Alcentra. Also, joining us today are Peter Glaser and Suhail Shaikh, our new Co-Presidents of Alcentra Capital Corporation.

Before we begin, please note that this call is being recorded. Replay information is included in our August 6, 2018, press release. It will be posted on the Investor Relations section of Alcentra Capital Corporation's website, which can be found at www.alcentracapital.com.

Please note that this call is the property of Alcentra Capital Corporation. Any unauthorized rebroadcast of this call in any form is strictly prohibited. Today's call may include forward-looking statements and projections. We ask that you refer to our filings with the SEC for important factors that may cause actual results to differ materially from those anticipated in any forward-looking statements and projections.

We do not undertake to update our forward-looking statements unless required by law. To obtain copies of our SEC filing, please visit our website or call Investor Relations at (212) 922-8240. The format for today's call is as follows: Vijay, Peter and Suhail will provide an overall business and portfolio summary, and I'll then provide an overview of our results, summarizing the financials, followed by Q&A.

I will now turn it over to Vijay.

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Vijay P. Rajguru, Alcentra Capital Corporation - Chairman, CEO & Global Co-CIO [3]

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Thank you, Ellida. Good morning. Thank you for joining us. I'm pleased to speak to you today for the first time as CEO, ABDC. We want to thank David Scopelliti for his service and wish him well in his future endeavors he has decided to pursue.

We continue to make progress in our plans to reorient ABDC's portfolio towards a more traditional, private equity-focused, mid-market, senior secured strategy. To that -- toward that end, I also want to welcome Peter Glaser and Suhail Shaikh, who have joined us at Alcentra to lead our U.S. direct lending effort as well as act as Co-Presidents of ABDC.

Suhail and Peter will work with me and the ABDC team to execute upon our strategy. I'm encouraged by the progress we have made to date and excited by our prospects. Peter, Suhail and Ellida will take you through some of the highlights of our quarter. Peter?

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Peter Glaser, Alcentra NY LLC - MD [4]

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Thank you, Vijay, and good morning. Suhail and I are pleased to have joined the Alcentra team. We've arrived at a robust time in the credit cycle with generally favorable conditions for our target market. While second quarter activity remained healthy, leverage levels stayed elevated and yields compressed. As a result, our focus will be to continue to rotate the portfolio to senior secured dollar 1 risk.

We have spent the past 2 months understanding the portfolio as well as gaining insights from many of our constituents, including shareholders, analysts and lenders. We appreciate the valuable feedback we have received from such perspectives. We intend to continue to implement the expanded investment strategy previously set forth by ABDC and transition assets as appropriate with the goal of closing the price to net asset value discount.

This entails a focus on the secured middle market sponsor credits that Vijay mentioned, with a particular focus on companies with EBITDA of $15 million to $75 million. While such transition will take time and not be free of challenges, we believe this segment of the credit market will continue to present compelling opportunities for investors.

We ended the quarter with $246.2 million in fair value of our investment portfolio with 35 positions, including 27 companies, 5 broadly syndicated loans and 3 rated debt securities in CLOs. Our NAV has gone from $157.2 million at the end of Q1 to $149.6 million at the end of Q2, which Suhail and Ellida will expand upon. Our regulatory debt to equity ratio of 0.76x is consistent with our publicly stated target area.

With that, let me turn it over to my partner, Suhail.

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Suhail A. Shaikh, Alcentra Limited - Co-Head of U.S. Direct Lending [5]

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Thank you, Peter. As Vijay mentioned in his opening remarks, Peter and I recently joined the Alcentra family to help build the world-class direct lending business in the U.S. ABDC is a core part of that strategy, and we are excited about its prospects.

As Peter mentioned, market conditions are healthy, but we remain cautious that we are very late in the economic cycle. Since joining Alcentra a couple of months ago, Peter and I have re-unwritten portfolio with that mindset. We are pleased to see that our team and previous management have been operating under the same assumptions and believe the team has been doing a great job in managing the legacy lower middle market despite the relative size of the underlying businesses.

We have had to make adjustments this quarter to 5 names based on company-specific circumstances. The net reduction in value during the quarter based on those adjustments is approximately $7.4 million. We believe that this reduction fairly represents the value of these investments based on the best information we had available by the end of the quarter or shortly thereafter.

The average portfolio investment on a cost basis was $7.1 million and $5.8 million on a fair value basis this quarter. First lien debt comprised 64% of the portfolio versus 62% last quarter with second lien positions at 15% versus 10% and subordinated debt at 10% versus 15% last quarter.

As an example of our portfolio rotation, we were able to refinance Pharmalogic Holdings from sub debt to second lien. Equity position's comprised approximately 10% of the portfolio.

The broadly syndicated loan and CLO positions continue to provide us liquidity and income as we rotate the portfolio. Our new deal pipeline continues to grow, and we are confident in our abilities to replace the more liquid assets with investments that are core to the company's strategy as mentioned by Peter.

We received proceeds from repayments and amortization of about $30.9 million while new investments and add-ons total $19.6 million, including the Pharmalogic Holdings' refinancings during the quarter.

Our weighted yield stands at 10.9% versus 10.6% last quarter as we continue our transition to lower-yielding senior secured credits. We had 3 nonaccrual positions down from 4 last quarter. Those names are Show Media, Southern Technical Institute, Black Diamond Rentals, for which we continue to actively monitor and work with their management teams and shareholders on corrective measures.

We were able to utilize the company's co-exemptive relief for our first investment during the quarter in Manna Pro Products, Inc., the company which manufactures and markets feeds for animal health and nutrition.

The co-exemptive relief will continue to benefit the company as we will be able to access our managers' other sources of capital.

In summary, we believe that continued focus on portfolio rotation should result in value creation for shareholders. Ellida will now take you through the details of the adjustments in value as well as other activity within our portfolio.

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Ellida McMillan, Alcentra Capital Corporation - CFO, COO & CAO [6]

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Thank you, Suhail. For the 3 months ended June 30, 2018, total investment income was $7.3 million, a decrease of $1 million over the $8.3 million of total investment income for the 3 months ended June 30, 2017. This decrease was due to the continued yield compression in the markets and the continued transition of the portfolio.

Net expenses this quarter, after the waiver of management fees for the amended advisory agreement, were $3.8 million, which was an increase of $0.3 million from the 3 months ended June 30, 2017.

Interest and financing expenses for the 3 months ended June 30 were $2 million and $1.9 million for the 3 months ended June 30, 2017. The base management fee was $0.9 million, a decrease of $.03 million from the 3 months ended June 30, 2017, due to lower average total assets and a reduced fee rate for the amended advisory agreement. There were no incentive fees earned for this quarter nor the comparable period in 2017.

Professional fees and other general and administrative expenses totaled $0.9 million, an increase of $0.4 million in the 3 months ended June 30, 2017, partially attributable to $0.2 million of nonrecurring consulting fees. There were no consulting fees for the comparable period in 2017.

Net investment income for the 3 months ended June 30, 2018, was $3.5 million, a decrease of $1.3 million from the $4.8 million during the 3 months ended June 30, 2017. The net realized loss this quarter from portfolio investments was $20.3 million. This was due to the reclass from the net change in unrealized appreciation for GST AutoLeather, which settled their bankruptcy; Media Storm, which we sold at a discount to cost; and a realized loss on the restructuring of Southern Technical. During the 3 months ended June 30, 2018, we recorded a net change in unrealized appreciation from portfolio investments of $13.5 million due to the reclass just mentioned and a further write-down of the 5 portfolio companies Suhail mentioned earlier.

As a result of these events, our net decrease in net assets resulting from operations during the 3 months ended June 30, 2018, was $2.2 million. Our NAV per share result for the quarter was $11.01. As of June 30, 2018, Alcentra had $12.7 million in cash and $58.6 million outstanding under the credit facility.

Chris, at this time, we will open the lines for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Robert Dodd with Raymond James.

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Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [2]

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Just a fairly simple question, I think. When we look at your subsequent events, Value Based Care Solutions, L + 8.125%, so I presume your expectations for total return from that asset over the next 3 to 5 years is somewhere in the range 10% to 11%. So is it fair to say that the management and the board expect -- by choosing not to reserve that cash to buy back stock, is indicating that they expect the total return in the shares to be less than 10% to 11% over the next -- over the same kind of period that, that loan would be outstanding?

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Peter Glaser, Alcentra NY LLC - MD [3]

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Yes. I think the way to think of VBC is that it's consistent with the rotation of the portfolio to more traditional middle-market and upper middle-market companies, that, that happens to be a second lien position, which the return characteristics are consistent with a second lien position of that sort. And I think that's the lens through which you should view that investment, which is, I think, consistent with what you've been hearing for a couple of quarter -- quarters now about rotating from the lower middle-market corporate strategy into a more upper middle-market traditional sponsor-based strategy.

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Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [4]

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But to narrow down on that, if I can, I think that kind of glosses over the point of the question, which is, is that rotation actually in the best interest of shareholders, when you can buy back stock with a double-digit yield at a 50% or 45% discount to book and generate 20-plus rates of return on capital deployed into your own stock? And that would seem to me to be a better return to shareholders than lending it at half that rate of return.

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Ellida McMillan, Alcentra Capital Corporation - CFO, COO & CAO [5]

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So Robert, it's Ellida. We did obviously participate in the buyback program. I think you can see that in the -- or what was purchased. So I think -- I would look at it as a double-pronged approach, right, moving the portfolio and also doing the share buyback program. I don't think it's necessarily one or the other.

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Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [6]

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But it seems to me that -- exactly on -- in the Q, you bought back $4.4 million of stock so far in the entire first half of the year. That loan alone, not including our other lending of capital, is obviously larger than that. So it still seems that the bias is towards lending, which, granted, was your reason to exist in the past. But the true reason to exist for ABDC, I think, is to create value for shareholders. If I'm wrong on that, please correct me.

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Peter Glaser, Alcentra NY LLC - MD [7]

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No. We agree that our primary focus is creating value for shareholders. And as Ellida mentioned, we'll certainly balance our core mission of investing in middle-market credits with smart use of our liquidity resources to think about share repurchases. One thing to obviously keep in mind is it's not the most liquid stock and you can't just buy back as much as you want to at any given point in time. That's a factor in all this as well. But it's not, as Ellida said, one or the other. It's both.

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Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [8]

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I appreciate your comments. Obviously, you can't buy back in the open market but -- in unlimited volume but there are other mechanisms, but I appreciate your color.

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Operator [9]

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And our next question comes from Leslie Vandegrift with Raymond James.

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Leslie Shea Vandegrift, Raymond James & Associates, Inc., Research Division - Senior Research Associate [10]

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Just a few portfolio questions this morning. I noticed the sale of Red Ventures in the quarter. Wasn't that a first quarter origination? And can you give me some color on that exit?

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Ellida McMillan, Alcentra Capital Corporation - CFO, COO & CAO [11]

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Sure. So there were the syndicated loans in the CLO debt that were mainly, I would put it, a part of the transitionary portfolio. They're not part of the core strategy, but they will be used and rotated out when needed. So that was really the purpose of that. We're not looking for them to be long-term holds.

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Peter Glaser, Alcentra NY LLC - MD [12]

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Yes. For all of those positions in the CLOs and the broadly syndicated loans, it's just to make sure we're getting at least some reasonable return rather than holding it in cash that doesn't get appropriate returns prior to reinvesting it or buying back shares or other uses. And therefore, you shouldn't, as Ellida says, look at it as a core investment, which we intend to hold for the long term but more just a transitory capital.

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Leslie Shea Vandegrift, Raymond James & Associates, Inc., Research Division - Senior Research Associate [13]

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Okay. And what was the short-term return there?

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Ellida McMillan, Alcentra Capital Corporation - CFO, COO & CAO [14]

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I can get that number for you, Leslie. I don't have it off the top of my head. I'm going to say it was maybe relatively flat, a little up. I can get you the exact numbers.

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Leslie Shea Vandegrift, Raymond James & Associates, Inc., Research Division - Senior Research Associate [15]

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It's okay. And then Southern Technical, you mentioned in the press release the changes there. So it was refinanced, [facilitated] into a subordinated debt investment from a second lien. Obviously, some of that was written off, about $5 million, but it's still a nonaccrual. So can we talk a little bit about the non-accruing yield going from 15% PIK to 6% PIK and then going down in the security of the structure? What kind of led you to do so? And what was the reasoning behind that?

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Suhail A. Shaikh, Alcentra Limited - Co-Head of U.S. Direct Lending [16]

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The portfolio was there; the position was restructured. We can come back to you with more details on exactly what prompted the restructuring, but we -- the revised portfolio security is consistent with what all the other lenders were able to negotiate. And so that -- what you see is exactly what we have right now, which is consistent with what the other lenders have. But we can get -- we can take it off-line and give you more detail on sort of the circumstances around the restructuring.

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Leslie Shea Vandegrift, Raymond James & Associates, Inc., Research Division - Senior Research Associate [17]

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Okay. And then, just on the fee income that you guys have -- any -- did you guys get any fee income related to the 3 repayments this quarter, Lugano, Superior, Cirrus or anything from that assignment, a part of Healthcare Associates of Texas?

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Ellida McMillan, Alcentra Capital Corporation - CFO, COO & CAO [18]

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Yes, there were some amendment fees, some prepayment fees, some structuring fees related with all of those, yes, and agent fees.

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Leslie Shea Vandegrift, Raymond James & Associates, Inc., Research Division - Senior Research Associate [19]

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Okay. And then, just the last quick one. On Media Storm and GST, I know you said you got them off the portfolio this quarter. Were they exited at the previous mark or was there a difference in that inter-quarter?

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Ellida McMillan, Alcentra Capital Corporation - CFO, COO & CAO [20]

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Yes. We received settlement from bankruptcy. It was fairly de minimis on GST. And on Media Storm, we sold our position off to the sponsor for also a fairly de minimis amount, probably half -- less than half of cost.

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Operator [21]

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And our next question comes from Allison Rudary with Oppenheimer.

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Laura Allison Taylor Rudary, Oppenheimer & Co. Inc., Research Division - Associate [22]

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So I guess, my picture is a little bit bigger -- our question is a little bit bigger picture, rather. I kind of like to talk about the liquidity that you guys have remaining to grow the portfolio and the percentage of the current portfolio that you would view, I suppose, as maybe transitional. So kind of you could talk a little bit about like what I would consider like the wood that's left to be chopped. And then maybe kind of if we can put some numbers around that, maybe we can talk -- you guys can talk a little bit about how long you think kind of the full transition or kind of full kind of portfolio -- what kind of remodeling, if you will, will take. Given that you don't always have control over market opportunity, and I understand market opportunities and when things might repay.

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Ellida McMillan, Alcentra Capital Corporation - CFO, COO & CAO [23]

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Yes, I think from a liquidity perspective, Allison, we're obviously rotating through the portfolio, looking at repayments to redeploy the CLO, syndicated loans, all that is a part of the transition. So that's how we're thinking of, I think, that perspective of liquidity. I don't know if Suhail or Peter, if you want to talk about the timing of things, the transition of the portfolio will take.

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Suhail A. Shaikh, Alcentra Limited - Co-Head of U.S. Direct Lending [24]

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Yes. I think -- I mean, it's not a science, and we don't have perfect visibility exactly into when all the positions will be able to be exited. But on an organic basis, we suspect it's going to take at least a couple of years. And it could be shorter, it could be slightly longer. But that's very good bogey to sort of think about as we rotate through and some of these positions are stickier than others. So we'll just have to work through, and we're going through that exercise on a name-by-name basis as we speak.

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Operator [25]

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And our next question comes from Paul Johnson with KBW.

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Paul Conrad Johnson, Keefe, Bruyette, & Woods, Inc., Research Division - Associate [26]

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My first question on the buyback. First of all, we applaud you for making pretty aggressive share repurchases during the quarter. But how much exactly, because you were so aggressive, how much exactly remains on the -- your current buyback program that you have in place?

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Ellida McMillan, Alcentra Capital Corporation - CFO, COO & CAO [27]

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It's about 100,000 on the current program.

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Paul Conrad Johnson, Keefe, Bruyette, & Woods, Inc., Research Division - Associate [28]

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Okay. And then my second question is on -- I just wanted to confirm this, so hopefully a quick one, was Black Diamond Rentals. It looks like you appear to place the first lien on nonaccrual this quarter, too, but the fair value mark looks like it was still fairly stable quarter-to-quarter. Is that correct? Are they also a nonaccrual?

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Ellida McMillan, Alcentra Capital Corporation - CFO, COO & CAO [29]

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Yes, that's correct. They're in the process of looking at opportunities. I think we footnoted that. So we are basing that on real-time activity with that portfolio company. Just because it was restructured at the end of 2017, at the beginning of 2018, and then now they're going through their -- looking at potential opportunities. So those figures are really just based on where we stand in the talks with them at this point in time. I don't know if you want to add anything...

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Paul Conrad Johnson, Keefe, Bruyette, & Woods, Inc., Research Division - Associate [30]

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And then, I guess, on the development with the credit facility amendments and the 200 -- regarding the 200% asset coverage covenant within that, are you guys still in negotiating -- negotiation with the bank facility agent on that?

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Ellida McMillan, Alcentra Capital Corporation - CFO, COO & CAO [31]

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Yes, we're still in discussions with that.

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Paul Conrad Johnson, Keefe, Bruyette, & Woods, Inc., Research Division - Associate [32]

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Okay. And then my last question really has to do with an activist investor, Stilwell Value Partners. And back in December, they wrote a letter to the board. I think at one point they had built their position as high as little over 9% of the outstanding shares in your stock. Has there been any sort of engagement or relationship between the manager and that investor? Has anything changed at all with any of the recent transition in management positions?

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Vijay P. Rajguru, Alcentra Capital Corporation - Chairman, CEO & Global Co-CIO [33]

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So this is Vijay Rajguru. We met with representatives from Stilwell, and frankly, it was a pretty -- it was a good conversation but nothing other than we're sticking to what we've mentioned on our calls for the last 2 quarters. So rotating the portfolio, improving the quality. And they -- that was it. There was nothing else to it.

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Operator [34]

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(Operator Instructions) And our next question comes from Lisa Thompson with Zacks Investment.

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Lisa R. Thompson, Zacks Investment Research, Inc. - Senior Technology Analyst [35]

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I was just wondering about the companies that are performing below expectations. Other than the nonperformers, can you just talk a little bit about the other few names?

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Suhail A. Shaikh, Alcentra Limited - Co-Head of U.S. Direct Lending [36]

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Sure. I mean, the -- we are always monitoring our portfolio, and all the names that are sort of at or below expectations, we are continuing to monitor those. Within those, there are a few names that are sort of -- the 3 that I mentioned earlier that are nonaccrual that we have a closer eye on. And otherwise, we continue to monitor the rest of the portfolio as we do. I think overall our assessment, and Peter and I have taken a pretty healthy look at this, we believe that, that portfolio is actually pretty stable. Businesses will continue to bounce around based on quarter-to-quarter, based on certain situations, depending on what sectors they're in. But overall, we think the portfolio has been pretty stable quarter-over-quarter. Peter, anything to add?

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Peter Glaser, Alcentra NY LLC - MD [37]

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No, I agree with that. And look, I mean, the portfolio we inherited, as you know, it's the size and some of the sectors of -- that they're in just require a lot of attention, which we're giving it. And it speaks to Suhail's earlier comment about how long it might take to rotate through some of this just because you need to be careful, you need to be smart and you don't want to do anything to rush things that would result in a negative impact to the value for shareholders.

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Lisa R. Thompson, Zacks Investment Research, Inc. - Senior Technology Analyst [38]

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Okay. So you don't want to talk about any specific names or...

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Ellida McMillan, Alcentra Capital Corporation - CFO, COO & CAO [39]

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They're all private companies. We can't get into too much detail, and I think they've remained relatively the same companies. There was Conisus, IGT, XGS and then the 3 that Suhail mentioned. So as Peter and Suhail just said, I mean, they have their challenges and we're working through them and there have been no new names added to that list.

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Operator [40]

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And I'm not showing any further questions at this time. I would now like to turn the call back to Vijay Rajguru for any further remarks.

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Vijay P. Rajguru, Alcentra Capital Corporation - Chairman, CEO & Global Co-CIO [41]

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Well, thank you, everyone, for joining. Thank you for your questions. The team's -- is here, if you've got any further follow-ups. And we look forward to coming back to you in a quarter. Thank you.

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Operator [42]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program; you may all disconnect. And everyone, have a great day.