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Edited Transcript of BANX earnings conference call or presentation 27-Feb-20 10:00pm GMT

Q4 2019 StoneCastle Financial Corp Earnings Call

New York Mar 27, 2020 (Thomson StreetEvents) -- Edited Transcript of StoneCastle Financial Corp earnings conference call or presentation Thursday, February 27, 2020 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Joshua Siegel

* Patrick Joseph Farrell

StoneCastle Financial Corp. - CFO

* Rachel Nachas Schatten

StoneCastle Partners, LLC - General Counsel and Chief Compliance Officer

* Sanjai Suryaji Bhonsle

StoneCastle Financial Corp. - CEO & Chairman

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Conference Call Participants

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* Christopher Thomas O'Connell

Keefe, Bruyette, & Woods, Inc., Research Division - Assistant Analyst

* Devin Patrick Ryan

JMP Securities LLC, Research Division - MD and Senior Research Analyst

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Presentation

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Operator [1]

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Greetings. Welcome to StoneCastle Financial Corp. Fourth Quarter 2019 Financial Release Conference Call. (Operator Instructions) Please note, this conference is being recorded. I will now turn the conference over to your host, Rachel Schatten, General Counsel for StoneCastle Financial. Thank you. You may begin.

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Rachel Nachas Schatten, StoneCastle Partners, LLC - General Counsel and Chief Compliance Officer [2]

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Good afternoon. Before we begin this conference call, I'd like to remind everyone that certain statements made during the call may be considered forward-looking statements based on current management expectations that involve substantial risks and uncertainties. Actual results may differ materially from the results stated in or implied by these forward-looking statements. This would depend on numerous factors, such as changes in securities or financial markets or general economic conditions; the volume of sales and purchases of shares of its common stock, the continuation of investment advisory, administrative and service contracts; and other risks discussed from time to time in the company's filings with the SEC, including annual and semiannual reports of the company. StoneCastle Financial has based the forward-looking statements included in this presentation on information available to us as of December 31, 2019. The company undertakes no duty to update any forward-looking statement made herein. All forward-looking statements speak only as of today, February 27, 2020.

Now I will turn the call over to Josh Siegel.

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Joshua Siegel, [3]

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Thank you, Rachel. Good afternoon, and welcome to StoneCastle Financial's Fourth Quarter 2019 Investor Call. In addition to Rachel, joining me today is Sanjai Bhonsle, the newly appointed Chairman and CEO of StoneCastle Financial Corp.; and Pat Farrell, our Chief Financial Officer. This conference call will commence the transition of the CEO role from me to Sanjai. I could not be more confident in handing the company to someone that I've gotten to know and respect over the past year. As my tenure as CEO ended subsequent to the end of the quarter, I will be providing StoneCastle Financial's quarterly results and portfolio review and then hand the call over to Sanjai to discuss the company and the StoneCastle-ArrowMark transition. Pat will then provide you with greater detail on our financial results before we open up the call for questions.

We are pleased to report that total earnings for the fourth quarter were approximately $3.5 million or $0.53 per share. This figure was comprised of net investment income of $2.7 million or $0.41 per share and approximately $800,000 in net realized capital gains of $0.12 per share.

Total assets were $164.7 million, and the value of the invested portfolio was $162.3 million. The net asset value at the end of the quarter was $21.83 per share, up $0.08 from the prior quarter. We believe no meaningful credit issues currently exist within the portfolio, and the majority of the underlying banks continue to be scored investment-grade by Kroll Bond Rating Agency.

Now let me turn to the portfolio review. During the quarter, the company invested $700,000 in FNBC of La Grange, located in La Grange, Illinois. This asset was acquired with an effective yield of 9.6%. We also sold our equity interest in Howard Bancorp, realizing a capital gain of $366,000. The company received partial call proceeds of $1.8 million from the position in MMCapS, fixed rate senior notes, realizing a capital gain of approximately $425,000.

Now let's move on to the recently completed transaction. As we previously disclosed, the company is pleased to report that StoneCastle-ArrowMark assumed the role of investment adviser following the required shareholder approval on February 7 and the closing of the transaction on February 12. Effective and condition upon the closing of the transaction, Sanjai Bhonsle assumed the role of Chairman and CEO. StoneCastle had been in earnest discussions with ArrowMark for the better part of 2019. The management and the Board of StoneCastle Financial selected ArrowMark because of the similar philosophies of our company and ArrowMark's commitment to continue StoneCastle's investment strategy. Collectively, we believe, the combination of our platforms will create a formidable leading bank investment platform that will offer multiple benefits for StoneCastle Financial shareholders. Therefore, at this time, I am pleased to introduce Sanjai Bhonsle, Chairman and CEO of StoneCastle Financial.

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Sanjai Suryaji Bhonsle, StoneCastle Financial Corp. - CEO & Chairman [4]

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Thank you, Josh. I'd like to start off by offering my congratulations to the StoneCastle team and to say that it is a pleasure speaking with you today in my role as Chairman and CEO. Also, I want to thank all of our shareholders for your ongoing support of the company. I was glad to have spoken with so many of you over these last few weeks and hope to continue our dialogue in the coming weeks and meet many of you in person. As discussed in the proxy, a new adviser, StoneCastle-ArrowMark Asset Management, expects to manage the company's securities portfolio, consistent with StoneCastle's strategy and focus on capital preservation and credit quality. This investment strategy aligns with ArrowMark's investment philosophy that emphasizes risk-adjusted returns and value creation for shareholders. As we have outlined in the investor presentation and our proxy, StoneCastle-ArrowMark will be supported by the wider infrastructure of ArrowMark Partners, an established investment firm with approximately $20 billion of assets under management, including $8 billion invested in credit strategy. As part of the purchase agreement, ArrowMark acquired StoneCastle's bank credit technology platform and certain personnel. Importantly, I also want to reiterate that the transition to StoneCastle-ArrowMark, as our external adviser, will be seamless to shareholders of StoneCastle Financial. ArrowMark and StoneCastle have worked together, originating investments in alternative capital transaction, including 2 investments that are currently in the bank's portfolio. We believe, in this market environment, alternative capital securities will provide an opportunity to prudently grow the company's assets under management as well as enhanced shareholder value.

The alternative capital securities, along with the community bank sector, represent a robust investment pipeline for the company. Our adviser has committed to originate approximately $30 million of bank-related investments earmarked for StoneCastle Financial. Although we do not disclose the actual pipeline for competitive purposes, ArrowMark has a track record investing approximately $2.5 billion in these types of securities, and we are confident in our proven ability to source investments.

Turning to the community banking sector. We have also been able to source pipeline investments for the portfolio. In fact, subsequent to the end of the quarter, we are looking at 2 community bank investment opportunities. These 2 opportunities had a similar profile as the FNBC transaction closed in the fourth quarter, which was made in collaboration with a large institutional investor. In general, the volume of community banking issuance is still below historical trends. However, community bank issuance did pick up late last year with nearly 53% of all 2019 issuances occurring in the fourth quarter. Therefore, in general, we are more optimistic regarding our overall pipeline, including issuance by community banks.

As knowledgeable investors in this space, we are able to creatively source new investment opportunities for the portfolio to take advantage of the pipeline, and we will be in a good position in 2020 with available capital. Our ability to originate from a broad investment pipeline, which includes community banks, alternative capital securities, and companies that provide goods and/or services to banking companies will allow StoneCastle Financial a distinct advantage of investing through multiple economic climates and market cycles.

Before I close my formal remarks, I want to touch upon the dividend strategy. As stated in the proxy, we intend to rotate our assets with a lower rate of interest into higher-yielding assets. Following the acquisition of these assets, the company expects to be in a position for the Board to declare a $0.10 per share special dividend. Additionally, management would seek to increase the stated quarterly dividend sometime in 2020, subsequent to the approval by the company's Board. I want to remind our shareholders that all dividends are subject to the approval and declaration by the Board of Directors.

Now I want to turn the call over to Pat to discuss the financial results and provide details on the underlying net asset value of the company.

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Patrick Joseph Farrell, StoneCastle Financial Corp. - CFO [5]

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Thank you, Sanjai. As I do each quarter, I will present the financial results by going through the components of the company's quarterly results in detail. The net asset value at December 31 was $21.83, up $0.08 from the prior quarter. NAV is comprised of 4 components: net investment income; realized capital gains and losses; the change in value of the portfolio's investments; and lastly, distributions paid during the period. So let's look at these components. Gross income for the quarter was $4.1 million or $0.63 per share. Net operating expenses for the quarter were $1.5 million or $0.22 per share, resulting in investment income for the quarter of $2.7 million or $0.41 per share. We also had net realized capital gains of $790,000 or $0.12 per share, resulting in total earnings of $0.53 for the quarter. Realized capital gains and losses in the quarter is the second component affecting the change in NAV. As I just mentioned, the net realized capital gains for the quarter were the result of the sale of Howard Bancorp and the partial call of the MMCapS position.

The third component, changes in unrealized appreciation or depreciation of the portfolio relates to how the value of the entire investment portfolio has changed from the previous quarter end to the current quarter end. For the fourth quarter, the unrealized appreciation of the portfolio decreased by approximately $443,000 or $0.07 per share. The fourth component affecting the change in net asset value is distribution. The cash distribution for the quarter was $0.38 per share. The distribution was paid on January 3 of this year to shareholders of record on December 23, 2019.

In summary, we began the quarter with a net asset value of $21.75 per share. During the quarter, we generated net income of $2.7 million, net realized capital gains of approximately $790,000, and the unrealized value of the portfolio investments decreased by $443,000. With some of these components, offset by a distribution of $0.38 per share, resulted in a net asset value of $21.83 per share at December 31, up $0.08 from the prior quarter.

As I do every quarter, it is worth noting that the vast majority of the portfolio continues to be independently marked from broker-dealer quotes. For the quarter, approximately 92% of the portfolio prices or marks reflect a minimum of 2 quotations or actual closing exchange prices. These quotations represent an independent third-party assessment of the current value of the portfolio. This differentiates StoneCastle from certain publicly traded closed-end funds and BDCs that self-mark their portfolios. At quarter end, the company had total assets of $164.7 million, consisting of total investments of $162.3 million, including a small cash position, interest and dividends receivable of $1.8 million, and prepaid assets of $618,000. Our dividend yield at the end of the quarter was approximately 6.8%.

Now let me update you on the balance of our credit facility. At December 31, the company had $17.7 million drawn from the facility, leaving approximately $44.3 million available. Based on regulated investment company rules, we may only borrow up to 33.3% of our total assets. Now I want to turn the call back over to Sanjai and Josh for closing remarks.

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Sanjai Suryaji Bhonsle, StoneCastle Financial Corp. - CEO & Chairman [6]

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Josh, I want to personally thank you for your leadership and your tremendous contribution to this company. We will continue to lead by your example and build on the mission and stewardship of the company in the best interest of our shareholders.

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Joshua Siegel, [7]

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Thank you, Sanjai. It's been an honor to serve the shareholders and stakeholders of StoneCastle Financial as Chairman and CEO over these past 6 years. I've come to know the company's research analysts and many of the shareholders personally, and I can't thank everyone enough for your continued support of the company. I hope that you will remain long-term shareholders and advocates of StoneCastle Financial. The company is in terrific hands, and I can't be more excited for the company's future, and I look forward to my continuing involvement with StoneCastle-ArrowMark Asset Management.

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Sanjai Suryaji Bhonsle, StoneCastle Financial Corp. - CEO & Chairman [8]

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Thank you, Josh. I'm extremely proud to assume the management of StoneCastle Financial. We look forward to working with you in your Board role as Adviser. Now operator, I'd like to open up the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from Chris O'Connell with KBW.

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Christopher Thomas O'Connell, Keefe, Bruyette, & Woods, Inc., Research Division - Assistant Analyst [2]

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So I was just hoping to get a little bit more insight into the pipeline, I guess, separating it into 2 parts, starting with the community bank investments. You mentioned you, kind of, were looking at 2 subsequent to the quarter end that were similar to FNBC transaction. And by that, did you mean similar, I guess, in size, I mean, sub-$1 million? Or do you think you can see larger than that? And -- or did you mean more the structure of the subordinated debt.

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Joshua Siegel, [3]

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This is Josh. More the structure. So if you recall, we've had some very interesting opportunities where there are positions that are at an interest rate for the asset themselves that are less desirable for us, but we really like the credit. And we've worked with a couple of institutional investors. Where -- it's not that they're being senior and we're sub. We're actually just sharing the piece pro rata, but they end up paying StoneCastle Financial a fee for effectively originating and managing that asset for them. And so it turns our yield from kind of a 6 handle to a 9 handle. So that's the structure. And I think we've talked about that in the past. So we see a few more of those coming down the pipe, but other things that are sort of new and interesting is the NCUA recently passed new rules that allow all credit unions to issue, what they call supplemental capital, which is basically 10-year sub-debt in the credit union space. So we've had a few inquiries already from referring agents if we're interested in that, and the answer is, yes, if it's a well-structured credit you need just like a well-structured bank, we're definitely open to that. So yes, we have a couple of interesting opportunities in the pipe from the community bank side. And Sanjai, maybe you want to talk about the pipeline for the larger bank paper?

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Sanjai Suryaji Bhonsle, StoneCastle Financial Corp. - CEO & Chairman [4]

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Sure. Chris, as previously mentioned, we are looking to, in the near term, at about $30 million of investments on the alternative capital security side. And there, we look at about $500 million to $600 million of investments on an annual basis. And so the pipeline, generally speaking, is fairly strong. So nothing different than that in terms of what we're seeing here today. And over the next couple months plus, you should see close to about $30 million of assets going into the company on the alternative capital security side.

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Christopher Thomas O'Connell, Keefe, Bruyette, & Woods, Inc., Research Division - Assistant Analyst [5]

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Got it. And so that $30 million, is that going to come do you think probably all in one slug at once? And you said that you think that can happen in perhaps the next 2 months or so?

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Sanjai Suryaji Bhonsle, StoneCastle Financial Corp. - CEO & Chairman [6]

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That's right. So no, they unfortunately don't come in one slug. You should kind of expect them to be staggered. And so one after the other. And I probably expect between 3 to 4 investments there.

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Christopher Thomas O'Connell, Keefe, Bruyette, & Woods, Inc., Research Division - Assistant Analyst [7]

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Got it. That's helpful. And then on the -- that's still going to be -- you expect it to kind of yield in that LIBOR plus 9% to 10% range?

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Sanjai Suryaji Bhonsle, StoneCastle Financial Corp. - CEO & Chairman [8]

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Correct.

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Christopher Thomas O'Connell, Keefe, Bruyette, & Woods, Inc., Research Division - Assistant Analyst [9]

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Got it. And then on the other side of the community bank investments, I guess, or what's already in the portfolio, how are we looking, I guess, towards calls and -- or even just -- or paydowns and any potential headwinds on that side that are spiking up? Or is it still -- are more of those calls, kind of, not expected to occur in the first half of the year?

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Joshua Siegel, [10]

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You should start.

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Sanjai Suryaji Bhonsle, StoneCastle Financial Corp. - CEO & Chairman [11]

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Sure. Well, if we sort of break down what's callable, we've had some of the early paper, like Katahdin already called out. Obviously, almost everything we put on is non-call 5. So for example, a lot of the community funding CLO assets will, kind of, come up for a call later this year. But as we've talked about, we're already proactive on looking to refinance that and entice those banks of staying longer with us for sort of rolling another 5 years further. So stretching a fresh 10.

Other -- outside of that, there really isn't a whole lot that we're aware of in the call prospects. Credit-wise, we're still very content. Banks in the portfolio are borderline grossly overcapitalized. Of course, it hurts their ROE, but a lot of these are private banks and they don't much care. In any given quarterly ROE, they care about the stability of the bank, which is what we care about. So no, we don't see a whole lot of calls in the short term.

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Patrick Joseph Farrell, StoneCastle Financial Corp. - CFO [12]

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This is Pat. I'd just add that from a data point of view, it's unpredictable. If you go back and look at where we've been over the last 3, 4 years, I mean, this year, we had a great number of calls in 2019. But the prior year in 2018, we only had $4.4 million for the whole year. This year, we had $50 million. So it's unpredictable. There's so many factors that weigh into this that it is hard to predict.

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Sanjai Suryaji Bhonsle, StoneCastle Financial Corp. - CEO & Chairman [13]

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And just to add a little bit more color -- sorry, just to add a little bit more color to what Josh mentioned. The banks or -- the fourth quarter, actually, our portfolio did fairly well and extremely well capitalized, and the portfolio, as we sit today, is fairly robust.

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Operator [14]

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Our next question is from Devin Ryan with JMP Securities.

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Devin Patrick Ryan, JMP Securities LLC, Research Division - MD and Senior Research Analyst [15]

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So maybe just 1 on kind of the market backdrop and pricing. I know we're maybe early days of stress here, but you had some pretty severe moves, at least, in the equity markets. So I'm just curious if you guys are seeing any changes in the credit markets. And really, just a bigger picture, whether you're almost rooting for there to be a bit of stress. I know it's -- you've been competitive on pricing and spreads have been tight and so -- and Josh, as you mentioned, banks are overcapitalized at the moment. So you're probably in good shape to weather some stress. But I'm just curious whether, kind of, we're sitting here rooting for a little bit of dislocation as that could create an opportunity to maybe put a lot more capital to work here?

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Sanjai Suryaji Bhonsle, StoneCastle Financial Corp. - CEO & Chairman [16]

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Sure. This is Sanjai. I'll start off and then, Josh, maybe you can fill in some of the blanks later. So market disruptions are good. It kind of makes the market a little bit more rational. And -- but however, you also want to make sure the fundamentals don't crack, right? And so from -- if we were to look at our portfolio today, what are they, community banks, locally based, don't really have any international exposure, and like I just mentioned, coming off some pretty strong earnings and fairly well-capitalized balance sheet. So with that as a backdrop, obviously, some market disruption is good for credit markets because it kind of resets people's expectations. And so to that end, we are hoping that rates do see a little bit of less sloppiness. And that as we structure these new deals that we're all looking together, we can actually get returns that are meaningfully more than what we're seeing, historically speaking. And so -- but again, I just want to make sure that the fundamentals are still intact as we look at all these investments, Josh?

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Joshua Siegel, [17]

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Devin, the only thing I would add is, if you remember and step back, we lend to lenders. That's our job. So obviously, a market correction is really not a fun day for an equity investor, common equity, but it's actually pretty good for debt. It puts us in a more leaning forward position because we want to see spreads back out. We're not terribly worried given the equity capitalization that Sanjai just mentioned, inside of the bank, he's not worried about a failure risk due to a market correction. We want to see some change in pricing, but so do our banks. They would like to see credit spreads expand. With a flat to inverted yield curve, it's obviously not the most ideal for a depository, but if they have a rationale to start pushing up credit spreads a little bit, makes a big difference, right, straight to the bottom line. So a bank can go from a 90 bp ROA to a 110 just by increasing its loan yield 20 basis points. That's a meaningful change. When you think about the levered benefit of that. So I hate to say we ever, sort of, are hoping and looking forward to a correction. But yes, in kind of a strange way, I think Sanjai and I -- we are -- and I definitely echo Sanjai's point about if you had to have an exposure to the markets, a Middle America community bank secured lending play, yes, I'd rather be there than dealing with the supply chain out of China.

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Devin Patrick Ryan, JMP Securities LLC, Research Division - MD and Senior Research Analyst [18]

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Absolutely. Appreciate the color, guys. Maybe a follow-up here. Sanjai, you had mentioned, just in terms of the overall investment strategy, you're looking, in addition to community banks, firms that sell goods and services to banks. And I know that was already, in some ways, part of the StoneCastle strategy. But I'm just curious, kind of, how you guys are thinking about that as an opportunity, the types of firms that fit into that bucket? And then what percentage you guys might be comfortable with in terms of, kind of, call it, nontraditional bank investments?

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Joshua Siegel, [19]

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Sure. We've seen a couple, still nothing that we want to act on. There is something that came in the door funny enough today. That is something that I haven't even yet briefed Sanjai on, that came in the door this afternoon. So we are seeing some interesting things coming through. Nothing that gets us terribly excited at the moment either because the risk is a little bit more than what we should be doing. And we're not a venture capital firm. So we're not going to take that kind of risk. But if we can effectively put dollars against a predictable series of cash flows or a well-capitalized company, that makes sense. So I would say, in the short term, we're still going to focus more on the alternative capital space, just better value and more probability of getting good credit at attractive rates. But don't be surprised if in next 6 months, you do see one of these bank-related transactions.

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Devin Patrick Ryan, JMP Securities LLC, Research Division - MD and Senior Research Analyst [20]

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Got it. Okay, great. Maybe last one here on just expenses and expense management. You guys have done a great job, I think, taking cost out of the system and just being -- you're pretty diligent, especially as the platform has remained somewhat steady in size. I guess, on one hand, is there anything more that you can do on the expense side, just at the current size? And then maybe talk a little bit about the expense ratios, if you will, as the firm scales? Because hopefully, the opportunity here is that you're going to clearly be able to grow quite a bit more with this combination. And so the firm will scale, and that's a good opportunity for investors. So maybe just make the case on -- kind of, on the expense side by the amount of leverage that you can get off of the expense base from here?

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Patrick Joseph Farrell, StoneCastle Financial Corp. - CFO [21]

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Yes, this is Pat. I mean, obviously, if you look at our expenses, you can see that in terms of what's variable, what can change over time, a lot of these -- most of these are pretty much fixed in terms of the insurance expense, valuation printing, directors' fees, bank fees, et cetera, a lot of -- even transfer fees and professional fees. The things that are moving would be interest expense. We've seen that moving downward for the last year or so as a combination of what we borrowed and also raised. So certainly, as we grow, you're going to see that line item increase. But all those other ones I mentioned, you're going to see those remain the same. And that's where our savings and our improvements and our expense ratio is going to come from. I would argue that for this type of fund, it's the income side that's more exciting rather than focusing on expense ratio. And I'm not saying you are. But typically, when people look at expense ratios, they're, like, wow, that's really high. But here, since that expense ratio has that leverage in there, you really got to look at the net number to see what's -- what we're producing for the investor.

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Operator [22]

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We have reached the end of our question-and-answer session. I would like to turn the call back over to management for closing remarks.

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Sanjai Suryaji Bhonsle, StoneCastle Financial Corp. - CEO & Chairman [23]

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Thank you, operator. And thank you all for listening. I look forward to visiting with you all here in the near future. And I also want to offer my sincere thanks for your support of StoneCastle Financial. And thank you, and good night.

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Operator [24]

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Thank you. This does conclude today's conference. You may disconnect your lines at this time, and thank you for your participation.