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Edited Transcript of KCAP earnings conference call or presentation 7-Nov-18 2:00pm GMT

Q3 2018 KCAP Financial Inc Earnings Call

NEW YORK Nov 7, 2018 (Thomson StreetEvents) -- Edited Transcript of KCAP Financial Inc earnings conference call or presentation Wednesday, November 7, 2018 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Dayl Pearson

KCAP Financial, Inc. - President & CEO

* Ted Gilpin

KCAP Financial, Inc. - CFO, Secretary & Treasurer

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Conference Call Participants

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* Paul Johnson

Keefe, Bruyette & Woods - Analyst

* Christopher Nolan

Ladenburg Thalmann - Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and welcome to the KCAP Financial, Inc. conference call. An earnings repress release was distributed yesterday. (Operator Instructions). As a reminder, this conference call is being recorded today, Wednesday, November 7, 2018. (Operator Instructions).

Today's conference call includes forward-looking statements and projections and we ask that you refer to KCAP Financial's most recent filings with the SEC for important factors that would cause actual results to differ materially from these projections. KCAP Financial does not undertake to update its forward-looking statements unless required by law.

I would now like to introduce your host for today's conference, Mr. Dayl Pearson, President and Chief Executive Officer of KCAP Financial. Mr. Pearson, you may begin.

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Dayl Pearson, KCAP Financial, Inc. - President & CEO [2]

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Good morning and thank you all for joining KCAP Financial for a review of our third-quarter 2018 results. Today I will review key highlights and activities from the quarter as well as provide context for our direct lending business and the performance of our Asset Manager Affiliates. I will then turn over the call to our Chief Financial Officer, Ted Gilpin, who will provide a more thorough review of our operating and financial results for the quarter. We will then open the line for your questions.

Our performance in the third quarter was consistent with the year ago period and we are pleased with the stability of our business. We recognize that while we are continuing to execute on our strategy of lowering our borrowing costs, optimizing our balance sheet and positioning ourselves for growth, we are operating in a highly competitive environment. This is particularly true of good quality investment opportunities and, as a management team, we are continuing to evaluate a number of actions we can take to put KCAP in a better position to put our capital to work prudently and efficiently.

Let me briefly touch on our sources of liquidity. As you will recall, we have a credit line of $50 million of which approximately $27 million remained undrawn as of September 30, and we also had cash on hand at September 30 of $27 million. So, our September 30 dry powder was approximately $54 million.

We have issued a redemption notice for the remaining $7 million of our 7.375 bonds which are due next October, so that would reduce the dry powder to $47 million. We also have a large pipeline of potential new deals with a reasonably high probability of closing in the fourth quarter or first quarter of next year. Fourth quarter has historically been one of our better quarters for originations.

Now let me give you a high-level summary of our third-quarter 2018 financial highlights before handing the call over to Ted. For the third quarter our net investment income was approximately $3 million or $0.08 per share, up from $0.06 per share in the second quarter. NII for the nine months ended September 30 was $0.21 per basic share, while estimated taxable distributable income for the nine months was $0.24 a share. Some of the improvement in NII came from repayments and exits on investments and also operating efficiencies.

Turning to our performance of our Asset Manager Affiliates during the quarter, Trimaran successfully closed a new $400 million CLO, Catamaran CLO 2018-1, during the third quarter, and KCAP purchased approximately 24% of the subordinated securities issued by that CLO. For the first nine months the AMAs have distributed $1.9 million to KCAP versus $2.2 million for the same period last year.

We recognized $750,000 of income on our joint venture investment during the third quarter, up from $685,000 for the third quarter of 2017. We are pleased with the performance of the joint venture and it is in line with our expectations.

Our third-quarter distribution was $0.10 per share, the same as the second quarter of 2018. At the end of the quarter we had approximately $27 million investable cash, as I mentioned, which we intend to deploy in transactions that can generate cash flows we need to fund further distributions to shareholders.

As of September 30, 2018, our weighted average mark to market on par for our debt securities was 93, slightly lower than the market in the second quarter. In terms of our CLO portfolio, our weighted average mark to market to [Paul] was 71.9, slightly higher than the prior quarter end.

The market for new CLO funds continues to be strong and we could see another reset or perhaps two resets in the near future. And while we have already done a fair amount of resets, there is always potential to do more. We will keep you updated on our decisions when they are made.

Our 100% ownership of our Asset Manager Affiliates was valued at approximately $35.8 million based upon assets under management and prospective positive cash flows. The AMAs have approximately $3.2 billion of assets under management with all CLO 1.0 deals redeemed and six 2.0 CLOs in the JV outstanding. Our CLO funds securities portfolio at the end of the quarter was approximately $48 million.

At the end of the third quarter debt securities approximated $140 million and represented 51% of our investment portfolio. Secured loans now represent 96% of the debt securities portfolio. All CLOs managed by our Asset Manager Affiliates continue to be current equity distributions and all management fees. The income stream from our AMAs allows them to make periodic distributions to us during the quarter. There was a distribution of $300,000.

We remain focused on reshaping the portfolio so that we can put capital to work and generate returns for our shareholders. We are open-minded in avenues that generate value and are constantly looking at opportunities to create shareholder value. And now I will ask Ted Gilpin to walk through the details of our financials. Ted?

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Ted Gilpin, KCAP Financial, Inc. - CFO, Secretary & Treasurer [3]

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Thank you, Dayl. Good morning, everyone. As of September 30, 2018 net asset values stood at $4.66 compared with $4.87 as of December 31, 2017. As Dayl just mentioned, our net investment income was $2.9 million or $0.08 per basic share for the third quarter of 2018. Net investment income for nine months ended September 30, 2018 was $0.21 per basic share, while the estimated taxable distributable income for the nine months of 2018 was $0.24 per basic share.

Interest income on our debt securities for the quarter ended September 30, 2018 was $4.8 million or $0.13 per basic share compared with $4.3 million or $0.12 per share for the second quarter of 2018. Interest income on our debt securities was $2.4 million or $0.06 per share in the third quarter of 2017.

Our debt securities portfolio contribution to total investment income for the quarter was 67%, which compares to approximately 62% for the second quarter of 2018 and 39% for the third quarter of 2017. Investment income from CLO funds securities decreased to $1.3 million or $0.03 per basic share in the third quarter of 2018 from $1.5 million or $0.04 reported in the second quarter of 2018 and $2.8 million or $0.08 per share in the third quarter of 2017.

We receive distributions from our Asset Manager Affiliates of $300,000 or $0.01 per share in the third quarter of 2018, none of which is expected to be returned to capital. The Asset Manager Affiliates distributed $800,000 or $0.02 per basic share in the second quarter of 2018, $500,000 of which was returned to capital.

For the three months ended September 30, 2018 total expenses were higher by $480,000 or $0.01 per basic share compared to the same period in 2017, primarily attributable to the increase in interest expense.

The Company recorded net realized and unrealized losses on investments of approximately $1.6 million or $0.04 per share for the three months ended September 30, 2018 compared with net realized and unrealized losses of approximately $3.8 million or $0.10 per share for the three months ended June 30, 2018 and net realized and unrealized gains of approximately $816,000 or $0.02 per share in the third quarter of 2017.

On the liability side of our balance sheet, as of September 30, 2018, we had approximately a $107 million par value of borrowings outstanding with a weighted average interest rate of approximately 6.1%. Our asset coverage ratio at quarter end was 259%, compliant with the current minimum required 200% for BDCs.

As you know BDCs can increase their leverage under our newly passed statute and KCAP's Board has approved the adoption of the new leverage, which will become effective March of 2019. KCAP would still be restricted in its ability to increase leverage by covenants in our outstanding publicly traded debt, but of course the new asset coverage ratios could give us significantly more flexibility in the future. Subsequent to the quarter end we redeemed the remaining $7 million par outstanding of our 7.375% notes.

With that we'd now like to turn the call over to you for any questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions). Paul Johnson, KBW.

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Paul Johnson, Keefe, Bruyette & Woods - Analyst [2]

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When I look at your portfolio, I mean it appears that the debt portfolio shrank third quarter 2018, but the CLO investments increased with the new CLO you guys issued. However, when I look at the interest income, it appears that the interest income increased while the CLO income fell quarter over quarter. And I was hoping you could reconcile the two. I mean, are there any kind of one-time items or fees that are flowing through the interest income line to make that appear so?

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Dayl Pearson, KCAP Financial, Inc. - President & CEO [3]

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Yes, I think the debt portfolio shrank primarily because of the repayment of the loan we made to Trimaran for the first loss in the warehouse. Since that warehouse closed out on September 27, that $23 million was repaid on September 27.

So other than that, our portfolio was up a bit if you took that out. So I think you've got to adjust for that. So we had the entire interest for the entire quarter on that $23 million at 9%. So that -- if you wanted to back that out you could do a pro forma and (multiple speakers).

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Ted Gilpin, KCAP Financial, Inc. - CFO, Secretary & Treasurer [4]

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And conversely, very little earnings on the new investment in the CLO.

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Dayl Pearson, KCAP Financial, Inc. - President & CEO [5]

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Correct. The investment in the CLO closed on the same day, so that $10 million investment we had was essentially no earnings on in the quarter. So you'd have to take that $10 million and put it into the numbers for the full quarter to sort of do the complete pro forma.

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Paul Johnson, Keefe, Bruyette & Woods - Analyst [6]

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Sure, that makes sense. That makes sense. And then, when I look at professional expenses -- I mean, this quarter it was around $900,000 or so. I mean, is that a good run rate? Because we've kind of consistently been a little bit under what you guys have put up there. But is $900,000 a quarter -- is that reasonable?

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Ted Gilpin, KCAP Financial, Inc. - CFO, Secretary & Treasurer [7]

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It should come back down again. There's a few items in the third quarter which raised that -- there's about $130,000 of things in the third quarter that aren't normally in the quarter. And as you know, we've had some other higher expenses through the years, mostly in legal fees. So we would expect that to come down a little bit more.

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Paul Johnson, Keefe, Bruyette & Woods - Analyst [8]

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Okay. And lastly, this quarter you guys -- there was a pretty good yield on your -- your JV. I think it was around like a 14.1% annualized yield, which is very good. I mean is that -- I mean is it reasonable to expect that that's what we can get going forward on your JV investment there?

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Dayl Pearson, KCAP Financial, Inc. - President & CEO [9]

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Obviously that's somewhat variable. I think when we upsized the JV in the fourth quarter of 2017, in order to be fully invested we had a fair amount of broadly syndicated loans in that upsize by $100 million. So those have lower yields in it. And over the course of the last three quarters we've rotated out of some of those lower yielding loans and therefore substituted those with middle market loans which have higher yields on them. So I think that's why that yield has moved up over the course of the year.

Now we get repayments and when we get repayments on an L500 loan and we want to keep it fully invested and we -- obviously, and we buy a L350 broadly syndicated loan that's going to have an impact. So it's going to be subject to the rapidity of repayments and the pipeline of new senior loan -- middle market loans.

That pipeline is picking up in the last few weeks, and so we would expect to continue to rotate out of some lower yielding loans. But then again, there are probably going to be some prepayments. There already have been some prepayments since the end of the quarter.

But we think it's going to be in that range of what it's been up till now. We'd like to keep it there but, as you know, spreads are under pressure to some extent. You do pick up a little bit with rising LIBOR because your liabilities are not 100% matched with your assets and the equity here is a pretty big chunk. So rising LIBOR has -- helps that as well.

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Operator [10]

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Christopher Nolan, Ladenburg Thalmann.

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Christopher Nolan, Ladenburg Thalmann - Analyst [11]

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Hey, guys. Ted, what's the weighted average portfolio yield in the quarter? I didn't see it in the Q.

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Ted Gilpin, KCAP Financial, Inc. - CFO, Secretary & Treasurer [12]

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I have to find it for you, Chris. Hold on one second.

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Christopher Nolan, Ladenburg Thalmann - Analyst [13]

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And I guess while Ted is looking for that -- Dayl, are there any plans to redeem the 6.125 notes?

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Dayl Pearson, KCAP Financial, Inc. - President & CEO [14]

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Well, they are not callable until September of 2019. We're always looking at alternatives and so there's a potential to redeem those notes next year so that we can take advantage of the higher leverage number. But since we're not anywhere near our leverage limit at this point there's not a rush and we can't call them until next September.

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Christopher Nolan, Ladenburg Thalmann - Analyst [15]

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And then on the leverage question, your leverage is still pretty low. Is the plan -- is the headwinds to you just repayments and so forth or are you sort of -- just other things?

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Dayl Pearson, KCAP Financial, Inc. - President & CEO [16]

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Yes, well, as I think I mentioned, there is a bit of seasonality in our origination business. Third-quarter probably being -- third quarter and first quarter being the worst, probably third quarter being worse than the first. So we did have some prepayments in the quarter and we would expect that in the fourth quarter we will -- we have a pretty robust pipeline of deals. And so, we would expect to start to tap more significantly into our credit facility.

We do have the ability and we've discussed with our banks that they are all very happy and we could potentially upsize that credit facility from 50 to something higher in the future. But obviously that's subject to their approval and subject to our having the assets that we like available to do that.

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Ted Gilpin, KCAP Financial, Inc. - CFO, Secretary & Treasurer [17]

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It's on the weighted -- the yield is on page 63, debt securities portfolio. But as of September 30, the weighted average contraction interest-rate on the loans and debt securities was approximately 10%. If you adjust that for things on partial nonaccrual it's more like 9% -- 8.9%.

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Christopher Nolan, Ladenburg Thalmann - Analyst [18]

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Great. Thank you, Ted. Last quarter you had two PIK nonaccruals, partial nonaccruals. Are those still there.

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Dayl Pearson, KCAP Financial, Inc. - President & CEO [19]

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Correct.

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Christopher Nolan, Ladenburg Thalmann - Analyst [20]

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And then Grupo HEMA continues to be on nonaccrual. You marked it down a little bit. I mean, what's the outlook for that given everything going on in Puerto Rico?

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Dayl Pearson, KCAP Financial, Inc. - President & CEO [21]

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Well, the Company has performed reasonably well. The leverage is quite reasonable. It's I think somewhere south of 5 times leverage, total leverage, which is not unreasonable for a hospital chain. They survived the hurricane last year quite well. I think part of the issue they've had has been the liquidity issue. A lot of their accounts receivable folks have been harder hit by the hurricane than they have, so there's been a slow to that. They are negotiating through that.

I think we're pretty confident that there's a way forward there. I think they just need some time to deal with the receivables, which they are doing a really terrific job of managing. So we are pretty positive on that. The first lien is particularly well positioned and we think the second lien, again at a total leverage of less than 5 times, is pretty well covered at this point.

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Christopher Nolan, Ladenburg Thalmann - Analyst [22]

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Great. Thanks, Dayl.

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Dayl Pearson, KCAP Financial, Inc. - President & CEO [23]

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That being said, there's a lot of uncertainty in Puerto Rico. And so, that's why we've marked it down. And that was also a name that was reviewed -- is reviewed by our outside valuation advisor.

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Christopher Nolan, Ladenburg Thalmann - Analyst [24]

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Yes, to support the economy down there, have your Analyst Day next year down there.

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Dayl Pearson, KCAP Financial, Inc. - President & CEO [25]

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There you go, not in the summertime though.

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Operator [26]

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I am showing no further questions in the queue at this time. I'd like to turn the call back over to Dayl Pearson for any closing remarks.

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Dayl Pearson, KCAP Financial, Inc. - President & CEO [27]

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Thank you all and we'll be speaking again soon. Thank you.

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Operator [28]

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Ladies and gentlemen, thank you for your participation in today's conference. This does conclude your program and you may all disconnect. Everyone have a great day.