BlackRock TCP Capital Corp. (NASDAQ:TCPC) Q4 2022 Earnings Call Transcript February 28, 2023
Operator: Ladies and gentlemen, good afternoon. Welcome, everyone, to BlackRock TCP Capital Corp.’s Fourth Quarter 2022 Earnings Conference Call. Today’s conference call is being recorded for replay purposes. During the presentation, all participants will be in a listen-only mode. A question-and-answer session will follow the Company’s formal remarks. And now, I would like to turn the call over to Katie McGlynn, Director of BlackRock TCP Capital Corp. Investment Relations team. Katie, please proceed.
Katie McGlynn: Thank you, Tia. Before we begin, I’ll note that this conference call may contain forward-looking statements based on the estimates and assumptions of management at the time of such statements and are not guarantees of future performance. Forward-looking statements involve risks and uncertainties and actual results could differ materially from those projected. Any forward-looking statements made on this call are made as of today, and are subject to change without notice. Additionally, certain information discussed and presented may have been derived from third-party sources and has not been independently verified. Accordingly, we make no representation of warranty with respect to such information. Earlier today, we issued our earnings release for the four quarter and full year ended December 31, 2022.
We also posted a supplemental earnings presentation to our website at www. tcpcapital.com. To view the slide presentation, which we will refer to on today’s call, please click on the Investor Relations link and select Events and Presentations. These documents should be reviewed in conjunction with the company’s Form 10-Q which was filed with the SEC earlier today. I will now turn the call over to our Chairman and CEO, Raj Vig.
Raj Vig: Thanks, Katie, and thank you all for joining us for TCPC’s fourth quarter and year end 2022 earnings call. I will begin today’s call with a few comments on the market environment and provide an overview of our fourth quarter and full year results. I will then turn the call over to our President and Chief Operating Officer, Phil Tseng, who will provide an update on our portfolio and investment activity. Our CFO, Erik Cuellar, will review our financial results, as well as our capital and liquidity positioning in greater detail. I will then conclude with a few closing remarks, before we take your questions. 2022 was a year in which the equity and fixed income markets experienced significant volatility, particularly in the latter half of the year.
This was driven by a combination of geopolitical uncertainty and the Federal Reserve’s ongoing actions to aggressively raise interest rates in order to curb inflation, an effort that appears will continue for the foreseeable future. This volatility persisted in the fourth quarter and adversely impacted spreads across fixed income markets, including middle market loan spreads. No sector or asset class was immune to the market volatility and in the fourth quarter, we experienced a decline in NAV due in part to the market volatility, but mostly due to lower valuations on three specific portfolio companies and company-specific items. I will touch on these in more detail later. Excluding the impact of these three names, our NAV decline would be closer to 3%.
In this environment, our team has more than two decades of experience lending through multiple market cycles, and our ability to work with our portfolio companies to manage through challenging operating environments is particularly valuable. We are also reminded of the benefits of direct lending that have historically delivered premium yields to the liquid markets and importantly, better downside protection in periods of market turbulence. One aspect of our investment strategy has led to strong downside protection and very low loss rates throughout our history has been our strong portfolio management and monitoring procedures. In addition to the ongoing monitoring our deal team to perform over investments in their individual portfolios, on a quarterly basis, TCPC’s Investment Committee also performs a several review of every company in the portfolio.
As part of this process, the same Deal team members that originated and underwrote these investments review the company’s most recent financial performance and engage in dialogue with the business owners and operators to assess both current and projected performance relative to our original underwriting assumptions. All of this is conducted within the context of our deep industry expertise. We evaluate each borrower’s ability to manage in times of stress, using both a forward-looking and historical lens. Additionally, our industry expertise has always enabled us to underwrite loans with strong lender protections in the form of covenants specifically tailored to contemplate both company and industry-specific dynamics. As you can imagine, these existing protections are more important today given the market environment as they allow us to take any actions required to protect our capital.
Before providing highlights from our fourth quarter and full year financial results, I’d like to provide some more context to the sequential decrease in our NAV. In addition to the more normative valuation adjustments across the portfolio due to wider market spreads in the quarter, two-third of the total unrealized losses recorded in the fourth quarter was attributable to three portfolio companies. Edmentum, Razor and AutoAlert. Each of these write-downs was driven by a unique set of circumstances impacting the company and/or the industry unless they operate. It is important to emphasize that the issues driving these valuation impacts are isolated. And in the case of Edmentum and Razor driven by exposure to well-performing equity investments, which tend to have more mark-to-market volatility.
Importantly, the credit quality of our portfolio remains in excellent shape. In the case of Edmentum, as many are aware, the company has delivered very strong performance over the last several years, driven in part by the ongoing shift to online running, which led to significant write-ups and significant realized gains on our investment. While Edmentum’s performance continues to be strong, the pace of growth and demand for online learning tools coming out of COVID has slowed but continues. Given the normalization of growth in the sector, combined with a more moderate outlook and general public market valuation declines, the value of our investment was marked down in the fourth quarter. However, the overall performance of our investment has been very positive, and we remain confident in the long-term performance of Edmentum.
Razor Group is the consolidator of small to medium-sized brands that sell through Amazon’s third-party platform. While we continue to view our loan to Razor as well covered, the company’s enterprise value has been pressured by the challenges facing the broader Amazon ecosystem, which resulted in a reduction of the value of our warrants as well as a modest decline on the value of our first lien level. Finally, Auto Alert is a company that provides marketing software to auto dealerships. Auto Alert was severely impacted at the start of the pandemic when other dealerships were closed and it has subsequently been impacted by the supply chain issues that have resulted in limited near — limited new car inventory. We are working with management and the sponsor on next steps.
We are encouraged by the fact that some of the macro issues seem to be abating and recent results reflect improving performance. Now turning to our fourth quarter and full year 2022 highlights. We delivered strong net investment income of $0.40 per share in the fourth quarter and $1.53 for the full year. Given the floating rate nature of our portfolio, our net investment income benefited from the increase in base rates in 2022, as well as wider spreads on new investments made throughout the year. As an acknowledgment of the higher ongoing earnings power of our portfolio, primarily driven by higher base rates, we announced a $0.02 per share increase in our dividend beginning with the fourth quarter dividend that was paid on December 31. And our Board of Directors today announced a $0.32 per share dividend distribution for the first quarter, payable on March 31 to shareholders of record on March 16, this, in addition to the $0.05 per share special dividend that was announced in December and paid last month to shareholders of record as of December 31.
As a reminder, we have always emphasized the stability of the dividend and the coverage through our recurring net investment income. Throughout TCPC’s history, we have consistently covered our dividends, we’re recurring net investment income, a commitment that remains important to us even with the recent dividend increase. Phil will discuss our fourth quarter and full year investment activity in more detail. But in summary, we are being disciplined in deploying new capital in this uncertain environment, while also taking advantage of the more lender-friendly investment environment. We reviewed a substantial number of transactions during the year and selectively deploy capital in a small percentage of those opportunities. Looking back at our historical performance as a public company, since 2012, and we have generated a 10.3% annualized return on invested assets and a total annualized cash return of 9.3%.
We believe our performance remains at the high end of our peer group, demonstrating our ability to consistently identify attractive opportunities, add premium yields and deliver exceptional returns to our shareholders across market cycles. Now I will turn it over to Phil to discuss our investment activity and portfolio positioning.
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Phil Tseng: Thanks, Raj. The public market volatility and uncertainty in the capital markets generally drove a slowdown in activity in 2022 versus the record levels in 2021. Positively though, we saw a meaningful shift toward a more lender-friendly investment environment marked by wider spreads and less pushback on deal terms. Against this backdrop, we continue to identify and review a significant number of potential investment opportunities as we capitalize on the scale of the broader BlackRock US private capital platform and the breadth of our team’s experience. At year-end, our portfolio had a fair market value of approximately $1.6 billion. 88% of our investments were senior secured debt spread across a wide range of industries, providing portfolio diversity, and minimizing concentration risk.
We also believe our portfolio is well positioned to perform amidst market uncertainty, given our emphasis on companies with established business models in less cyclical industries. The portfolio at quarter end consisted of investments in 136 companies an all-time high. As the chart on Slide 6 of the presentation illustrates, our recurring income is distributed broadly across our portfolio and is not reliant on income from any one company. In fact, more than 90% of our portfolio companies each contribute less than 2% to our recurring income. 85% of our debt investments are first lien, providing substantial downside protection and 94% of our debt investments are floating rate, proving an important benefit in this rising rate environment. Moving on to our investment activity.
We believe our deal source channel-agnostic approach and our industry specialization provides an advantage, particularly at a time that we’re seeing a slowdown in traditional sponsor-backed activity. Our industry-focused deal teams continue to identify unique investment opportunities from a wide range of sources, including directly through our industry context and management teams, in addition to our traditional sponsor relationships. In reviewing these opportunities, we emphasize transactions where we act as the lender of influence, which enables us to negotiate deal terms and conditions that we believe provide meaningful downside protection. These include substantial collateral and tailored covenant packages that are particularly important in periods of economic volatility like we are in today.
In addition, our industry specialization, which our borrowers value, bolsters our ability to assess and effectively mitigate risk in our underwriting and when we negotiate terms in the credit documentation. Despite the slowdown in activity in 2022, TCPC invested $338 million, including $75 million in the fourth quarter. The deployment in the fourth quarter included loans to seven new and six existing portfolio companies. Following investments in existing holdings continue to be an important source of opportunity for us. In terms of dollars invested, 50% of total investments in the fourth quarter and 44% in the full year of 2022 were in existing portfolio companies. We believe this incumbency is an important advantage, where we source investments given these are companies who already know and understand well, we’ve seen them execute on their investment thesis and have a healthy existing dialogue with the management team.
TCPC’s largest investment during the fourth quarter was a senior secured first lien loan to Madison Logic, a provider of account-based and a content marketing services to B2B marketers. We view this as an opportunity to invest in an industry leader that is benefiting from tailwinds in account-based marketing sector. We also believe that the high ROI on account-based marketing versus other marketing services will be more resilient in periods of economic stress. BlackRock’s prior experience and expertise in the complex account-based marketing sector, allowed us to understand the real merits of the credit and obtain a conservative deal structure at an attractive risk-adjusted return. Our second largest investment in the quarter was a senior secured first lien term loan to Integrity Marketing, the leading independent distributor of life and health insurance products in the US.
During the fourth quarter, given our familiarity with the business model, the industry and our relationship with the sponsor, we led an incremental first lien term loan to the company to support ongoing M&A. Integrity operates in a stable and growing segment of the insurance market. It has demonstrated a track record of strong organic and inorganic growth. New investments in the fourth quarter were offset by total dispositions of $75 million. The overall effective yield on our debt portfolio increased from 9.2% at the end of 2021 to 12.7% at the end of 2022, reflecting the benefit of higher base rates, as well as higher spreads. Investments in new portfolio companies during the quarter had a weighted average effective yield of 12.2%, exceeding the 9.9% weighted average effective yield on exited positions.
As I noted earlier, we are seeing a shift toward a more lender-friendly environment with improvements in both pricing and terms relative to 12 and even six months ago. Year-to-date, we have seen a modest pickup in activity and have been investing selectively, maintaining our underwriting discipline and being mindful of the inflationary environment. We emphasize companies that have significant pricing power to pass on higher input costs, including increases in their cost of capital. It’s also important to note that we did not underwrite to perfection, but we do build in sufficient buffers to ensure companies can withstand higher costs and changes in the market environment without impairing their ability to service our loans. Our pipeline continues to remain healthy and the yields on investments in our pipeline are generally in line with our current portfolio.
To-date, we have had limited prepayment income in the first quarter. Let me now turn it over to Erik to walk through our financial results as well as our capital and liquidity positioning.
Erik Cuellar: Thank you, Phil. As Raj noted, our net investment income in the fourth quarter benefited from the increases in base rates in 2022. Net investment income of $0.40 was up nearly 30% versus the fourth quarter of 2021, and it exceeded the fourth quarter dividend of $0.32 per share. On an annual basis, net investment income was $1.53, an increase of approximately 22% over 2021. Today, as Raj noted, we declared a first quarter dividend of $0.32 per share. We remain committed to paying a sustainable dividend that is fully covered by net investment income as we have done consistently over the last 10-plus years. Investment income in the fourth quarter was $0.81 per share. This included recurring cash interest of $0.68, recurring discount and fee amortization of $0.02, and fixed income of $0.05.
Investment income also included $0.02 of dividend income, $0.01 of other income, and $0.03 from accelerated O&D and exit payment. As a reminder, we amortize upfront economics over the life of an investment rather than recognizing all of it at the time of the investment in May. Operating expenses for the fourth quarter were $0.33 per share and included interest and other debt expenses of $0.18 per share. Incentive fees in the quarter totaled $4.9 million or $0.08 per share. Net unrealized losses in the fourth quarter totaled $71 million or $1.22 per share. As Raj discussed earlier, unrealized losses were primarily driven by three items; a $21.5 million unrealized loss on our loan to — and unrealized losses in our investments in Edmentum and Razor Crew of $18.6 million and $6.3 million, respectively, as well as unrealized losses across the portfolio from wider market spreads.
Net realized losses for the quarter were only $46,000. The net increase in net assets for the quarter was $47.8 million or $0.83 per share. We have a robust valuation process and substantially all of our investments are valued every quarter using prices provided by independent third-party sources. These include quotation services and independent valuation services. And this process is also subjected to rigorous oversight, including back testing of every disposition against our valuation. The credit quality of our overall portfolio remains strong. We placed our loans to AutoAlert on non-accrual during the fourth quarter. A total of three portfolio companies are now on non-accrual, representing only 2.0% of the portfolio at fair value and 4.2% at cost.
Turning now to our liquidity. Our balance sheet position remains strong, and we ended the quarter with total liquidity of $367 million, relative to our total investment of $1.6 billion. This included available leverage of $286 million and cash of $82 million. Unfunded loan commitments to portfolio companies at quarter-end equaled 8% of total investments or approximately $127 million, of which only $28 million were revolver commitment. Our diverse and flexible leverage program includes two low cost credit facilities, two unsecured note issuances and an SBA program. Notably, our unsecured debt continues to be investment grade rated by both Moody’s and Fitch. Given the modest size of each of our debt issuances, we are not overly reliant on any single source of financing and our maturities remain well added.
Additionally, we are comfortable with our current mix of secured and unsecured financing, and do not have any immediate financing needs. Combined, the weighted average interest rate on our outstanding borrowings, increased modestly to 3.9% from 3.26% at the end of 2021. That is an increase of only 64 basis points while base rates increased approximately 4.25%. This is the result of currently having over 75% of our borrowings from fixed rate sources. Now, I’ll turn the call back over to Raj.
Raj Vig: Thanks, Eric. While the economic outlook may be uncertain, our team is focused on delivering the results our shareholders have come to expect from TCPC. We remain highly disciplined in our underwriting. We make investment decisions based on a comprehensive analysis of each company, its management team and strategy and relevant industry dynamics. Our investment committee evaluates each investment and regularly monitors the financial performance of each of our holdings. From our perspective, where we are in the credit cycle, that is less than our ability to selectively capture opportunities throughout the cycle. To that end, we draw upon our team’s two decades of experience and BlackRock’s extensive resources to prudently identify opportunities that align with our selective investment approach while providing our borrowers with financing solutions to help grow their businesses.
We continue to source strong senior secured credit opportunities, which have historically outperformed equities, bonds and other unsecured debt through economic downturns. While underweight highly cyclical industries, we will also continue to maintain a broadly diversified portfolio. In closing, while 2022 presented challenges, we successfully navigated the evolving environment and are cautiously optimistic about the year ahead. We remain focused on generating strong adjusted returns for our shareholders. And with that, operator, please open the call for questions.
See also Early Retirement Portfolio: 15 Stocks to Live Off Dividends and Value Investor Joel Greenblatt’s Dividend Stocks .
Q&A Session
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Operator: We will now begin the Q&A session. The first question comes from the line of Robert Dodd with Raymond James. Please proceed.
Robert Dodd: Hi guys. Couple of questions about the NAV, on AutoAlert and then the equity pieces in a second. I mean, to your point, it was impacted in the beginning of the pandemic, and then supply chain and getting new vehicles, et cetera. I mean, none of those trends seem to be particularly new yet the markdown this quarter was obviously pretty significant, I mean, $21.5 million. Can you give us any more — what was the fact that it was originally meant to mature in January? Obviously, it hasn’t, or can you give us what was the driver of that being so large, the markdown being so relatively large when the trends you described don’t seem to be particularly new or new in the fourth quarter 2022?
Raj Vig: Hey, Robert, it’s Raj. Thank you. I’ll try to answer that in the way I can, and there’s probably some elements that I can’t address directly. But I would say that the trends aren’t new. I agree with that. The compound effect — I mean, but the trends are neither a one quarter trend. And you have accumulating and compounding effect of things coming out of the pandemic that are top line oriented, either dealership shutting down. And then as they are opening up, you have an inability to actually get the inventory because the supply chain issues that hinder the value proposition of the business, the applicability of it. So I think you had a series of things that compound that led to finally non-accrual, and I guess, an acquiescence if you will, on — in terms of where the company is and where they need to go.
Ironically, coming out of Q4, couple of other things that actually abated. The supply chain issues are loosening up. We are seeing some early signs of recovery. But I think to answer your question, you’re capturing the wood saw effect of things that are creeping through the prior couple of years, accumulating in a way in this quarter on a company basis, and then there are some external data points that we just have to take into account that I think really brought the valuation into something in the range that we’re talking about here. And I think there’ll be more detail that we can provide in subsequent quarters. But I would try to leave the answer at that, hopefully it addresses your question.
Robert Dodd: It does answer that part of the question. I mean, obviously, the maturity on the loan was February 15th, which has already passed. I think if they did repay since quarter end, you would have probably said so. So I’m going to presume that it hasn’t. Was all of that taken into account whatever the situation actually is today at the time the fair value was determined at 12/31 or we got — is Q1 going to be another evaluation given it probably, I’m guessing, I missed the maturity there?
Phil Tseng: Yeah, Robert, this is Phil. Thanks for that follow-up. So you’re right, the maturity is imminent, and that has precipitated deeper discussions with the management team and the private sponsor on next steps. We can’t provide too many details at this point, but we’re eager to perhaps next quarter. But I think it’s important to note that what Raj had mentioned, which is the signs of improving performance on the business. And perhaps it’s worthwhile giving a quick reminder. AutoAlert, a software and data analytics business used by auto dealerships to drive sales growth, but in the past several years, with inventory levels being so low due to supply chain, as we’ve discussed, and consumer demand being so robust kind of post pandemic, the dealerships just couldn’t keep cars on the lots, so the need for sales optimization software with less of a parity.
