First Eagle Alternative Capital BDC, Inc. (NASDAQ:FCRD) Q1 2022 Results Conference Call May 10, 2022 9:30 AM ET
Sabrina Rusnak-Carlson – General Counsel
Chris Flynn – President, First Eagle Alternative Credit
Jen Wilson – Chief Accounting Officer
Jim Fellows – Chief Investment Officer
Conference Call Participants
Lee Cooperman – Omega Family Office
Ryan Lynch – KBW
Matt Tjaden – Raymond James
Good morning, and welcome to First Eagle Alternative Capital BDC, Inc. earnings conference call for its first fiscal quarter ended March 31, 2022.
It is my pleasure to turn the call over to Sabrina Rusnak-Carlson of First Eagle Alternative Capital BDC, Inc. Ms. Rusnak-Carlson, you may begin.
Thank you, operator. Good morning, and thank you for joining us. Joining me on today’s call are Chris Flynn, President of First Eagle Alternative Credit; Jen Wilson, our Chief Accounting Officer; Jim Fellows, our Chief Investment Officer.
And before we begin, please note that statements made on this call may constitute forward-looking statements within the meaning of the Securities Act of 1933 as amended. Such statements reflect various assumptions by First Eagle Alternative Capital BDC concerning anticipated results that are not guarantees of future performance and are subject to known and unknown uncertainties and other factors that could cause actual results to differ materially from such statements.
The uncertainties and other factors are, in some ways, beyond management’s control and include the factors included in the section entitled Risk Factors in our most recent annual report on Form 10-K as updated by our quarterly report on Form 10-Q and our periodic and other filings with the Securities and Exchange Commission. Although we believe that the assumptions on which any forward-looking statements are based on are reasonable, any of those assumptions could prove to be inaccurate. And as a result, the forward-looking statements based on those assumptions also could be incorrect.
You should not place undue reliance on these forward-looking statements. First Eagle Alternative Capital BDC undertakes no duty to update any forward-looking statements made herein unless required by law. All forward-looking statements speak only as of the date of this call. Our earnings announcement and 10-K were released yesterday afternoon, copies of which can be found on our website, along with our Q1 earnings presentation that we may refer to during this call.
A webcast replay of this call will be available until May 14, 2022, starting approximately 2 hours after we conclude this morning. To access the replay, please visit our website at www.feacbdc.com. With that, I’ll turn the call over to Chris.
Thanks, Sabrina. Good morning, and thank you for joining us on our earnings call. On today’s call, I want to discuss recent actions we’ve taken to drive strategic initiatives as well as review our first quarter results and share some portfolio highlights. From there, I’ll hand the call over to Jen to discuss our portfolio and financial results in more detail.
We had a busy quarter working toward our 3 strategic initiatives: one, reducing our cost of debt; two, increasing our portfolio yield; and three, increasing our portfolio diversification. We made progress on these 3 goals this year. First, we’ve effectively reduced our debt financing. As announced in Q1 through our 8-K, we amended our credit facility to reduce the weighted average borrowing cost by 26 basis points. Further, since December 31, 2020, we have reduced our weighted average borrowing cost by 148 basis points.
Second, we refinanced the Logan JV into a middle market CLO structure, which we expect to increase the dividend to FCRD as a result of this incremental leverage. We are very pleased that we were able to close the Logan JV CLO transaction on April 19. Despite a challenging market stemming from the war in Ukraine, inflationary pressures, competition for AAA buyers, we were able to secure a deal that we believe is favorable to our shareholders, and that’s thanks to the overall strength of our platform.
The Logan JV CLO supports our strategic initiatives by increasing portfolio diversification through a reduction in FCRD’s exposure to Logan to a 15% to 16% and increasing our portfolio yield. Moreover, we expect the Logan JV return on equity to increase from around 10% historically to approximately 14% going forward with this new structure. At the same time, the middle market CLO, like many refinances, entail some upfront onetime cost to achieve longer-term benefits.
To show our alignment with shareholders, we agreed to waive $400,000 of our management fee in Q1 and part of the management fee waiver in Q2 in order to maintain the $0.10 dividend. We noted during our last call in connection with increasing portfolio yield, we aim to increase our leverage range and increase our allocation to higher-yielding asset-based loans. In connection with the amendment to the credit facility, we have increased the credit facility size to $175 million and pushed out our maturity date, which allowed us to further increase leverage. At 3/31, our consolidated leverage was 1.26x, up from 1.18 at the end of Q4.
This brings me to the results of FCRD. First quarter net income was in line with expectations at $0.10 per share. We anticipate the reduction in financing costs, more flexible capital and increased utilizations of leverage to drive more investment activity, which will help further stabilize NAV and drive NII. We ended the quarter with a net asset value of $6.12 per share, down 3.5% on a quarter-over-quarter basis. The decrease in NAV was primarily driven by the change in unrealized depreciation.
Our nonincome-producing second lien position in Loadmaster and our first lien position in Matilda Jane were written down $0.06 per share. The remaining write-downs were not material on an individual investment basis and spread across a handful of names in the portfolio. In line with our goal to reduce or eliminate exposure to nonincome-producing positions, as noted in our recent update section in 10-Q, in early April, Aurotech, LLC entered into a purchase agreement to sell its common shares.
The proceeds of the sale, which includes cash and amounts placed in escrow, were used to pay off and terminate the outstanding credit agreement. The company realized a loss of $1.8 million as a result of this transaction. This amount will be offset by a reversal in the unrealized loss on the investment. The remaining value on nonaccrual in the portfolio represents about 1.8% of the total portfolio based on fair market value at March 31.
We announced last quarter Aurotech defaulted. Since, we monitored, reunderwrote the company and the prospects and ultimately believe that exit was in the best interest for shareholders, therefore, sought to exit the position as quickly as possible. Overall, the core portfolio continues to perform well in line with expectations. We believe our portfolio companies continue to remain good liquidity profiles and the support from private equity sponsors. There were no significant amendments to existing loans in Q1 and no new loans placed on nonaccrual.
Similar to the broader market trends, we have seen a few of our portfolio companies facing supply chain challenges, labor shortages as well as inflationary pressures, including in-place wages and material costs. Matilda Jane, in particular, was impacted by supply chain issues and labor shortages. We continue to keep a close eye on impacted companies and the economy for signs of further weakness.
As we’ve noted before, portfolio diversification and stabilization of our investment portfolio is of paramount focus. Our ability to increase leverage across more flexible capital terms will further these goals over time as we unbreast capital and add new investments. From an origination perspective, the private debt market kept up its typical trend of a slower Q1 relative to the rest of the year. We saw our private equity partners focused on closing and settling into new deals from a record year of deployment in 2021.
First Eagle Direct Lending origination activity in the first quarter was mainly focused on portfolio add-ons plus 1 new investment. Total deployment was $114 million versus $69 million in Q1 of 2021. In line with that trend, the FCRD portfolio invested $2.3 million in a new portfolio investment in Q1 with an additional $17.5 million invested in follow-on investments, including revolvers and delayed draw fundings. There were no significant repayments during the quarter, which resulted in atypical quarter with no prepayment premiums received or accelerated amortization of OID this quarter.
Looking forward, our direct lending pipeline remains strong, including agency cash flow and asset-based deals. The BDC continues to benefit from deal flow generated by First Eagle’s approximate $5 billion Direct Lending platform. The growth of the platform allows the BDC to hold a more diversified portfolio, with the number of positions up from 45 in Q1 of 2018 to 77 this quarter, while also allowing First Eagle to provide more capital to middle market businesses.
First Eagle’s Direct Lending platform has remained robust, and we expect it to continue to provide us with attractive investment opportunities. We continue to be very selective about where we deploy capital and are mindful of the macro environment and our investment committee discussions. With that, I’ll turn the call over to Jen.
Thanks, Chris, and good morning, everyone. First, I’ll start off with some investment and portfolio highlights. As Chris mentioned, Q1 was a relatively muted quarter for a new activity with 1 new and several follow-on investments totaling $9.8 million at a blended yield of 6.5%. We had no notable realizations during the quarter.
As of March 31, our portfolio was valued at $400.7 million, up slightly from $392.1 million at the end of Q4. It was invested 78% in first lien senior secured debt and 18% in the Logan JV. As a reminder, Logan JV is 99% invested in first lien assets. The remaining 4% of the BDC’s portfolio was held in second lien debt and other nonincome-producing and equity holdings, including our restructured equity-like second lien investment in OEM.
The weighted average yield on the debt and income-producing portfolio, based on costs and including Logan, was 6.5% in Q1, which was flat with Q4. As Chris noted, we did not place any new investments on nonaccrual during Q1. Total nonaccruals as a percentage of our portfolio at fair value and at cost were 2% and 4.5%, respectively.
Now I’d like to address the financials for the first quarter. During Q1, we recognized $7.4 million of investment income primarily from interest and dividends. Interest income decreased approximately $548,000 from Q4 to $5.5 million for Q1. The decrease was primarily driven by the decline in accelerated amortization of OID from $367,000 in Q4 to $17,000 in Q1. This decline resulted from the decrease in repayments and refinancings during the current quarter.
Dividend income from Logan JV was relatively flat quarter-over-quarter at $1.7 million, and other income of $230,000 was approximately half of Q4. Total expenses net of management fee waivers for the quarter were $4.5 million, down from $5.3 million in Q4. The biggest driver of the decrease were a $379,000 decrease in interest and fees on borrowings during the quarter due to our 2023 notes being fully redeemed prior to year-end as well as the $433,000 decrease in management fees due to a decrease in our net asset value and a $400,000 waiver during Q1.
From a leverage perspective, we ended Q1 with a debt-to-equity ratio of 1.26x. We have ample borrowing capacity on our credit facility to continue to grow and increase leverage towards our increased target of 1.3 to 1.4x. With that, I’ll turn the call back over to Chris.
Thanks, Jen. Before I turn the call over to Q&A, I wanted to take a moment to assure our shareholders that we’re committed to doing what’s right here. We have the benefit of a $20 billion platform in direct and tradable credit assets where we successively managed private funds, CLOs, separately managed accounts, levered and unlevered for institutional investors. We, after the benefit of our shareholders, shifted our strategy and rotated out of legacy assets, outlined a specific process for driving higher NII. We brought in ABL assets to provide higher-yielding loans. We have restructured Logan to create a more accretive structure for the BDC. Along this process, we have waived management fees repeatedly to demonstrate to our shareholders that we are committed and invested in the success of the BDC.
Notwithstanding the foregoing, we wish our stock price would be higher, recognizing these events. This transition of the balance sheet has taken longer than expected and as designed, had little room for error in terms of execution. I’ve asked the shareholders to be patient as we go through this process and the shareholders have been compensated for said patience with management fee waivers supporting the dividend.
As noted in previous releases, now that Logan is closed later than budgeted, we should be in a position to see NII growth, which should result in a dividend increase starting in Q3. If the dividend is not able to be increased or stock continues to trade at a significant discount to our peer group, we recognize the status quo isn’t acceptable to our shareholders. And to be clear, it’s not acceptable to the management team.
While our track record on executing this plan has been far from perfect, our track record of supporting the shareholders and doing what’s right for the shareholders has been impeccable. I would ask the shareholders to look at the latter track record and take comfort that we, as the largest shareholder, are aligned with you. Operator, you can open the line for questions now.
[Operator Instructions] Your first question comes from the line of Lee Cooperman from Omega Family Office.
I really could replay the conference call about a year ago. I turned 79 last Monday, but I think I asked these same questions when I was 78. And I made the same comment then that I’ll make now that you have done a great job in trying to support the shareholders. But basically, I really question whether we’re at a size which makes sense for us to be publicly owned. And so I’m going to ask you 5 or 6 questions.
I’ll get them out on the table and I’d like to get your response, some of which you’ve already anticipated. What is that cost of public ownership, number one? Number two, are you willing to explore a sale of the company? We have a market cap of $115 million. We’re a relevant — you’ve done a great job in trying to support the shareholders, but we’ve done a poor job in executing up until now, okay?
What are the intentions regarding your continued waiver of the fees? With $400,000, it’s about $0.01 and a fraction. So the dividend is in excess of fully weighted — a fully accrued fee income. Your expectations for dividend, you mentioned that you expect it to be increased in the third quarter. Order of magnitude that you’re thinking? And another question I’d ask is excess capital. if you have any to buy back equity, would you rather buy back equity at a discount to NAV? Or would you rather make a new loan and take the risk of what’s going on in the economy?
Those will be my question. Again, I compliment you on your support of the shareholders, but I think what we hope to accomplish when we went public cannot be accomplished. Our cost of capital is too high, and Wall Street has created a lot of companies in the BDC, MLP, REIT space that only worked if they were able to sell stock at a premium to NAV. You sold stock. You bought assets to raise the dividend. You sold stock, bought assets, raised the dividend and so on and so forth.
But we’re on a vicious cycle, the wrong way. Our stock is at a low. You went public, I think, at [$13] or thereabouts, then you had an offering of [$14.09], and another offering at [$14.62]. You can’t sell stock, and you know the story. And so the question is whether you’re going to become proactive or you want to continue to stay public? And what is the cost of you being a public company? That’s it.
Lee, thanks. I appreciate the questions. I’m going to take them probably in a random order, if that’s okay.
Sure. Whatever works for you.
Yes, yes. First, the cost of being public is high. I can come back and give you the exact numbers. Just as a rule of thumb, as you look at the market today, I think being a public company at less than $1 billion of equity is probably punitive. So I don’t disagree with your statement. We’re too small, and that puts us at somewhat of a disadvantage.
As it relates to waivers, we’ve said publicly that we’ll support the dividend through Q2 on that $0.10. We did that in Q1. We expect to have a waiver of some sort in Q2 to maintain the $0.10, primarily related to the expenses associated with putting these financing packages in place.
As it relates to the dividend, I think we said in the press release that based on our expectations of the new financing that you could see the dividend go up by anywhere from some 20% from where we are, so call it, $0.11 to $0.12.
Excess capital, we have more capital now that we’re able to — we have more flexibility of capital that we were able to upsize the ING facility. We do have a program in place where we are buying shares, albeit at modest amounts just given the way the program works and the fact that our stock doesn’t trade that much.
Your second question, which was related to a sale of the business, I’m not in a position to comment on that today. What I tried to address in my closing remarks was we call the play. I paid for it, I paid for the optionality associated with the play. And if the play results in our stock price sitting where it is today, obviously, it didn’t work, and we’ve always come back and said that we’ll do what’s right for the shareholders. So I’m in a wait-and-see mode, but the period of time that we’re going to wait and see is probably much shorter than it was historically.
Got you. I wish you luck. And again, I compliment you on standing behind your shareholders. I’m not happy with the results, and the environment has become more hostile. And I guess I’d like to dwell a little bit on the question. Given your excess capital, would you rather make a new loan? Or would you rather buy stock back at $4? We have a book value of [0.618].
Yes. I mean, mathematically, it’s easy, we’d rather buy back stock. Obviously, the return on that is higher. If you look at what we did in the portfolio, we primarily just supported our existing portfolio of companies, which is — that’s part of doing this business.
So — the issue though is we’re at odds, right? I just said being small is a competitive disadvantage, and buying back the stock only makes us smaller. So we’re trying to find a balance between the 2, but we have been actively buying stock in the market, and we’ll continue to do so on the program that we have in place that was approved by the Board. But…
You must be buying it very carefully, but it keeps going down. Okay. But thank you very much. I appreciate your answer, and I wish you well, and you’re a good guy.
[Operator Instructions] Your next question comes from the line of Ryan Lynch of KBW.
Chris, I wanted to follow up a little bit on Lee’s question. I know he asked a few. And I kind of want to take it just from a little bit of a different approach. If I look at your slide deck, you have Slide number 11 and Slide 29 that really shows kind of the growth of your overall direct lending platform at First Eagle.
And it shows that FCRD is really just a small component of the overall direct lending platform as far as the deals you participate in, and then Slide 29 shows that you all have deployed $2.4 billion of capital across the platform, and obviously, FCRD was a really small percentage of that. So it just seems that FCRD is such a small little component of the overall direct lending platform.
Obviously, FCRD , it’s not been a good run for shareholders for the last 5 or 6 years as there’s been the notable issues that you all have been trying to work through. I can’t imagine — as you’ve been very shareholder-friendly, I can’t imagine this has really, FCRD’s, been a super profitable entity for the overall First Eagle manager given all the fee waivers and the low fees it generates.
It’s a big time commitment to run a public company. Chris, your time is obviously very valuable. So it’s a lot harder to run a public company than these private funds. And so I’m just wondering like I’m not sure really what — why this entity, like what are the reasons that it makes sense for this entity to stay public? I’m not really sure what parties are really benefiting from FCRD being a public company. And is there any point where you think that, that would not make sense?
Ryan, I appreciate the question and the perspective. You’re right. It’s interesting. If you think about the beginning of, I guess, it was legacy THL and now First Eagle Direct Lending platform, the BDC used to be the only vehicle that we had. I mean at one point, I think it was like a $750 million vehicle. Unfortunately, due to lots of things that we’ve talked about in the past, they had some portfolio issues. That vehicle has shrunk from $750 million down to, call it, $400 million. Outside of that, we basically have grown private markets business from 0 to over $5 billion.
So the team is very good at what we do, and we know how to build portfolios, we know how to execute. And therefore, we’re bringing in a significant amount of capital alongside the BDC. If you look at the publicly-traded vehicle and the way we look at it, we knew the vehicle was under pressure. We knew there was a — I thought there would be a path. I hoped there was a path forward to repositioning of the portfolio to stabilize it and start seeing some growth.
We’re in the late stages of this. It’s taken time. And like I said in my prepared remarks, is if it works and the dividend is able to be increased and we narrow the gap in book, that’s great. If we don’t, listen, we’re 100% aligned with the shareholders because where you are the single — we’re still the larger shareholder in the platform. So there is a lot of value to a permanent capital vehicle when it’s run well. And when it’s trading as Lee said, when they’re above book, you can have — you can generate a lot of value.
This one has obviously been more difficult. So we ask ourselves these same questions all the time. That’s why I think there’s a good alignment of interest between us and the manager. We appreciate the patience of the shareholders as we’ve tried to execute this turnaround. And as I said, we’ll know here in short order how the market is going to react, and we’ll plan accordingly.
Your next question comes from the line of Matt Tjaden from Raymond James.
Chris, I wanted to pivot a little and maybe go a little more high level. I was wondering what your outlook is for the private credit default environment at year-end ‘22 and how that’s changed versus maybe 6 months ago.
That’s a good question. I don’t know if — I’m not going to put a specific number on it. But I’ll tell you as we sit back and we’re underwriting new business and we’re looking at our portfolio of companies, listen, we’re credit people. So it’s always raining outside for us. I’d say maybe the intensity of the rain has increased as you just look at the different trends that are flowing through.
The good news from our position across the entire platform is we are not sitting here as unsponsored mezz in portfolios we’re going to see a lot of volatility. We control senior secured top of the capital structure to control the liquidity. So to the extent there is something that there’s a shock to the system, we’re able to navigate that.
If you go back and look at the COVID shock, I think our BDC and all of our private funds and I think the private market, in general, performed very, very well in those circumstances. Right now, I think it’s hard to come back and put a number on it, but I would just say, to your point, yes, we’re probably more bearish than bullish as it relates to how we’re underwriting credit.
Now we’re trying to reposition the portfolio, hence the reason why we’re not chasing yield right now, we’re not going deep on the capital structure. When we are deploying, we’re going to do it on a controlled basis at the top of the capital structure to minimize any loss given default if there is a step back in the economy.
Got it. That’s helpful. Last one for me as most have been asked and answered. When you’re talking about potentially taking the dividend higher, are you embedding any benefit from rotation of either Loadmaster or OEM that the remaining fair value in those assets?
We are not.
[Operator Instructions] We have a follow-up question coming from the line of Ryan Lynch from KBW.
The other question that I had was you talked — you have, obviously — you’ve already started working on — you outlined some initiatives, some of they’ve already been executed like refinancing and restructuring Logan to increase the ROE for that entity. I’m just curious, in your slide deck, these initiatives, do you guys have any sort of target ROE that you guys are hoping FCRD will generate?
And obviously, I know there’s a lot of uncertainties out there. One of the sort of the positive uncertainty is that rising rates are going to benefit your entity. So that will obviously interplay into what sort of ROE do you think you can generate in times of where the risk-free rate ends up. But any sort of guidance that you have kind of where we sit here today? If you can execute on these strategies, what sort of operating ROE you think FCRD can generate?
Yes. I mean it’s a critical component. The asset side of the equation is basically the market. I mean we’ve got some differentiated strategies with like ABL lending, where I think you can pick up some incremental yield. But being in a position now with a much more diversified portfolio to lower the liability side is what’s driving what we believe to be, going forward, a more stable ROE.
If you look at the balance sheet of FCRD on a stand-alone basis, that should be in the, call it, the 8% to 8.5% range in this market. When you add in Logan, because we’re using more synthetic leverage there, we’ve already quoted that, that’s around a 14% ROE. So if you blend those out, you’ve got 15% of the portfolio out of 14%, you get the balance at an 8% or 9%. And I’m not going to do that math in my head because I’ll get it wrong, but that’s basically where things stand.
Lowering that cost of debt was mission-critical because we never want to be in a position, even though our cost of debt was higher than it should have been, where we’re taking excessive risk in chasing yield. So you can see the discipline on the ROA side. Now we’ve got the balance sheet ripe, now we can lower our cost of debt to drive a much more stable ROE on a combined basis. But that’s how I look at it inside those 2 pockets. Logan stand-alone is around 14%. FCRD on its own is probably 8% to 8.5%.
Okay. And then as far as the ABL lending, I know that’s kind of a newer initiative. Can you give us a sense of maybe just both the broader direct lending platform? What percentage of the deals that you guys have closed have been in that ABL space? And do you see that changing going forward? Like do you expect to grow that going forward? Or is that going to be kind of consistent from what we’ve seen over the last couple of quarters?
Yes. If you look at ABL across the entire platform, it’s, call it, a 10% to 15% allocation. There could be SMAs or asset-specific funds where that’s 100% allocation to ABL for institutions that want direct access, but think of it as about 10% to 15% of the book across the entire $5 billion.
[Operator Instructions] We have a follow-up question coming from Mr. Lee Cooperman from Omega Family Office.
Some rough approximations, but if you were able to raise your dividend by $0.02, there would be a $0.48 annual dividend. You divide that by 6, it’s an 8% return on your book, okay? It’s not adequate to justify being a public company, okay? And I would just say that very strongly, listen, everything you’re saying, you seem to be very objective, but I think the conclusion is obvious. We have to bulk up and either First Eagle could buy us or somebody else could buy us.
That is my conclusion. It’s been my conclusion for well over a year. And the facts have supported that conclusion, I think your own comments as well. So I wish you luck, but I would say an 8% return on equity in this environment is not adequate. And that’s the way you want to run the company, and I appreciate that given the risks out there. That’s it. Over and out.
And we don’t have any questions over the phone. Chris, please continue.
Thank you, operator. We appreciate the support of our shareholders, and we look forward to providing you an update of our Q2 results this summer. If you have any questions, feel free to reach out to myself or Jen Wilson.
And ladies and gentlemen, this concludes today’s conference call. Thank you for your participation. You may now disconnect.