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BlackRock TCP Capital: IIIQ 2021 Transcript – ANNOTATED

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Q3 2021 BlackRock TCP Capital Corp Earnings Call

Santa Monica Nov 4, 2021 (Thomson StreetEvents) — Edited Transcript of BlackRock TCP Capital Corp earnings conference call or presentation Wednesday, November 3, 2021 at 5:00:00pm GMT

Corporate Participants

Erik L. CuellarBlackrock Direct Lending Corp. – CFOKathleen McGlynnBlackRock TCP Capital Corp. – VP of IRPhil TsengRajneesh VigBlackRock TCP Capital Corp. – Chairman of the Board & CEO

Conference Call Participants

Christopher Whitbread Patrick NolanLadenburg Thalmann & Co. Inc., Research Division – EVP of Equity ResearchKevin FultzJMP Securities LLC, Research Division – AnalystRobert James DoddRaymond James & Associates, Inc., Research Division – Research AnalystRyan Patrick LynchKeefe, Bruyette, & Woods, Inc., Research Division – MD

Presentation

Rajneesh Vig BlackRock TCP Capital Corp. – Chairman of the Board & CEO

… Before we begin, I wanted to take a moment to thank our team for all of their hard work and dedication through this challenging period. As many of you know, I have served as TCPC’s President and COO since our IPO almost 10 years ago and have been a senior member of the investment team for over 15 years. It has been very rewarding to be a part of the group that has consistently delivered for our investors, and I look forward to serving as TCPC’s Chairman and CEO going forward.

Also, I’m excited to formally welcome my longtime partner, Phil Tseng, as President and COO, and reiterate my congratulations to our CFO, Erik Cuellar, for his new role. As part of my commentary, I will be continuing our quarterly tradition and begin with a few comments on the market environment as well as highlights from our third quarter. I will then turn the call over to Phil, who will provide an update on our portfolio and investment activity. Erik will then review our financial results and our capital and liquidity positioning in greater detail. After our prepared remarks, we will all be available to take your questions.

Now turning to the current market environment. Overall, activity levels in the middle market remain very robust. Direct lending and broader private capital markets have clearly emerged from the global pandemic as a reliable and well-positioned source of financing for a broad spectrum of businesses. This has typically been the case at times other avenues of financing have been less accessible, but appears now to be an even more systemic shift as a wider array of companies are looking to private credit as a primary source of capital.

We continue to work with a broad range of businesses as they seek to finance growth, make acquisitions or simply refinance existing debt. We also believe that our investors benefit from these efforts as our direct lending investments continue to deliver a reliable and resilient source of income. I’d now like to review our third quarter earnings and discuss some highlights from the quarter. In summary, TCPC delivered another solid quarter of results.

First, net investment income in the quarter was $18.7 million or $0.32 per share, which again exceeded our dividend of $0.30 per share. Second, portfolio credit quality remains strong. While we added one additional portfolio company to our non accruals during the quarter, non accruals remained low at just 1% of the portfolio at fair value.

BDC Reporter Notes: This continues a double trend we’ve noted previously in the BDC sector: i) overall credit conditions remaining favorable but ii) new non performers are popping up in many places.

For the record, the new non accrual is Hylan Datacom. The BDC Credit Reporter has written an update on the company.

In the case of TCPC, this setback does seem unrelated to general market conditions, and the impact on NAV and earnings should be very modest. As the BDC Credit Reporter article notes , TCPC is even optimistic that some sort of turnaround is possible. Still, the company has been in trouble since 2019 and the trend is down…

Third, and as Philip will discuss in more detail, investment activity continues to be robust. We deployed more than $150 million in capital during the quarter and continue to identify attractive opportunities across our target sectors. Direct lending remains a relationship business, and we continue to benefit from the more than 2 decades of developing and cultivating strong relationships.

We also continue to benefit from the extensive resources for the broader BlackRock platform.

BDC Reporter Notes: You’d expect TCPC – which has a platform of its own, which was one of the reasons the firm was bought out by BlackRock. As management does not provide details here, we don’t know if joining up with BlackRock has provided a substantial amount of new deal flow or the CEO is just being polite and telling investors what they expect to hear. Other BDCs are more specific in calling out the percentage of deals brought in by their asset manager owners.

In the third quarter, we also experienced an elevated level of refinancing activity with approximately $227 million of repayments, resulting in prepayments and exits that outpace deployment and slightly reduced our total portfolio size quarter-over-quarter.

Fourth, we continue to manage our balance sheet and liability profile. In August, we issued a $150 million add-on to our existing February 2026 notes at a yield to maturity of 2.475%, bringing the total issuance to $325 million. In conjunction with this financing, we redeemed $175 million of outstanding notes that were due next August, which had a much higher coupon of 4% and 8%. We will continue to seek ways to diversify and enhance our strong balance sheet and liquidity positioning given overall market conditions.

BDC Reporter Notes: An example of yet another BDC taking advantage of the low yield debt environment. In this case the BlackRock name must be helping as a 2.475% yield is one of the lowest achieved by any public BDC this year.

And finally, we have maintained NAV stability. Although our NAV declined 80 basis points during the quarter. This was primarily a result of a $6.2 million loss associated with prepayment charges on the early redemption of the August 2022 notes. Excluding the impact of this charge, NAV was essentially flat quarter-over-quarter and year-over-year is up approximately 11%. It’s also worth noting that we continue to exceed our total return hurdle.

BDC Reporter Notes: We accept that unusual events such as an early debt repay which bring down NAV Per Share are not a reason to worry about asset quality. Moreover, even with that ($6.2mn) loss, TCPC’s NAV Per Share is 7% above its 2019 level – one of 19 BDCs out of 42 in that category.

Nonetheless, we have to point out that there was little net positive change in the quarter as the 10-Q itself spells out. TCPC did book a realized gain on Edmentum – a company that used to be a credit hotspot but turned into an unexpected winner thanks to changing educational practices brought on by Covid. Otherwise, when that gain was reversed in the unrealized depreciation calculation and a ($3.7mn) unrealized loss booked on Hylan, the only good news was an unrealized gain of $5.7mn , mostly appreciated warrants in German company Razor Group. That’s an idiosyncratic gain for TCPC. We have to wonder how much net asset value appreciation TCPC still has left in the tank going into the end of the year.

As a reminder, TCPC maintains a 7% hurdle rate with a cumulative look back based on total returns, including realized and unrealized gains and losses. Since 2012, we have generated a 10.7% annualized return on invested assets and a total annualized cash return of 9.7%, consistently outperforming the Wells Fargo BDC index. And in the last 12 months alone, TCPC has delivered a 19% ROE.

BDC Reporter Notes: Seeking Alpha calculates total return numbers for every BDC. For the record, the 5 year total return for TCPC is 46%, or 9.2% per annum. That’s towards the bottom of the league table of the 37 BDCs for which there are five years of results. Here, too, is the BDC’s lifetime stock chart over its 9 year time frame:

Yahoo Finance Stock Chart – 2012 – November 5 2021

The BDC paid out a very consistent $0.36 quarterly distribution between 2013 and 2020, but dropped the payout (17%) since the pandemic. There have been 6 $0.30 distributions in a row, but 2021 total distributions are lower than 2020 and 2019. Our friends in the analyst community are projecting 2021 EPS of $1.27, rising to $1.32 in 2022. No return to the prior earnings or distribution level seems to be in the cards.

TCPC traded on Friday at $14.34, which is a 2% premium to book. The BDC’s 52 week high is 5% higher at $15.07 and its all-time some way off at $18.550. The current yield is 8.4% and the price to projected 2022 Net Investment Income Per Share is 10.9x – somewhat on the low side for a large cap BDC with a famous owner.

Worth noting, though, is that the BDC – despite paying out (17%) less in 2021 than in 2019 is trading at its pre-pandemic level.

Outside of performance and financial results and as an indication of our commitment to strong corporate governance, TCPC’s Board of Directors recently elected Eric Draut to serve in the newly created role of lead Independent Director, effective October 28.

Eric’s outstanding commitment to serving TCPC shareholders throughout his more than 10 years of service on the Board has been invaluable, and we look forward to his continued contributions as lead Independent Director. In conjunction with this appointment, the Board also appointed existing board members, Peter Schwab as Chair of the Governance and Compensation Committee; and Freddie Reiss as Chair of the Audit Committee.

Phil Tseng

Thanks, Raj. As a member of the TCP and now BlackRock U.S. private capital team for more than 16 years, I’ve had the benefit of getting to know many of you, and I look forward to getting to work with you more closely. As Raj noted earlier, we are capitalizing on the scale of our platform and breadth of our team’s experience to capture an increasing share of this expanding market.

At quarter end, our portfolio had a fair market value of approximately $1.8 billion. 90% of our investments are senior secured debt and are spread across a wide range of industries, providing portfolio diversity and minimizing concentration risk. Our portfolio is also weighted towards companies established business models in less cyclical industries. The portfolio at quarter end was made up of investments in 106 companies.

BDC Reporter Notes: Given its AUM, we classify TCPC as a large-cap BDC but is far down the table in this category – around 15th.

As the chart on the left side of 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, over half of our portfolio companies each contribute less than 1% to our recurring income. Additionally, 86% of our debt investments are first lien, providing substantial downside protection. And 94% of our debt investments are floating rate, positioning us well for when rates eventually rise.

Now moving on to our investment activity. In our view, many of the competitive market dynamics that existed prior to the pandemic have resurfaced. However, we remain one of a small group of reputable lenders that are able to provide complete and customized financing solutions. As such, we act as a lead or co-lead lender in the majority of our transactions.

Also of note, while the environment is competitive, our team continues to find attractive opportunities to invest at a higher spread than the average market transaction. We continue to source a wide range of investment opportunities. And while we have been actively deploying capital in this market, we maintain a very disciplined approach to investing.

We regularly review a substantial number of opportunities, but we end up investing in only a small percentage of them. Investment activity in the third quarter was robust for both new deployments and repayments. We invested $157 million, primarily in 16 investments, including loans to 7 new portfolio companies and 9 existing companies.

Follow-on investments in existing holdings continue to be an important source of opportunity for us, accounting for more than 40% of our total investments over the last 12 months alone. Incumbency clearly has become a differentiator. And from a risk management perspective, these are companies we already know, and we understand it very well, and therefore, we’re comfortable making these follow-on investments.

As we analyze new investment opportunities, we continue to emphasize seniority in the capital structure, portfolio diversity and transactions where we can act as lead or co-lead. Our largest new investment during the third quarter was a first lien loan to James Perse, a founder-owned luxury fashion apparel brand with a strong long-term operating history and a growing e-commerce presence. BlackRock acted as the sole lender, and our loan was structured with a low leverage profile and strong collateral protection.

Our second largest investment in the quarter was a first lien term loan to Infobip. Infobip offers a mobile-first omnichannel customer engagement platform that leverages direct connections to a global network of over 650 telecom operators.

The company has a diversified customer base with strong blue-chip representation. And the investment represents a new loan — sorry, a low loan-to-value with structured downside protection and the proceeds will support the company’s growth initiatives.

New investments in the third quarter were offset by disposition and repayments totaling $227 million. These included the partial sale of our equity investment in Edmentum and the payoff of our loans to Sphera, Paula’s Choice, GlobalTranz as well as Apex.

Our investment in Sphera is a great example of how our team leverages our industry expertise to identify opportunities in situations that may not be widely understood. Sphera software helps energy companies, ensure that they are complying with environmental regulations. Despite serving some of the largest global energy companies, we did not believe Sphera’s business is directly impacted by energy price volatility, which was a perceived market concern actually at the time of our investment in 2016.

As a result of our team’s software expertise, we identified this unique opportunity to invest in a strong company that performed well throughout our 5-year investment period and will just ultimately acquired at an attractive valuation in September of this year. The overall effective yield on our portfolio was 9.4% as of September 30. Investments in new portfolio companies during the quarter had a weighted average effective yield of 8.5%, in line with the 8.6% weighted average yield on exited positions.

Since December 31, 2018, LIBOR has declined by 268 basis points or by 95%, which has pressured our overall portfolio yield. However, 94% of our loans are floating rate with approximately 90% of them operating with LIBOR floors. Therefore, we believe that we’re well positioned to benefit when rates eventually rise.

So we continue to invest selectively, as I noted, that maintaining our discipline and focusing on companies with established business models that are well positioned in the current economic environment. Our investment activity in the fourth quarter-to-date totals approximately $32 million, primarily in 2 senior secured loans with a combined effective yield of approximately 10%.

While it is still early in the quarter, we remain encouraged by the opportunities in our pipeline and continue to source from a broad range of industry sectors. The yields on investments in our pipeline are generally in line with our current portfolio. And to date, we have had limited prepayment income in the fourth quarter.

BDC Reporter Notes: This is guidance for the IVQ 2021. The analyst consensus is for NIIPS of $0.32, unchanged from the IIIQ. Given what we said about likely future NAV Per Share, the next quarter for both earnings and net book value should look very much like the current one.

Erik L. Cuellar Blackrock Direct Lending Corp. – CFO

Thanks, Phil. Turning to our financial results for the third quarter. We generated net investment income of $0.32 per share, which exceeded our dividend of $0.30 per share. We continue to be committed to paying a sustainable dividend that is fully covered by net investment income as we have done every quarter since our IPO in 2012.

Today, we declared a third quarter dividend of $0.30 per share. Investment income for the third quarter was $0.74 per share. This included recurring cash interest of $0.60, recurring discount and fee amortization of $0.03 and PIK income of $0.02. Notably, our PIK income continues to be at the lowest level in more than 3 years.

As a reminder, our income recognition follows our conservative policy of generally amortizing upfront economics over the life of an investment rather than recognizing all of it at the time the investment is made. Investment income included $0.03 of dividend income and $0.06 from accelerated OID and exit fees. Dividend income in the third quarter included $1.2 million or $0.02 per share of dividend income from our equity investment in Edmentum, including $600,000 from the portion of our investment that was sold during the quarter. Operating expenses for the third quarter were $0.33 per share and included interest and other debt expenses of $0.18 per share. Incentive fees in the quarter, which included $600,000 of previously deferred fees totaled $4.7 million or $0.08 per share.

As we have previously noted, we voluntarily deferred incentive fees related to our income from 2020 over a period of 6 quarters, amounting to $0.01 per share per quarter, with the final catch-up amount having been recognized this quarter. Our net increase in net assets for the quarter was $10.9 million or $0.19 per share, which included net realized gains of $7.9 million or $0.14 per share. Unrealized losses of $9.5 million or $0.16 per share and a $6.2 million realized loss associated with the early redemption of the August 2022 notes.

Unrealized losses during the third quarter primarily reflected a $6.8 million reversal of previously unrealized gains on Edmentum and a $3.7 million unrealized loss on our investment in Hylan, partially offset by a $5.1 million unrealized gain on our investment in Razor Group. Realized gains of $7.9 million were primarily due to the partial sale of our equity investment in Edmentum.

Substantially, all of our investments are valued every quarter using prices provided by independent third-party sources. These include quotation services and independent evaluation services, and our process is also subject to rigorous oversight, including backtesting of every disposition against our evaluations. We placed 2 of our loans to Hylan on nonaccrual during the third quarter.

Hylan is an engineering and construction company that provides electrical, telecom, and utility services in New York City. Hylan operates in a strong sector but has faced operational challenges, and our team is working closely with the sponsor to navigate these challenges. As Raj noted earlier, our overall credit quality remains strong with nonaccrual loans limited to 3 portfolio companies that represent just 1% of the portfolio at fair value and 1.8% at cost at September 30.

BDC Reporter Notes: The other 2 non accruals are Avanti Communications – still highly leveraged and still a question mark – and CIBT Solutions – on non accrual since IIIQ 2019 and with a FMV of $4.3mn. Even taken collectively these non performers should have no material impact on TCPC going forward.

Turning to our liquidity position. We ended the quarter with total liquidity of $396 million relative to our total investments of $1.8 billion. This included available leverage of $379 million and cash of $37 million, net of trade spending settlements of $20 million. Unfunded loan commitments to portfolio companies at quarter end equaled 3.8% of total investments or approximately $67 million, of which $32 million were revolver commitments.

BDC Reporter Notes: We calculate that TCPC can add $219mn in debt-funded AUM before reaching its target size and leverage, well within its available liquidity. That does not mean, though, that management might not tap the very indulgent unsecured debt market shortly. If unsecured debt repays revolver borrowings, the negative impact on interest expense should be very modest and the capital structure further strengthened.

We continue to opportunistically take advantage of the favorable bond market environment to refinance higher-cost debt. In August, we successfully issued an additional $150 million of our notes due February 2026 at a yield to maturity of 2.475%, bringing the total issuance of the 2026 notes to $325 million. Additionally, we redeemed $175 million of outstanding 4.125% notes due August 2022 as we continue to reduce our overall cost of capital.

Our diverse and flexible leverage program now includes 2 low-cost credit facilities, a convertible note issuance, 2 unsecured note issuances and an SBA program. Our unsecured debt continues to be investment-grade rated by both Moody’s and Fitch. Additionally, given the modest size of each of our debt issuances, we are not overly reliant on any single source of financing, and our maturities are well-laddered.

Our nearest maturity is March of 2022. And given the success of our latest bond issuance, we are very well positioned to redeem or refinance those notes. Combined, the weighted average interest rate on our outstanding liabilities decreased to 3.22% from 3.54% at the beginning of the year.

BDC Reporter Notes: That March 2022 debt is the $140mn convertible, which yields 4.625% and is unlikely to be converted into equity. If refinanced at 2.5%, TCPC should save ($3.0mn) a year in interest expense, or about ($0.05) per annum.

Rajneesh Vig BlackRock TCP Capital Corp. – Chairman of the Board & CEO

Thanks, Erik. I’ll conclude now with a few comments on the market environment. We are pleased with our strong third quarter results and remain confident in our team’s ability to deliver strong risk-adjusted returns for our shareholders. We also remain cautiously optimistic on the investment environment. On the one hand, transaction volumes remain at historically high levels and revenue and EBITDA growth trends are strong across the middle market.

However, we remain cognizant of the broader market risks and are closely monitoring inflation trends, supply chain disruptions and energy market volatility as we analyze our pipeline of investment opportunities. In this environment, we are leveraging our team’s competitive advantages, including over 2 decades of experience lending to middle-market companies.

Our industry specialization makes us a unique and valuable partner to our borrowers and deal sponsors as well as our special situations experience to structure loans that are downside protected. These advantages enable TCPC to deliver a 19% ROE over the last 12 months and a 16.4% ROE since the start of the pandemic in March of last year. Additionally, excluding the impact of the early redemption of the August 2022 notes, our NAV is up 7.5% since the start of 2020.

Questions and Answers

Operator

(Operator Instructions) Our first question comes from Devin Ryan from JMP Securities.

Kevin Fultz JMP Securities LLC, Research Division – Analyst

This is Kevin on for Devin. Touching on quarter-to-date investment activity, can you give us a sense how originations are tracking so far as well as your expectation of portfolio growth in the fourth quarter?

Rajneesh Vig BlackRock TCP Capital Corp. – Chairman of the Board & CEO

Yes. Maybe I’ll turn it over to Phil to just touch on just originations activity and getting the process, and then I’ll touch on expectations for the portfolio and growth.

Phil Tseng

Yes. Thanks for the question. So our origination activity continues to be quite robust. The pipeline, as we’ve seen in past quarters, it continues to be — show substantial growth year-over-year, and we’re tracking that very closely. We think we’ve made great progress in a number of industries in terms of our mindshare with private sponsors, with advisers, with other lenders and management teams. So our origination pipeline continues to be robust, and we think it bodes well for our Q4 deployment.

Rajneesh Vig BlackRock TCP Capital Corp. – Chairman of the Board & CEO

Yes. And just in terms of overall growth, Kevin, I think we’ve said numerous times in the past, we really are credit focused on making the right decision and being disciplined versus being oriented growth for growth’s sake. We obviously have grown successfully. I expect that we will continue to, just given the overall market dynamic, just a number of companies that are looking for private credit solutions and our — each fill trade mindshare within that dynamic, but we will not be compromising the credit view or the credit decision to do that as a mandate, but I do expect that we’ll continue to be able to grow just given the overall secular story.

Kevin Fultz JMP Securities LLC, Research Division – Analyst

Okay. That’s helpful. And I appreciate the color of that color there. And then just on the competitive environment, obviously, geo pricing has been a prominent conversation over the past quarters. Are you still seeing continued downward pressure? Or has that begun to normalize a bit recently?

Rajneesh Vig BlackRock TCP Capital Corp. – Chairman of the Board & CEO

Yes. Let me take that one and just provide a little context. We obviously had a little bit lower effective yield in the portfolio this quarter. I would highlight, though, that it was around flat, if not slightly below the yield on the exits for the same quarter. So I think when you look at the overall portfolio yield, it doesn’t really — hasn’t really changed. That’s also not taking into account the benefit on the right side of the balance sheet that we’ve been able to create through the debt refinancing.

And I think what that does is it lets us be very strategic in our pipeline, where we want to spend time, who we want to work with and make some strategic decisions without compromising the portfolio yield. And it is more competitive. But to highlight or reiterate a point Phil made earlier, 40% of our volume is from existing deals.

So while it is competitive, incumbency and the ability to stay relevant with your deal sources. Is absolutely imperative. And what we can do with the portfolio, I think, allows us to have some flexibility there. Overall, things do seem to be settling out, but no one quarter makes a trend, as we say. But the quarter-to-date activity has been encouraging with a roughly 10% effective yield on deployments, although it’s still early.

Operator

The next question comes from Ryan Lynch from KBW.

Ryan Patrick Lynch Keefe, Bruyette, & Woods, Inc., Research Division – MD

I just had a follow-up because on the last question, you talked about kind of a robust pipeline, which I believe you guys also had — we’ve spoken about last quarter. Obviously, there’s a lot of market activity, which increased repayments and prepayments. In the third quarter, you also talked about kind of some caution out there and what you guys are looking to deploy in new opportunities being pretty cautious on the environment. So I’m trying to kind of square all that away, with a robust environment and robust pipeline this quarter versus what I think you guys said was kind of the same thing last quarter. That resulted in pretty meaningful net repayments this quarter. Is there expectation that, that should flip going into the fourth quarter?

Rajneesh Vig BlackRock TCP Capital Corp. – Chairman of the Board & CEO

Yes. Let me try to start and add a little context. Keep in mind that part of a decent part of our repayments was actually an exit from the Edmentum position, which is kind of a one-off. It’s a good one to exit because we’ve got a lot of value, picked up a lot of gain and redeploy equity into credits. But that being said, repayments were high through the quarter. In any one quarter, it’s hard to tell. So far, they’re low. And so I think if you took that as an indication, maybe they level off, but really, it’s just hard to predict. The nice thing is when we do get the repayments, we pick up typically pick up some fees and unamortized discount, which shows up as it did this quarter as a benefit. But I just — I don’t want to predict anything that — to make it a sort of forward-looking statement and then have it reverse on us. But thus far, has — the potential’s [???] been low. We benefit from them when we get them. But I would also adjust our current quarter repayment level for a one-off item, which was the Edmentum exit.

Ryan Patrick Lynch Keefe, Bruyette, & Woods, Inc., Research Division – MD

Okay. That’s fair. The only other question I had was the $6 million loss prepayment penalty loss from calling the August 2022 notes. That was very high. I mean, that’s a 3.5% loss on those notes or acceleration of fees. I mean, those notes in total have just over a 4% coupons. So why was that number so high? And why did you choose to repay those early to incur that loss when the costs actually is looking that much higher just have it sit on your balance sheet, to use that as a source of funding for the next 9 months?

Erik L. Cuellar Blackrock Direct Lending Corp. – CFO

Yes. Thanks, Ryan. I’ll take that question. Yes, the prepayment fee really was a function of the MACO provision within the venture itself. But it was a decision that we did make both to take advantage of current — the current rate environment and to lock in the rates longer term. As you saw, the execution on our new deal was — we’re very happy with it. And so overall, we think it’s a good trade-off on a long-term basis.

Rajneesh Vig BlackRock TCP Capital Corp. – Chairman of the Board & CEO

And I would just add, I think Erik highlights, we can’t predict where rates go. It feels like they’re more inclined to go up and down. And we were blocking the lowest level we’ve seen for our business. I also would highlight that the benefit of that, aside from the onetime $6.2 million that’s incurred the run rate benefit of that new financing does not show up really, given the timing of it in the quarter. So go forward — on a go-forward basis, we do anticipate that to be a benefit to just NII.

Ryan Patrick Lynch Keefe, Bruyette, & Woods, Inc., Research Division – MD

Okay. So what was the nature of the $6.2 million make whole? Was that you paying out the remaining interest that would have been due if we held to maturity? Or what was the composition of that $6.2 million?

Rajneesh Vig BlackRock TCP Capital Corp. – Chairman of the Board & CEO

Yes. It’s basically the remaining interest payments discounted. Yes. That’s standard make-whole.

BDC Reporter Notes: Till recently we’d rarely seen BDCs bother to repay institutional notes with a make-whole provision. However that taboo – if there was one – has been broken. As regular readers will know Capital Southwest (CSWC) made the same decision to take the pain now for lower debt service cost later and to lock in a longer maturity. Still, Mr Lynch’s query is a fair one and one could readily argue that waiting till maturity might have been the better course. Of course, this opens up the possibility that many other unsecured note facilities might get repaid early – at a high cost in the short term to shareholders – in the name of better earnings down the road.

Operator

The next question comes from Robert Dodd from Raymond James.

Robert James Dodd Raymond James & Associates, Inc., Research Division – Research Analyst

Congrats on the quarter. I mean, sticking with the capital structure for the second. I mean, on the convert, which — I mean, it matures in March next year. I mean, based on where you stand today, what do you expect to just refile that into your revolvers? Or I mean, on a blended basis, you’re fixed plus convert plus SBA, I mean your fixed-rate funding, unsecured funding, so to speak, is a pretty high proportional mix. Would you like to keep it that high? Or should we expect that the most likely scenario is for that to locate into or get paid down with the revolvers and increase your floating rate liability mix a little bit.

Erik L. Cuellar Blackrock Direct Lending Corp. – CFO

Yes, this is Erik. I’ll take that. And the latest deal that we did really put us in a very good position to do either one. We certainly have plenty of liquidity and room under our credit facilities to just pay those off in March when they come due. However, we’re comfortable with where we are in terms of secured versus unsecured debt. So we’re planning on exploring both options, and we have the ability to do either one.

Robert James Dodd Raymond James & Associates, Inc., Research Division – Research Analyst

Okay. I appreciate that. And you certainly have the flexibility. One if I can, I know you don’t like to answer questions about specific assets. But on Hylan, can you give us any color? I mean you said operate, I think it was operational challenges. I mean, are those challenges related to supply chain issues, which I can imagine there are a lot. So it’s a lot easier to rectify all personnel challenges. Any color you can give us on how we should think of that in terms of how fixable it is.

Rajneesh Vig BlackRock TCP Capital Corp. – Chairman of the Board & CEO

Yes. Thank you for the question. I’ll try to take that. And I will highlight, I will be a little — obviously, given the stage, the early stage of what’s going on there, we have to be a little careful not to — just be sensitive to the discussions and the nature of them. But overall, I would say — this is a very isolated incident. It is not a supply chain issue as their work is really more implementing and it’s installing — it’s an E&C business, essentially, with good growth trends in the market –in a market in the Northeast that is experiencing the need and dollars flowing towards their services.

So we believe it’s a good business. In a good sector, and that’s a good place to start. And we’ve had, obviously, based on prior experience, we have done this before. We’ve done it effectively, and an extreme example is Edmentum, for instance. But operationally, I would say, it’s just the nature of implementing and carrying out their service wasn’t run as well as it could have been. And in the meantime, the impact of that with the level of debt they’ve had, put challenges on them in terms of liquidity.

So those seem to be resolvable issues, obviously, is going to be a longer tail process to get to the right outcome. We feel like we know what we’re doing there, and we have a good asset with which to start with. But I think we’ll just provide updates as we can quarter-over-quarter. We just emphasize that this is kind of a one-off versus anything systemic or characteristic for the broader portfolio, including supply chain exposure, just given our sectors, we just really don’t have a lot of traditional supply chain exposure on working capital or tangible assets when you look at our end market and industry that we focus on. And that also is the case for Hylan.

Operator

(Operator Instructions) Our next question comes from Christopher Nolan from Ladenburg Thalmann.

Christopher Whitbread Patrick Nolan Ladenburg Thalmann & Co. Inc., Research Division – EVP of Equity Research

By the way, congrats on your first quarter as senior management team.

Rajneesh Vig BlackRock TCP Capital Corp. – Chairman of the Board & CEO

Thank you.

Christopher Whitbread Patrick Nolan Ladenburg Thalmann & Co. Inc., Research Division – EVP of Equity Research

Can you share with us your perspective in terms of where you think interest rates will be, how it will change in 2022?

Rajneesh Vig BlackRock TCP Capital Corp. – Chairman of the Board & CEO

Boy, if I could do that effectively, I might be in a different … role, but I think I said it earlier, it feels like the trend is to be higher. I don’t know that we can predict that or I think all we can do is really position the portfolio to benefit from it. And between the level of fixed-rate debt on the right side of the balance sheet that we reduced the cost of and the positioning of floating-rate assets on the left side of the balance sheet, even with the floors that protect us, I feel like we’re well-positioned for rising rates. We just can’t predict how quickly or how much, but it feels like that’s more likely than not, but it’s just not our business to make explicit rate predictions versus being positioned for something that we can benefit from.

Christopher Whitbread Patrick Nolan Ladenburg Thalmann & Co. Inc., Research Division – EVP of Equity Research

Raj, given that it seems like a possibility of the Fed will tighten and also the long end of the curve could go up just from the Fed starting to taper. Would that impact your book value so far as your quarterly valuation of your investment portfolios are done on a discounted cash flow and the discount rate used would necessarily go up as well?

Rajneesh Vig BlackRock TCP Capital Corp. – Chairman of the Board & CEO

I think it’s possible, I guess. But when we look at how our evaluations are done, it’s not only discounted cash flows. There is a lot of — a fair bit of market comp data being incorporated. And obviously, those multiples have benefited both portfolio and loan-to-value coverage on a market value basis. There are transaction comps. And again, those have all been moving up and to the right. And then there is discounted cash flow as sort of — and they triangulate. So at the end of the day, and then there’s always backtesting, which we do frequently, but that shows our book, I think, is marked quite well and accurately unrealized exits. So I think the providers, and they should probably answer for themselves, do try to take a more balanced approach and triangulate it around the nature of the asset and the fundamental business value. So I don’t anticipate that any one is going to disproportionately impact us even if there is, as you say, a mechanical change in DCF.

Erik L. Cuellar Blackrock Direct Lending Corp. – CFO

Yes. and with that mostly floating rate portfolio, that should — that sort of most of the impact from rates as far as the evaluation goes.

CONCLUSION

Except for the small new non accrual and the sale of some of the Edmentum equity, this was a pretty standard quarter for TCPC which met our expectations and those of the analysts.

Looking forward, the BDC can still grow AUM; and decrease its borrowing costs but will still face flat to lower yields; no further dividend from the Edmentum position sold.

Likewise, except for a few individual portfolio companies that could add or detract to the BDC’s asset value, there’s little movement likely to occur in NAV Per Share.

As we’ve seen, the stock price is fully valued, but not irrational.

For our part, we have a 5 year target price of $16.58 and are projecting a 61% return (12.2% per annum) but that does include an assumption that the quarterly dividend will increase to $0.325 quarterly, which may be overly ambitious. Our projection includes the assumption that TCPC will trade one day at a multiple of 12.75x its payout, basing ourselves on historic performance. At the moment, the highest multiple achieved in 2021 was 12.50x.

If we project an unchanged $1.20 in distributions and a 12.5x multiple, the target price becomes $15.00 and likely 5 year total return 46%.

Either way, TCPC seems like a relatively safe bet – if that’s the right term – for the foreseeable future and despite the change of management that is occurring.

Of course, we continue to believe TCPC should absorb its sister BDC BlackRock Capital Investment Corporation (BKCC) and increase its heft in a market where size – if not everything – is important.

Should that happen, though, we’ll have to revisit all our projections.

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