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BlackRock Capital Investment: Key Issues IIIQ 2022

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NEW YORK Nov 4, 2022: Transcript of BlackRock Capital Investment Corp earnings conference call


Rising interest rates, stronger pricing on new originations and solid fee income during the third quarter combined to drive a 27% increase in adjusted quarterly net investment income. Importantly, our NII more than covered our dividend this quarter. The company’s weighted average portfolio yield based on fair value increased to 10.5% as of September 30, up from 9.1% as of the prior quarter end, driven by a rise in LIBOR and SOFR rates during the quarter.

BDC Reporter Notes: Like almost every other BDC, BKCC is recording higher interest income, mostly due to the increase in interest rates. Maybe we’re all getting numb to the numbers but a 15% increase in the “weighted average portfolio yield” in 3 months is a huge – and an unprecedented development. A year ago, adjusted Net Investment Income Per Share was (20%) lower and that was only after management had to waive some fees to keep profits up.Nor is the impact of the surge in rates over. The 10-Q shows that a 200 basis point increase in rates – a likely proposition – will boost EPS by $0.09 a year – a 22.5% increase. That does not include any earnings added from higher asset deployment; wider spreads on new loans or fee changes. Admittedly, the analyst consensus for 2023 is muted at $0.39. We have a different view and believe it’s likely earnings and dividends will increase, and we’ll see the allter – after many years stuck at $0.40 per annum – increase to $0.48.

We added 16 new portfolio companies and now have 111 portfolio companies, an all-time high, up from 86 at the end of 2021 and 47 at the end of 2019. A core tenet of our underwriting is the emphasis on seniority in the loans we originate. First lien investments now make up 77% of our portfolio, more than doubling the 34% we reported at the end of 2019. Junior capital investments now comprise only 6% of our portfolio, down from 43% at the end of 2019. We also reduced our noncore portfolio to less than 2% of our entire portfolio by the close of the third quarter. We now view the transition away from the legacy portfolio as largely behind us…During the third quarter, our new deployments were almost entirely in first lien investments, consistent with our strategy of maintaining a lower risk profile, especially as we enter uncertain economic times…our focus has been more on the private markets where we are able to actually control the structure and the documents and the protections associated to them. …We’ve had a key core focus of trying to create a little bit more NAV stability and more diversification and resiliency with regard to the NII, but also the NAV.

BDC Reporter Notes: This is not a new development per se, but BKCC’s management rightly shines a spotlight on the emergence of a very diversified portfolio in recent years. The current asset mix, size and type of loan is a million miles away from the BDC’s prior strategy, which involved having “chunkier” positions, much more junior capital and a far greater portion of syndicated loans. This strategy failed on a massive scale, causing BKCC to lose – at its worst point – seven eights of its market value. Unfortunately, the turnaround in the portfolio we were are now witnessing has taken a very long time to occur causing us to draw comparisons with turning around oil tankers in mid-ocean. However – while not immaculate – the BKCC portfolio can be termed “turned around”, and management can look forward.

We might as well mention here that this also opens the door for parent BlackRock to consider merging small sized BKCC into its other – much larger – public BDC : BlackRock TCP Capital (TCPC). The BDC Reporter has been predicting – Cassandra-like – for some time that a merger makes eminent sense and would probably involve BKCC shareholders exchanging their shares valued at net book value for TCPC shares. If that would occur – as we saw with First Eagle Credit (FCRD) being acquired by Crescent Capital (CCAP) in a similar fashion – the BKCC stock price should sharply rise as the BDC trades well below book.

As a result of our focus on investing in well-structured first lien loans in less cyclical businesses, we had no new nonaccrual loans in the quarter.At the end of the quarter, the portfolio had 3 nonaccrual investments, representing 3.3% of our portfolio’s total fair value.

BDC Reporter Notes: One of the main reasons for re-positioning the portfolio is to improve credit outcomes. So, BKCC shareholders will be glad to see that there are no new non accruals being added, and that those which still exist are modest in number and value. The BDC Credit Reporter has surveyed the 111 company universe and identified only 6 underperformers. Even more encouraging far and away the biggest credit challenge in dollar terms is the former Gordon Brothers investment. As this article from the BDC Credit Reportershows, any damage to to BKCC’s income or capital from this investment seems to be in the past. As to new problems ? We were able to identify only one addition to BKCC’s underperforming company list this quarter: Persado, Inc, which we downgraded to CCR 3 in the IIIQ 2022 for valuation reasons.

Additionally, we fully exited our debt investments in Juul, Metricstream, Dude Solutions and Power Home. In each of these, we realized principal at par with an aggregate realized IRR of 11.6% over the holding period across these 4 names.

BDC Reporter Notes: We were concerned a few weeks ago that portfolio company Juul Labs – which apparently flirted with bankruptcy – might turn into a credit problem for BKCC (and TCPC – alsao a lender). We learned on the conference call that the loans were repaid in the IIIQ 2022 at par. This, too, was discussed by the BDC Credit Reporter. [By the way, to read the Credit Reporter articles, just sign up with an email address. For a few days more a subscription is free and involves no credit cards].

Total available liquidity for investment deployment and general operating use, including cash on hand, was $124.9 million at quarter end, subject to leverage and borrowing base restrictions. Our net leverage ratio was 0.71x, up from 0.64x at the end of the prior quarter, due to $17 million of net deployments during the quarter, resulting in a higher ending debt balance.

BDC Reporter Notes: One of the consequences of BKCC’s very deliberate reset is that many assets were sold off, which de-leveraged the company. Even now, BKCC remains one of the most under-leveraged BDCs out there amongst the 43 we track. Most BDCs have GAAP regulatory leverage between 1.0-1.5x debt to equity. As noted above, even after much loan making, BKCC remains at 0.71x. With a recession around the corner this is encouraging and suggests the BDC is unlikely to be much affected if the debt markets get roiled as they usually do at times of financial stress. Further down the road, and with many attractive loan opportunities out there, BKCC has considerable “dry powder” available to boost its AUM; improve its portfolio yield and grow EPS. Our model shows that at full target leverage BKCC’s AUM would be $769mn versus $615mn currently, a pro-forma 25% growth. If past is prologue, BKCC may take a considerable time to get there, but the prospect is intriguing for its shareholders who will not need to look to higher interest rates alone for growth prospects.

BEST IDEA: By the way, BKCC is a Best Idea pick over at the BDC Reporter’s just launched new publicationBDC Best Ideas” aimed at long term BDC investors. Where the BDC Reporter seeks to be even handed and analytical, BDC Best Ideas is where we offer our BDC investment views. We track and value all the public BDC players in our exclusive 5 year financial model, which includes annual dividend projections and set Target Prices. On occasion, we highlight BDCs that we believe are good buys for the patient investor, and BKCC – to our surprise – fits the bill, promising a 100% “total return” through 2027. We also write a weekend market snapshot at the week-ends and much more.

If you’re interested, please check out BDC Best Ideas. Like with the BDC Credit Reporter, we are in beta mode , working out the kinks, so registration is easy and free (no credit card involved). We’ll become a Premium publication at $50 a month before too long, but first we’ll be tackling those kinks.

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