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spk02: Our Q1 2021 investor conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Now, I would like to turn the call over to Julie Morocco, investor relations of Stonecastle Financial.
spk01: Please go ahead. Before we begin this conference call, I'd like to remind everyone that certain statements made during the call may be considered forward-looking statements based on current management expectations that involve substantial risks and uncertainties. Actual results may differ materially from the results stated in or implied by these forward-looking statements. This would depend on numerous factors such as changes in securities or financial markets or general economic conditions, the volume of sales and purchases of shares of common stock, the continuation of investment advisory, administrative, and service contracts, and other risks discussed from time to time in the company's filings with the SEC, including annual and semiannual reports of the company. Stone Castle Financial is based on the forward-looking statements included in this presentation on information available to us as of March 31, 2021. The company undertakes no duty to update any forward-looking statement made herein. All forward-looking statements speak only as of today May 13th, 2021. Now I will turn the call over to Sanjay Bosele.
spk04: Thank you, Julie. Good afternoon and welcome to Stone Castle Financial's first quarter investor call for 2021. Along with Julie, here with me today is Pat Farrell, our CFO. During today's presentation, I will briefly comment on the banking industry and the credit market before commenting on the company. Then I will provide Stone Castle Financial's quarterly results and portfolio review, and Pat will provide you with greater detail on our financial results before we open up the call for questions. In general, the first quarter of 2021 had large money center banks and community banks reporting better than expected earnings. Furthermore, industry research continues to show that banks are well capitalized and should benefit from an expansion of the economy. The FDIC also reported that in the fourth quarter of 2020, net income increased 9% across all banking institutions. For community banks, that number was higher, as they reported 21% net income growth. During that same period, net charge-off rates across all banks fell nearly 20%. I also want to point out that in the fourth quarter, bank equity capital increased by 1.9% versus the previous quarter. We have seen this trend continue during the first quarter. A majority of the company's portfolio of community banks have reported their first quarter results. Stone Castle's community bank's portfolio reported net income and deposit growth of 7.1% and 4.6% sequentially during the quarter, and 62 percent and 23 percent on a year-over-year basis. They also reported average Tier 1 capital ratios at 13.3 percent, which is up slightly from Q4. Also, Stone Castle's community bank portfolio reported a fourth quarter change in reserves up 1.2 percent, and in addition, loan book growth was up 2% from the prior quarter. During the first quarter, we also saw strong performance in the Money Center Bank regulatory capital space. The company's regulatory capital investments performed extremely well. Several investments were either paying down at par or continuing to amortize ahead of schedule since some of these investments were purchased at a discount. I would also like to point out that regulatory capital yields remain 25 to 50 basis points higher than pre-COVID levels, despite most other credit market yields tightening. Now, let me comment on the credit markets. The stimulus packages issued during the height of the COVID crisis, including the proposed infrastructure bill, among other factors, have led to heightened inflation fears. This has contributed to the US 10-year Treasury widening from 93 basis points to approximately 160 basis points, despite the Federal Reserve signaling that US interest rates will remain low for the foreseeable future. With this uncertainty, the markets may be volatile on the perception of rising rates through the second half of 2021. Regarding impending inflationary pressures, we believe during an upward trend in rates, the banking sector stands to benefit from higher net interest margin, or NIM, which would positively impact bank earnings. Also, an expanding economy should lead to businesses needing more capital for growth, part of which will be funded from bank loans. This increased bank lending should result in loan book growth, thus positively impacting bank earnings. In addition, an expanding economy should also lead to a decrease in loan default probabilities. This combination of positive fundamentals along with resulting growth in bank earnings should meaningfully decrease the risk premium related to the banking sector overall. Therefore, Stonecastle Financial's underlying investment portfolio will be positioned to reap the benefits of these constructive trends. In addition, a rising rate environment should benefit Stonecastle's portfolio since over 70% of the portfolio today is in floating rate securities. Next, I will cover the origination pipeline. In the first quarter, regional and community banks continued to be active, issuing approximately $1.1 billion of subordinated debt in the primary markets, which was basically flat from Q1 of 2020. In the Money Center Bank regulatory capital market, primary issuance during the first quarter was approximately $800 million, in line with historical activity in the first quarter and down slightly from the seasonally strong fourth quarter. Of note, during the first quarter, there was a regulatory capital issuance from a well-known U.S. regional bank, a possible start to a new trend. When Aramark took over as advisor to Stone Castle Financial, we believed there might be opportunities for expansion of regulatory capital issuance in the United States across regional and community banks. We believe a recent regulatory capital security issuance by a regional bank may prompt other non-money-centered banks to do the same. In the press release, the bank stated that the decision to enter this market was to proactively optimize its balance sheet and take an innovative approach to capital and risk management to benefit their company, clients, and their shareholders. With Stone Castle Financial's long-term relationships and expertise in the regional and community bank space, we may be in a unique position to take advantage of this expansion across the entire banking industry under the Aramark platform. Now on to Stone Castle Financial's results for the first quarter. We are pleased to report that net investment income for the first quarter was approximately $2.6 million, or 40 cents per share. At the end of the first quarter, the value of the investor portfolio was 178 million flat sequentially. The net asset value at the end of the first quarter was $21.62 per share, up 18 cents per share from the prior quarter. Now let me turn to the portfolio review. During the first quarter, the company invested a total of $17.5 million in six regulatory capital investments. The six new investments positively contributed to the portfolio, with a weighted average coupon of 9.5% and a weighted average yield to maturity of approximately 8.6%. The majority of the securities were purchased in the second-year market this past quarter. Yields of these new assets remain accretive to the investment portfolio. During the first quarter of 2021, the company also received proceeds of $9 million from maturing securities and paydowns. At quarter end, the estimated annualized effective yield generated by the invested portfolio, excluding cash and cash equivalents, was approximately 9.35%. This portfolio yield has held stable above 9% for 17 consecutive quarters. or over four years running. Our investment team is positioning the portfolio for the most advantageous risk-adjusted returns available in the banking-related assets with a long-term view of creating shareholder value. A full schedule of investments can be found on our website. Before I turn the call over to Pat, I want to point out that at Stone Castle Financial, We believe we are at the beginning of a new credit cycle that will position our company with significant incremental value. We have an economy that is reopening with increased probability of rising rates. This new cycle has potential to positively enhance the entire banking industry's financial performance, which should further reduce the risk profile of Stone Castle's investment portfolio. In short, the fundamentals are in our favor. Within the investment portfolio, we have always been focused on capital preservation and optimizing risk-adjusted returns. Today, we believe the risk premium of the underlying portfolio will continue to decrease, thus offering investors of Stone Castle Financial exceptional returns given a nearly 7.5% dividend yield while delivering a portfolio that is majority investment grade. Since second half of 2015, we have earned or exceeded our 38-cent dividend, providing consistent performance for our shareholders. Today, the company still offers nearly 500 basis points of incremental yield versus other banking-related income-oriented vehicles. All the while, we continue to deliver consistent and stable investment income a stable and growing NAV, and a consistent annualized portfolio yield of over 9%. We believe the company's stock, whether for an equity or a fixed income strategy, is offering significant value to its shareholders. Now, I want to turn the call over to Pat.
spk05: Thank you, Sanjay. As I do each quarter, I will present the financial results by going through the components of the company's quarterly results in detail. The net asset value at March 31st was $21.62 per share, up 18 cents from the prior quarter. Now onto the breakdown of the NAV components. The NAV is comprised of four components, net investment income, realized capital gains and losses, the change in value of the portfolio's investments, and lastly, distributions paid during the period. Let's review these components. Gross income for the quarter was 4.1 million or 63 cents per share. Net operating expenses for the quarter were 1.5 million or 23 cents per share, resulting in net investment income for the quarter of 2.6 million or 40 cents per share. As a reminder, in Q4, we had 3 cents per share of non-recurring income related to the reimbursement of certain expenses in connection with the transition to Aramark. As is the case every quarter, the timing of calls, paydowns, and option assignments, if any, impact the income generation of the company. Realized capital gains and losses in the quarter is the second component affecting the change in NAV. The net realized capital gains from investments were approximately $91,000 or one penny per share. Realized gains due to foreign currency transactions were approximately $1.8 million or 28 cents per share. The third component, changes in unrealized appreciation or depreciation of the portfolio, relates to how the value of the entire investment portfolio has changed from the previous quarter end to the current quarter end. For the first quarter, the change in net unrealized depreciation on investments and foreign currency transactions was approximately $860,000 or 13 cents per share. I want to point out that gains and losses from foreign currency hedging activities do not impact our net income. The fourth component affecting the change in net asset value is distribution. The regular cash distribution for the quarter was 38 cents per share, which was paid on March 25th to shareholders of record on March 18th. In summary, we began the quarter with a net asset value of $21.44 per share, During the quarter, we generated net income of $2.6 million, net realized capital gains of approximately $1.9 million, and the unrealized value of the portfolio decreased by $860,000. The sum of these components, reduced by a distribution of 38 cents per share, resulted in a net asset value of $21.62 per share at March 31st, which was up 18 cents from the prior quarter. Turning to the valuations for our portfolio holdings, it is worth noting that the vast majority of the portfolio continues to be independently marked. For the quarter, approximately 88 percent of the portfolio prices or marks reflect a minimum of two quotations or actual closing exchange prices. These quotations represent an independent third-party assessment of the current value of the portfolio. This should provide a greater degree of confidence in the company's underlying value versus other publicly traded closed-end funds and BDCs whose portfolios are comprised of assets that do not have readily available market quotations and therefore self-mark many of the assets in their portfolios. At quarter end, the company had total assets of $182.5 million consisting of total investments of $178 million and cash, interest, Dividends receivable in prepaid assets totaling approximately $4.5 million. Our dividend yield at the end of the quarter was approximately 8%. Now let me update you on the balance of our credit facility. On March 31st, the company had $39 million drawn from the facility, or 21% of total assets, leaving $23 million available to draw. Based on regulated investment company rules, we may only borrow up to 33.3% of our total assets. Now I want to turn the call back over to Sanjay for closing remarks.
spk04: Thank you, Pat. Now, operator, I'd like to open up the call for questions.
spk02: We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question comes from Chris O'Connell with KBW. Please go ahead.
spk03: Hi. Good evening, guys.
spk04: Hello there.
spk03: Hey, Chris. Hope all is well. Hey. Thanks. Same. So, I just want to start off with the portfolio yield this quarter. Came down, I guess, a little bit more than I was expecting given, you know, the shift over the past couple quarters toward, you know, the regulatory capital investments, which are, you know, typically higher yielding. You just walk through, you know, some of the dynamics there and maybe, you know, based on what you're putting on the books now, where you can see that yield kind of stabilizing going forward.
spk05: Sanjay, I'll take that.
spk04: Sure. You can start. I'll add if you miss anything. Yeah.
spk05: Yeah, that's fine. Yeah, this quarter we had one of the big securities that came off was the maturity of young partners. and that was earning a 10.5% yield for us. So that was a big piece that came off. We also had a number of paydowns that also came through on securities that were earning in the eights to high nines. We did put on a number of securities, some at 12, 10, 10, but we did have a couple that were in the mid sevens or low sevens. So it's just a function of during this period what we happen to put on. Overall, in terms of the income, as you know, it's timing of when securities are called or sold. At the end of last quarter, we had a number of securities that were called right at the end of December. So it takes a little time to put all that money to work. Sanjay, you want to add on?
spk04: Yeah, I mean, the only thing I'd add, Chris, is When I look at our pipeline, it is still holding on to some fairly healthy coupons. So I think high nines, low tens type of spread over a base rate, right? And over the last year, you've probably seen from some of the active trading too that we're trying to optimize the portfolio. But if I were to venture, I'd say going forward, you know, our pipeline looks pretty good in terms of kind of asset spreads.
spk03: Got it. And the low sevens yields that you were mentioning, was that what was being rolling off this past quarter or was being put on?
spk05: We had a mix. We actually had a resonance came off at 750. And we had a, let's see, we've had a OPAL 2 came on at a 738. So it's really just a mix. Like I mentioned, we put on 6.5 million that was earning between 10 and 12. Okay, got it. Okay.
spk03: So is it fair to, you know, characterize the yield as kind of bouncing, you know, somewhere around, you know, the 950 range or kind of similar to, you know, somewhere between this quarter and last quarter going forward, almost equal?
spk04: I would, yeah, I would say so.
spk03: Agreed. Okay, great. Okay. And then just looking at, you know, the outlook here, you know, I appreciate your comments on, you know, the overall environment and, you know, the potential for some ramp up from the U.S. based on the regulatory capital securities going forward. I know that, you know, given, you know, the seasonality dynamics, 4Q is a little bit stronger, you know, on those investments, and 1Q is usually a little bit of a laggard. The first month or so, if you triple that, seems to be some pretty good origination volumes to kick off 2Q. Is the overall pipeline holding up to what you guys have already put on in the second quarter? Do you think it can continue at that pace as you move through the rest of the quarter?
spk04: The short answer is yes. What we saw Even during the, first of all, just taking a step back, one queue was a bit of a slow start just because it seems like this year people kind of took their time coming back to the desk. I'm assuming it's all about COVID fatigue. But however, early part of February, the markets kicked in pretty nicely and it was really on the secondary side, right? Because New Deal ramp up primary issuance, they have to structure, et cetera, so it takes a bit of time. However, fortunately, the secondary market was active. And then from there, you know, we have seen a pretty healthy mix as of today between kind of what we're seeing in the primary market and we're seeing in the secondary market. And, you know, I would guide that. It's going forward for the balance of this quarter and early part of next quarter, you'll probably see the same mix in terms of new issue versus secondary.
spk02: There are no further questions. I would like to turn the floor over to management for closing comments.
spk04: Yeah, Stacey, I'll just probably give another few seconds here to see if there's any other questions coming through. I think we have Chris back.
spk02: Chris O'Connell.
spk03: Hi, yeah, just hoping to follow up a little bit. Kind of a small item, but I was just wondering if, you know, what the dynamics were around, you know, the other feline, I think like miscellaneous fees, and it seems like it dropped off, you know, to one of the lower levels, you know, that you guys have seen recently, and maybe some of the drivers around that.
spk05: Sure. The other income was that a reimbursement last quarter was the reimbursement that we have related to the transition. The arrow marks that we had a reimbursement that came in last quarter is a one-time item.
spk03: Okay. I mean, it seems like the run rate even prior to last quarter, though, was, you know, close to kind of, you know, just over, like, double, you know, where it came in this quarter. Is this kind of the new run rate for that line item, or is there anything else kind of dragging that?
spk05: No, this will be the new run rate for there.
spk03: Okay, got it. And then in terms of, you know, just maybe a little basic overview, could you just walk me through again, you know, just exactly what the, you know, foreign hedging strategy is and, you know, how that, you know, runs through, you know, you get the financial statements each quarter?
spk05: Sure. So what we do on a monthly basis is the PMs will look at the amount of securities that are in euros or pounds or whatever currency we happen to have and then hedge that for the month. At the end of the month, they'll close out that position. And as a result, you'll see this quarter we had some big gains there, 1.8, 1.9 million. in currency gains this quarter. The other side of that then is that the portfolio securities, some of them go the other way. So the value of those decreased and that's the whole purpose for doing the hedge. All of those transactions flow through on the income statement, on the statement of operations separately. And those are all laid out right there. So the $1,675,000 for realize gain loss on the contracts and then translations, et cetera. But everything flows through separate line items there. Is that helpful?
spk03: Yeah, absolutely. And so those are being fully hedged, is that correct? Yes. Got it. Okay, that's it. I think I'm all set, so I'll step out of the queue for now. Thank you. Okay.
spk02: Once again, if you would like to ask a question, please press star one on your telephone keypad.
spk04: Okay. And with that, thank you, operator. And to everyone, we look forward to meeting you soon.
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