ArrowMark Financial Corp.

Stonecastle Financial Corp Q2 2021 Investor Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question and answer session. At that time, if you have a question, please press the 1 followed by the 4 on your telephone. If at any time during the conference you need to reach an operator, please press star and zero. As a reminder, this conference is being recorded. Now I would like to turn the call over to Julie Morocco, Investor Relations of Stone Castle Financial.

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 has based the forward-looking statements included in this presentation on information available to us as of June 30, 2021. The company undertakes no duty to update any forward-looking statement made herein. All forward-looking statements speak only as of today, August 5, 2021. Now, I will turn the call over to Sanjay Bosele.

Thank you, Julie. Good afternoon, and welcome to Stone Castle Financial's second 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 markets before commenting on the company. Then I will provide Stonecastle Financial's quarterly results and portfolio review, and Pat will provide you with greater detail on financial results before we open the call for questions. In general, the banking industry continues to perform well. In the latest FDIC quarterly profile report, net income across all banking institutions more than tripled versus a year-ago quarter. In fact, 75% of all banks reported higher quarterly net income, and for community banks in particular, net income grew 77%. Also in June, which rating reported that the number of banks with a stable rating doubled on a year-over-year basis. Overall, we continue to believe in the help of the banking industry. Now let me comment on the credit markets. Recently, the Federal Reserve signaled that interest rates are expected to be stable over the foreseeable future. The 10-year U.S. Treasury yield has now contracted to approximately 1.2%, or nearly a 50 basis point decline since the beginning of the second quarter. The treasury markets were somewhat volatile during the quarter, given the combination of timing of the Fed's comments, concerns on inflation, and concerns over a new strain of COVID. The corporate credit spreads, however, were relatively stable over the second quarter, suggesting the economy is recovering as expected. As I mentioned last quarter, an expanding economy should positively impact bank fundamentals, and we believe Stonecastle's underlying investment portfolio should reap the benefits of this trend. In addition, if continued economic strength results in future interest rate hikes, Stonecastle is poised to benefit from increases in rates, as approximately 80% of the portfolio today is in floating rate assets. Next, I will cover our origination pipeline. In the second quarter, regional and community banks issued approximately $2.5 billion in subordinated debt. Issuance rates, for the most part, were at sub-4%, and therefore continue to be below stone-castle threshold for investments. At this time, we continue to find red-cap issuances by large money-centered banks much more attractive. In fact, in Q2, the regulatory capital relief market for money-centered banks had a strong issuance of approximately $3 billion. We expect a strong pipeline to continue into the third and fourth quarters as banks seek to optimize their balance sheets. The secondary market had consistent activity in the quarter as well. However, the transactions were competitively priced. As mentioned in our previous call, we continue to look across the entire spectrum of banking institutions for opportunities to participate in regulatory capital release transactions. Of note, we are seeing activity within regional and community banks as it relates to issuance of REDCap securities to optimize their respective balance sheets. Stone Castle is positioned to benefit from these issuances if the deals offer optimized risk-adjusted returns. Now onto Stone Castle Financial's results for the second quarter. We are pleased to report that net investment income for the second quarter was approximately 2.6 million or 40 cents per share. At the end of the second quarter, net asset value was $21.80 per share, up 18 cents from the prior quarter.

Now let me turn to the portfolio review.

During the second quarter, the company invested a total of $17.1 million in four regulatory capital transactions. The four new investments positively contributed to the portfolio with a weighted average coupon of 10.1% and a weighted average yield to maturity of approximately 10.3%. The majority of securities were purchased in the primary markets. Yields of these new assets remain accretive to the investment portfolio. During the second quarter of 2021, the company received proceeds of $4 million from one call and five paydowns. Subsequent to the end of the quarter, the company invested approximately $5.5 million and received partial paydowns to date of $1.8 million. We have targeted another investment of approximately $3 million at the time of this call. At quarter end, the estimated annualized effective yield generated by the invested portfolio, excluding cash and cash equivalents, was 9.47%, up from 9.32% in Q1. This portfolio yield has held stable above 9% for 18 consecutive quarters, or four and a half years running. I want to point out that this yield is produced with a majority of high-quality investment-grade assets. I also want to mention that subsequent to the end of the quarter, we successfully closed an issuance of $10.8 million in a registered direct offering. This transaction was executed off the company's active $150 million shelf registration. The issuance price was $21.89, a slight premium to NAB at the time of the transaction, and therefore, accretive to our shareholders. Last year, One of the commitments Aramark made during the Stone Castle transition was to grow assets by investing our available credit line and through opportunities in the equity capital markets. We plan on growing assets using the shelf for accretive transactions in alignment with shareholder interest. We're excited about the closed transaction and look forward to executing on more of these opportunities when market conditions are favorable. In my closing remarks, I want to point out the continued advantages of our company and our stock. Our investment team continues to position the portfolio to seek the most advantageous risk-adjusted returns available in banking-related assets in the industry today. Yet, we believe our stock price does not reflect the significant value added by our team and the continued outsized returns we are delivering to our investors. Since the second half of 2015, we have earned or exceeded our 38-cent dividend, providing consistent performance for our shareholders. Today, the company still offers over 500 basis points of incremental yield versus other banking-related income-oriented vehicles. All the while, we continue to deliver consistent net 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 at its current yield of approximately 7%. Now, I want to turn the call over to Pat. 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 on June 30th was $21.80 per share, up 18 cents from the prior quarter. Now, on to the breakdown of the NAB components. The NAB 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 4.2 million, or 65 cents per share. Net operating expenses for the quarter were 1.6 million, or 25 cents per share, resulting in net investment income for the quarter of 2.6 million, or 40 cents per share. 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 losses from investments were approximately 960,000 or approximately 15 cents per share. Realized losses due to foreign currency transactions were approximately 519,000 or 8 cents per share. The third component changes an 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 second quarter, the change in net unrealized appreciation on investments and foreign currency transactions was approximately $2.6 million, or $0.39 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 distributions. The regular cash distribution for the quarter was $0.38 per share, which was paid on June 28 to shareholders of record on June 21. In summary, we began the quarter with a net asset value of $21.62 per share. During the quarter, we generated net income of $2.6 million, net realized capital losses of approximately $960,000, and the unrealized value of the portfolio and foreign currency transactions increased by 2.6 million. The sum of these components, reduced by a distribution of 38 cents per share, resulted in a net asset value of $21.80 per share on June 30th, 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 87% 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 values 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-marked many of the assets in their portfolio. At quarter end, the company has total assets of $250.1 million consisting of total investments of $246.5 million in cash, interest, and dividends receivable and prepaid assets totaling approximately $3.6 million. The total assets reported this quarter reflects approximately $51.7 million of investment-related activities which closed in the first week of the third quarter. Net of this transaction, the company's total assets were $198 million at the end of the quarter, up from $182.5 million in Q1, or 7% sequentially. Our dividend yield at the end of the quarter was approximately 6.9%. Now let me update you on the balance of our credit facility. On June 30th, the company had $53.5 million drawn from the facility, or 27% of total assets. 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. Thank you, Pat. Now, operator, I'd like to open up the call for questions.

Thank you.

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One moment please for the first question.

And our first question comes from the line of Chris O'Connell with KBW. Please proceed with your question.

Hi, good afternoon. So I'd like to start off with just the investment portfolio and, you know, what we're seeing in the investments versus, you know, the posted amount of $247 million. It seems like there might have been something to reconcile with the $52 million due to the custodian in kind of netting those out. Can you just provide a little call around that?

Yeah, this is Pat. That's exactly right. Due to the timing of a cash money movement that we had with the custodian on a hedge transaction, that's what caused that discrepancy there, if you will. And it was resolved immediately after quarter end.

So it was just the timing issue really that popped that up. Okay, got it.

And is that is, you know, just filed, but I'm seeing, you know, there's like $54 million, I think, with the money market funds. So that basically, you know, $51 million or so of that, you know, take that out of the investment portfolio and the assets to get the leverage ratio 27% that you guys referred to.

You're exactly right. Exactly right. That cash in the money market directly offsets that due to custodian amounts.

Okay, got it. Makes sense. And congratulations on the successful offering. I was hoping to just have you guys provide a little color update. Is that an indication of a higher growth outlook that we could see in the second half of the year here?

Yeah. Hey, Chris. This is Sanjay. How are you? Good. How are you, Sanjay?

Yeah, not bad. Yeah, so in regards to the investment pipeline, it continues to be fairly active. And as you might recall from our previous comments, Q3 and Q4, generally speaking, are fairly active quarters, the fourth quarter being the most that relates to issuance of new regulatory capital securities by banks, right? And today we do have some availability on the credit line, but having said that, we would like to ideally match the investment pipeline with the growth of the company. And if the capital markets allow us to issue additional shares, we would be looking at that. So hopefully that helps.

Yeah, absolutely. And as far as the credit line goes, is that something that if there is a robust kind of growth outlook as you come into the back half of the year here, that it's something that you might consider increasing in sizes?

Yeah. So we do have a fairly good relationship with our banking partner there who has indicated to us from time to time that they like to grow alongside the company. And, you know, all things constant, we do expect them to grow with us.

Got it.

And then as far as the outlook goes with the pipeline on the REDCAP side, you know, is it Is the, you know, stuff that you're putting on still around the same yields and kind of, you know, high nines, low ten yields?

Yes, that's right. I mean, that's kind of what we're seeing in the market today. You know, there will be, on average, I'd say that's kind of where we'll end up in the nines. And, yeah, so really no material changes there.

Okay, great. And then excluding, you know, the cash or custodian amount that's going to fall off the balance sheet. Can you just remind us of, you know, the interest rate sensitivity profile and, you know, how much of the portfolio, investment portfolio is floating rate?

Sure. Pat, do you want to take that or do you want me to start?

You can take it and I'll add on.

Sure. Sure. So, Chris, you know, today, if you were to look at it on a total asset basis, about 60% of the portfolio is in floating rate. And so, you know, and that's, you know, it's either LIBOR or SOFR type of index assets. So again, to clarify on about 195 million of assets, think about 60% of those being floating.

Okay, great. Got it. Yeah. All right. That's all I had. Thank you. Step out. Thanks, Chris. Okay.

There are no questions at this time. I will now turn the call back over to management for closing remarks.

Well, everyone, thank you very much for listening in, and I look forward to answering any questions you all folks might have, and have a great night. Thank you.

That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.