First Eagle Alternative Capital BDC, Inc.

Good morning and welcome to the First Eagle Alternative Capital BDC Incorporated's earnings conference call for its first fiscal quarter ended in March 31st, 2021. It is my pleasure to turn the call over to Ms. Sabrina Rusnak-Carlson of First Eagle Alternative Capital BDC Incorporated. 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, Terry Olson, Chief Operating Officer and Chief Financial Officer of First Eagle Alternative Credit, and Jen Wilson, Chief Accounting Officer. Before we begin, please note the 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 material from such statements. The uncertainties and other factors are in some ways beyond management's control and include factors included in the section entitled Risk Factors in our most recent annual report on Form 10-K filed yesterday. and other filings with the Securities and Exchange Commission. Although we believe that the assumptions on which any forward-looking statement are based on are reasonable, any of the 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 undertakes no duty to update any forward-looking statements made herein. All forward-looking statements speak only as of the date of this call. Our earnings announcements and 10Q were released yesterday afternoon, copies of which can be found on our website, along with a Q1 earnings presentation that we may refer to during this call. A webcast replay of this call will be available until May 17, 2021, starting approximately two 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'll provide an overview of our first quarter results, some portfolio highlights, and then Terry will discuss our portfolio and financial results in more detail. Let's begin with our results for the quarter. Net investment income for the quarter was $0.11 per share compared with $0.10 dividend and $0.11 per share in Q4. NAI continued to benefit from the management fee waiver that ended in March 31st. As a reminder, the management fee waiver constituted a $0.03 per share impact to NAI per quarter. It was intended to reduce the impact to shareholders as we exited and de-risked our remaining concentrated non-core positions. We made considerable progress on our portfolio transition and overall. We are very pleased with how the portfolio has performed through the pandemic. In light of the improvement and stability of our portfolio, as Bruce previously communicated, we have begun to increase our leverage. We are levered at 0.093 times at the end of the quarter, 0.96 times if you take into account our unsettled trades at quarter end, and we are targeting long-term leverage levels of up to 1.2 times by the end of 2021. We expect this increase in leverage to be accretive to NII at a level that we believe will be in line with or exceed our current dividend. In Q1, our book value increased approximately 3.6 percent from $6.15 per share at the end of Q4 to $6.37 per share at the end of Q1. Similar to Q4, we think it is important to highlight the contributors to the increase in our book value. First, the continued improvement in the broadly syndicated market, similar to what you saw in Q4, lifted the value of our holdings in the Logan joint venture, specifically in an 11 cent per share positive impact in NAV this quarter. We remain pleased with the overall credit quality across the 92 names and Logan's $241 million of assets. Non-accruals within Logan represent less than 1% of the portfolio in Q1. Second, we saw overall increases in portfolio related to certain equity positions in Wheels Up, C&K Market, Marical, and Igloo. Performance in all four investments remained strong, and the increase in book value reflects improved credit metrics and market multiples. In aggregate, the increase in these values of equity represent a seven-cent increase in NAV. Lastly, the overall improvement in our portfolio performance I mentioned earlier, together with further spread tightening in the market, resulted in net appreciation in the rest of the portfolio of three cents per share. Ninety-five percent of our debt investments reported either the same or increased values in Q1 versus Q4. Now let's delve deeper into the portfolio. Overall, the portfolio continues to perform well amid the continuing impact of the pandemic. Revenue and EBITDA levels and liquidity for most COVID impacted businesses continue to improve and in many instances have returned to or exceed pre-COVID levels. Companies that are not fully rebounded continue to maintain good liquidity profiles. No significant amendments were necessary in Q1 related to COVID. We did not add any new non-accruals during the quarter. LoadMaster is the only portfolio company on non-accrual. While we do not exit any of our two remaining legacy concentrated positions, OEM and IGLU, each continue to perform in line with expectations. Specifically with respect to OEM, as the plasma therm transaction consummated in Q4 to commercialize and distribute its technology to the market is proceeding well. As a reminder, the principal consideration was in the form of deferred payments for several years contingent on certain milestones, including minimum annual payments for the first four years that will be used to service their debt and cover certain operating costs. The BDC retained all the equity in the remaining business. In Q1, we upsized the $8.5 million first-lane term loan slightly as planned to provide short-term transitional capital in connection with the sale transaction. Second, EGLU, the largest single holding at the year-end, represented 6% of our portfolio. The company continues to form well. The debt investment is marked at par, and the equity position was written up this quarter, reflecting strong performance and the continued impact of spread tightening. These two positions represent the last remaining of the 14 concentrated positions we held in our portfolio starting in early 2018. As I noted earlier, we are pleased with our progress on exiting these legacy investments and hence our comfort with proceeding with our plan to increase leverage. Additionally, our direct lending pipeline remains strong. The BDC continues to benefit from deal flow generated by First Eagle's $5 billion direct lending platform. Our growing platform benefits the BDC by allowing the BDC to be more diversified positions while also allowing First Eagle to provide more capital to middle market companies. The first quarter of the year tends to be slower compared to year end, but nonetheless, the BDC made two new directly originated investments, totaling $6 million this quarter. Further, the BDC made $15 million of broadly syndicated investments in four companies that are not necessarily intended to be long-term positions in the portfolio, but rather replace the directly originated positions over time. Separately, there were two debt repayments at par, plus a prepayment premium during the quarter. Since the beginning of the pandemic, First Eagle's direct lending platform has remained robust, and we continue to provide us with investment opportunities. We continue to be very selective about where we deploy our capital. Our goal is to continue to diversify our investment approach as we grow the BDC's portfolio in 2021. Lastly, you may have seen in our earnings release that our board approved a $10 million stock repurchase plan at our board's meeting earlier this week. The plan gives us discretion to buy back stock and open windows should we feel it makes sense. With that, I'll turn the call over to Terry.

Thanks, Chris, and good morning, everyone. First, some investment portfolio highlights. As Chris mentioned, we had an active quarter with six new and several follow-on investments totaling $25 million at a blended yield of 6.6%. Excluding the four broadly syndicated loans, the blended yield on the new investments is 7.8%. And we had two notable realizations through the exit of our first lien positions in Neiman Marcus in App Buyer Technologies in Q1, generating $6.2 million of cash proceeds, which included prepayment premiums. As of March 31st, our portfolio of $363 million, up from $338 million at the end of Q4, was invested 70% in first lien senior secured debt, 20% in Logan JV. As a reminder, the Logan JV is 98% invested in first lien assets. The remaining 10% of the BDC portfolio was held in second lien subordinated debt and other non-income producing and equity holdings, including our restructured equity-like second lien investment in OEMs. The weighted average yield on our debt and income-producing portfolio based on cost, including Logan, was 7%, which is in line with the prior quarter. As Chris mentioned, we added no new investments to the non-accruals in Q1, and total non-accruals of the percentage of the portfolio and fair value and cost were 2.1% and 3.7%, respectively. Moving to the financials for the quarter, I'll highlight some of the components of our $7.2 million in investment income this quarter. These include interest income of $5.4 million, which rose slightly quarter over quarter as we added new names to the portfolio while experiencing some back-ended repayments with call protection. Included in the $5.4 million is $100,000 related to prepayment premiums and $300,000 related to accelerated amortization of OID. Dividend income decreased this quarter to $1.6 million from 2.1 as we are no longer receiving a dividend from our holdings in C&K. All dividend income in Q1 was related to Logan. Total expenses of the quarter were $3.9 million, which were down about $300,000, largely due to higher costs in Q4 associated with the write-off of certain deferred financing costs related to our credit facility amendment. With respect to other items below the net investment income line, Net realized losses for Q1 were 3.1 million. 1.9 million of these were related to the recognition of a full reserve on our equity holdings and Alex Brands, so no NAV impact in Q1. And 1.1 million related to adjustments to certain of our escrows. From a leverage perspective, we ended the quarter with a debt-to-equity ratio of 0.93%. We settled several trades post-quarter end and have made $9.1 million of new and follow-on investments since March 31st. We have ample borrowing capacity on our credit facility, having increased our $100 million facility to $125 million at the end of the quarter. We continue to grow and increase leverage towards our target. From an unsecured debt standpoint, we are continuing to evaluate alternatives to refinance our 60% million of currently callable 2022 bonds, considering both our current and expected investment rating, and overall lowering our cost of capital. With that, I'll turn the call back over to Chris.

Thanks, Terry. Overall, this is another solid quarter for FCRD with steady NAV and credit improvement. We again recorded positive results at most of our portfolio companies. The economy has begun to open up over the last several months. We've made progress at de-risking the portfolio attributed to outsized legacy positions. Originations remain strong and remain confident in our ability to prudently increase our leverage profile to put us in a position to cover our dividend going forward without management fee waivers. I would now like to turn the call over to the operator for Q&A. Operator?

Thank you, sir. And as a reminder, if you wish to ask a question, simply press star then the number one on your telephone keypad. If you wish to withdraw your question, press the pound keys. Once again, if you wish to ask a question, simply press star, then the number one on your telephone keypad. Your first question is from the lineup. Lee Cooperman from Omega Family Office. Your line is now open.

Thank you. Good morning. How are you doing with Chris? Hope all is well. All well, thank you. I think you've addressed it, but I just want to make sure I hear right. You feel the dividend is sustainable after returning to a full fee, correct? Is that what you said?

That's correct.

Okay. Given things as they exist today, not tomorrow, but today, how do you view making additional loans versus stock repurchase, given the big discount to book value? The discount seems to be justified by what we're earning on our book, but how do you view the relative merits of repurchase versus growing the business?

Yeah, it's a complicated – go ahead, Lee, if you had a second question. I didn't mean to interrupt.

No, no. And then, you know, on the repurchase, what is the actual order of magnitude that you would have available if you decided to do repurchase?

Yeah, perfect. I think the second question first, under the current borrowing base that we have with ING, I don't believe there would be any restrictions that we'd have full access to the full $10 million to the extent we elected to do that. Obviously, it would take time for us. $10 million is the size of the program. Obviously, it would take time for us to do that, just given how thinly traded the stock is. So there shouldn't be any restrictions to limit that. With that said, as you said, how do you balance it? It is a balance because, obviously, the BDC has shrunk tremendously. We're trying to turn that around and actually see growth. We're trying to manage both shareholder expectations and making sure we're being good fiduciaries of capital and making capital available to make new investments and new loans, but also recognize that we still do trade at a discount to book. One of the points we tried to make last quarter, and I want to emphasize it here, there are other levers that we can pull here to continue to fix the equation. We had to fix the asset side of the equation first. That's done for the most part. We're debt players, so we never declare victory, but we feel very comfortable with the balance sheet to increase the leverage to cover the dividend. Step two is moving forward and improving our rating and, therefore, lowering our cost of financing. You know, we have a set of bonds that are callable now. We have another set that are callable in October. As the asset side of the balance sheet continues to improve, we continue to, you know, push for an upgrade, which would substantially reduce our costs, which would be further accretive to the dividend and, therefore, shrink the gap between book and NAV and our stock price.

So the answer to the question is you haven't decided.

We haven't decided. That's correct. We're looking at them on a case-by-case basis. But again, my focus right now is trying to fix the liability side of the equation, coupled with maintaining some growth in the existing investments. But I also do recognize that we're still trading at a significant discount, and that's a good prudent use of capital as well. So I would anticipate all three.

Actually, two last questions. Given a full fee schedule for your compensation scheme and the way you want to run the business in terms of the quality of credits you're investing in, what is a reasonable return on equity as a target? In other words, what should that $6 and some change in book value yield in the way of earnings?

Yeah, once we get the liability side corrected, because right now the cost of the debt stack is absolutely too high. I wasn't saying it was unjustified before the balance sheet was fixed, but now that it's fixed, we need to bring that down. But we're still targeting a 9% to 10% ROE. I don't think that's substantially different than any other BDC.

Gotcha. Okay. Thank you very much. I'll yield the call to somebody else. All right. Thanks, Lee. Thank you.

Your next question is from the audience. Your next question is from the line of Matt, Jayden, Raymond, and James. Your line is now open.

Hey, all. Good morning and appreciate the time. And apologies if I ask something that's been covered as I had to join late. First question, I guess, kind of for me, any high-level commentary you can give on spreads and structures versus kind of pre-COVID levels and what you're seeing in the pipeline? Sure.

Yeah, sure, Matt. Appreciate the question. We didn't cover that in our script. You know, when COVID hit, spreads probably gapped out, you know, 200 to 300 basis points. The market has become more competitive or stabilized. Those spreads have come down. I'd say now you're probably still maybe 50 basis points wide from where you were pre-COVID levels. But, you know, I'd call the market right now on a high quality senior secure deal, you know, LIBOR 550 on our traditional transactions. We're probably LIBOR 600 to 650 on our ABL transactions.

Okay. I guess on a more unrelated note, just kind of looking at the fair value to cost marks in the broad portfolio. So by my calculations, I've got about, call it $1.70 in just embedded depreciation on the book. Any commentary you can give on how much of that, I know that obviously embeds like Loadmaster and OEM, but how much of that is from what I might call the non-non-accrual book and any further nab upside from that?

Yeah, this is Terry. I'd have to get back to you with the math. I hadn't bifurcated the answer to that question ahead of this call. So if need be, I can circle back with you. There is a decent, you know, the only other name I would say where you're probably seeing that gap is with Matilda Jane. And you can see that gap has closed over the last few quarters there. based on its performance. So that would be the only other larger area where there's, you know, related to a specific name that I'd point out. But I don't have the exact split.

Okay, fair enough. That is it for me. I appreciate the time. Thanks, Matt.

Once again, if you wish to ask a question, simply press star, then the number one on your telephone keypad. Your next question is from the line of Robert Doug of Raymond James. Your line is now open.

Morning, guys. This is a weird morning, so I joined from a different call from Matt. Lee actually asked the question, but I'm going to follow up on it. On the target ROE, a 9% ROE seems realistic for your strategy, etc. You're obviously well below that today. What do you think is a realistic timeframe to actually get to that level of ROE? Because if you can hit 9%, the valuation could potentially move. So what's the timeframe where you think that's realistic?

Yeah, Robert, it's a great question. I wish I could give that to you. But unfortunately, we don't control all aspects of the business per se. What we did control was the asset side of the equation. We've worked tremendously hard to reposition the portfolio, exit these facilities that didn't make sense. massively reduce our concentrated position, so now we feel like we've got an asset balance sheet that can be financed substantially cheaper. What do I need to make the other part of the equation work? We need an upgrade. We need to be investment grade, and if we hit an investment grade status in the near term or in the future, That will enable us to substantially reduce the cost of our financing, which will be extremely accretive to the dividend, which will make that ROE calculation that much easier. But, you know, unfortunately, I don't have a crystal ball. And when that upgrade is coming, we're obviously having conversations with the rating agencies, as Terry alluded in his prepared remarks. So, you know, we have, as I said before, bonds that are callable now. We have another set that are callable in October. I'm hopeful that we can get all this stuff wrapped up by the end of the year. But, of course, again, that's still subject to the rating agencies. As we see here today, it's currently rated. We could refinance the bonds at a savings. But I think from my perspective, I think we've done enough to get that investment grade rating, and we want to hold for that to take a bigger step down in the cost of debt. Once the cost of debt comes down, obviously the ROE equation becomes substantially easier.

Mm-hmm.

Maybe, Robert, maybe just to put some numbers around it, just to order a magnitude, you know, 50 basis point savings on the bond themselves, just on a rate perspective, drives about, you know, two cents of annualized NII, just on 50 basis points. So... You know, you could potentially multiply that by three, and that could come up to five or six cents per share on an annualized basis if you can get the bonds down 150 basis points. So I'm sure you've done that math, but I just wanted to highlight that to tie the two points together. Thank you.

Yeah, I have done that. But I appreciate your math as well.

Absolutely.

There are no further questions presented. I'm sorry, presenters, there are no further questions. Please continue.

Oh, operators, no more questions?

Yes, sir.

Robert, that was it? Okay, perfect. All right, well, thank you. Thanks, operator. Before I make my final remarks, I'd be remiss if I didn't highlight the fact that this was Terry's last earnings call with us. I believe this is 44 in a row for him. While I didn't do all 44 with Terry, I can tell you I'm pleased that he did all of mine with me. I couldn't think of a better partner to help navigate the last few years, so on behalf of First Eagle, I just wanted to say thank you. We wish you all the best. We also appreciate the support of our shareholders, and we look forward to providing you with an update in early August on our future results. Hope everyone has a good day. As usual, feel free to reach out to Sabrina and myself if you have any questions before then.

And with that, this concludes today's conference call. Thank you for attending. You may now disconnect.