First Eagle Alternative Capital BDC, Inc.

Ladies and gentlemen, thank you for standing by and welcome to the First Eagle Alternative Capital BDC Inc. Q2 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone keypad. Please be advised that today's conference is being recorded. If you require any further assistance, please press store then zero. I would now like to hand the conference over to your speaker today, Sabrina Resnick Carlson. Thank you. Please go ahead.

Thank you, operator. Good morning and thank you for joining us. On today's call are Chris Flynn, President of First Eagle Alternative Credit, and Jen Wilson, our Chief Accounting Officer and Treasurer. Before we begin, please note that 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 materially from such statements. The uncertainties and other factors are in some ways beyond management's control and include the factors included in the section entitled risk factors in our most recent annual report on Form 10-K as updated by our quarterly report on Form 10-Q and our periodic and other filings with the Securities and Exchange Commission. Although we believe that the assumptions on which any forward-looking statements are based on are reasonable, Any of those 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 four statements. First Eagle Alternative Capital BDC 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 announcement and 10Q were released yesterday afternoon copies of which can be found on our website along with a Q2 earnings presentation that we may refer to during this call. A webcast replay of this call will be available until August 16, 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 second quarter results and some highlights in the portfolio. And Jim 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 $0.09 per share compared with a $0.10 dividend and $0.11 per share of NII in Q1. As a reminder, the management fee waiver, which contributed $0.03 per share in NII, ended in Q1. The waiver went into effect in Q3 of 2020 and was provided by the advisor to reduce the impact of shareholders as we continue to complete the reposition of our portfolio by exiting and de-risking the remaining concentrated non-core positions. This portfolio reposition, you know, is substantially complete. In light of the improvement and stabilization of the portfolio, we increased our leverage to 1.1 times, up from 0.96 times at the end of Q1. We had previously communicated our plan to move closer to our long-term leverage target of 1.2 turns. Based on the deal pipeline and the lending environment today, we believe we have the ability to hit our target leverage ratio by the end of the year. At that level, assuming all conditions remain the same, we are in targeting an increase to our earnings to $0.10 per share next quarter. During the quarter, book value increased by approximately 2%, from $6.37 per share at the end of Q1 to $6.52 per share at the end of Q2. we think this is important to highlight the key contributors to this book value increase. First, continued improvement in the broadly syndicated loan market lifted the value of our holdings in the Logan joint venture. This had a six cent per share positive impact on NAV this quarter. We remain very pleased with the overall credit quality across the 92 names in the Logan's $241 million portfolio. Non-accruals were less than 1% in Logan as of Q2. Second, Other parts of the portfolio experienced increases in value as well. The IPO of Wheels Up, in which the BDC holds an equity position, and continued performance improvements at Matilda Jane, together contributed $0.04 a share. Lastly, the overall improvement in the portfolio performance I mentioned earlier, together with further spread tightening in the market, resulted in a net appreciation for the rest of the portfolio equal to $0.06 per share. Now let's delve deeper into the portfolio. Overall, the portfolio companies continue to perform well amid the continuing impact of the pandemic. Revenue and EBITDA levels and liquidity for most COVID-impacted businesses in the portfolio continue to improve and, in many instances, have returned or exceeded pre-COVID levels. Companies that have not yet fully rebounded continue to maintain good liquidity profiles. No significant amendments were required to the existing loan portfolio in Q2. Consistent with Q1, we did not add any new non-new accruals for the quarter. ModeMaster is the only portfolio company on non-accrual. OEM and Igloo are two remaining concentrated positions. Both continue to perform in line with expectations. At OEM, the plasma therm transaction that we consummated in Q4 to commercialize and distribute the technology into the market is proceeding well. As a reminder, the principal consideration was in the form of deferred payments over several years. These payments are contingent upon certain milestones, including minimal annual payments of the first four years that would be used to service our debt and cover certain operating costs. The BDC retained all the equity in the remaining business. In Q2, we upsized our first loan position by $300,000, as planned, to provide short-term transitional capital in connection with the sale transaction. Big Blue represents a 6% position in the portfolio and is the largest holding that we have as of June 30th. The company continues to form well, the debt investment is marked at par, and the equity position was written out this quarter, reflecting strong performance and continued impact and spread tightening. These two positions represent the last of the 14 concentrated positions we held in the portfolio in early 2018. We are pleased with our progress in exiting these legacy investments, and this gives us comfort with proceeding with our plan to increase leverage. We were very active in the quarter, making new portfolio investments across the direct lending platform, totaling $350 million. of which $46 million in 12 new investment companies was allocated to FCRD. FCRD made an additional $4 million of follow-on investments during this quarter. Separately, there were two debt prepayments at par plus a prepayment premium during the quarter. Our direct lending pipeline remains strong, and the BDC continues to benefit from the overall deal flow generated by First Eagle's $5 billion direct lending platform. The growth of the platform allows the BDC to hold a more diversified portfolio, with the number of positions up from 45 in Q1 of 2018 to 64 this quarter. Since the beginning of the pandemic, First Eagle's direct lending platform has remained robust, and we expect it to continue to provide us with attractive investment opportunities. We continue to be very selective on where we deploy our capital, and we are mindful of the macroeconomics environment in all of our investment committee decisions. Our goal is to continue to diversify our investment approach as we grow the BDC's portfolio into 2021 and beyond. With that, I'll turn the call over to Jen.

Great. Thank you, Chris, and good morning, everyone. I'll start off with some investment and portfolio highlights. As Chris mentioned, we had an active quarter with 12 new and several follow-on investments totaling $50 million at a blended yield of 6.6%. And we also had two notable realizations through the repayments of our first lean positions in Communication Technology Intermediate and Whitney Bradley and Brown, Inc. generating $17.3 million of cash proceeds, including prepayment premiums. As of June 30th, our portfolio was valued at $395 million, up from $363 million at the end of Q1. It was invested 73% in first lien senior secured debt and 19% in the Logan JV. As a quick reminder, the Logan JV is 98% invested in first lien assets. The remaining 8% of the BDC's portfolio was held in second lien, subdebt, and other non-income producing and equity holdings, including our restructured equity-like second lien investment in OEM. The weighted average yield on the debt and income producing portfolio based on cost and including Logan was 6.9% in Q2. This is in line with the prior quarter. As Chris mentioned, we didn't place any additional investments on non-accrual during Q2. Total non-accruals as a percentage of our portfolio at fair value and at cost were 2.1% and 3.6% respectively. Now I'd like to address the financials for the second quarter. During the second quarter, we recognized $7.8 million of investment income, primarily from interest and dividends. Interest income increased by approximately half a million from Q1 to 5.9 million for Q2. Coupon interest increased approximately 300,000 as we added new names to the portfolio, and we also benefited from some back-end repayments with call protection. Included in the 5.9 million is 245,000 related to prepayment premiums and approximately 236,000 related to accelerated amortization of OIDs. Dividend income from the Logan JV was relatively flat quarter over quarter at $1.6 million. Total expenses for the quarter were $5.1 million, up $1.2 million from the prior quarter, primarily due to the payment of the management fee in Q2 totaling $963,000. The remainder of the increase was due to incremental fees on our credit facility and notes. With respect to other items below the net investment income line, the net realized losses for Q2 were approximately $1 million. This included $447,000 related to the adjustment to certain escrows and $543,000 related to the extinguishment of debt in connection with the redemption of our 2022 note. From a leverage perspective, we ended Q2 with a debt-to-equity ratio of 1.1 times. with ample borrowing capacity on our credit facility to continue to grow and increase leverage towards our target of 1.2 times. With respect to unsecured debt, we were pleased to refinance our callable bonds in Q2, lowering our overall cost of capital. We closed on the $69 million public debt offering in May of 2021. The new bonds, which mature in 2026, are priced at 5% and are not callable for three years. Proceeds from the issuance were used to redeem our 6.75% 2022 bonds at par, as well as to partially pay down our revolving credit facility. The refinancing resulted in a loss on the extinguishment of debt equal to the difference between the amount we paid to redeem the bonds and the carrying value of the bonds, which reflects the impact of unamortized deferred financing costs. With the refinancing of the 2022 bonds, we were able to reduce our weighted average cost of debt by 84 basis points from 5.45% as of March 31st to 4.61% as of June 30th. We continue to evaluate opportunities to further reduce our cost of capital, especially as our 2023 bonds become callable. With that, I will turn the call back over to Chris.

Thanks, Jen. Overall, this is another solid quarter for FCRD. We delivered steady improvements in NAV and credit quality. We again recorded positive results at most operating portfolio companies. We also made additional progress in de-risking the portfolio with respect to several remaining legacy positions. Origination activity remains strong, and we are confident in our ability to prudently increase our leverage profile to put us in a position to meet or exceed our dividend level. I think we'll now turn the call back over to the operator for any questions.

At this time, if you would like to ask a question, please press star then the number one on your telephone keypad. Again, that is star then the number one. We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Lee Cooperman with Omega Family Office.

Good morning. Thanks. Hope everybody is safe and healthy. Hi, Lee. I just... I guess you've answered one of my questions, which is you feel comfortable that the dividend is secure at 40 cents?

Correct.

Okay. I'm trying to figure out, you know, how does deploying capital at 6.6% beat repurchasing stock at a 30% discount to NAV? I assume you feel comfortable that the NAV of 652 is real and that it's secure?

We do.

Yeah, okay. So wouldn't your best alternative be to buy back stock rather than making new loans?

Yeah, Lee, it's a balancing act, obviously. I'm trying to maintain some stability in the portfolio. And, again, the ultimate goal here is for us to increase the size of the BDC, not decrease it. But we do have a program in place. I think it's a $10 million program that we can buy, and we'll – We'll consider that as we weigh those. But, again, mathematically, you're correct. It's a decree to buy that stock, and that's why we layered in the option of doing that.

Yeah, but you've currently not used it, right?

We didn't use it last quarter. That's correct.

Right. Okay. Let me ask you this question. I don't want to put you out of business, but we have a $140 million equity market cap. We're really insignificant in the galaxy. I don't even know why I spend time on it other than I own a lot of stock. But basically, I was very instrumental in MVC, another BDC, merging with BBDC bearings. And we have a stock price far in excess of what we would have gotten if they stayed independent. What is your attitude towards seeking a merger partner where we gain – you're trying to gain size. You can gain size one of two ways. You can try to internally grow. where we could basically merge with a larger, more successful, lower cost of capital BDC. What's your attitude towards that?

Listen, Lee, one of the reasons why we ended up joining First Eagle was to gain access to a bigger balance sheet and a larger asset manager to put us in a position where we can be more proactive strategically in pursuing those types of opportunities. The fact is, until we were able to clean up our balance sheet, we weren't that attractive of a partner. Now that our balance sheet is clean, um we feel like we have the ability to come back and start having those types of discussions to the extent they make sense if they don't make sense we'll continue to do and control what we can which is to manage the portfolio continue to try to find good relative value in investments and right now focus on lowering the cost of capital on the debt side which will in effect drive a higher roe and again continue to support growth to the dividend so we're looking at all options in front of us we recognize the bdc is too small that's not been something that we've ever disagreed with. It's just a matter of trying to find the right avenues for growth, and they could take a lot of different options. And, again, we're considering all of them.

I know it's complex, but I would think shrinking the share cap at a big discount to NAV would get us a better price in the end if a transaction was to ever occur. But that, to me, is obvious, and I'm sure it's obvious to you as well.

It is. We're a large shareholder, too, Lee.

Not as large as me, probably, but whatever. Anyway, good luck. Thank you very much. Stay safe. Stay healthy.

Perfect. Thanks, Lee. Appreciate the call.

And again, to ask a question, please press star, then the number one on your telephone keypad. Your next question comes from the line of Robert Dodd with Raymond James.

Hi, guys. Sorry, I missed the prepared remarks because there's so many earnings this morning. So, I mean, and I did mention, obviously, focusing on fixing up the capital structure now. I mean, you've started that. Can you give us any color on next steps? I mean, obviously, there's still some expensive debt on the balance sheet that could be refinanced at some point. What do you think... Um, I mean, we know that the pricing of, of, of the debt you have done, do you think that's the likely pricing, um, for future debt refinancings or, or where do you think that could go? Cause obviously, you know, the lower the cost of debt capital, the better, um, for obvious reasons. Um, but any color on, on, on what the plans are that are not just the, the, the, uh, the potential imminent refinancing, but you know, longer term, what would you like the debt stack? And particularly if you have a target cost of debt long term, what would that be?

Yeah, no, thanks, Robert. Appreciate the question. Um, obviously getting the investment grade status, um, at the beginning of the year was, was, was a big win. Um, we immediately took action and called the bonds and substantially lowered our cost of debt. As you can see in our filings, we've got another set of bonds that are callable in October. Probably not the right position for me to predict what I think future rates are going to be out to October, but based on current market conditions today, the bond market for BDCs and these types of financings continue to be very, very strong. So my expectation, as I sit here today, would be to execute at or very similar levels. Another comment that you made regarding the, the, the cost of that is just, you're right. It's not just the unsecured bonds. It's also the debt facility and how we finance the BDC and how we finance Logan as we continue to grow a more diversified senior secured portfolio. If you remember in the, in the repair remarks, I guess you said you missed those, but I think we've gone 40 or low 40 names up to 64. Our target would be to get this into the end of the low seventies. That's a highly diversified first lien portfolio. that we feel we all have significant optionality and how we want to finance that both inside the BDC and then inside the Logan structure, which to your point, as we bring those costs down, that'll drive a higher ROE and hopefully create a situation where you have some upside to continue dividend coverage.

Got it.

But again, we couldn't fix the debt side of the equation until the asset side of the equation was stable. Now that that's stable, we can come back and significantly reduce the debt going forward.

Understood. I mean, one of the questions, the obvious question as well is, with the investment grade rating, I mean, rating agencies aren't generally, for BDCs at least, aren't generally fans of stock buybacks. Was there any, rating agencies don't apply pressure per se, but is there any dynamic between the buyback and the rating and the plans on refinancing? I mean, basically, are you conceptually blocked from buying back stock?

Blocked is not the right word. I just describe it as a balancing act. As we looked at Q1, getting the investment grade rating and reducing our cost of debt, in our opinion, was an extremely valuable get, if you will, for us and for the shareholder, and that was our priority. Now that we've received that and we've, you know, refinanced a significant portion of our bonds at a lower cost of capital, we'll We'll hopefully be able to do the same in October, but we are, you're right, trying to balance the goal of buying back stock, maintaining the investment grade, and reducing our cost of debt. It's not just one item that you have to take into account. You've got to take multiple items into account as you sit back and do these calculations, if you will.

Got it. Thank you.

Thanks, Robert.

And there are no further questions at this time. I will now turn the call back over to the speakers for any closing remarks.

Thank you, Operator. We appreciate the support of our shareholders, and we look forward to providing you with an update in early November on our third quarter results. Feel free to reach out to me or Jen if you have any questions before then. Thank you.

This concludes today's conference call. Thank you for your participation, and you may now disconnect.