BANX - NASDAQ

Greetings, welcome to the StoneCastle Financial Corp Fourth Quarter 2019 Financial Release Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note this conference is being recorded. I will now turn the conference over to your host, Rachel Schatten, General Counsel of StoneCastle Financial. Thank you. You may begin.

Good afternoon. 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. StoneCastle Financial has based the forward-looking statements included in this presentation on information available to us as of December 31, 2019. The company undertakes no duty to update any forward-looking statement made herein. All forward-looking statements speak only as of today, February 27, 2020. Now, I will turn the call over to Josh Siegel.

Thank you, Rachael. Good afternoon, and welcome to StoneCastle Financials fourth quarter 2019 Investor Call. In addition to Rachel, joining me today is Sanjai Bhonsle the newly appointed Chairman and CEO of StoneCastle Financial Corp.; and Pat Farell, our Chief Financial Officer. This conference call will commence the transition of the CEO role from me to Sanjai. I could not be more confident in handing the company to someone that I've gotten to know and respect over the past year. As my tenure as CEO ended subsequent to the end of the quarter, I will be providing StoneCastle Financials' quarterly results in portfolio review and then hand the call over to Sanjai to discuss the company and the StoneCastle-ArrowMark transition. Pat will then provide you with greater detail on our financial results before we open up the call for questions. We are pleased to report that total earnings for the fourth quarter were approximately $3.5 million or $0.53 per share. This figure was comprised of net investment income of $2.7 million or $0.41 per share and approximately 800,000 in net realized capital gains of $0.12 per share. Total assets were $164.7 million and the value of the invested portfolio was $162.3 million. The net asset value at the end of the quarter was $21.83 per share, up $0.08 from the prior. We believe no meaningful credit issues currently exists within the portfolio and the majority of the underlying banks continue to be scored investment grade by Kroll Bond Rating Agency. Now let me turn to the portfolio review. During the quarter, the company invested 700,000 in FNBC of La Grange, located in the La Grange, Illinois. This asset was acquired with an effective yield of 9.6%. We also sold our equity interest in Howard Bancorp realizing a capital gain of $366,000. The company received partial call proceeds, the $1.8 million from the position in [] MMCapS fixed rate senior notes realizing a capital gain of approximately $425,000. Now let's move on to the recently completed transaction. As we previously disclosed, the company's pleased to report that StoneCastle-ArrowMark assumed the role of investment advisor following the required shareholder approval on February 7 and the closing of the transaction on February 12. Effective and condition upon the closing of the transaction, Sanjai Bhonsle assumed the role of Chairman and CEO. StoneCastle had been in furnace discussions with ArrowMark for the better part of 2019. The management and the Board of StoneCastle Financial selected ArrowMark because of the similar philosophies of our company and ArrowMark's commitment to continue StoneCastle investment strategy. Collectively, we believe the combination of our platforms will create a formidable leading bank investment platform that will offer multiple benefits for StoneCastle Financial shareholders. Therefore, at this time, I am pleased to introduce Sanjai Bhonsle, Chairman and CEO StoneCastle Financial.

Thank you, Josh. I'd like to start off by offering congratulations to the StoneCastle team and to say that it is a pleasure speaking with you today in my role as Chairman and CEO. Also, I want to thank all of our shareholders for your ongoing support at the company. I was glad to have spoken with so many of you over these last few weeks and hope to continue our dialogue in the coming weeks and meet many of you in person. As discussed in the proxy, a new adviser StoneCastle-ArrowMark asset management expects to manage a company's security portfolio consistent with StoneCastle strategy and focus on capital preservation and credit quality. This investment strategy aligns with ArrowMark investment philosophy that emphasizes risk adjusted returns and value creation for shareholders. I do have an outline and the investor presentation in our proxy, StoneCastle-ArrowMark will be supported by the wider infrastructure of ArrowMark Partners and established investment firm with approximately $20 billion of assets under management, including $8 billion invested in credit strategy. As part of the purchase agreement, ArrowMark acquired StoneCastle's bank credit technology platform and certain personnel. Importantly, I also want to reiterate that the transition to StoneCastle-ArrowMark as our external advisor will be seamless to shareholders of StoneCastle Financial. ArrowMark and StoneCastle have worked together, originating investments in alternative capital transaction, including two investments that are currently in the bank's portfolio. We believe in this market environment, alternative capital securities will provide an opportunity to prudently grow the company's assets under management, as well as enhance shareholder value. Alternative capital securities, along with the community bank sector, represent a robust investment pipeline for the company. Our advisor has committed to originate approximately $30 million of bank related investments earmarked for StoneCastle Financial. Although we do not disclose the actual pipeline for competitive purposes, ArroMark has a track record investing approximately $2.5 billion in these types of securities and we are confident in our provability to source investment. Turning to the community banking sector. We have also been able to source pipeline investments for the portfolio. In fact, subsequent to the end of the quarter, we are looking at two community bank investment opportunity. These two opportunities have a similar profile as the FMBC transaction closed in the fourth quarter, which was made in collaboration with the large institutional investors. In general, the volume of community banking issuance is still below historical trend. However, community bank issuance did pick up late last year with nearly 53% of all 2019 issuances occurring in the fourth quarter. Therefore, in general, we are more optimistic regarding our overall pipeline, including issuance by community banks. As knowledgeable investors in this space, we are able to create a resource new investment opportunities for the portfolio to take advantage of the pipeline and we will be in a good position in 2020 with available capital. Our ability to originate from a broad investment pipeline, which includes community banks, alternate capital security and companies that provide goods and/or services to banking companies will allow StoneCastle Financial, a distinct advantage of investing through multiple economic climates and market cycles. Before I close my formal remark, I want to touch upon the dividend strategy. As stated in the proxy, we intend to rotate our assets with a lower rate of interest into higher yielding assets. On the acquisition of these assets, the company expects to be in a position for the Board to declare a $0.10 per share special dividend. Additionally, management would seek to increase the status quarterly given sometime in 2020, subsequent to the approval by the company's Board. I want to remind our shareholders that all dividends are subject to the approval and declaration by the Board of Directors. Now I want to turn the call over to Pat to discuss the financial results and provide details on the underlying net asset value of the company.

Thank you, Sanjai. As we do each quarter, I will present the financial results by going through the components of the company's quarterly results in detail. Then net asset value for December 31was $21.83, up $0.08 from the prior quarter. NAV is comprised of four components net investment income, realized capital gains and losses the change in value of the portfolio of investments, and lastly, distributions paid during the period. Let's look at these components. Gross income for the quarter was $4.1 billion, or $0.63 per share. Net operating expenses for the quarter were $1.5 million, or $0.22 per share, resulting net investment income for the quarter of $2.7 million, or $0.41 per share. We also have net realized capital gains of $790,000, or $0.12 per share, resulting in total earnings of $0.53 for the quarter. Realized capital gains and losses in the quarter it's the second component affecting the change in NAV. As I just mentioned, the net realized capital gains for the quarter was the result of the sale of Howard Bancorp and the partial call of MMCapS position. 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 fourth quarter, the unrealized appreciation of the portfolio decreased 5 times from at least 443,000, or $0.07 per share. The fourth component affecting the change in net asset value is distribution. Cash distribution for the quarter was $0.38 per share, the distribution was paid on January 3 of this year to shareholders of record on December 23, 2019. In summary, we began the quarter with a net asset value of $21.75 per share. During the quarter, we generated net income of $2.7 million, net realized capital gains are approximately 790,000 and the unrealized value of the portfolio investments decreased by 443,000, some of these components offset by a distribution of $0.38 per share resulted in a net asset value of $21.83 per share at December 31 up $0.08 from the prior quarter. As I do every quarter is worth noting that the vast majority of the portfolio continues to be independently marked for broker dealer quotes. For the quarter approximately 92% 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 differentiates StoneCastle from certain publicly traded closed-end funds and BDCs that self mark their portfolios. At quarter end, the company had total assets of $164.7 million consisting of total investments of $162.3 million including a small cash position, interest and dividends receivable of $1.8 million and prepaid assets of 618,000. Our dividend yield at the end of the quarter was approximately 6.8%. Now let me update you on the balance of our credit facility. At December 31, the company have $17.7 million drawn from the facility, leaving approximately $44.3 million available. Based on regulated investment company rules and may only borrow up to 33.3% of our total assets. Now I want to turn the call back over to Sanjai and Josh for closing remarks.

Josh, I wanted to personally thank you for your leadership and you have tremendous contribution to this company. You'll continue to lead by example and build on the mission and stewardship of the company and the best interest of our shareholders.

Thank you, Sanjai. It's been an honoured to serve the shareholders and stakeholders of StoneCastle Financial as Chairman and CEO over these past six years. I've come to know the company's research analysts and many of the shoulders personally, and I can't thank everyone enough for your continued support of the company. I hope that you were remained long-term shareholders and advocates the StoneCastle Financial. The company is in terrific hands and I can't be more excited for the company's future and I look forward to can my continuing involvement with StoneCastle Financial ArrowMark Asset Manager.

Thank you, Josh. I'm extremely proud to assume the management of StoneCastle Financial. We'll look forward to working with you and your board role at advisor. Now operator, I'd like to open up the call for questions.

Thank you. [Operator Instructions] Our first question is from Chris O'Connell with KBW. Please proceed.

Good. So I was just hoping to get a little bit more insight into the pipeline. I guess separating it into two parts. Starting to community bank investments. You mentioned, you kind of looking at two subsequent to the quarter-end that were similar to FMBC transactions. By that do you means similar I guess the size and sub $1 million or two to see larger than that. And -- or did you mean more the structure of the subordinated debt.

Hi, this is Josh. More of the structure. So if you recall, we've had some very interesting opportunities where there are positions that are at an interest rate for the assets themselves that are less desirable for us, but we really like the credit. And we work with a couple of institutional investors where it's not that they're being senior and were sub we're actually just sharing the piece pro rata, but they end up paying StoneCastle Financial a fee for effectively originating and managing that asset for them, and so it turns our yield from kind of a six handled to a nine handled. So that's the structure. We've talked about that in the past. So we see a few more of those coming on the pipe. But other things that are sort of new and interesting is the NCUA recently passed new rules that allow all credit unions the issue of what they call supplemental capital, which is basically 10 years of debt in the credit union space. So we've had a few inquiries already from referring agents, if we're interested in that, and the answer is yes. A well structured ready and just like well structured bank, we're definitely open to that. So yes, we have a couple of interesting opportunities in the pipe from the community bank side. And Sanjai, do you want to talk about the pipeline for larger bank paper?

Sure. Hey, Chris. As previously mentioned, we are looking to in the near term had about $30 million of investments on alternative capital security size. And, there we look at about $500 million to $600 million of investments on an annual basis. And so the pipeline, generally speaking is fairly strong. So nothing different than that in terms of what we're seeing here today. And in the next couple of months plus you should see closed to about $30 million assets going into the company on return to capital security side.

Got it? So and that $30 million is that going to come, do you think probably all in one slug at one? And you said that you think that can happen in perhaps the next two months or so?

That's right. So no the unfortunately don't come in one slug. You should kind of expect them to be staggered? And, so one after the other, and we expect them between three to four investments there.

And that's still going to be you expected to kind of yielding that LIBOR plus 9% to 10% range.

Correct.

And then on the other side of the community bank investments, I guess or what's already in the portfolio. How is -- how are we looking I guess, towards calls and or even just pay downs and any potential headwinds on that side that are spiking up or is it still more of those calls kind of not expected to occur in the first half of the year?

Sure. We sort of break down what's callable, we've had some of the early papers like Katahdin and already call out. Obviously almost everything we put on as long call for. So for example, a lot of the community funding CLO assets will come up for a call later this year. But as we've talked about, we're already proactive on looking to refinance that and entice those banks of staying longer with us for sort of rolling another five years further. So stretching a fresh time Other -- outside of that, there really isn't a whole lot that we're aware of in the call prospects. Credit wise we're still very content, banks in the portfolio are borderline grossly overcapitalized. Of course I've heard there ROE but a lot of these are private banks and they don't much care, in any given quarterly ROE, they care about the stability of the bank, which is what we care about. So now we don't see a whole lot of calls in the short term.

This is Pat, I just add that from a data point of view, it's unpredictable. If you go back and look at where we've been over the last three, four years, I mean this year we had a great number of calls in 2019. But the prior year in 2018, we only had, $4.4 million for the whole year. This year we have $50 million. So it's unpredictable. There's so many factors that weigh into this that it is hard to predict.

Just to add a little bit the color to what Josh mentioned, the banks or the fourth quarter, actually, our portfolio did fairly well and extremely well capitalized. And the portfolio as we sit today is very robust.

Our next question is from Devin Ryan with JMP Securities. Please Proceed.

So maybe just one on the market backdrop and pricing and I know we're maybe early days of stress here, but there's some pretty severe moves at least in the equity markets. So I'm just curious, if you guys are seeing any changes in the credit markets and really just the bigger picture, whether you're almost rooting for there to be a bit of stress, I know it's you've been competitive on pricing and spreads have been tightened, so, and Josh, as you mentioned banks are over capitalized at the moment, so you're probably in good shape to weather some stress. I'm just curious, whether kind of we're sitting here rooting for a little bit of dislocation is that, could you create an opportunity made the point a lot more capital to work here?

This is Sanjai. I'll start off. And then, Josh, maybe you can fill in some of the blanks later. So market disruptions are good. It kind of make some market a little bit more rational. And -- but However you also want to make sure that the fundamentals don't track, right. And so from, if we were to look it up or for you today, what are the community banks locally based? Don't really have any international exposure and like I just mentioned coming off some pretty strong earnings and fairly well capitalized balance sheet. So with that as a backdrop obviously some market disruption is good and for credit markets because it's kind of resets people's expectations. And so to that end, we are hoping, we do see a little bit of last frothiness. And that, as we structure these new deals that we're all looking together, we can actually get returns that are meaningfully more than what we've seen, historically speaking. And so, but again just want to make sure that those fundamentals are still intact as we look at all these investments. Josh.

Davin, the only thing I would add is if you remember in step back, we lend to lenders that's our job. So obviously a market correction is really not a fun day for an equity investor common equity but it's actually pretty good for debt. It puts us in a more leaning forward position, because we want to see spreads back out. We're not terribly worried given the equity capitalization assigned is just mentioned inside of the bank's not worried about a failure risk due to a market correction. We want to see some change in pricing but set to our banks, they would like to see credit spreads expand with a flat to inverted yield curve. It's obviously not the most ideal for a depository, but if they have a rationale to start pushing up credit spreads a little bit makes a big difference, right space the bottom line. So bank can go from a 90 bp ROI to a 110 just by increasing its colonial 20 basis points. That's a meaningful change. When you think about the leverage benefit of that. So, I hate to say we, sort of are hoping in and looking forward to a correction. But yes, and I have a strange way I think Sanjai and we are. And I definitely echo Sanjai's point about if you had to have these exposure to the markets a middle America community bank secured lending play. Yes, I'd rather be there than dealing with the supply chain out of China.

Maybe a follow up here. Sanjai you'd mentioned, just in terms of the overall investment strategy, you're looking in addition in to community banks, you firms that sell goods and services to banks. And I know that was already in some ways part of the StoneCastle strategy, but I'm just curious kind of how you guys are thinking about that as an opportunity the types of firms that fit into that pocket? And then what percentage you guys might be comfortable with in terms of going over called non-traditional bank investments?

Sure, see a couple. Still nothing that they want to act on. The reason they came in the doors, it's plenty enough today. That is something that I haven't been here Sanjai that came in the door this afternoon. So we are seeing some interesting things coming through nothing that gets us terribly excited at the moment, because the risk is a little bit more than what we should be doing. There were not a venture capital firms, we're not going to take that kind of risk. But if we can effectively put dollars against a predictable series of cash flows or well capitalized company that makes sense. So I would say, in the short term we're going to focus more on the alternative capital space, just better value and more probability of getting good credit at attractive rates. But don't be surprised if in the next six months you do see one of these banks related transactions.

Maybe last one here on just expenses and expense management you guys have done a great job. I think taking costs out of the system and just being pretty diligent, especially as a platform is has remained somewhat steady in size. I guess on one hand, is there anything more that you can do on the expense side just the current size? And then, maybe talk a little bit about the expense ratios if you will as the firm scales because hopefully the opportunity here is that you're going to clearly be able to grow quite a bit more with this combination. And so the firm will scale and that's good opportunity for investors. So maybe just make the case on kind of on the expense side by the amount of leverage that you can get off of the expense base from here.

Yes. This is Pat. I mean, obviously, if you look at our expenses that you can see that in terms of what's very -- what's variable, what can change over time. A lot of these, most of these are pretty much fixed in terms of the insurance expense valuation printing, directors fees, bank fees, et cetera. A lot of even transfer fees and professional fees, the things that are moving would be interest expense. We've seen them moving downward up to last year or so. The combination of what we borrowed and also rate. So certainly, as we grow, where you're going to see that line item increase. But all those other ones I mentioned, you're going to see those remained the same. And that's where our savings and our improvements in our expense ratio is going to come from. I would argue that for this type of fund, it's the income size. It's more exciting, rather than focusing on expense ratio. And I'm not seeing you are, but typically when people look at expense ratios, they're like, wow, that's really high. But here, since that expense ratio how does that leverage in there. You've really got to look at the net number to see what we're producing for the investor.

We have reached the end of our question-and-answer session. I would like to turn the call back over to management for closing remarks.

Thank you all for listening. I look forward to visiting with you all here in the near future. And I also offer my sincere thanks for your support of StoneCastle Financial. And thank you and good night.