BANX - NASDAQ

Greetings, and welcome to the StoneCastle Financial Corp. Quarter One Financial Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to Rachel Schatten, General Counsel of StoneCastle Financial. Thank you. Please 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 will depend on numerous factors, such as changes in securities of 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 March 31, 2020. The company undertakes no duty to update any forward-looking statements made herein. All forward-looking statements speak only as of today, May 7, 2020.Now, I will turn the call over to Sanjai Bhonsle.

Thank you, Rachel. Good afternoon, and welcome to StoneCastle Financial's first quarter investor call for 2020. Here with me today are Pat Farrell, our CFO; and Josh Siegel, a member of the Board of StoneCastle-ArrowMark Asset Management.I would first like to start off this call by acknowledging the many organizations and workers who are helping our country in this time of crisis. This is a challenging time for all, including our families and friends. And our thoughts and best wishes are with the entire medical community, including first responders and those families most affected by the coronavirus. Like many of you, we at, StoneCastle Financial, have been working remotely these last 2 months. Our technology teams work quickly to ensure that daily operations would not be affected, and I'm happy to say that the company had a seamless transition to remote operations. The management teams in Denver and New York City are working in concert in the best interest of our shareholders.Now on to the first quarter results. During today's presentation, I want to spend time discussing the company. Then I will provide StoneCastle Financial's quarterly results and portfolio review, and Pat will then provide you with greater detail on our financial results before we open up the call for questions. StoneCastle Financial's common stock was not immune to the extreme market volatility experienced since late February. Putting aside the market conditions weighing on the stock, the company's operations are solid and stable, and the investment team has been active in originating portfolio assets.Over the last few months, the credit markets tightened as the Federal Reserve stepped in to provide liquidity. Even though Q2 and Q3 predictions for U.S. GDP and unemployment are uncertain, we believe that once the current restrictions are lifted and the economy fully responds to the stimulus initiatives, we will see additional stability in the capital markets.Throughout 2019, our company took a conservative position and invested prudently as we did not see commensurate and optimal risk-adjusted returns. Although we could not predict the current pandemic caused by COVID-19, nor the duration of this impact, we continue to be in an advantageous position due to the available capital on our $62 million revolving credit line.Now, I would like to take a moment to review the investment characteristics of StoneCastle Financial. The company's investment portfolio primarily consists of investment-grade fixed rate assets. Our leverage remains low, and we do not self-mark our portfolio, which, we believe, should provide a greater degree of confidence in the company's underlying value relative to other income-focused investment vehicles. Also, StoneCastle Financial has a highly diversified portfolio as measured geographically across the United States and by industry sectors and our underlying credits.Our largest state concentration is Missouri, with just under 9%. Generally, our community banks are in the rural markets, with low demographic density. They cater to their local markets primarily in real estate, like multifamily or owner-occupied residential, C&I loans and other small business loans.Now, let me comment on the investment pipeline. It may be worth noting that year-to-date, we have seen primary market transactions that closed with coupon rates in the 5% to 5.5% range, similar to rates we saw in the second half of 2019. We consider this data point positive, and it suggests that the widening of spreads in the banking sector were not as extreme as we saw in other parts of the credit market. We also continue to see investments in the secondary market for both community banking and alternative capital securities. Alternative capital is regulatory capital issued by larger banks with the majority of the underlying assets being investment-grade and typically with terms of non-call three to five years.In the alternative capital space, we are seeing secondary market activity, with size ranges of $5 million to $10 million, and secondary pricing at a discount. Our investment team, including myself, have been on the phone with many of the portfolio banks over the last few months, with initial increase relating to capital raises either for growth or refinancing. Given our long-standing relationships with banking community, we believe StoneCastle Financial will be well positioned to provide capital as the issuance market continues to open.Let me share my current views on the banking industry. In general, the community banks as well as some larger banks are currently focused on issuing loans under the Federal Stimulus Payment Protection Program, and monitoring their small business and commercial real estate clients regarding deferments and/or covenant relief for principal and interest as needed. The banks to which we have spoken to, are cautiously optimistic that this will be manageable, particularly since there is likely to be revenue offset from the underwriting fees of 100 to 500 basis points received from the stimulus program. However, although we are cautiously optimistic, we are also guarded about the current and near-term environment.Based on past economic downturns, credit defaults are likely to rise and troubled credits may take several quarters to fully reveal themselves. Banks who have reported quarterly earnings have already begun to increase loan loss reserves, and it is natural to think that there will be an increase in nonperforming loans. The banks we have spoken with are on top of this and are stress testing for multiple economic recovery scenarios. In the short-term, we believe some banks may experience degrees of stress on their balance sheet, it is too early to tell to what degree. As I conclude my initial remarks, I want to remind everyone that many banks entered the pandemic in a fundamentally strong position, with ample capital and deposit liquidity.Now on to StoneCastle Financial results for the quarter. We are pleased to report that net investment income for the first quarter was approximately $2.5 million or $0.39 per share. Total assets were $134.9 million, and the value of the invested portfolio was $132.9 million. The net asset value at the end of the quarter was $19 per share, down $2.83 from the prior quarter.Now, let me turn to the portfolio review. As you know, in mid-February, the StoneCastle-ArrowMark team became the company's investment adviser, and I began my tenure as Chairman and CEO. Early in the first quarter, we began to see growing signs of a probable market decline, followed by extreme volatility of the markets in March. During this period, we continue to follow our methodical approach and maintain discipline in evaluating opportunities in the marketplace.While not the methodical criteria for the investments during that period, subsequent to the end of the quarter, the company made 3 investments for a total par amount of $14.3 million, with a weighted average effective yield to maturity of 8.3%, and a weighted average yield to call of 16.5%. These assets were purchased at significant discounts driven by 4 sellers in the market. Over the coming quarters, we believe there will be continued volatility in the markets that may offer additional attractive opportunities. Therefore, we continue to take a patient sense regarding investing in the portfolio.During the first quarter, the company received full calls for $10.4 million on two investments and a partial call and pay-down proceeds of approximately $3 million. Therefore, year-to-date, the company had calls and pay-downs of $13.4 million and made new investments of $14.3 million.Before I turn the call over to Pat, I want to touch upon the relative value of StoneCastle Financial stock. At the quarter end, StoneCastle Financial stock traded at a 14.6% discount to NAV, with a 9.4% dividend yield. This is in comparison to other vehicles such as the Financial Select Sector Spider Fund, which had a dividend yield of 3.1%, or the Invesco KBW Bank Index, that traded at a 4.3% dividend yield during the same period. StoneCastle Financial is also an attractive relative value to the Bloomberg Barclays U.S. Aggregate Bond Index, which traded at a 3.4% distribution yield at quarter end.I would like to point out that as of March 31, StoneCastle Financial traded at approximately 580 basis points wide to the average dividend yields of the income-oriented vehicles peer group I just mentioned. In closing, I would like to reiterate that our investment strategy remains consistent, which is to deliver attractive risk-adjusted returns and to invest for income generation and capital preservation.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 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 31 was $19, down $2.83 from the prior quarter. 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 $3.7 million or $0.56 per share. Net operating expenses for the quarter were $1.2 million or $0.17 per share, resulting in net investment income for the quarter of $2.5 million or $0.39 per share. Realized capital gains and losses in the quarter is the second component affecting the change in NAV. The net realized capital losses were approximately $301,000 or $0.05 per share, primarily due to premiums related to the 2 full calls in the quarter. 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 portfolio recorded unrealized depreciation of approximately $18.3 million or $2.79 per share. The fourth component affecting the change in net asset value is distributions. The cash distribution for the quarter was $0.38 per share. The distribution was paid on March 25 to shareholders of record on March 18.In summary, we began the quarter with a net asset value of $21.83 per share. During the quarter, we generated net income of $2.5 million, net realized capital losses of approximately $301,000, and the unrealized value of the portfolio investments decreased by $18.3 million. The sum of these components, offset by a distribution of $0.38 per share, resulted in a net asset value of $19 per share at March 31, down $2.83 from the prior quarter.Next, I'd like to take a moment to review the NAV performance of StoneCastle Financial for the first quarter. As we reported in our press release on April 16, the company's first quarter NAV performance was significantly better than the market performance of the company's stock and other major financial indices. While we have no control over the market price of StoneCastle Financial, I believe it is worth noting the underlying performance of the company on a book or NAV basis. Specifically, the first quarter 2020 NAV was down only 10.8% versus the company's common stock price decrease of 25.4%, including dividend reinvestment.During that same period, the S&P 500 Financials decreased 32.3%, and the KBW Bank Index decreased 42.4%. We believe this, once again, demonstrates the tremendous underlying value of the company.Turning to the valuations for our portfolio holdings. It is worth noting that the vast majority of the portfolio continues to be independently marked from broker-dealer quotes. For the quarter, approximately 92% of the portfolio prices or marks reflect a minimum of 2 quotations or actual closing exchange prices. These quotations represent an independent third-party assessment of the current value of the portfolio. We believe this differentiates StoneCastle Financial from certain publicly traded, closed-end funds and BDCs that self-mark their portfolios.At quarter-end, the company had total assets of $134.9 million, consisting of total investments of $133 million; cash, interest and dividends receivable totaling $1.3 million; and prepaid assets of $595,000. Our dividend yield at the end of the quarter was approximately 9.4%.Now, let me update you on the balance of our current credit facility. At March 31, the company had $9 million drawn from the facility, or 7% of total assets, leaving $53 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 Sanjai for closing remarks.

Thank you, Pat. Now operator, I would like to open up the call for questions.

[Operator Instructions] Our first questions come from the line of Chris O'Connell of KBW.

So just wanted to start with the investment portfolio and, I guess, a little bit of the quarter and then some of the outlook. First off, during the quarter, as I understand it, there was no investments made. First of all, is that correct? And then if so, I think there had been referenced to a couple of potential investments in community banks similar to the FNBC deal on last quarter's call.Can you just talk about maybe what happened with those investments? If they're still in the pipeline and got delayed? Or if you pulled back because of pricing or other reasons? Or if they pulled back and yes, start there.

So during 1Q, obviously, starting about mid-March, the country basically went down -- went into a shutdown, and we started to see an acceleration in market disruptions. And so during that time, I think people were just trying to find level on investments and probably just minding their -- the portfolios on a day-to-day basis. So in short, some of the transactions that we're looking at during 1Q naturally got pushed into 2Q. And as you know, we have a decent amount of dry powder to spend. And during this time, we kind of took the opportunity to assess the market because we want to be very prudent and methodical in how we deploy the capital. And as kind of dust cleared towards the end of 1Q, in 2Q, we started to see some pretty interesting investments across both the community banking space and the alternative capital space. And so during the quarter, we invested across three different transactions, one of them being the community banking investment.And generally speaking, these investments were driven by four sellers. And we believe that we've got them at a fairly attractive price and very happy with those three investments. And we do expect to see some of the investments that kind of went on pause during 1Q to materialize during 2Q or maybe even 3Q. But rest assured, the pipeline is fairly strong. We are seeing some attractive investments, but -- and like I mentioned a second ago, we will be prudent and methodical as we progress.Josh, would you like to add something?

That was pretty comprehensive. I mean, I do think the demand for capital is going to pick up either smart bankers who are ahead of the curve and want to reserve and have some dry powder for defensive reasons, and we're getting some inbound calls from banks that are thinking about leaning in and being offensive, that, if one of their neighboring banks runs into more trouble than they expected, it could be an opportunity to acquire an adjunct physically located bank.

Got it. That's helpful. And yes, I guess going on that point at the end there, I mean, I think we've already seen a good amount actually in last, I guess, as earnings has kind of started to wind down in the last week or two, some preferred and sub debt raises from $10 billion plus, but still community banks pick up here so there does seem to be a greater demand for capital. If you could maybe separate the portfolio to kind of community bank investments and then the alternative capital investments and maybe frame the types of opportunities or the demand for opportunities that you're seeing into the second quarter?And then on the alternative capital side, is $30 million still the goal in order to bring over kind of in the short-term? Is that time line been pushed back at all as you kind of wait to see how the market plays out?

Yes. So Chris, taking the first part of your question, we are seeing, and we are having calls as it relates to the community banking space for new issuance in the primary market, right? And that's -- we're getting a lot more inbound inquiry there than, say, we did during 4Q or even the beginning of 1Q, and so excited about that. But as you know, in that -- in the primary market, that the community banking space is fairly resilient and the spreads there are still pretty tight, like I mentioned in my initial comments, between 5% and 5.5%. So the opportunities that we've seen that are attractive are more in the secondary. And I'm fairly certain that a couple of deals will come through in the primary market that will kind of fit our investment criteria. And then moving on to the alternative capital space, like I said, the pipeline there is fairly strong, too. And I -- probably equal weight in terms of the opportunities that we're seeing on both sides and that's definitely a lot more exciting than, say, 4Q.And in regards to your last question, the last part of the question regarding the $30 million, obviously, we made some decent progress during 2Q. And over the next couple of months, we think, we are on target to kind of hit the $30 million investment goal that we had mentioned in the prior calls.

Great. That's helpful. And then I guess just rounding off portfolio growth here. I mean, it sounded like from the prepared comments that there has not been any pay-downs, redemptions or calls to quarter to date. Is that -- did I hear correctly?

Pat, do you want to take that?

Yes. Do you mean -- well, in Q1, we certainly did. But for Q2, we haven't reported anything on that yet. We have not had any so far this quarter.

Great. All right. And then just moving on quickly. What was the investment yield this quarter?

10.92%.

Got it. Okay, great. And then -- and I'll just do one more and then step out. But is there -- we can get the call reports as they come out. But is there anything preliminarily that you're worried about in the current portfolio within the community bank investments? I know it's early on, and it's mostly just reserve builds right now so there's not too much probably that's changed quarter-over-quarter really in the actual financials. But is there any single investment or area of investments that you're taking particularly good care putting under the magnifying glass?

Chris. I'll take the first part of the question, which is more our portfolio-specific. And I'll let Josh kind of talk a little bit more the wider industry background. And so, as it relates to our portfolio, like I've mentioned, we are in touch with a decent of our portfolio investments. And I'm happy to say that, to date, we have not heard of any red flags popping out from banks management teams in the particular markets. And as it relates to the banks, obviously, they are increasing their allowances. They'll probably see some increased defaults. But as you know, these banks went into this downturn with fairly strong balance sheet and with Tier 1 capital ratios meaningfully above the minimum required and decent amount of liquidity.Also, the PPP program, the banks are fairly excited about that, as you might guess. There, the underwriting fees of anywhere between 100 basis points to 500 basis points, that income is going to be fairly strong for banks -- some of the banks. And that should help partially mitigate any increases in allowances, etcetera. So in summary, we have not -- none of the banks have waved any red flags to us yet. And we really don't expect that in the near-term here.Josh, anything to add?

Sure. I think we have just some general views. And as Sanjai just said, if you look at Q1 in general, all right, which is obviously the most current data anyone has on banks in the banking industry outside of some head hog 8-K, which is quite rare of an event, Q1 was, for the most part, unstated, right? Through basically mid-March, life was life. So while we would expect the beginnings of things, two weeks of lockdown isn't going to show up in bank's balance sheets that quickly. So if we just think about the general cycle, banks report 30 to 45 days after the quarter. So March 31 would be end, you're talking May 1 to May 15, right. Kind of the window we're in here. But that's only talking about credit issues, TDRs, any of those issues on the banks, that would have occurred in Q1. That's not showing up in any great way.Now that doesn't mean that most, if not all, bankers are expecting Q2 is not going to be as rosy. But that doesn't show up until, again, 30 to 45 days after the end of the quarter. So now we're talking in June to in July, to August 1 to August 15. So I don't expect to see from almost any bank in our portfolio or generally material information until probably near the end of June at the earliest. And for credits, yes, that'll start to play out. You've already seen some relief from the regulators, giving banks flexibility that if credits were in good standing before COVID lockdown, they can defer payments or do some restructuring without classifying it as a TDR. And from chats I have been having with folks in DC., there are definitely discussions about other types of regulatory easing to give the economy time as well as to give the Federal Government time to put more stimulus dollars into the system.So the short version of this long answer is, no, I don't think we're going to see anything in the short run. I think, over the coming months, you'll start to see where some of the pain is occurring. It's probably going to be more weighted to metropolitan markets just due to where COVID concentrations are. In Duluth, Minnesota or [indiscernible] Fontana, the lockdown is nowhere near as severe and so the economic impact to the local pound isn't as bad. We've heard that pretty consistently. So I'm not expecting to hear and see any real data for a bit of time, if that makes sense?

Our next questions come from the line of Devin Ryan of JMP Securities.

This is Brian Mckenna for Devin. So just first one for me. I'm curious if the remote working environment impacts your ability at all to underwrite and source deals? And really, how much of your business gets done in person?

Brian, good question. And the short answer to that is it has not impacted us whatsoever. With all the technology that's available to us, it's been fairly seamless. Our sourcing calls, our due diligence calls, our investment community calls, that I'm glad to say, has been all seamless. And as probably you have read, having work at home makes for some fairly long days.So we're pretty efficient, and we get things done on a pretty timely fashion.

Got it. And then net investment income has been pretty steady the last several quarters here. So, I'm just curious how you're thinking about the dividend and dividend coverage? And is it your expectation that you'll continue to cover it moving forward?

Yes. So in regards to that, as you know, any dividend decisions that we make has to be approved by the Board. And as time progresses here, we will be having some meaningful discussions with our -- I shouldn't say, meaningful, we'll have discussions with our Board in regards to dividend on a quarter-by-quarter basis. And as where we sit today, like I've mentioned, our portfolio is still fairly robust. And we really don't see any changes there here in the near-term.

We have no further questions in the queue. I will now hand the call back over to management for any closing remarks.

Yes. So I just want to thank everyone for listening, and we appreciate your support of StoneCastle Financial, especially during these uncertain times and market volatility. We are confident we'll come out of this stronger and more resilient. And I look forward to finally meeting all of you in person in the future as the country reopens, and we're back to our new normal.So, have a good evening. And again, thank you very much, and happy to answer any questions that you might have on the follow-on.