ArrowMark Financial Corp. (BANX)·Q4 2017 Earnings Summary

Executive Summary

• Q4 2017 was steady operationally: NAV per share held flat at $21.56, NII covered the dividend ($0.41 NII/share vs $0.38 dividend), and estimated portfolio yield remained >9% for the fifth straight quarter .
• Capital deployment and balance sheet mix improved: leverage fell to 15.1% (from 20.4% in Q3; 25.9% in Q2) as calls exceeded originations during the quarter, though management deployed $36.1M subsequent to quarter-end, including a $17.6M preferred equity stake in a new pooled vehicle expected to be accretive to NII per share .
• Earnings mix shifted: lower gross income and unrealized depreciation (-$0.58M) reduced total operating return QoQ, partly offset by $0.38M realized gains; management cited mark changes (MM Caps) for most of the unrealized move .
• Credit and macro commentary remained constructive: “no material credit issues” and most assets “scored investment-grade,” with rising-rate dynamics and potential CECL-driven Tier 2 demand seen as medium-term tailwinds .

What Went Well and What Went Wrong

• What Went Well

  • Dividend fully covered by NII with NAV stable: “Net investment income was nearly $2.7 million or $0.41 per share… NAV per share was $21.56… unchanged from the third quarter” .
  • Portfolio yield durability and diversification: estimated annualized portfolio yield 9.05% (5th consecutive quarter >9%) and “no material credit issues… majority of the assets scored investment-grade” .
  • Scale and accretion from pooled vehicle and post-quarter deployments: $36.1M subsequent investments including $17.6M preferred equity in a new vehicle; “We expect this transaction to be accretive to net income per share” .

• What Went Wrong

  • Lower gross income and unrealized depreciation drove a smaller total operating return QoQ: total investment income declined to $4.24M (from $4.36M) and unrealized depreciation of $(0.58)M reduced the net increase in net assets from operations to $2.46M (vs $3.08M in Q3) .
  • Reinvestment drag from elevated calls: $23.4M of full/partial calls vs $13.2M of originations in Q4 pressured earning assets intra-quarter .
  • Mark volatility in MM Caps: CFO attributed ~$0.78M of the unrealized change to MM Caps (including a transfer from unrealized to realized due to partial call and markdown from Sep to Dec), highlighting valuation sensitivity in certain positions .

Financial Results

KPIs and Activity

• Originations/Investments: $12.5M (Q2) ; n/a disclosed for Q3; $13.2M (Q4) .
• Calls/Repayments: $12.2M (Q2) ; $13.0M (Q3) ; $23.4M (Q4) .
• Subsequent to Q4: $36.1M invested; $17.6M preferred equity in pooled vehicle with $43.4M of contributed assets .
• Expense ratios and turnover (Q4): expenses before waivers 4.43% (annualized, % of avg net assets); portfolio turnover 8% (not annualized) .
• Market discount: -4.27% (Q3) and -6.63% (Q4) to NAV .

Guidance Changes

Notes: Management reiterated constructive macro tailwinds but did not issue quantitative forward guidance; the Board had raised the dividend to $0.38 in Q3 and maintained it in Q4 .

Earnings Call Themes & Trends

Management Commentary

• Strategy and positioning: “We continue to utilize a patient long-term view in the deployment of capital” .
• Credit and quality: “I want to reiterate that StoneCastle has seen no material credit issues on our portfolio to date and we continue to have the majority of the portfolio assets scored investment-grade” .
• Accretive growth vehicle: “We hope to scale the company’s initial investment of $17.6 million… to $40 million. We expect this transaction to be accretive to net income per share” .
• Macro tone: “Banking is one of the few industry sectors that can typically benefit from rising interest rates… NIM tends to increase in higher interest rate environments” .
• CECL opportunity: “These increased loan loss reserves will likely precipitate an increased need for capital… Tier 2 capital is likely the most cost-efficient form… StoneCastle stands ready to provide capital” .
• Valuation context: Dividend yield “over 500 bps above the 10-year U.S. Treasury and over 400 bps above the… BBB Effective Yield Index” at quarter end .

Q&A Highlights

• Pooled vehicle exposure and returns: Management is cognizant of risk/return, highlighting more conservative structure (60% debt/40% equity) vs prior pool and targeting “high 8s to >10%” effective yields via structured solutions to access larger banks .
• Interest rate sensitivity and hedging: A meaningful portion of underlying financing is fixed 10-year; given low leverage, floating facility impact on FCF is modest; may consider terming out when fully deployed .
• Fixed-to-float features: Many direct preferreds have fixed-to-float components post certain thresholds; typical market convention for sub debt is 10NC5 fixed, then float at LIBOR + spread .
• CECL implications: Expect increased demand for Tier 2 sub debt as banks manage higher lifetime loss reserves; Tier 2 preferable to dilutive equity in many cases .
• Q4 unrealized depreciation drivers: MM Caps position accounted for ~$.78M of the unrealized change (half reclass from realized gains on partial call; half markdown post asset payoff impacting coverage metrics) .

Estimates Context

• We attempted to retrieve S&P Global (Capital IQ) consensus for Q4 2017 (Primary EPS, Revenue, EBITDA) but could not access due to S&P Global daily request limits. As a result, sell-side consensus comparisons are unavailable for this quarter from S&P Global [SPGI access error].
• BANX’s reported per-share metrics (NII/share $0.41; total earnings/share $0.47) are disclosed above and compared sequentially and vs prior year where available from company filings .

Key Takeaways for Investors

• Dividend coverage is intact with room for modest reinvestment-driven upside as subsequent $36.1M deployments and the new pooled vehicle ramp; management expects the pool to be accretive to NII per share .
• Balance sheet risk moderated in-quarter (leverage down to 15.1%), positioning BANX to add assets into an improving rate backdrop without stretching the facility; funding costs are partly insulated by fixed-term structures under the pools .
• Mark-to-market noise (MM Caps) drove most unrealized volatility; underlying credit remains solid with majority of assets investment-grade and no material credit issues observed .
• The regulatory/CECL setup is a medium-term volume catalyst for bank Tier 2 capital, directly aligned with BANX’s origination strengths and could support attractive yields and deployment .
• Relative value remains favorable: persistent double-digit yield premium vs BBB corporates and mid-single-digit spread over 10Y USTs are supportive of income-focused demand, though the market discount to NAV widened QoQ, offering potential rerating upside if deployment and accretion play out .
• Near-term watch items: pace of Q1 deployments from the identified pipeline, spread/yield trends on new originations, and any follow-on scaling of the pooled vehicle toward the $40M target .

Appendix: Additional Data Points

• Q4 distribution: $0.38/share paid Jan 3, 2018; shares outstanding 6,542,289 .
• Expense initiatives: ABA contract renegotiation savings cited at ~$0.0105/share annually in Q4 (previously noted at ~$0.015/share annually in Q3); credit facility spread cut to L+235 bps with potential quarterly savings up to ~$156K under full draw assumptions .

Sources: Q4 2017 8-K 2.02 and press release ; Q4 2017 earnings call transcript –; Q3 2017 earnings call transcript –; Q2 2017 earnings call transcript –.