ArrowMark Financial Corp. Q2 FY2022 earnings call

Market Environment

• Equity and credit markets experienced volatility in Q2 with S&P 500 down 16% for the quarter and nearly 20% in first six months; bond markets also declined with Bloomberg Barclays U.S. Aggregate Bond Index down nearly 5% for the quarter and 10% in first six months.
• Heightened fears of recession due to high inflation, tightening Central Bank monetary policy, supply chain disruptions and geopolitical risks from Ukraine war contributed to volatility.
• Federal Reserve raised Fed funds rate by 75 basis points, second 75 bp hike in two months, with more increases expected in second half of year.

Company Portfolio Positioning

• Portfolio consists of securities issued by money center banks and U.S. community banks, well positioned despite macro factors.
• Defensive approach based on capital preservation, income generation and maximizing total risk-adjusted returns.
• Investments structured to mitigate risk: regulatory capital relief investments in well-capitalized G-SIBs; community bank investments in term loans, trust preferred and preferred securities; diversified across money center and community banks; frequent contact with issuers and stress testing portfolio against economic scenarios.

Investment Activities in Q2

• Invested $23.8 million in four regulatory capital transactions in primary market with effective weighted average coupon of 10.6%; offset by $14.8 million from sales and paydowns.
• Portfolio yield as of June 30 was 10.11%, first time above 10% since Q2 2020.

Origination Pipeline

• Industry-wide regulatory capital origination robust in Q2 with estimated $3 billion to $3.5 billion issuance, year-to-date 2022 issuance ~$4 billion to $5 billion; new issue market expected to meet or exceed 2021 levels.
• Community banking space: subordinated loans issued by community banks yielding 5% higher vs 3%-4% in 2021; still find more attractive opportunities in regulatory capital securities but monitor community bank subordinated loan and preferred equity markets.

Net investment income for the second quarter of 2022 was approximately $3 million or $0.43 per share, up 2.5% from the prior quarter. For the first six months of 2022, net investment income was up approximately 15% compared to the same period in 2021. During the second quarter, the company invested a total of $23.8 million in four regulatory capital transactions. The $23.8 million of investments was offset by $14.8 million from the full sale of PFF, the full call of first marquee and other partial paydowns. The estimated annualized yield of the portfolio investments as of June 30 was 10.11%, up 58 basis points over the last quarter end. Total assets of portfolio were reported at approximately $201.6 million and invested portfolio was reported at $196.4 million at quarter end. Revenue contribution: The regulatory capital investments and community bank investments are key segments, with the majority of investments in floating rate assets which is about 78% of total investments.

Forward-looking Statements

• Firm believes it is well positioned to deliver superior financial results during volatile times.
• ArrowMark Financial continues to offer exceptional value to investors with its strategy and 8.6% yield.
• Credit facility amended and extended: interest rate based on SOFR, upsized to $59 million from $62 million with option to increase to $90 million, extended maturity another three years with option to extend to fourth year, ensuring strong and stable access to debt capital over next four years.

Risks

• Market volatility due to high inflation, tightening Central Bank monetary policy, supply chain disruptions and geopolitical risks.
• Impact of interest rate changes on portfolio value; the change in net unrealized depreciation on investments and foreign currency transactions was approximately $6.4 million or $0.90 per share in Q2.
• Uncertainty in economic downturn affecting banking sector despite belief in resilience; potential impact on investment portfolio value.

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