Investcorp Credit Management BDC Inc (ICMB) 2019 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to CM Finance's Second Quarter Earnings Release Conference Call. Your speakers for today's call are Mike Mauer, Chris Jansen and Rocco DelGuercio. (Operator Instructions) I'll now turn the call over to your speakers. Please begin.

Thank you, operator. Thank you all for dialing in today. I'm joined by Chris Jansen, my Co-Chief Investment Officer; and Rocco DelGuercio, our CFO. Before we begin, Rocco will give you our customary disclaimer regarding information and forward-looking statements. Rocco?

Thanks, Mike. I would like to remind everyone that today's call is being recorded and that this is the property of CM Finance, Inc. Any unauthorized broadcast of this call in any form is strictly prohibited. Audio replay of the call will be available by visiting our Investor Relations page on our website at www.cmfn-inc.com.

I would also like to call your attention to the safe harbor disclosure in our press release regarding forward-looking information and remind everyone that today's call may include forward-looking statements and projections. We ask that you refer to our most recent 10-Q filing for important factors that may cause actual results to differ materially from these projections. We will not update forward-looking statements unless required by law. To obtain copies of our latest SEC filings, please visit our Investor Relations page on our website. At this time, I would like to turn the call back over to our Chairman and CEO, Michael Mauer.

Thanks, Rocco. I'll begin today's call with some commentary on the state of the markets. Chris will walk through our investment activity during and after the quarter, and then Rocco will discuss our financial results. I'll conclude with specific detail about our largest marks both positive and negative. Our outlook and thoughts on our progress repositioning the portfolio. As always, we will end with Q&A.

Last quarter was a tale of 2 entirely different markets. September and October saw robust new issue volume with relatively stable secondary pricing and activity. Secondary pricing moved steadily lower through November and the loan market saw some spike in volatility in December that we all observed across markets globally. Although the broadly syndicated loan market is not our primary focus, it influences us in several ways. Most directly volatility in the broadly syndicated market can create opportunistic investments for us in pricing whether spread and OID in the primary market where dollar prices in the secondary are the first levers to move. This also affects the value of the existing portfolio. Clearly, secondary market pricing backed up through November and very significantly in December. This gave us a chance to make several investments at attractive levels.

To highlight this tale of 2 quarters, in the first half of the quarter, our investments had an average yield of 9%. In the second half this was 13.2%. Structural changes in the market flowed through more slowly. Using the example of an underwritten loan, leverage security, the size of the equity check and often the presence of or lack of covenants are agreed to by an underwriter weeks or even months before a broadly syndicated loan comes to market. Pricing is all that you move. Over the course of weeks and months, both price and terms shift, deals become less borrower friendly and more lender friendly. In the syndicated markets, this is a slow process even in a fast moving volatile market. As we observed, when we spoke last throughout 2018, most broader market syndications were covenant light, long dated and at terms, which favored the equity investors interest. In the middle markets, we believe loan term starts in a better place and are not underwritten as far in advance. Covenants assure maturity, amortization access to management and lower leverage are the norms. Terms shift more quickly in lenders favor as well we are beholden to a multi-month lead time on structuring a big syndicated transaction. We can adapt the terms we offer more quickly. We continue to invest opportunistically in short weighted average life assets where we see the opportunity to generate returns through secured investments and seasoned issuers often with a catalyst for early repayment. In the current environment, our bias has strongly favored first liens. Our core mission remains unchanged. We target direct investments in core middle market, either in a bilateral transaction or as part of a club of lenders who know and trust.

Over the course of 2018, our team has worked tirelessly to reposition and diversify the portfolio. I'd like to put some numbers around that. We entered the year with 24 portfolio companies with an aggregate fair value of $286.5 million. Our average size was just under $12 million. 50% of our investments were first lien and 45% were second lien.

As of December 31, our portfolio looks much different. We increased the number of investments approximately 20% to 29 portfolio companies with an aggregate fair value of $283.3 million. Our average position size decreased by 20% or $2.2 million lower than last year to $9.8 million. Our investments were 63.7% first lien, and 31.7% second lien.

I also like to mention that last year we had approximately 20% exposure to oil and gas. Our largest position at 12/31, Caelus was repaid after quarter end, which reduces our energy exposure significantly.

Before I turn the call over to Chris, I'd also like to take a moment to address the decline in our NAV quarter over quarter. To state the obvious, we are unhappy with our results and in particular, the markdown that was necessary in Trident Health U.S.A. Trident was the last remaining investment made prior to the IPO in February 2014. We are concerned about the company's performance for the past couple of years and have been reducing our value accordingly. That said, the speed of Trident's decline surprised us. We wrote down the position in full as of 12/31, which accounts for the loss of $0.67 per share or 73% of the total NAV decline this quarter. After the loss on Trident, we would have had a decline of 2% per share this quarter, essentially attributable to the changes in our marks from the market volatility I discussed earlier. I now like to turn the call over to Chris to discuss our portfolio activity.

Thanks, Mike. We were active in both the primary and secondary markets during the quarter, investing in 9 portfolio companies, including 4 new portfolio companies. Of our 4 new portfolio company investments, 3 are first lien and our fourth is a junior DIP loan. We added on investments in 3 first lien loans and 1 second lien loan and added an equity position through an existing portfolio company. We also had 6 full realizations during the quarter. As I mentioned on our last call, we invested in the first lien loan of Cook & Boardman in connection with its LBO by Littlejohn, its new private equity sponsor. Cook & Boardman is a speciality distributor of commercial boards and hardware. Our yield at cost is approximately 8.7%.

We invested in this first lien loan of Infrastructure and Energy Alternatives, IEA, a construction services firm that focuses on the wind, transportation and rail markets. Our yield at cost is 10.4%.

We also invested in the first lien secured bonds of [Techniclos], the leading manufacturer of complex, lightweight products for the automotive industry. This is a short-dated bond, which matures in 2020. Our yield at cost is approximately 14.1%. We also invested in the junior DIP loan for Sears Holdings, which is being used to finance the company's operations during the bankruptcy. We expect that this will be repaid shortly as the company is in the market with its bankruptcy exit financing. Given the multi-draw structure of the DIP loan, the yield to maturity at cost calculation we typically refer to is indicative of our expected return for this loan. We anticipate realizing an IRR in excess of 20% for investment in Sears.

Turning to the secondary market. We purchased additional first lien loan of Arcade Bioplan. We began building our position in Arcade last quarter. The company is a leading provider of sampling solutions for the personal care and beauty industry. Our yield at cost, including this purchase, is approximately 9%.

We added to our position in 4L Technologies first lien loan. This is another short-dated term loan, maturing in 2020. Our yield at cost is now 8.1%. We increased our position in the first lien loan of CareerBuilder. CareerBuilder is a North American leader in human capital solutions and provides a comprehensive and integrated product for employers and job seekers. Our yield at cost is now 10.6%. We also added to our second lien loan position in TouchTunes Interactive Network. TouchTunes is a leading in-venue music and entertainment company with over 60,000 locations in North America and internationally. Our yield at cost is now 11.3%. As I mentioned, we had 5 realizations during the quarter. First, we received repayment of our first lien loan to AP Gaming. This is our lowest yielding asset and our fully realized IRR was 6.4%. Over the course of our investments, in AP Gaming dating back to the fourth quarter of 2013, our realized IRR was 9.8%. We were repaid on our first lien position in FleetPride as TPG sold the company to American Securities. Our realized IRR on this investment was 12.5%.

Over the course of our 2 investments in FleetPride, our realized IRR was 15%. We were also repaid on our first lien position in Hostway, as the company completed a merger. Our fully realized IRR was 13.2%. We sold our position in Intermedia's first lien term loan at a gain. We held this position for about 4 months. Given the opportunity to make investments in shorter-dated loans with more price upside, we felt this was a prudent shift for better opportunities. Our fully realized IRR for this short holding period was approximately 16.8%. And our realized IRR across all of our investments in Intermedia from the beginning of 2017 through our sale in October 2018 was 14.7%. We were also repaid on our second lien loan to Montrose Environmental. Montrose is one of our largest positions. Our fully realized IRR on the investment was 15.3%. Finally, I would like to explain our partial realization of our position in U.S. Well Services. U.S. Well was acquired by SPAC and now trades as a public company. In conjunction with this transaction, approximately 92% of our first lien term loan was repaid in cash. We received 77,212 shares of U.S. Well Services with a ticker USWS, representing the 8% of our loan which was not repaid with cash. The entire lender group received the same percentage of shares in the debt repayment, other former lenders also received shares for their LLC interest in the company as well. But you'll recall that we sold the shares that we held in the private company in the second quarter of 2018. Additionally, U.S. Well's revolving credit was repaid and our commitment to that facility was terminated. Our realized IRR under revolver position was approximately 11.7%. After quarter end, we made 3 investments: We finished building our position in the first-lien loan of Arcade Bioplan. Our yield at cost across the entire position decreased to 9.6%.

We increased our position in the first lien loan of ProFrac, a pressure pumping services provider, operating in the Permian, DJ and Hainsville basins. Our yield at cost is now 8.6%.

Finally, we invested in the first lien loan for FleetPride, which had funded with the underwriters to repay us in December but was marketed to prospective lenders in January. FleetPride is the largest independent distributor of aftermarket, heavy-duty truck and trailer parts in North America. Our yield at cost on this new loan is 7.9%. We had 2 realizations after quarter end as well. Our first lien loan to Zinc Borrower was repaid. We continue to hold an equity coinvest position in the company. Our fully realized IRR on the loan was approximately 14.5%.

Caelus Energy, our largest position as of last quarter, paid off its second lien loan at the end of January. Caelus sold its largest asset to Eni and repaid all lenders in full. Our realized IRR was approximately 12.3%. I would also note that this repayment significantly reduces our exposure to oil and gas as Caelus was approximately 8% of the portfolio.

Our portfolio company count stood at 29 as of December 31, and stands at 29 today due to our investment in FleetPride and the repayment of Caelus, just a few days ago. Using the GICS standard as of December 31, our largest industry concentration was professional services at 15%, followed by media at 12.8%. Energy, equipment and services at 10.6%, oil, gas and consumable fuels at 8.5% and diversified telecommunication services at 7.7%. I'd now like to turn the call over to Rocco to discuss our financial results.

Thanks, Chris. For the quarter ended December 31, 2018, our net investment income was $3.7 million or $0.27 per share. The fair value of our portfolio was $283.3 million compared to $330.7 million at September 30. Our investment activity accounted for a $34.4 million decrease in our portfolio, including $13.1 million of net realized and unrealized losses. Of these gains and losses a full write down of our investment in Trident accounted for $9.2 million of the $13.1 million of the net realized and unrealized losses. The weighted average yield of our portfolio increased 18 basis points from 10.9% on September 30 to 11.08% on December 31. Our new investments during the quarter had an average yield of 10.77%. As of December 31, our investment in Trident was on nonaccrual. Our portfolio consisted of 63.7% first lien investments, 4.1% unitranche investments, 31.7% second lien investments and approximately 0.5% equity warrant and other positions. 94.8% of our debt portfolio was invested in floating-rate loans and 5.2% in fixed rate positions. Our average portfolio company investment was approximately $9.8 million and our largest portfolio company investment was Caelus at $24 million. We were 0.86x levered as of December 31, and 0.86x levered as of September 30.

Finally, with respect to our liquidity, as of December 31, we had $6.2 million in cash, $6 million in restricted cash, and $50 million of capacity under our revolving credit facility. Additional information regarding the composition of our portfolio is included in our Form 10-Q, which was filed yesterday. Investment activity after quarter end through February 5, included purchases of $23.4 million and $29 million of proceeds from [repayment] of Zinc and Caelus.

With that, I would like to turn the call back over to Mike.

Thank you, Rocco. As I mentioned earlier, this quarter was challenging for us and the write down of Trident was particularly difficult. That said we have been actively repositioning the portfolio prior to this quarter, and we think there are several elements to that process, which we don't want to lose sight of. As part of this broader repositioning, we reduced our average position size and simultaneously increased the number of sectors we are exposed to. Going forward, we would expect to see our average position size to be in current $10 million context. We remain extremely selective in our new investments, underwriting conservatively, focusing on the quality of management teams, loan documentation, collateral security and loan-to-value analysis. We focus on preserving capital and maintaining a stable dividend. We are sensitive to the ebb and flow of repayments and reinvestments and are always disciplined in making investments with appropriate protections for our capital and return to -- for our shareholders. We maintained our company count at 29 this quarter despite unplanned prepayments that [has stacked] us to be over 30 portfolio companies over the near term as we experience larger repayments. We target reinvestment into multiple portfolio companies where there used to be a single one. On the subject of repayments and reinvestments, we had 2 realizations, which, I think, are very significant for us. During the quarter, we added substantial realization of our investment in U.S. Well. You may recall that we sold our shares in U.S. Well in May at a gain versus our basis. Those shares were received in U.S. Well's restructuring in January '17. This quarter, we had another partial realization. Our position in the revolver was repaid in full and 92% of the remaining term loan was paid in cash. All term loan lenders took approximately 8% of their loan principal in the form of public shares, when U.S. Well was acquired by SPAC. We have less than a million dollars exposure now, the aforementioned U.S. Well Services shares, and we have a double-digit IRR to-date on U.S. Well, including all transactions and holdings since our original investment in 2014. Second, Caelus was repaid last week. Caelus is a great example of what our team does best. We leveraged a direct relationship with management and the sponsor that predated the investment. We added to the position opportunistically at a lower level than our original purchase price, and we had conviction on this thesis through a volatile market. Our marks on Caelus moved higher throughout 2018 as fundamental results were strong and our analysis of Caelus's underlying assets proves out value well in excess of the loan. Ultimately, the company sold its primary assets to Eni and fully repaid the loan with those proceeds. Caelus was our largest position and its realization we're very proud of. As Chris mentioned, our fully realized IRR was approximately 12.4%. These 2 realizations represent about half of our exposure to the energy sector. Energy once represented over 25% of the portfolio, today, it's close to 10%. We have brought our energy exposure down through profitable sales and repayments not markdowns. We are comfortable with our energy industry rating in its current context. We covered the December quarterly dividend with NII and fully earned our incentive fee. We expect to cover the dividend and earn an incentive fee in the March quarter. Our Board of Directors declared a distribution for the quarter ended March 31, 2019, of $0.25 per share payable on April 4, 2019, to shareholders of record as of March 15, 2019. We believe our dividend level is consistent with our ability to generate NII without reducing our investment quality or changing our focus from secured lending opportunities, and further believe our quarterly dividend is both stable and attractive to shareholders. For the full year 2018, we fully covered our annual dividend of $1, our run-rate portfolio yield, and our current portfolio quality gives us confidence as we entered 2019. Last calendar year, our board authorized a share buyback program. In the quarter ended December 31, we repurchased approximately 31,000 shares of stock at an average price of $8.25, representing a 28.19% average discount to NAV. Since the inception of the program through today, we have repurchased almost 85,000 shares, increasing our NAV by approximately $0.02. As a reminder, our total capacity for repurchases under this program is $5 million, of which we have used $749,000. Operator, please open the line for Q&A.

(Operator Instructions) Our first question comes from Robert Dodd.

On kind of the market environment and thanks for the color on all that, Mike, with the first half of the quarter yields being at 9%, but then by the second 13%, I mean, where -- obvious question, where did they stand so far as you can tell today as we go into February? And then, along with that, and you obviously, you gave us deployments and everything and repayments to-date. What is the pipeline look like and maybe yields in that context as well as we head into February and March?

A couple of things. From the yield today the pipeline we've got probably, I would say, up to half a dozen real active opportunity, it's probably a couple more than we have capacity for today. But we think that there will -- we know that there will be some monetizations coming over the next several months. And we'll continue to trend toward more names in a $10 million target. That pipeline is anywhere from, I'll call it, 8.5% up to 15%. It's a wide spectrum. There is only one up in that 15% neighborhood. Most are centered in 8.5% to an 11%, and I'd say one at 8.5% and then a couple in the 9.5% to 11%. So with our average yield over the last few quarters on the portfolio of being in this, I'll call it 10.5% to 11% in a quarter, I would say that the average of what we continue to look at is in that 10.5%-plus or minus.

Got it, got it. Structurally, obviously, you talked about the -- you've grown the number of assets on the portfolio, et cetera. And the portfolio -- the average size has come down. I mean, is there and I realize this is a lot easier to ask this question than it is to actually do it. But is there more you can do on that because obviously looking at Trident, it was a 7% at cost, 7% of the portfolio at cost and a 0 on a 7% portfolio position is painful. If that had been a more diversified portfolio or not diversified, smaller positions, if it was a 2% asset having problems is a lot less painful than a 7% asset having problems to NAV. So kind of can you give us maybe a longer-term view, obviously, you expect your average portfolio, your position size to be $10 million in the near time, but long term where would you like that to be with a caveat that obviously these bigger positions, if something goes wrong and bad credits always happen, it can be very, very painful to shareholders NAV?

Yes, listen, I appreciate your observations. We agree with you 100%. And that's why we're working to reposition it. I would say to you that long term, we would look to and I'll remind everyone that, May 2nd, we have increased leverage coming on board. We have not set final, final with the board yet. We had our board meeting this week. And we will set everything final the next board meeting, which will be the 1 year anniversary of that approval. But directionally, I'd expect us to be in a 1.25 to 1.5 times leverage. That will put us directionally, $350 million to $400 million of assets. And I would -- with that as a backdrop of a total portfolio be targeting somewhere in a 40 to 50 names, and that is the $8 million to $10 million on average. We will occasionally do $15 million and there'll be reasons to do that. One may be that we think that and it'll be more typically in 2 scenarios: One, where it's first lien, we really like it and it may or may not have some liquidity. Everyone will recall, we got as high as I think $28 million, $29 million with AP Gaming, it was first lien, performing well. It was very liquid, it was almost a substitute for being long cash at point and ended up being a nice overall return. The other situation is where it is opportunistic to protect a position and to facilitate a refinancing or something else, maybe at $10 million or $12 million or we're going to $15 million but we're not going to be doing those that are not well secured first liens. We're going to avoid the concentrations that we've had in some of the second liens historically on the larger side. So hopefully I addressed the question?

Yes, got that. I mean, and I have to ask about Trident obviously. I mean, you said it surprised you much, the speed of the deterioration. I mean, what -- the mark 0 now and obviously that could -- so the expected recovery I presume is 0 or very even close to it. When you did the -- I mean what's the view on the asset value. And when we look at something like Caelus, which obviously was energy it raised concerns because of commodity exposure, but there was tremendous asset value underpinning that which obviously manifested by selling one asset and paying everybody off. So on Trident, why was it -- why isn't the asset value there?

There -- because there has been deterioration of the core business and beyond that it's hard for me to answer because as you I'm sure aware, we've got a lot of confidentiality on the financial information and everything else it. But it is not like a reserve-based loan or an asset based similar to Sears, where we had something in bankruptcy, and we had assets below it that we could quantify whether or not they were stratified in 4 or 5 different buckets or they were receivables and inventory. Most companies that we look to have equity value that is justified by the sponsors. This had sponsors, had several sponsors, some very good sponsors involved. I think there were 5 BDCs involved, lending both second lien and first lien. So a lot of us looked at it, came to a similar conclusion around the opportunity and the risk return. And we were wrong, it is the bottom line.

Okay, got it. One more if I can. I mean, Chris, you mentioned on the Sears the junior DIP an expected IRR at 20% when it repays and that could be soon or could shift around a little bit. I presume the IRR, there is going to be, for lack of a better term, prepayment fee type income when that repays rather than it being a realized gain kind of event.

The answer is yes to that. And Robert, I think, it's public knowledge, so I can say this, that there is court hearings and everything else. They are trying to get this thing out of bankruptcy in the next 2 days, days not weeks, let's put it that way.

Yes, yes. Very public knowledge, thank you, Mike.

And then you are right, it is basically acceleration of OID, the primary contributor to that IRR.

Our next question comes from Chris Kotowski.

I was just also curious about the comment you made about the first half and the second half and just when you said it was 9% in the first half and 13% in the second half , is that the yield on deals you saw in the market or is that just your coupon divided by where you're marks were at the respective time points?

So during the quarter, we put on approximately 12 new investments and some of those were in the same name because we used the secondary opportunity to buy. And anything before November 15, we took into the weighted average cost yield of what we bought, okay. Not a market, this is what we did. And so that was 9%. And then the second half of the quarter, November 15th after was the 13% of what we did and what we put on.

Okay. So that's that deals you saw in the market is it...

We saw a lot more. Those are the ones we executed on.

Okay. And is it reasonable to assume that with the snapback in the markets in the new year, probably much more limited opportunities now. And that you seem to be have confidence that you can continue to add new loans. But are we looking at adding at 9% or are we looking at adding at 13% or something else?

That was where I tried to give some guidance. So we've got half a dozen things in the pipeline low being 8.5%, high being 15%. I center around the 10% to 11% on average of the opportunities we have out there. And a little bit of preamble earlier in the call, talking about how the markets move quickly on price and not on structure. We actually -- there's one that we are knee deep in and hopefully we'll execute on over the next few days that because of that disruption in December, pricing did come back some, Chris. So it would have been, let's call it 14% to 15%, if that had to get done in December. But because it grew out it's probably coming down in the different components between 10% to 12%. However, we are able to get a lot tighter [DOCs] on restricted payments, on other debts and things like that, that we know they were talking to people in December, and we all said no to that. But we've been able to shift that with some time.

All right. And then the other question is on the buybacks. I understand that given your cap on capital, on some level hate to use any capital to buy back stock. But on the other hand, I do have to believe that at less than 70% of NAV, that it's the most compelling way you could possibly deploy capital. And -- but you've been very -- your buybacks have been very measured and modest, and I mean, I guess, what do you think are -- is there room to be more aggressive on that or are there are other options to kind of close the gap between where your stock is trading in NAV?

We are looking at all of that and everything is on the table.

Our next question comes from Christopher Nolan.

Follow-up on Chris Kotowski's question on buybacks. If you're going to lever up the balance sheet, why don't you just do it tender?

Chris, we keep looking at everything and nothing is off the table.

Yes, it just seems makes a lot of sense on multiple levels given where we are in the credit cycle and everything else. On your comments in terms of your average portfolio size, which was 9.8%, am I correct that you are comfortable with that level or should we see the average portfolio investment go down?

And I think that anything in a 8% to 11% on average we're comfortable with, we are not comfortable with a 12% to 15% on average. And I think that trying to get more specific between 9% versus 9.8%, I'd be misleading you on trying to be that exact because when we're committing to deals we're normally committing in a 5% to 8% or 10%. Those are normal increments if you are at 10% or below. You can't really commit at 9.3% or 9.5% to a deal. So from an average, we think that 8% to 11% across the portfolio will probably be the book ends of what we are targeting.

And then, I guess, more of a objective question would be where do you see the risk? You see the risks higher this year than it was 12 months ago, and how has that affected how you are running things?

Okay. From a credit risk, we have thought that, that's been going up for the last 1.5 years. So if you look at our portfolio shift, where it was more predominant, second lien than first lien, because of credit risk and very importantly because of documentation and structural risk, we had seen that going up. Over the next 12 months, I think, that what we were worried about is watching for a cycle, watching for softness in certain industries. There are some industries that because of it are actually going to have to give us better terms and may become more attractive, things like home-building and building materials, housing, et cetera, where we think that, that is one that could cycle. It's always going to be there. But what is the right level of leverage and how much equity do you want below you. So we want to be conscious of cyclicals and noncyclicals. I think so from a credit risk, we are cautious. We do think that from a structural standpoint over the short term that is actually moving our way. That is an area that having done this for 25 years now, 3 to 6 months from now that could be dramatically different depending on the environment.

(Operator Instructions) At this time, we have no further questions.

Thank you, everyone. We appreciate the time, and we will talk to you, again. Thanks.

This concludes today's conference call. Thank you for attending.