Investcorp Credit Management BDC Inc (ICMB) 2019 Q3 法說會逐字稿

Welcome to the CM Finance Earnings Release Call Third Quarter Ended March 31, 2019.

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 this afternoon. I'm joined by Chris Jansen, my Co-Chief Investment Officer; and Rocco DelGuercio, our CFO.

Before we begin, Rocco will give 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 call 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 the latest SEC filings, please visit our Investor Relations page on our website.

At this time, I'd like to turn the call back to our Chairman and CEO, Michael Mauer.

Thanks, Rocco. Last night, we reported our results for our fiscal third quarter ended March 31. We added more new positions than we have in any prior quarter and had a net addition of 3 portfolio companies. We have diversified our portfolio more than ever before, with investments in 20 different industries. Oil and gas, which was once, by far, our largest sector weighting, is now our third-largest sector at 10.5% of the portfolio. I'm very proud of the work our team has done originating new opportunities, proactively managing the risk and repositioning us into a more resilient portfolio.

The market in the first calendar quarter of 2019 was surprisingly active. After a tumultuous December, secondary levels snapped back faster than we and probably anyone expected. Volatility, which we saw not only in our market but across the global equity and fixed income markets, resolved itself quickly. And we saw a tightening of spreads beginning to take hold fairly early in the quarter.

While new deal economics snapped back to fall levels, we are heartened by the fact that new issue deals have not quickly regressed to the borrower- and sponsor-friendly terms we saw then, especially when considering leverage levels, maintenance covenants and the ability to pay dividends and other elements, which add risk from a lender's perspective.

We have a broad perspective on structural terms in the leverage finance market as we invest in direct club loans and secondary opportunities, where we see catalysts and strong relative value and even selectively, in primary syndications. This quarter, we made investments in a DIP loan, in a high-yield bond, in private club transactions and in the secondary market purchases of loans. Dislocated loan pricing created secondary opportunities but also echoes in new issue loan terms and pricing.

When the secondary market is weak, the primary market is effectively forced to increase coupon and in many cases, change noneconomic terms in the lender's favor. To state the obvious, this makes for a better environment for us to deploy capital.

For the last several quarters, our bias has strongly favored investments in first liens. Between realizations in second liens and new first-lien investments, we've grown our exposure in first-lien investments to over 40 -- I'm sorry, 75% of our portfolio. While this may be higher than it will be in the future, it is directionally indicative of where we focus our origination efforts. We continue to invest in short weighted average life assets, where we see opportunity to generate superior returns through early repayment. We are also focused on adding positions in club deals, which we will be a step removed from market volatility.

With that, Chris will go through our investment activity during and after the quarter in greater detail. And then Rocco will discuss our financial results. I'll conclude with the specific detail about our largest marks, both positive and negative. I'll discuss our write-off of Trident and movement of Fusion to nonaccrual. I'll talk about our outlook over the next few months, and as always, we'll end with Q&A.

With that, I'll turn it over to Chris.

Thanks, Mike. We had a very active quarter, investing in 10 portfolio companies, including 5 brand-new portfolio companies and one which had previously been a portfolio company in which we have previously exited.

Of our $65.6 million of new investments, all but $2 million were first lien. We also had 4 full realizations during the quarter.

I'll quickly cover our additions to existing positions first. We continued adding to our first-lien investment in Arcade Bioplan. We began building this position 2 quarters ago. Our yield at cost, including this quarter's purchases, is approximately 9.6%.

We added to our position of ProFrac, a pressure-pumping services provider operating in the Permian, DJ and Haynesville Basins. Our yield at cost is now 8.6%.

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 approximately 8.1%.

The next category I'd like to cover are our fundings on revolving and delayed draw positions, which included Sears Holding's DIP loan, Open Mobile's delayed draw loan and 1888's revolver. In total, these fundings accounted for approximately $8.9 million of our new investments this quarter.

We had 7 other new investments this quarter. First, we invested in the FILO exit loan for Sears. This loan was part of the financing package which allowed the company to exit bankruptcy, and this loan repaid our investment in Sears' DIP loan. Our yield at cost on the FILO loan is 10.6%. Our investment in the DIP loan was paid off concurrently with this transaction.

We invested in FleetPride, which had previously been a company -- a portfolio company of ours. This new first-lien loan backed the LBO of the company by American Securities. Over the course of our 2 prior investments, we have had an IRR to date of 15%. While we expect to realize a lower return on this investment, we also have a great deal of confidence in the company. Our yield at cost is 7.9%.

We invested in ACTi, a manufacturer of kitchen and bathroom cabinets. Our first-lien loan supported the company's acquisition of ELKE. Our yield at cost was 9.8%.

We made an investment in the first-lien loan of KIK Custom Products. KIK is a diversified manufacturer of consumer packaged goods, in particular, personal care products, antifreeze and pool chemicals. This is a shorter-dated loan maturing 4 years from now. Our yield at cost is 8.4%.

We have a small investment in the first-lien notes for Nexeo Plastics. These notes were part of the financing package for the carve-out of the plastics distribution business from Univar. The sponsor is One Rock. Nexeo Plastics is a portion of Nexeo Solutions, a former portfolio company of ours. Our yield at cost is 10.5%.

We invested in a club deal with both the first-lien loan and a second-lien loan to Carlton Group. The company manages rewards programs for corporate customers. These loans were originally placed as an acquisition financing. Our first-lien yield is 9.9% at cost, and our second-lien yield is 14.8%.

Finally, we invested in the first-lien loan to Empire Office. Empire is the nation's largest Steelcase dealer and is the largest commercial furniture dealer more broadly. The yield at cost of this investment was 10.5%.

We had 4 fully realized investments this quarter as well. The first of these, the DIP loan for Sears Holding I mentioned a few moments ago. By its nature, the DIP was a short-term financing, and this obviously has a meaningful effect on the IRR. Our yield was 18.2%, and our fully realized IRR in this investment was 59.1%.

We were repaid on Caelus Energy, which had been one of our largest positions since early 2014. Caelus was approximately 8% of the portfolio, and its par repayment is one of the major drivers of the reduction in our exposure to oil and gas. Our realized IRR was 12.4%.

Our first-lien loan to Zinc Borrower was repaid. The company's performance has been excellent, and we continue to hold an equity co-invest position in the company. Our fully realized IRR on the loan was approximately 14.4%.

Finally, we have now fully realized our position in U.S. Well Services. Like Caelus, U.S. Well was a debt investment we made in the oil and gas sector in 2014. U.S. Well reorganized in 2017, and our first-lien loan was structured into a new term loan as well as Class A and Class B LLC units. At the time of the restructuring, we also participated in a new revolving credit facility for the company. We sold our LLC units in the second quarter of 2018, fully realizing that portion of our exposure.

In the fourth quarter of 2018, U.S. Well was acquired by SPAC. Our revolver exposure was repaid, and we fully realized that portion of our exposure then. In conjunction with the SPAC transaction, 92% of the first-lien loan was repaid with cash, and the remaining 8% of the loan received shares in the newly public company. The cash was a substantial portion of the first-lien realization. But this quarter, we sold our USWS shares. With the USWS shares sold, we have now fully realized our investment in U.S. Well. Our IRR from our first investment in the first-lien loan in May of 2014 to our final sale of shares in March this year was 15.1%.

Our portfolio company count was 32 at March 31 versus 29 as of December 31 and stands at 33 today. We have not had any full realizations since quarter end, but we did make a new investment in the first-lien loan of Limbach Holdings, a contractor focused on HVAC, plumbing, electrical and mechanical services for commercial construction. Our yield at cost on Limbach was 10.8%.

Using the GICS standard as of March 31, our largest industry concentration was professional services at 14%; followed by media at 10.7%; energy, equipment and services at 10.5%; commercial services and supplies at 8.9%; and construction and engineering at 7.1%.

I'd now like to turn the call over to Rocco to discuss our financial results.

Thanks, Chris. For the quarter ended March 31, 2019, our net investment income was $3.4 million or $0.25 per share. The fair value of our portfolio was $299.1 million compared to $283.3 million at December 31. Our investment activity accounted for a $21 million increase in our portfolio, including $4.8 million of net realized and unrealized losses. Our new investments during the quarter had an average yield of 10.63%.

The weighted average yield of our debt portfolio was 10.44%, a decrease of 64 basis points from 11.08% on December 31. The major drivers of this decrease was a decline in LIBOR; the repayment of Sears debt, which had an extremely high yield; and the movement around investment in Fusion Connect to nonaccrual.

As of March 31, our portfolio consisted of 32 portfolio companies. 75.9% were in first-lien investments, an increase from 63.7% last quarter mainly driven by the repayment of $24.3 million of Caelus second-lien and $63.6 million of new first-lien investments in this quarter. As of March 31, 19.9% of the portfolio is in second lien, 3.8% is in unitranche investments and approximately 0.3% is in equity warrants and other positions.

94.9% of our debt portfolio was invested in floating-rate loans and 5.1% in fixed rate positions. Our average portfolio company investment was approximately $9.3 million, and our largest portfolio company investment was PGi at $18.7 million.

We were 0.91x levered as of March 31 versus 0.86x levered as of December 31.

Finally, with respect to our liquidity, as of March 31, we had $6.8 million in cash, $3.9 million in restricted cash and $46 million of capacity under our revolving credit facility. Additional information regarding the composition of our portfolio is included in our Form 10-Q filed yesterday.

With that said, I'd like to turn the call back over to Mike.

Thank you, Rocco. We're proud of the progress we've made repositioning the portfolio. Not only have we maintained our focus on secured lending, but the team has done a phenomenal job originating first-lien opportunities. We may not always have in excess of 3/4 of the portfolio in first-lien investments, but the lower-risk profile that we have developed is something that we do intend to maintain over the near to medium term. We do not have a significant portion of the portfolio in second-lien investments, and we don't see any reason to reach down the capital structure for yield to keep the portfolio in the 10% to 11% context that we think is appropriate in the current market environment.

This quarter, we did write off Trident as well as 2 markdowns, which I want to discuss with you. Since we believe the probability of any material recovery on Trident is minimal, we have written off the 0 value in the current quarter. There is no cash effect of this write-off. It is simply a change from unrealized loss on Trident to a realized loss. That is why you won't see Trident on the schedule of investments.

We marked down our position in the first- and second-lien loans on Premiere Global Services by an aggregate of $3.1 million. PGi's fundamental results have been challenged as the company transitions its business to subscription-based models, continues to make operational changes and reduce costs and faces a capital structure that now has higher leverage than anyone expected when we underwrote the transaction.

That said, the sponsor, Cyrus Capital, continues to be supportive and behaves in a manner that gives us confidence in the business over the long term. We monitor PGi closely and maintain a consistent dialogue with fellow lenders and with Cyrus.

Finally, we reduced our mark on Fusion from 95 to 80. Fusion is a public company trading under the ticker FSNN. They released an 8-K on April 2 announcing that they had failed to make a scheduled amortization payment to the first-lien lenders, including us. Since then, there have been a series of forbearances signed, but the principal payment has not been made. As such, our expectation is that the company will fail to make interest payments as well and will likely need additional liquidity in the near term. Given our confidentiality obligations, I'm not at liberty to say more, but we are working closely with our fellow lenders and legal and operational advisers.

We remain extremely selective in our new investments. We have added club deals, originated through the team's long-standing relationships with other lenders. We have utilized our relationships with investment banks to see opportunities that others have not. We have also found short-dated loans in the secondary, where we expect to generate above-average returns.

Our focus is on the quality of the management team, the rigorous evaluation of loan credit and security documentation and on loan-to-value

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balances to ensure

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protection. This approach is dedicated to preserving capital and maintaining a stable dividend. Last quarter, I guided that we expected to be over 30 portfolio companies in the near term. And we're very pleased to have crossed that threshold during this quarter and further grown the company count to 33 today. And we have an additional investment that we have committed to that we'll fund in the coming days.

Despite the unpredictable nature of unscheduled prepayments, we think the growth of the company count is evidence of our progress and portfolio repositioning that we began several quarters ago. We have targeted opportunistic sales to help fund the purchase of new loans, and we have reinvested the proceeds of larger repayments in multiple new portfolio companies. Our largest single investment is now $15 million versus $26 million a year ago.

We just reached the anniversary of our Board's approval of the modified asset coverage requirements of the Small Business Credit Availability Act. Put in plainer terms, as of May 2, we have the ability to increase our leverage from a limit of 1x to 2x. We have the leverage line capacity to increase beyond 1:1 today and are negotiating additional capacity presently.

I would guide that our new leverage target will be in a 1.25x to 1.5x context. This change in the leverage limit is the main reason that our leverage increased quarter-over-quarter as we ramped up with good opportunities as they have become available to us.

Lastly, on this point, the adviser will waive the base management fees in excess of 1% over the next quarter on leverage above 1x. We covered the March quarter dividend with NII and fully earned our incentive fee, although we waived a portion of that incentive fee. We expect to cover the dividend and earn our incentive fee in the June quarter.

Our Board of Directors declared a distribution for the quarter ended June 30, 2019, of $0.25 per share payable on July 5, 2019, to shareholders of record as of June 14. We have maintained our dividend of $0.25 since March of 2017 and are confident that this is a level that is supported by our ability to generate NII without reducing the quality of our investments or changing our focus from secured lending opportunities.

This quarter, we were in an extended blackout period and as such, were unable to purchase any additional shares. On May 1, the Board approved the extension of this $5 million program through May 1, 2020. We are currently continuing to work with the Board to evaluate the reactivation of the share buyback program.

Operator, please open the line for Q&A.

(Operator Instructions) Our first question comes from Christopher Nolan.

On your new investments, how many turns of EBITDA?

Chris, I'm sorry, you're breaking up. Could you try it again? Maybe if you're on speakerphone, pick up, I'm not sure.

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Can you hear me now?

Go ahead. Give it a shot. Sorry.

Okay. How many turns of EBITDA for the new debt investments?

Yes. So this is Chris Jansen. Hey, Chris, the most recent ones we've done are more club deals, which have lower leverage. We don't disclose how much leverage we have on each individual investment. We are focused on the equity cushion, using reasonable multiples of enterprise value to EBITDA. And it's ranged between 40% and 55% for the last 3 or 4 deals, the equity cushion.

Okay. And then on the higher leverage limits, Mike, I believe, mentioned that the target level is 1.25x on a regulatory basis. When do you anticipate to reach that if ever? And also, do you have to get any sort of compliance changes or covenant changes with your debt or debt facilities?

Yes. So what I mentioned was a range of 1.25x to 1.5x. I would expect that within 90 to 120 days, we will be in that range. And no, we do not need any amendments or adjustments to our current lending agreements that will allow us to go toward that range. And we have received offers that are actually more attractive on most fronts than our current lending terms to expand up, but we are continuing to have discussions to make sure we maximize returns on that point. And just to clarify, today, we are at just shy of 1 turn. So we have continued to increase post quarter end, anticipating that, as of this week, we could go above that 1x.

Our next question comes from Robert Dodd.

A couple of numbers questions first. I mean how much -- can you give us a ballpark, at least, on accelerated fees or onetime fees that occurred in the interest income line this quarter maybe because of the Sears DIP or anything else that did repay?

Hold on, Robert. Let me look because I believe we disclosed it in our financials. Give me a sec.

Okay. Got it. Obviously, I'm pulling some at the queue, but maybe just another one to go with that while you're looking up that maybe. The custodian fees this quarter were -- custodian and administrative fees were very high, right, I mean, $0.25 million this fee? I mean the 9 months last year, it was only slightly higher than that. So is there -- is that a new higher run rate going forward? Or was there something going on in the quarter that drove those higher, and we'd expect them to drop back down to a more historically normal rate going forward because, obviously, that moves the numbers?

No. So Robert, on that, basically, what happened was we were kind of chewing up the accruals, and that's why you're going to see a little bit uptick. And then next year, for next year, you should see that it should level out back to normal levels. Okay. And then on the repayments, 2 deals. It was Sears and Caelus, were, basically, that had the accelerated. We're talking about $600,000 on that.

Got it. And then -- but for -- on credit quality, obviously, Premiere and Fusion Connect, you gave some color on them. There's limited amounts you can say. But at the same time, I mean, we saw not that long ago a rapid deterioration in Trident, which caught you a bit by surprise, quite a bit by surprise. What's the risk that we're seeing a repeat of that with Premiere and Fusion because, obviously, their marks are well above where Trident ultimately exited obviously? But what's the embedded risk there given some of these things have had surprising and rapid results in the not-too-distant past?

Yes. I'm going to try to answer a little bit of this. Obviously, as you acknowledged in your question, we are bound by confidentiality, so I can't go into specifics. What I would state, as a -- our view, a very, very significant difference between the 2 is that if you look at 2 things. Number one, most importantly, we're first lien here. We were second lien in Trident. And number two, in that context, public information. Prior to the surprise, you had an equity cushion, I believe, it was between $150 million, plus or minus, and you had junior capital of about $100 million below.

Okay. Okay. Understood. Understood. And then the only other -- I mean your comment at the beginning in terms of the market bouncing back in terms of loan bids, and this isn't just a case with you guys but with a number of other bid issuers as well. We really haven't seen that other than the specific credit issues. We really haven't seen a lot of NAV rebound from just a rebound in kind of secondary loan pricing as a feed into the fair value methodology. So is there any color you can give on why we haven't seen a little bit more of a benefit from that just in pure mark-to-market?

I think it's a great question. We have this kind of debate among ourselves, and we also spent a lot of time thinking about fair value. Where something is actively traded and you see large volume in it, it's pretty easy to figure out what fair value is and end them all in something like that, where you saw it move up. Outside of that, where there's not a lot of activity, then what you're doing is you're trying to say what are some of the market dynamics at work, and you could talk about where the market has moved. Number two, where LIBOR has moved, and that moved against us by about 20 basis points, give or take, during the quarter from a mark perspective. And number three, it is really looking at fundamentals. And you try to take all of those things, the market dynamic, the fundamentals, the activity. And in the fundamental category, this quarter is a unique quarter where a majority of -- and I'm talking to the market right now, and I would say I don't think we're different than the market. The majority of investments don't report new information because it's year-end. And so you have until after quarter end, where every other quarter, the majority are reporting new numbers mid-quarter because it's a quarter end, it's not a year-end.

So I think that you have a little less information when you're going through your analysis from the fundamental side because you don't have new fundamentals. And then you do have the market information, our portfolios tend to be less liquid, less traded, less data points. And so we are, I think, always going to make sure that we're doing the right thing from a conservative standpoint and not quick to write things up if that helps.

Hey, Robert, it's Rocco again. While Mike was talking, I was able to look through the financials a bit. Well, in the acceleration, on Page 14, the acceleration was a little over $1 million.

Our next question comes from Paul Johnson.

First, I just want to make sure that I heard you correctly. Did you say that you will be planning to waive fees on assets above the 1x leverage level to 1% for base fees?

Yes. The base fee for assets above 1 turn of leverage will be 1%, not 1.75%.

Okay. And is that effective immediately? Or is that -- does that need to be essentially voted on to be effective? How does that work?

It's effective immediately. It is -- we, as a Manager, can do that unilaterally. We can waive it. We don't have to ask permission to reduce the fee.

Okay. Great. I think that's absolutely the right thing to do. And then, I guess, on that point, could you maybe -- you mentioned your target leverage range earlier. Could you talk to anything on what sort of strategy you would pursue, if anything, different from what you pursue today in terms of the asset mix for assets above that 1x debt-to-equity leverage level?

Yes. Thank you for the question because it's one that probably I didn't spend enough time around. If you watched over the last 24 to 36 months, you've watched our mix move from 60% second lien to today, 20-odd percent second lien. So one was a shift of where we are in the cycle and where terms have been, especially during 2018 and late '17. Consistent with that, we have shifted to more first lien, targeting a 60% first lien, 40% max second lien in the current environment. The opportunities we continue to see as we have increased our leverage have been attractive on the first lien. I think I said in my script that while we're at over 75% today, I don't think that we necessarily will stay at that level. But directionally, we will continue to be more weighted toward first lien than second lien or more unitranche, where we have a first-lien claim and more control of -- around situations. So we will continue to do that as we ramp into the 1.25x to 1.5x. The market may change if we end up back in the 2010, 2011 environment. We will communicate with all of you. But that would be a very different environment than today as far as the amount of equity that's in the covenants, the controls and the returns you can get for second liens versus today.

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

Thank you very much. We appreciate everyone's time, and we look forward to talking to you, I think, in September because we've got our year-end at June 30. Thank you very much.

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