Investcorp Credit Management BDC, Inc. (ICMB) Q2 2016 Earnings Report, Transcript and Summary

Welcome to the Earnings Call Fiscal Second Quarter Ending December 31, 2015 Conference. Your host for today's call are Mike Mauer, Jai Agarwal and Chris Jansen. [Operator Instructions] I'll now turn the call over to your speakers. Gentlemen, you may begin.

Thank you, operator. Thank you all for joining us today. With me are Chris Jansen, my co-Chief Investment Officer, and Jai Agarwal, our CFO. Before we begin, Jai will first give our standard disclaimer regarding information and forward-looking statements. Jai?

Thanks Mike. I'd like to remind everyone that today's call is being recorded. Please note that this call is the property of CM Finance Inc. and that any unauthorized broadcast of this call in any form is strictly prohibited. Audio replay of the call will be available by using the telephone numbers provided in our press release announcing this call. I'd also like to call your attention to the customary Safe Harbor disclosure in our press release regarding forward-looking information. Today's conference call may also include forward-looking statements and projections, and we ask that you refer to our most recent filing with the SEC for important factors that could cause actual results to differ materially from these projections. We will not update our forward-looking statements unless required by law. To obtain copies of our latest SEC filings, please visit our website at www.cmfn-inc.com. At this time, I'd like to turn the call back to our Chairman and CEO, Mike Mauer.

Thank you, Jai. I'm going to begin our call with the discussion of the market. I'll then turn the call over to Chris to walk through our portfolio activity in the quarter. And then I'll speak a bit about some key metrics and fair value remarks. The fixed income markets continue to experience weakness last quarter and were exceptionally volatile. Spreads have widened across fixed income, especially within the broadly syndicated loan market to high yield market, and our focus, the middle market. We are starting to see a better balance through supply and demand since the start of this quarter although volatility continues to create a great deal of uncertainty. Of course, volatility also creates opportunity. Over the past few months supply has clearly outstripped demand pushing secondary prices lower. The lack of demand has also led directly to a slower pace of originations in our market. This environment remains investor friendly with structures and terms favorable to capital providers. I'd now like to turn the call over to Chris to discuss our investment activity.

Thanks Mike. Our portfolio activity during the quarter was like as we discussed on our last conference call, we made one new investment in NWN Corporation. This is a small club deal back in the acquisition of the company by a sponsor, New State Capital Partners. Our investment was a $10 million firstly loan, at a price of $98, as well as a small equity co-investment of approximately $150,000 alongside our lending partners and the sponsor. During the quarter we also had two investment realizations. We sold our second lien loan to Physiotherapy Associates. This was a $5 million physician with a yield of less than 10%. We evaluated our ability to grow the physician to a more meaningful size for us or to exit, and we opted to exit. Our realized IRR was 9.8%. Our investment at LightSquared was also repaid in December. This repayment was expected as this was a dip loan and LightSquared exited bankruptcy. I realized IRR was 9.4%. Our expectation is that overtime we'll continue to increase our number of portfolio companies from 22 today. As we do, we'll continue to focus on diversifying our portfolio. By industry, our largest concentration is in gaming at 18.1% of the portfolio at fair value. This is up from 16.5% last quarter and as a result of changes in our marks. Our second largest sector was healthcare at 12.9%, followed by energy at 11.9%. Telecommunications followed as our fourth largest sector at 10.6%. I'd now like to turn the call back over to Mike.

Thanks Chris. As of December 31 we were 0.84X levered versus 0.75X as of September 30 and 0.71X at June 30. We maintain a balance of first and second lien investments with 50.7% of the portfolio in first lien, 46.1% in second lien, and we have 3% of the portfolio in an unsecured investment with the remainder in equity and warrants. The weighted average yield on our debt and income-producing securities at cost decreased to 10.31% from 11.02% as of September 30. While our investment in NWN and realizations of LightSquared and Physiotherapy improved our average yield, the effect was more than offset by our non-accruals. As of December 31, the fair value of our portfolio was $293 million. As of September 30, the fair value of our portfolio was $321 million. Our investment activity include sales, pay downs and repayments, accounts for $7.5 million of the fair value reduction. The remainder is due to declines in our fair value marks. Portfolio valuations for all BBCs, not just CM Finance are rightly in focus at the moment. Investors and analysts continue to focus on energy investments in particular. Knowing all this I thought it might be helpful to give an update on our most significant changes to our fair value at March this quarter. Six of our physicians were marked down by $1 million or more. AAR as you will remember is a Colorado-based oilfield services company. As I mentioned in November, company's results are significantly dependent on drilling activity in the DJ basin. With a continued decline in oil prices seen during the second half of 2015, AAR's customers have cut back their operations and pushed service providers like AAR to reduce pricing. AAR is by no means unique within the oilfield service space; this dynamic is playing out across the industry. AAR is in forbearance after violating financial covenants, and we are working with our fellow lenders and the company to amend our loans terms. In addition, we have moved the interest to pick [ph] and we have AAR on partial non-accrual. We reduced our mark on AAR from 80 to 65. Bird Electric Enterprises is based in Texas and provides utility services to both, the oil & gas and regulated utility industries. Bird services the electrical group performing maintenance and repair, as well as doing electrical work on projects in West Texas. We invested in Bird in October of 2014. It is really a story of two business lines; Bird's operations in Texas have been stressed by the activity in the Permian Basin has declined with oil prices. Bird has made some progress expanding the utility portion of its business, as well as expanding operations outside the oil patch. The diversification into the utility business into Florida and Southeast continues but this has required greater upfront cost-to-date and is behind schedule. Weakness in Bird's utility business is what surprised us most and was a big input to our mark. We have taken a conservative approach in valuing Bird and we have not assumed any near term recovery in drilling activity in the Permian. We have also assumed a gradual restoration and profitability to the utilities business. In addition, the company is currently in covenant default under their first lien credit agreement. We've placed Bird a non-accrual and reduced our mark from 95 to 50. Caelus is an exploration and production company operating on the north slopes on Alaska. Operational performance has been outstanding and we feel the management team is one of the strongest in the industry. Caelus's result has been excellent. The company enjoys a strong hedging profile and has excellent cash flows and has done an excellent job proactively managing capital and operating expenditures. In 2014, Caelus hedged the majority of their production for 2016 and 2017. That said, the price of oil is a third of what it was at the time of our investment which has an effect on collateral values and investor sentiment. In recognition of the broad repricing of risk in the sector, we have reduced our mark from 79 to 65. Thematically our marks on TNT Crane and Endemol were reduced, for reasons which are quite similar. You'll see TNT Crane listed as North America Lifting Holdings in our financial statements. TNT is an equipment rental company specializing in operated and maintained lifting services, meaning that TNT provides both the operator as well as the equipment. Endemol appears in our financial statements as AP-NMT acquisition BV. The company is one of the largest independent television programming companies producing both scripted and realty TV content. With TNT and Endemol have in common is that they are second lien loans behind relatively illiquid syndicated first lien loans. Both companies enjoy strong sponsorship from First Reserve in the case of TNT and Fox and Apollo for Endemol. Both capital structures are more levered than our average portfolio company. Finally, both TNT and Endemol's results have been modestly behind their respective budgets. Neither company is experiencing material financial strain and we don't think either should have an issue servicing their debt. That said, the modest weakness in results coupled with higher starting leverage with less liquid markets for their loans created very poor dynamic in the volatile widening spread environment. Both TNT and Endemol's loans really trade. When the loans did trade during the first quarter, the first liens gaped down, as a result, the second liens have been marked down as well. We marked TNT down from 92 to 72, and Endemol marked down from 91 to 83. Finally, our other significant mark was in YRC Worldwide. The company provides less than truckload transportation services in North America. YRC Worldwide is our most liquid investment which means it's responsive to changes in the information available to investors. YRC's performance has been generally in line with our expectations and the company was upgraded by S&P in August of 2015. We are first lien lender, YRC is a public company, and as disclosed that their leverage is 3.2X as of December 31. This has delivered from 4.6X over the past year. However, the macro environment for transportation companies has been challenging, particularly from a volume standpoint. Ultimately YRC is another market related mark as other investors clearly view the company less favorably than we do. We've reduced our mark from 97.5 to 88.5. During the December quarter we earned our full base management fee. As you know, we agreed to wave our income incentive fee to the extent necessary for NII to cover our dividend. We also have a three-year high water mark. Due to the decline in the fair value of our investment portfolio, the high water mark was triggered. The resulting fee waiver caused an increase in NAV of $1.2 million or $0.09 per share. We did not earn any of the incentive fee in the quarter due to our high water mark and we expect to fully waive our incentive fees for the next two quarters. On February 2, our Board of Directors declared a distribution for the quarter ending March 31, 2016 of $0.3516 per share payable on April 7 to shareholders of record as of March 18. We made a commitment to our shareholders to increase our dividend and this is our second annual increase. Our new dividend level represents a 9X and 3X [ph] yield on our IPO price of $15 and a 16% yield based upon yesterday's closing price of $8.75. With that, I'd like to turn the call back to Jai to review our results for the quarter. Jai?

Thanks, Mike. Our net investment income for the quarter was $6.3 million or $0.46 per share. Our aggregate net realized and unrealized losses were $21.8 million or $1.59 per share. The weighted average yield at the cost on our debt portfolio was 10.31%. Our debt portfolio was comprised of 80% floating rate and 20% fixed-rate investments. The average portfolio company investment was approximately $13 million, and our largest portfolio company investment was $29 million. Additional information regarding the composition of our portfolio is included in our Form 10-Q filed yesterday. With respect to our $50 million financing facility, we had $44 million borrowed at quarter-end and $41 million as of today. And with that, I'll turn the call back over to Mike.

Thanks, Jai. As I mentioned, we have moved Bird to non-accrual and AAR to partial non-accrual. While we are disciplined with the performance of these investments, our portfolio is solid. Over 96% of our investments are senior secured. Our underwriting is focused on the quality of management team, capital structure, our security and covenants for the protection and preservation of capital over the long term. We are in a very difficult investing environment but we believe that being patient and conservative is the right approach. As to BDC, we have limited capital available to invest at any given time. The markets continue to be volatile; we continue to have a great dialogue with our origination sources including watching secondary markets closely. We have directly originated investments in our pipeline and we are seeing offerings in several investments that are reasonably attractive. That said, we are going to be patient and we will continue to look for signs of stability before we step in and resume deploying capital. With that operator, please open the lines for Q&A.

[Operator Instructions] Our first question comes from Robert Dodd. Please state your question.

Hi guys. Looking at obviously non-accrual -- partial non-accrual for AAR and working through the process. Can you give us kind of any idea about the timeline to come to a conclusion, be that a total non-accrual or return to accrual or however that works out, but I mean what kind of timeframe are we looking at? And then secondly, what do you think would be required for, to either come back onto accrual or to get a full non-accrual?

Thank you, Robert. So AAR, I think we've talked about it couple of times so I think a very relevant question. We are -- we did put a restructuring officer into the company over the last quarter. They went in at the end of the December quarter. They are in working now. I would expect that they are in this quarter and it may go into the next quarter, we're not sure. Depending on the product that they are producing we want to make sure we get all the information and we get the reporting and everything set up. As a result of that information it will allow us to finalize the process around and amendment with the company. So to answer that question, I think it's either late March quarter or sometime into the June quarter before we've got amendment in place. That's the first part. The second part is around some clarity of accrual going off and back to cash versus fighting down and not being recoverable. So they continue to have a very, very stable base centered around one principal customer noble in the DJ Basin. And they continue to have a very preferred basis of operation of the wells ranch, this is all documented if you research the DJ Basin. And based upon that we would expect that this will stay on pick for the foreseeable future until we work our way through a trough [ph], we feel very good about the company but we do not think that it goes back onto a cash basis until you see a recovery in oil. And I will tell you, I don't think that it's in the next six months, I'd be surprised if it is. And anyone who can tell me when it does come, I'd love to talk to them but I think it's further out the next.

Okay, perfect. On Bird if I can, on the utility side of the business which usually I'd expect, can expect -- was there a change in terms of anything regulatory change or role change in any of the states they're operating that drove that or just something.

No it wasn't a regulatory change, what it was, was that they have been operating in Texas and some surrounding states and they actually as part of the ramp up of the utility business have been awarded a fairly significant contracts in with Florida Power & Light. And as a result of that 13 Cruise were relocated to Florida in late October, early November, and the cost redeployment timing were all significantly more than originally budgeted for. And as of the end of January, end of February, that appears to be working the way expected but on a significant delay.

Okay, great, thank you. And then, on the capital availability side, just picking a name, Van Dame [ph] and really it isn't Van Dame, I'm not naming anybody. The TNS marked roughly at par on the schedule investments. I mean given your relatively constrained capital position by now, have we considered basically selling some of your better performing loans that you've got that haven't been marked down yet to kind of free up some capital to be a bit more opportunistic given your expertise in some of the more shaky credits?

Again I appreciate the question because it is a dialogue that daily as we sit around and we look at whether or not it's pipeline or secondary opportunities where there is first lien or second lien available at some attractive levels. We are conservative from saying, we don't want to stop in until you step in, until we think there is really some stability around some of these, we don't need to bottom ticket to be very profitable. We're focused on making sure that we do have NII to cover the dividend, we more than have that today going forward. So we're comfortable with that. We don't want to roll off a bunch before we see opportunities. Without saying names we do think that there is $50 million to $60 million of relatively liquid positions that we could rotate out of over the short end, probably 30%, 40% of that over 7 to 10 days and the other 50% to 70% of that over several weeks to create liquidity to the extent we see opportunities.

Thank you.

Okay.

Our next question comes from Greg Mason. Please state your question.

Great, good afternoon. Thanks for taking my questions. First, just on the incentive fee waiver due to the high hurdle, the high water mark there, if that is waived for the next two quarters, if these marks come back quicker than expected, is there any claw back to those incentive fees that have been waived this quarter and maybe the next two quarters?

Greg, this is Jai. There is now claw back to those incentive fees even if the marks come back. It is a quarter-by-quarter calculation.

So it's a permanent waiver Greg. Thank you for the question because I think that's very important for investors to recognize.

Yes, okay great. And then on the leverage currently at 0.88 debt equity, can you remind us again about your target and how do you feel about running above that target for a while and how much capital do you have based on that leverage target? You said you've got $50 million to $60 million of liquid investments but due to some of those have to go back to reduce your leverage closure to your target.

Yes, so our target which was kind of 0.7% plus or minus 10%, we are above that and that's driven by the marks obviously. We're very comfortable operating in and around that. From the standpoint of liquidity and I talked about $50 million to $60 million, we have the ability to create liquidity there and reinvest it, a 100%. If we did elect to do that we would be neutral on our leverage from pre-rotating to post-rotating, in and out of the investment. We could elect to partially delever if we wanted to in that situation.

Okay. And then just one last question, AAR partial pick non-accrual, could you quantify how much is accruing versus how much not, is it 50-50 or…

Yes, I will tell you when we first went through this, this was kind of -- I wanted to make sure I fully understood how we think about this and the key thing is that basically given our mark to 65, we are recognizing 65% of the pick income. What we don't want to do is take fees on the full pick accrual when our principal is marked at 65%. So the partial non-accrual means it will recognize income on a percentage basis proportional with the mark.

Got it, we've seen that with other firms in the past. Alright, thanks guys, I appreciate all of the comments.

Thank you very much Greg.

Our next question comes from Merrill Roth [ph]. Please state your question.

Hi, good afternoon. I'm wondering if outside the oilfield services on the energy patch, are you finding that your companies are hunkering down expecting recession or real backup in growth in the current environment or do you really think that these -- a lot of these marks were related to preservations I would say, a volatility in the markets?

Merrill, thank you for the question. I absolutely think it's the later. Overall the portfolio companies are performing. You could see a modest miss or something here there but we've seen that over years and typically you will see a little miss in one quarter, a little make up in another quarter. But though that's more of the exception than the rule, and we really think that this is more of a volatility and spread widening that you're seeing across the fixed income markets, all the way from investment grade, down through the middle market.

Thank you.

Our next question comes from Craig Godowsky [ph]. Please state your question.

Yes, most of mine have been asked and answered. But I'm just wondering can you describe again the sensitivity of Bird Electrical -- Electric to -- obviously, they are operating in Texas, and I was wondering what was exactly their exposure to the weakness of -- in the energy markets? And then are there -- I was thinking about the other non-energy credits, are there any that are particularly dependent on an energy intensive geography or end market in some way?

Yes, I'd say two things. One on the energy side, the sensitivity is as you would have expected and that is that it really started January of '15, so a little over a year ago you had their large customers come back and say we're getting hit so we want you to reduce your rate. And at the same time there has been some pullback in the volume over that period of time. The second piece to your question around the utilities and first or second derivative risk as we think about it is, you've got Texas and Florida and some of surrounding but for Bird, specifically, that is maintenance work and that really we've not seen a significant if any follow-up and we've actually seen a ramp up related to the contracts awarded in Florida. And so that maintenance work is going to get done no matter what, it's a matter of execution, and that's where they did stop their trip in the fourth quarter in Florida.

Okay. And the other -- your portfolio companies that kind of have a stuff -- exposure, the second derivative?

Yes, actually there is one or two and I'll roll back to Chris because I know he is very close to both of these to answer that question.

Hi Craig, it's Chris Jansen. TNT is another -- it's a crane company, it does lifting services. So think of aerial lifts or crane work, they are embedded a lot within their customer base. At the time the deal was done in late 2013, it was about 25% gear two oil & gas and E&P. And in recent quarters it's down to between 10% and 15%. So we've seen the predominant portion of effect against that. They've also seen some weaknesses from delays in their maintenance work which was a deferral business rather than a cancellation of projects. But that still needs to happen. We're expecting TNT's results to improve in 2016 from that deferral planting refinery maintenance.

Okay.

As far as other commodities, Nexio is a stocking distributor of chemicals and plastics. They take inventory risk and in a rising price environment, that inventory can be a big benefit and a climbing price environment is bit of a risk. In our judgment, Nexio's management has done a great job working through the volatility in combining prices. They've done very well, Nexio has since the time of our investment they delevered from over 6X to about 5.3X leverage today.

Okay, thank you.

[Operator Instructions] At this time, we have no further questions.

Thank you to everyone who joined us today. We look forward to speaking with you again next quarter. And operator, thank you.

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