Investcorp Credit Management BDC, Inc. (ICMB) Q2 2017 Earnings Report, Transcript and Summary

Welcome to the CM Finance Second Quarter Earnings Release Conference Call. Your speakers for today’s call are Mike Mauer, Chris Jansen and Rocco DelGuercio. [Operator Instructions] A question-and-answer session will follow the presentation. I’ll now turn the call over to your speakers. Please began.

Thank you, Operator. Thank you all for joining us today. I’m joined today by Chris Jansen, my Co-Chief Investment Officer; and Rocco DelGeurcio, our CFO. Before we start, 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 call is a 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 using the telephone numbers provided in our press release announcing this call. 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 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 would like turn the call back over to our Chairman and CEO, Michael Mauer.

Thanks, Rocco. As is our custom, I will begin today’s call with the discussion of the leveraged finance market. I’ll turn the call over to Chris to walk through our investment activity during and after the quarter, and then Rocco will speak about our financial results. I will conclude with some commentary on our portfolio. Leveraged finance new issuance volumes during the quarter were the highest since 2014. New issue activity in the broadly syndicated market and the upper ends of the middle market continued to improve borrower friendly terms, tightening spreads with the vast majority of deals being covenant light. Refinancing activity including re-pricings, incremental first lien loans to repay second lien loans and drive-by high yield issuance has a resulted in the repayment of a number of loans which were made in less aggressive environment for lenders. 2016 was a challenging time to find opportunities with attractive term and structure. We were extremely selective in choosing our new investments and we passed the numerous deals due to pricing, aggressive capital structures or weak protections for the lenders. A very attractive capital markets environment also has benefited us. We received two unplanned repayments during the quarter, both of which included call premiums. This helped boost our NII during the quarter and gives us the opportunity to redeploy our capital as we entered 2017. We’ve made investments in three new portfolio companies since quarter-end, and we have one commitment outstanding that we expect to close during the quarter. Our current pipeline is very active; with several potential investments, we would assign a high probability to. We’re maintaining our focus on first and second lien lending, the high-quality management teams and companies with structural protections for us as lenders. Despite the challenges of the syndicated market, our team continues to originate a lot of exciting deals in the middle market and where we are optimistic about the direct and club lending opportunities in our pipeline. I’d now like to turn the call over to Chris to discuss to discuss our investment activity.

Thanks, Mike. We made four investments during the quarter, including two investments in new portfolio companies and two different investments in an existing portfolio company. We had four realizations, two of which came at prepayment premiums. As we discussed on our call in November, we invested in the first lien loan of Dayton Superior. Dayton is a leading manufacturer and supplier of concrete construction products in North America, supported by engineering and other value-added services. The yield at cost was approximately 10.2%. Our second lien portfolio company investment is Montreign Resort Casino, a development project in Sullivan County, New York. This first lien loan helps fund the construction of the new casino and hotel, which will be operated by Empire Resorts, which is controlled by the Genting Group. Montreign was granted one of the four new gaming licenses in New York state and is scheduled to open in 2018. Our yield at cost was approximately 10%. We also made two investments in PGi, one of our existing portfolio companies during the quarter. We participated in the new second lien note for PGi; our yield at cost on this investment was 11.5%. We also added to our position in the first lien loan. We had four investment realizations during the quarter. First, we realized our investment in NWN Corporation, both in its first lien loan and our equity co-investment. We made this investment in the fall of 2015. Our fully realized IRR, including our loan and equity investments was 11.8%. Our investment in JAC Holdings was called at its make-whole premium in November at a price of approximately 115. The company sponsor, Wynnchurch, sold the company to Argonaut, and our debt was repaid in connection with that transaction. Our realized IRR in this investment was 18.3%. We also received two repayments in December. Our loan to A.S.V. was repaid with the premium of 101. Our fully realized IRR there was 13.9%. Our loan to AM General was also repaid late in the quarter. We had held this loan since prior to our IPO, and our fully realized IRR on this investment was 10.9%. Since quarter-end we’ve been quite busy. We have made additional investments in two of our portfolio companies, U.S. Well Services and Montreign, and have also added three new portfolio companies. Intermedia is a leading provider of cloud-based software solutions for small and medium sized businesses. We hold the small position in both the first and second lien loans, which were placed in connection with the LBO of the company by Madison Dearborn. Our yield at cost is approximately 7.1% on the first lien and 11.2% on the second lien. The blended yield is approximately 10.5%. We also invested in Immucor’s first lien loan in the secondary market. Immucor develops, manufactures and sells manual and automated analysis equipment which is used to test blood prior to transfusions. TPG is a sponsor of the company. Our yield at cost is approximately 7.2%. Finally, we participated in new second lien loan for Lionbridge which backed the LBO of the company by H.I.G. Lionbridge provides translation and globalization services to companies worldwide. Our yield at cost on this investment is approximately 11.1%. We had 22 portfolio companies as of September 30th, and we had 19 as of December 31st. Today, we have 22 portfolio companies. As of December 31st, our largest industry concentration was in gaming at 19.6% of the portfolio at fair value. This is up from 15.5% last quarter, and the increase is largely attributable to our investment in Montreign. Our second largest sector was energy at 14.4%, followed by telecommunications at 12%, business services at 10.5%, and trucking and leasing at 9.3%. I would now like to turn the call over to Rocco to discuss our financial results.

Thanks, Chris. For the quarter, our net investment was $4.9 million or $0.36 per share. As of December 31st, the fair value of our portfolio was $245.4 million compared to $264.2 million at September 30th. Our investment activity accounts for $23.4 million decline in our portfolio, offset by $3.6 million increase from our net changes in our marks. As of December 31, the weighted average yield of our debt portfolio including amortization was 9.8% compared to 10% at September 30, 2016. Our debt portfolio was comprised of 95.4% floating rate, 4.6% fixed-rate investments. All of our floating rate investments have LIBOR floors, and average floor was 1.06%. The average portfolio company investment was approximately $12.9 million and our largest portfolio company was $28.8 million. As of December 31, 57.2% of our portfolio was in first lien and 42.8% of the portfolio was in secondly investments. We do not hold any unsecured investments. Additional information regarding the composition of our portfolio is included in our Form 10-Q, filed yesterday. We were 0.7 times levered as of December 31, compared to 0.72 as of September 30. With respect to our liquidity, as of December 31, we had $26.8 million in cash, $27.8 million in restricted cash and $35.7 million capacity under our $50 million revolving credit facility with Citi. With that, I’ll turn the call back over to Mike.

Thank you, Rocco. The aggregate mark on our positions in energy and oilfield services, increased significantly this quarter, driven by improvements in oil prices as well as improvements in the operations of our portfolio companies. Caelus continues to exhibit outstanding fundamental results, and we think its management team has done an outstanding job considering capital and resources to manage liquidity and capital expenditures through a couple of challenging years. Our mark increased from 70 to 78 this quarter. AAR concluded its restructuring in our September quarter. Now, that the balance sheet restructuring is complete, management has refocused on building its business as activity in the D.J. Basin has picked up. Our mark on term loan B, which is junior term loan in the capital structure improved by approximately 5.5 points this quarter. Finally, our mark on U.S. Well Services first lien loan improved slightly. The pricing environment in the pressure pumping services remains challenging, and we have seen that reflected in weakness in the company’s results. We reduced our mark to 75 last quarter as discussions about balance sheet restructuring was underway. And we increased that mark to 77.6 as of December 31st. After quarter-end U.S. Well completed an out-of-court restructuring to address issues of leverage and liquidity. The first lien loan was partially equitized and the first lien lenders now own the majority of the equity of the company. Our $6.7 loan, as shown on December 31st financials is now $3.8 million loan. We also have a pro rata share of the equity which is approximately 2% of the total. We and other first lien lenders also provided a new revolving credit facility to company. Our commitment to the revolver is approximately $1 million. The net result of this restructuring is that U.S. Well is more conservatively levered; we retained a secured position; and we have upside through our current fair value due to our position in the equity. We think there is a great opportunity here over the near and medium term. We are pleased with the overall performance of our portfolio. Bird Electric and the term loan B for AAR remain on non-accrual as we monitor these positions very closely. While the percentage of our fair value increased from 4.5% to 5.1%, that’s solely the result of changes in fair value of the portfolio rather than new non-accruals. Our portfolio yield decreased to 9.8% from 10% last quarter due largely to the repayment of JAC Products and A.S.V., which had a higher coupon than our average position. Our new investments in the quarter ended December 31st had an average yield of 10.1% and our investments this quarter-end have an average yield of 10.2%. We’ve deployed $22.3 million of capital and we expect to invest an additional $15 million to $30 million this quarter. We anticipate one repayment from our existing portfolio at this point. Cable ONE has a agreed to acquire NewWave Communications where we currently hold a second lien loan. The transaction is slated to close next quarter and we are actively managing our pipeline to prepare for that. We are committed to paying an attractive sustainable dividend to our shareholders. Our Board of Directors previously declared a distribution for the quarter ended March 31, 2017 of $0.25 per share, payable on April 6 to shareholders of record as of March 17. Our objective setting our dividend at $0.25 per share is to ensure their dividend level is consistent with our ability to generate NII without reducing our investment quality by reaching for yield or changing our focus of secured lending opportunities. The $0.25 per share per quarter represents 10.1% yield as of the close of business yesterday. We fully earned our incentive fee in the December quarter but we waived a portion of that fees to cover the $0.35 that was paid on January 5th. We expect to partially earn our incentive fee in the current quarter. We see exciting opportunities in secured investments in the primary and secondary markets today. Our team continues to identify attractive risk reward opportunities and is always focused on structural protections for our investments. While the syndicated market remains very challenging for lenders, club and direct lending opportunities are attractive, and we have several high probability deals in our pipeline. Our realizations in calendar 2016 were exceptional with the weighted average gross IRR of 14% and all of our realizations at a gross IRR of at least 10.9%. These realizations help boost our NII and also give us the chance to redeploy our capital into new loans as we enter the new year. The portfolio as a whole continues to show signs of stability and growth with net fair value appreciation of $3.6 million this quarter. Our underwriting will always focus on the quality of management teams, capital structures, our security, and covenants for the protection and preservation of capital over the long term. We are focused on managing to protect against downside risk but we also think there is real upside NAV protection in our current portfolio. With that, operator, please open the lines for Q&A.

So, I have two questions for you. The first one is, I was just wondering if you could let us know how much of this quarter’s gross interest income was a result of your robust repayment versus like -- or an any accelerated fees that you would have received from that versus kind of the -- so we can kind of break out that core earnings?

Yes. We can walk you through that. And what’s the second one?

The second would be, so, we are starting to see three-month LIBOR around that kind of 1% mark, and I know that you have a floating rate portfolio that is benchmarked to LIBOR. So, I guess broadly, is this -- are your loans based off of three months LIBOR? Do you think that -- are they starting to reset and kind of hit their floors? How should we think about the portfolios, positive leverage to interest rates in 2017 and 2018?

Sure. I’ll take the first half and I’ll pass second half over to Chris.

Okay.

On the first half, we had a $0.62 of income. And the way we would break it out and you guys can dissect it how you like, but kind of core net income from interest was about $0.29; exit fees that we got, whether or not there were prepayment fees or make-wholes were about $0.14; and then we had appreciation in the portfolio of about $0.27. That’ll take you up to $0.69, and then offsetting that was incentive fees that we earned as a result of those earnings of $0.07; that represents the $0.62 in the financials.

Got it.

And Chris, do you want to address the LIBOR?

Yes. Our borrowers can either do one or three-month LIBOR at their option. The one-month three-month spread is about 20-25 basis points. So that right now today is about 78 basis points versus 1.03 for three-month.

Okay. So, have you -- and your loans, do they have somewhere between 1% and 1.5% LIBOR floor, so I guess they are choosing one month right now, so will have to get the one-month mark above 1% before we start to see some interest pickup?

Yes. We have two loans that are above the 1% LIBOR floor, and it’s less than 5% of our portfolio. Everybody else is 1% or lower.

Our next question comes from Paul Johnson from KBW. Please state your question.

I had a question about one of the portfolio companies, U.S. Well Services, I know you guys said that you restructured that in the quarter, in the current quarter, correct, first quarter 2017?

It was restructured in the first quarter. Yes.

Okay. Do you guys -- are you able to provide an idea of whether or not that took the realized gain or loss from doing so?

We cannot walk you through that. What I’d say is that we are comfortable with the fair value, okay, as of 12/31. If there is upside to that fair value as a result of the restructuring, we have to go through a formal valuation with the Board at the end of every quarter. But, we feel that that restructuring enhanced our position. Now, there is a second piece to your question. So, when we get to next quarter, Rocco will walk through it, because GAAP accounting treats restructurings little bit different from unrealized gains and losses transferring to realized and new positions that are reconstituted from the restructuring coming on and then fair value creating a new unrealized. So, I am just going to caveat it. Next quarter, you will see a lot of activity around that.

And then, I had another question on North American listing. I was wondering, maybe if you can give at least a little bit of description around what the company is and maybe where the stress is coming from, given that the investments kind of have been marked down slowly here over the past few quarters or so?

Hi. This is Chris Jansen. North American listing is a crane services business, mainly located in the Southeast Gulf Coast, owned by First Reserve for the last three plus years. And they have been little bit susceptible to a little bit on the oil and gas rig business but that’s a very, very small percentage of their business now, less than 5%. And they have also begun to see a bit of a pickup on the refining business. As you guys are aware, the refiners had put off their turnaround downtime repairs because margins, crack margin is so high. And that’s more -- and there has been other deferred maintenance by their customers, but we’re starting to see an upturn in that.

Okay. That’s good to hear. And then, one final question, I don’t know if you’re able to answer this or not. But, regarding the casino investment, I was wondering if you can kind of provide, at least what’s typical for a gaming transaction, what sort of leverage you guys would come in at as a first lien investor in a company like Montreign?

Yes. I’ll let Chris go into more detail on that. But, something like Montreign, you don’t really think about it as leverage per se because you’re -- during the development stage, the basis is really -- equity in front of you, the loan-to-value against the property and then, you do look at the leverage once it’s gotten up and running. But I’ll let Chris go through some of the specifics around that?

Yes, it’s very hard to speak about Montreign in particular. We’re not going to give up any information. But, particularly, we’re looking for less than four times total debt to what we feel is a reasonable EBITDA run rate. And again reiterate Mike’s point that this is 12 more months estimated before it opens and probably is another 12 months until -- in our view, until it’s more of a run-rate. So, we also look to companies to make sure they have an adequate interest reserve to cover that. So, that’s one of the key tenets on what we look forward structuring these types of deals.

Okay, yes. That make sense. That’s all I had. So, thanks for taking my questions.

Thank you very much. We appreciate it.

Our next question comes from Robert Dodd from Raymond James. Please state your question.

Hi, guys. Actually sticking with the gaming exposure. You mentioned since the end of the quarter you’ve done follow-on on Montreign. So, your gaming exposure overall now probably north of 20% of the portfolio, I presume. So, what’s the feel about the exposure to one industry being so high? Obviously, the last industry exposure that was very high was oil and gas that didn’t work out too well. So, cyclical, very, very cyclical business, completely different dynamics. But, high exposure can have some risks that come with that. So, what’s your feel about the relative diversification around such a big exposure to one industry right now?

Sure. Good question, Robert. Let me take it name-by-name. Land Holdings, the Scarlet Pearl Casino, which is a new build that opened up recently in the Biloxi, Mississippi. It’s owned by a very-wealthy investor entrepreneur. Our loan-to-value there conservatively is under 20% of the cost of the build. The sponsor continues to put money into the company -- into the casino for improvement. So that is a rock solid investment, again, in the Biloxi, Mississippi market. Montreign owned by Resorts World; Resorts World is owned by eventually the Genting Group out of Malaysia, widely diversified multi-billion dollar capital company and family actually with a lot of casino experience. They operate Resorts World, which is located in Queens; they operate Yonkers Raceway; and they have their finger on the pulse of the very important Asian gaming market, particularly in New York. They have made a substantial equity investment already in the casino, which is almost 15% of the cost of the casino overall. So, you have an experienced operator with huge capital underneath us. And again, this is more than New York City market. So, much different market than Biloxi. And last but not least, American gaming, which is our largest exposure. American gaming provides the games for class II and class II casinos. The company went in May of 2015, made a huge acquisition to double the size of the business; that acquisition has performed exceedingly well. I went to the G2E Gaming Exposition in October for another management meeting. They are rationing their new products, which are very, very much in demand to make sure they can deliver. Class II and class III as largely the tribal gaming, which is the much different characteristic than either New York City area or Biloxi and is a widely diversified nationwide market.

Okay, I appreciate it. Very, very helpful.

So, as much a great question, Robert, but three vastly different market dynamics.

Got it, I appreciate it. Last one from me, if I can, just going back to the interest rate issue, I don’t Rocco if you have it handy. But obviously, presumptively the next move in rate typically goes up 25 basis points, brings it up right to the floor on the one month, if it takes that option. Can you give us a ball park sensitivity? Obviously, so that would increase your interest expense but not your income, slightly negative if that move happens but not substantial. But beyond that relative sensitivity, if rates are up a 100 basis points from here, normally we see this -- somebody sees, obviously put the table in Q, but I’m found it yet full earnings today; if it’s in your Q, I apologize. But, can you give us a sensitivity to [Indiscernible] if rates go up 100, what’s the benefit to earnings on that?

Rocco, I’m not sure, if we’ve got that table. I apologize I should know that answer and I don’t. I do not have; I know we’ve talked about it but I don’t have the number at the tip of my fingers.

And I don’t have it handy. I do know in our Q, we do a sensitivity analysis on, if the interest rates go up X how much it is -- bear with me one second, let me just see if I can find it. So, assuming that -- so, I’m not sure if this answers your question Robert, but I’m going to give it a shot. Okay? Assuming that the LIBOR goes up 1%, that’s going to increase our net investment on net interest income by about $950,000. Assuming it goes up 2%, that increases net interest income by about $2 million.

I am sorry. This is Chris, Robert. It’s on page 40 and Item 3 of the 10-Q as well.

Got it. I appreciate that. So, I can look at it up with the page number. [Multiple Speakers] There it is. I see it now. It’s in the text instead of in the table. So, I got it. Thank you.

I think that’s great that you bring it up Robert because that’s come up a couple of times; Allison brought it up also. Basically, we are at the inflection point between the one and three months, and depending on what people are selecting right now, as far as their borrowing rates. As you can see the 1% is 900,000, 2 is full -- an incremental 1.1. So, we are basically starting to participate now. And as you saw, the average LIBOR floor is 1.05.

[Operator Instructions] Gentlemen, at this time, I have no further questions.

Thank you, Operator. I would like to thank everyone for calling in and participating, and thank you very much for the questions and the follow-ups. We look forward to talking to you in the future.