Investcorp Credit Management BDC, Inc. (ICMB) Q2 2018 Earnings Report, Transcript and Summary

Welcome to the CM Finance 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 begin.

Thank you, operator. Thank you all for calling in today. Joining me are 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 the 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'd like to turn the call back over to our Chairman and CEO, Michael Mauer.

Thank you, Rocco. As in past quarters, I will begin with our observations about the leveraged finance market, Chris will then review the past quarter's investment activity. And then Rocco will walk you through our financial results. I will conclude with our outlook for the portfolio. Our origination looks at directly sourced investment opportunities, as well as opportunistically add investments, that are syndicated and available in the secondary markets. The syndicated markets remain borrower-friendly. In 2017, 75% of loans tracked by LCD were covenant-light. 2017 marked a record year in the leveraged loan market, with over $600 billion in issuance. Issuance eased in the fourth quarter from last year's loans. 2017 middle market issuance showed a significant increase from prior year with activity in every quarter of 2017 exceeding the corresponding quarter of 2016. High leverage, weak definitions and significant adjustments all contribute to an environment with structure and documentation of loans available in the market add to the risk profile of potential investments. Directly sourced loans including our recent investments in Zinc Oxide, Montrose Environmental and Liberty Oilfield Services have improved our portfolio yield as well as given us investments with significant structural protections for our capital. The team's attention to loan structure, including covenants, repayment provisions and documentation is an essential part of our investment process. While many of our peers approach origination through the lens of sponsored finance, we leveraged the investment teams' relationships and our strategic partnerships with Cyrus and Stifel to look outward into the broader middle market. Our pipeline is focused largely on direct lending opportunities, including sponsor companies, public companies and privately owned businesses. The potential transactions in our pipeline are focused on secured lending opportunities for quality management teams and companies, where we can invest capital with attractive risk return characteristics. I'd now like to turn the call over to Chris to discuss our portfolio activity.

Thanks, Mike. We made four investments during the quarter, two of which were to new portfolio companies and two of which were to existing portfolio companies. We also had two realizations during the quarter. As I mentioned on our last call, we made a first-lien loan and co-invested in the equity of Zinc Oxide, a producer of a key raw material used in tire manufacturing as well as chemical [Technical Difficulty] was approximately 12.1%. We made an investment in the new second-lien loan for ZeroChaos, a provider of workforce management solutions globally. Carlyle is the sponsor of the company. Our yield at cost was approximately 10.5%. We also added to our position in AP Gaming as part of the incremental loan raised in December, Apollo remains the sponsor here. Our yield at cost was approximately 7.3%. Our first realization in the quarter was Redbox, which repaid its loan in full in October. Our fully realized IRR was approximately 13.5%. Finally, PR Wireless, which does business as Open Mobile was both of one of our realizations and one of our investments during the quarter. Sprint and Open Mobile completed their previously announced joint venture agreement [Technical Difficulty] 14.5%. We alongside the other prior lenders made a new loan which yields approximately 7.1% at cost. Our new loan is fully guaranteed by Sprint. [Technical Difficulty] Our portfolio company count has increased by 1 since September 30, from 23 to 24 today. As of December 31, our largest industry concentration was in business services at 23.5% of the portfolio at fair value. Oil, and oil and gas services represented 19.3% of our portfolio. Split as follows: 11.3% oilfield services and 8.0% E&P. Entertainment and leisure was our third largest concentration at 14.2%, followed by healthcare at 8.0%, and environmental services at 6.8%. I'd now like to turn the call back to Rocco to discuss our financial results.

Thanks, Chris. For the quarter, our net investment income was $3.7 million or $0.27 per share. As of December 31, the fair value of our portfolio was $285.5 million, compared to $271.9 million at September 30. Our investment activity accounts for $11.8 million increase in our portfolio. We also had a $1.2 million unrealized depreciation from investments in the quarter. As of December 30, the weighted average yield of our debt portfolio including amortization was 10.25% versus 10.67% at September 30. The major driver of the decrease in our average yield was a differential in yield between investments made and realized during the quarter. Our new investments had an average yield of 8.9% versus a 12.5% average yield on realized investments. As of October 1, we removed Bird from non-accrual status leaving us with no assets on non-accrual. Our debt portfolio comprised of 96% floating rate and 4% fixed rate investments. Both one and three month LIBOR are in excess of the applicable floors on all our loans. Our average portfolio company investment was just under $12 million, our largest portfolio company PGi was $25.4 million, our second largest portfolio company Caelus was $22.9 million. As of December 31, 50.1% of our portfolio was in first lien investments, 44.9% of our portfolio was in second lien investments, 0.3% was in unsecured debt, and the remaining 4.7% was in equity and warrant positions. Additional information regarding the composition of our portfolio is included in our Form 10-Q, which was filed yesterday. We were 0.69 times levered as of December 31, compared to 0.75 times levered, as of September 30. With respect to our liquidity. As of December 31, we had $5.4 million in cash, $1.7 million in restricted cash and $32.2 million of capacity under our revolving credit facility with UBS. With that, I'd like to turn the call back over to Mike.

Thank you, Rocco. Our marks this quarter increased by an aggregate of $1.7 million, offset by $500,000 in accretion. With five marks to changed by $0.5 million or more. These were AAR, Bird Electric, Dayton Superior, Endemol and Trident. AAR completed its restructuring just over one-year ago. Since that time the company's results have stabilized and begun improving, especially as the price of oil has spurred additional activity in the D.J. Basin. We increased our mark on the second our term B loan from 65 to 75 this year. Bird Electric benefited from improving fundamentals as well as significant work associated with hurricanes in 2017. We increased the mark on our preferred equity position by approximately $1 million this quarter. And as Rocco mentioned, removed it from non-accrual status. Dayton Superior was mark down from 94 to 88 this quarter. The company's results did not meet our expectations and leverage is higher than we'd like to see, although, the prospect for significant federal infrastructure spending and operational improvement at the company give us reason for optimism. Our mark on Endemol improved from 86 to 95 this quarter. Endemol's results continue to improve as we have marked up the position by an aggregate of 18 points over the past two quarters. Finally, our position in Trident Health was imagined and partially restructured this quarter. We now hold the position in the Tranche A secondly lien loan, Tranche B second lien loan in a preferred position as the holding company. When comparing our position as of September 30 to December 31, the aggregate value of our marks on Trident Health decreased from 58 to 52. Importantly, our net claim has not been reduced. We continued work constructively with our other stakeholders toward a longer term solution for the company debt structure. We remain committed to paying a sustainable dividend to our shareholders. We earned an excess of our dividend in December quarter and our run rate for fully yield, and portfolio size position us to continue to cover our current dividend rate. We are sensitive to repayment and reinvestments of capital. And in the current market environment, we recognized that unscheduled prepayments and re-pricings may occur with little warning. That said, we are managing our pipeline within an eye toward directly sources opportunities, which are less directly tied to market conditions. Our investment activity in the quarter grew our portfolio by $11.8 million. Our leverage was 0.69 times as of December 31, which is slightly below our target of plus or minus 0.75 times. We are comfortable at our current leverage level and we will try to keep our leverage between 0.65 and 0.85 times. We fully earned our incentive fee in the December quarter, and we expect to earn our incentive fees in the current quarter as well. Our Board of Directors declared a distribution for the quarter-ended March 31, 2018 of $0.25 per share, which will be payable on April 5, 2018, to shareholders of record as of March 16. We believe our dividend level is consistent with our ability to generate NII without reducing our investment quality for changing our focus from secured and lending opportunities. As pipeline and market opportunities permit, we will sell positions in lower yielding loans into favor of direct investments with more attractive yields and structures. We continue to have additional opportunities to rotate, the current portfolio out of lower yielding, more liquid assets, in favor of direct investments in the future. Since this time last year, our average position size has decreased by approximately $1 million. And our total number of portfolio company investments increased from 19 on December 31, 2016 to 24 on December 31, 2017. We have improved our diversification lowered our risk profile all while underwriting conservatively, focus on quality management team, sustainable capital structures, security packages and financial covenants for the protection and preservation of value over the long-term. Operator, please open the line for Q&A.

Ladies and gentlemen, at this time we will conduct…

Great, okay. Well, recording sounded great. And we will have it up.

Ladies and gentlemen, at this time we will conduct a question-and-answer session. [Operator Instructions] Our first question comes from Chris Kotowski from Oppenheimer. Please say your question.

Yeah, good - good afternoon. Your press release noted the average new investment in the quarter yielded 8.9% and the total yield went down from 10.67% to 10.25%. And so, I guess, question is, is that 8.9%, is that representative of what you characterized as the more liquid lower spread kind of investment or is that - do you think the yield on what you would expect to self originate?

Thank you very much for the question. So that 8.9% is made up of several components and when you dig through the numbers they're a little more than half a dozen and some of that is draw under revolver of AOR [ph]. AP Gaming, PR Wireless, U.S. Well. Those are all existing names that are in, I'll call it a high-6 to mid-7s range. The two new investments that were not in the portfolio prior are Zinc Oxide or Zinc Borrower [ph] LP and ZeroChaos. Those two names were 12.06% yield and a 10.51% yield. When you add in the incremental borrowing from the other previously held names, our average is 8.93%. So if you look at new originated direct lending, we are still focused around the 10%-plus. And those names continue to point toward that. That having been said, there is a little over 15% of the portfolio that is in more liquid names. And there are four or five of those names, and you can go through them and look at them, and those are basically 7% or just shy. I think the exact number is 6.95% average yield across those names. And those have good liquidity and we would look to rotate out of some of those as more opportunistic names come in and we talked about this last quarter and from that standpoint, that would be accretive to the overall yield on the portfolio. I hope that answers your question.

Okay. Yes. And then you flagged that all the loans are through the LIBOR floors now. And so I'm curious like if we think about the December rate hike, that 25 basis point rate bump, when should we see that in - reflected in the interest income for the quarter? Is that a first quarter event or a second quarter event?

Yeah, Chris, it's - three month LIBOR is in the high 1% right now. So it all depends on how LIBOR is acting and reacting to that news. But we will see that on a current basis, because most of our loans are 1% floors. And we've been above 1% for at least the last six to nine months, even on a lagging basis, because they'll set the LIBOR three or six months forward. So we will see that contemporaneously with the market moves, and our [Multiple Speakers].

All right, theoretically, the December bump helps for 1Q, right?

Correct, 100%.

Okay. And then lastly, I was wondering the - your term lending facility, I guess it matures December 19. When does it become time to think about what - or can you outline for us your plans for the right hand side of the balance sheet and liability management strategies over the next year or two?

Hey, Chris. It's Rocco. Actually, we extended that an extra year. When we edit the revolver, we pushed that out an extra year. So it's actually [indiscernible].

Okay. All right, great. Thank you. That's it for me.

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

Sorry about that. I was on mute there. I just - first I wanted to congratulate you real quick on a pretty good quarter. I have one question with around U.S. Well Services. Just kind of with, obviously, the positive momentum in the fuel markets in the fourth quarter, with the price of oil increasing and those markets doing fairly well now. I'm just wondering what needs to happen in order for the investment in U.S. Well Services to sort of participate in that and continue to increase value?

Yeah, it's a question of potential liquefying that investment, when we run the U.S. well versus the comps - the publically traded comps. We take a pretty sizeable discount to the valuation metrics, which are based on in LTM revenue, based on thousands of horse power, and based on the LTM EBITDA. So if we were to put the numbers where Key [ph] and Liberty, which did an IPO, which we didn't mentioned on our remarks, a couple of weeks ago trade at, the numbers will be a lot higher than that. As you - this is a restructured loan and the majority of equity holders are the lenders and we were unclear, so the timing of the company will pursue a sale or some kind of liquefying event for the equity.

I see. So it's all on the comps…

It's all in the comps and - when the comps kind of go a little haywire to the good side, we don't - we try not to reflect that or we don't - we discount that for the lack of perceive liquidity. There is some liquidity in these instruments, but we are very, very comfortable where we have been marked.

Sure. Thanks. Those are all my questions.

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

Hi, guys. A couple of semi-housekeeping ones. On the - just the total investment income in the quarter, was there anything one-time in that, obviously, Bird came off on a call et cetera. But even then it seems like equity big jump, given the portfolio size didn't changed that much and the newer investments were relatively lower yield. So is there any kind of accelerated amortization or prepay to you anything like that embedded in the total number this quarter?

Yeah, Robert. I'll take a little bit of jump and I'll let Rocco also jump into that he wants to expand on it. I said, there were two significant components. One-time item was acceleration related to the repayment on PR Wireless. But I'd say equally have not more important is, we look at the ongoing and our confidence in continuing to cover the dividend and earned our incentive fee. Is that in the prior quarter, if you remember, we had gotten early in the quarter several repayments. And we were very diligent about trying to make sure that we went to good investments, we did not rush to redeploy. And some of the cash is literally invested in the last 48 hours of the September quarter. And then there was another investment made within the first day or two of the December quarter. So when you think about the actual average assets invested during the quarter, they went up significantly from an NII perspective.

Right, right. So Rocco, can you quantify roughly like what the PR Wireless impact was, so in the top line?

Hey, Robert. It's Rocco. So there was actually PR Wireless, which is about when you factor in the acceleration of accretion was about $900,000. And we also had a pay down, we had a repayments - Redbox, which was I believe about $140,000 in accelerated accretion, slightly over $1 million I would think.

Got it. Got it. Perfect. And then, a second one, Mike, and this maybe I may have misheard and may have been overheard, in your prepared comments you said that in this quarter, obviously you fully earned the incentive fees in this quarter. And then the second part of that was expect to earn them in upcoming quarters? I noticed the second part of that statement, it didn't say fully. So was that - was it fully submitted in the second part, because I'm just missed that it. And if it was - can you give us any color as to why chose to bid it in the second half.

Yeah, the reason - or maybe if you look back I think over time, we've avoided saying the word fully from anticipated. But I would say, we expect to earn a significant amount of that incentive fee, if not fully earned it. I'm not sure on the fully, but significant amount we are very comfortable with.

So, thank you. And then my last question if I can, on the buyback. I mean, when I look at deploying capital, it's a follow-on in PR Wireless, a 7.1%. Right now you can buy your own stock at a current yield, almost double that and at a 40 point discount on an NAV basis. Why is investing in PR Wireless, that's just one example, right, at 7 - I think that was 7%, a better deal than buying your own stock.

Yeah, let me go back for a second, then I'll answer that. Part of the reason on the prior question on why you don't say where - I don't - we don't say full years, if you look over time, our repayments come very lumpy and unpredictable. So it's - that we want to caveat a little bit, because if we get a bunch of repayments in the next two weeks, they go to cash. We're not going to just make sure we reinvested, so we covered the dividend. We're going to do the right thing by shareholders like we did over the summer and redeploy in a prudent manner. So that has a little bit of uncertainty. The second piece on the buyback is that we have had discussions over time with directors and management and everything else. And if we were over a $1 billion in NAV this is something that we think would make sense from a shareholder's standpoint. One of the things that we think contributes to where we trade, which gets into should you be looking at buying it back is that we are low $200 million NAV and we don't have a lot of liquidity. And to the extent that we go and do some buyback that may be accretive, we think it is not in the long-term interest of shareholders because we become less relevant. Our ability to go in and help drive on some of the deals that we can today that ability goes down. And that, that is in the interest of shareholders the long-term objective to cover our dividend, produce returns and make sure that we are relevant in what we do.

Okay, I appreciate that. Thank you.

Yes. Thank you, Robert.

Our next question comes from Greg Mason from Ares Management. Please state you question.

Hi, good afternoon, guys. This is Troy Ward with Ares. Hey, just wanted to kind of follow-up a little bit on Robert's question, more just, Mike, on what is the long-term strategic vision for you and CM obviously? I think you just crossed your four-year anniversary of public company. I don't think there is any way you thought that you'd have the current equity base that you have. But that's been the reality, and quite honestly, we don't see you going into a trading position where you can raise new equity. So at what point does that low equity base that you just used as a rationalization not to buy back stock. That's just where you're going to be for the foreseeable future, if not, indefinitely. What is your strategic vision for this? I mean, what is - if you're talking about long-term shareholder value maybe it isn't just keep doing what we've been doing, let's find something that can unlock that value, which could be buybacks, which could be a strategic combination of some sort…

All right, Troy, thanks for the question. And I do appreciate it. We constantly are looking at and discussing with some of your old colleagues and competitors, bankers about what is it that we can do, what is it that makes our stock trade where it is. And we constantly re-evaluate. And I think one of the key things that if we looked back over the four years, it's probably two or three different stories there. But one of the stories was, well, people said, well, look at this energy, you've got 15% plus or minus in energy and that's a real problem. I think that we've proven over the last few years' ability to manage it, that's good return. And we continue to be focused around making sure that's right-sized and we have upside from where it is today. But we also believe that part of it, over the last three or four months is because we didn't redeployed cash really quick in the September quarter, the market and some of the analyst said, oh, you didn't cover your dividend this quarter, you're not going to cover it going forward. And we more than covered it and we expect to continue to cover it. So part of it is getting through some of the current uncertainties and stability around portfolio and expectation from the analysts. And when we look at size and we can point to people like Alcentra and others who have done secondaries, who were our size from a NAV over the last two three years that in a market that unless what we're accepting here and I do not accept it that the BDC asset class is going to trade at 90% of NAV as a class except for a handful of people, that if we do what we're supposed to be doing, and we continue to make traction like we did with Montrose on sourcing interesting opportunities out of our Stifel network and some of our other networks, that when the market is trading the asset class at an NAV to NAV premium that we will be within a band that makes sense. That having been said, we continue to listen to anything that anyone wants to say and including all of you as far as suggestions. We are not stuck in one view.

Great. Thanks for your commentary, Mike.

Thank you.

[Operator Instructions] At this time, there are no further questions.

Operator, I just want to thank everyone who dialed in today. And thank everyone for joining us. And we look forward to taking next quarter. Thank you.