Investcorp Credit Management BDC, Inc. (ICMB) Q3 2019 Earnings Report, Transcript and Summary

Welcome to CM Finance’s 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] 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 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 you our customary disclaimer regarding information and forward-looking statements. Rocco?

Thanks Mike. I would like to remind everyone that today’s call is being recorded, and that this is the property of CM Finance, Inc. Any unauthorized broadcast of this call in any form is strictly prohibited. Audio replay of the call will be available by visiting our Investor Relations page on our website at www.cmfn-inc.com. I would also like to call your attention to the Safe Harbor disclosure in our press release regarding forward-looking information and remind everyone that today’s call may include forward-looking statements and projections. We ask that you refer to our most recent 10-Q filing for important factors that may cause actual results to differ materially from these projections. We will not update forward-looking statements unless required by law. To obtain copies of our latest SEC filings, please visit our Investor Relations page on our website. At this time, I would like to turn the call back 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 a prior quarter, and had a net addition of three 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 waiting is now or third largest sector at 10.5% of the portfolio. Very proud of the work our team has done, originating new opportunities proactively managing risk and repositioning us into a more resilient portfolio. The market in the first calendar quarter of 2019 was surprisingly active. After it’s a tumultuous December, secondary level snapped back faster than we in 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 snap 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 leveraged 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 create secondary opportunities, but also echoes in new issue will terms and pricing when the secondary market is weak, the primary market is effectively forced to increase coupon, and in many cases change non economic terms in the legislature. 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-lien, between realizations in second liens and new first lien investments, we've grown our exposure in first-lien investments to over 75% of our portfolio. Well, 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 repayments. We’re 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 non-accrual. 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 five brand new portfolio companies, and one which has previously been a portfolio company in which we’ve previously exited. Of our $65.6 million of new investments or about $2 million were first lien. We also had four full realizations during the quarter. I’ll quickly cover our additions to existing positions first. We continue adding to our first lien investment in Arcade Bioplan. We began building this position two quarters ago. Our yielded cost including this quarter's purchases is approximately 9.6%. We added to our position in ProFrac, a pressure pumping services provider operating the Permian, DJ, and Haynesville Basins. Our yield at cost is now 8.6%. We added to our position in 4L Technologies first lien loans. This is another short data term loan maturing in 2020. Our yielded cost is approximately 8.1%. The next category I'd like to cover are our fundings on revolving in delay dropped positions, which included Sears Holdings DIP loan, Open Mobile's delayed draw loan and [indiscernible] revolver. In total, these fundings accounted for approximately $8.9 million of our new investments this quarter. We had seven other new investments this quarter. First, we invested in the FILO exit loans for Sears. This loan was part of the financing package throughout the company to exit bankruptcy. In this loan repaid our investment in Sears DIP loan. Our yielded costs on the silo loan is 10.6%. Our investment in the DP loan was paid-off concurrently with this transaction. We invested in fleet prize, which had previously been a company, a portfolio of company of ours. This new first-lien loan backed the LBO of the company by American Securities. Over the course of our two 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 ACPI, 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 load of Kick custom products. Kick is a diversified manufacturer of consumer packaged goods. In particular, personal care products, antifreeze and pool chemicals. This is a shorter dated load maturing four years from now. Our yield at cost is 8.4%. We have a small investment in the first thing notes for Nexeo Plastics. These those 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 meeting yield 9.9% of costs and our second line yield is 14.8%. Finally, we invested in the first one loans 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 four fully realized investments this quarter as well. The first of these the depth loan Sears Holdings 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 on this investment was 59.1%. We were repaid on KOS Energy, which has 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 are fully realized IRR on the loan was approximately 14.4%. Finally, we have now fully realized our position in U.S. wealth services. Like Zinc Borrower -- well was it that 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 participate 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 s to pay with cash and the remaining 8% of the loan receive 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 share sold we have now fully realized our investment in U.S. as well. Our IRR from our first investment in a 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 31st, and stands at 33 today. We have not had any full realization since quarter end, but we did make a new investment in the first lien loan of Limbach Holdings, and contractor focused on HVAC, plumbing, electrical and mechanical services for commercial construction. Our yield of cost on Limbach was 10.8%. Using the GICS standard as a March 31st, 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 31st. Our investment activity accounted for $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 driver 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 non-accrual. As of March 31st, our portfolio consisted of 32 portfolio companies. 75.9% foreign 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 an equity warrant and other positions. 94.9% of our debt portfolio was invested in floating rate loans and 5.1% in fixed rate position. Our average portfolio company investment was approximately $9.3 million and our largest portfolio company investment was PGI at $18.7 million. We were 0.91 times levered, as of March 31, versus 0.86 times levered, as of December 31. Finally, with respect to our liquidity, as of March 31st, we had $6.8 million in cash $3.9 million 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 three quarters 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 it write-off Trident as well as two mark downs, 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 zero 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 realize 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 premier 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 Sears 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 Sears. 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 2nd announcing that they had failed to make scheduled amortization payments to the first lien lenders, including us. Since then, there have been a series of forbearances signed but the principle of 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 advisors. 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 second year, where we expect to generate above average returns. Our focus is on the quality of management team, the rigorous evaluation of loan credit and security documentation, and on loan to [Technical difficulty]. This approach is dedicated to preserving capital and maintaining a stable dividend. Last quarter, I guided that we expected to be over 30 portfolio of 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 in the proceeds of larger repayments in multiple new portfolio of 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 requirement of the small business credit availability act. Put in plainer terms, as of May 2nd, we have the ability to increase our leverage from a limit of one-times to two-times. We have the leverage and line capacity to increase beyond one-to-one today and are negotiating additional capacity presently, I would guide that our new leverage target will be in a 1.25 to 1.5 time the context. This change in the leverage limit is the main reasons that our leverage increased quarter over quarter as we ramped up with good opportunities as they become available to us. Lastly, on this point, the advisor will waive the base management fees in excess of 1% over the next quarter on leverage above one times. We covered the March quarter dividend with NII, and fully earned our incentive. Although we waved a portion of that incentive fee, we expect to cover the dividend and earn our in 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 June 14th. We have maintained our dividend of $0.25 since March of 2017 are confident -- 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, we are unable to purchase any additional shares. On May 1st the board approved extension of this $5 million program through May 1, 2020. We are currently continuing to work with the board to evaluate the re-activation of the share buyback program. Operator, please open the line for Q&A.

Ladies and gentlemen, at this time, we will conduct a question and answer session [Operator Instructions]. Our first question comes from Christopher Nolan. Please state your question.

So on your [Technical difficulty]…

Chris, I'm sorry, you're breaking up. Could you try it again? Maybe a drive through your phone pick up? I'm not sure. How many terms of EBITDA for the new debt investments?

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 its range between 40% and 55% for the last three or four deals, the equity cushion.

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

So what I mentioned was the range of 1.25 to 1.5, 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 to clarify, today, we are at just shy of one turn. So we have continued to increase post quarter end anticipating that as of this week, we could go above that one time.

Our next question comes from Robert Dodd. Please state your questions.

A couple of numbers questions, first. How much can you give us a ballpark on accelerated fees or one time fees that occurred in the interest income line this quarter, maybe because of the sales dip or anything else that they repay?

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

Obviously, I'm pulling some at the queue. But maybe just another one to go with that one you're looking up that maybe, the custodian fees this quarter were -- custodian and administrative fees were very high. I mean, a quarter million bucks as fee. I mean, the nine months last year, it was only slightly higher than that. So 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.

So Robert on that basically what happened was, we were truing up the accruals, and that's why you're going to see a little bit uptick in the next year. For next year, you should see this should level up back to normal levels. And then on the repayment, two deals, it was Sears and Caelus were basically -- that have been accelerated. We're talking about $600,000 in that.

And then on credit quality, obviously, Premiere and Fusion Connect, you gave some color on that and there's limited amount you can trade. 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 repeat of that with Premier and Fusion, because obviously, that marks 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?

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 say is as in our view, a very, very significant difference between the two is that if you look at two 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, Christian, I believe it was between $150 million plus or minus, and you had junior capital of about $100 million below.

And then the only other -- I mean your comment at the beginning, in terms of the market bouncing back in terms of the loan bids, and this isn't just a case with you guys but with a number of other BDCs. Well, we haven't seen that other than the specific credit issued. We really haven't seen a lot of NAV rebound from just a rebound in 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 benefit from that than pure mark-to-market?

I think it's a great question. We have this debate among ourselves and we also spend 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 is 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 can 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 market perspective. And number three, it is really looking at fundamentals. And you trying to take all of those things, the market dynamics, the fundamentals, the activity. And in the fundamental category, this quarter is a unique quarter where 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 its 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 and 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 point. 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.

Yeah, yeah, that helps a lot. I appreciate that color. Thank you.

A Robert, its Rocco. While Mike was talking, I was able to look through the financial well. And the acceleration on Page 40, the acceleration was a little over a million dollars.

Our next question comes from Paul Johnson, please say your question.

Good afternoon, guys. Thanks for taking my question. First, I just want to make sure that I heard you correctly. Did you say that you will be planning to waive the fees on assets above the one-times leverage level to 1% for base fees?

Yes, the base fee for assets above one turn of leverage will be 1%, not one in three quarters.

And is that effective immediately or is that -- does that need to be essentially voted on to the effective, how does that work?

It's effective immediately? It is we as a manager can do that unilaterally? We can wait but we don't have to ask permission to reduce the fee.

I think that's absolutely the right thing to do. And then I guess on that point, could you maybe. Todd, you mentioned your target leverage range earlier. Could you talk to anything on what sorts of strategy you're pursuing, if anything different from what you pursued today in terms of the asset mix for assets above that one time debt to equity leverage level?

Thank you for the question, because it's one that probably I didn't spend enough time around is if you watch 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 70s. Consistent with that, we have shifted to more First lien, targeting 60% first lien 40% mix 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've said it 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 then second lien, or more units watch where we have a first lien claim and more control around situations. So we will continue to do that as we ramp into the one and a quarter and one and half times. 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 control and the returns you can get for second lien 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 30th. Thank you very much.

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