Cion Investment - Q2 2024

Transcript

Operator (participant)

Greetings, and welcome to the CION Investment Corporation second quarter 2024 conference call. At this time, all participants are on a listen-only mode. A brief question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Charlie Arestia, Head of Investor Relations. Thank you. Please go ahead.

Charlie Arestia (Head of Investor Relations)

Good morning, and welcome to CION Investment Corporation's second quarter 2024 earnings conference call. An earnings press release was distributed earlier this morning before market open. A copy of the release, along with a supplemental earnings presentation, is available on the company's website at www.cionbdc.com in the Investor Resources section, and should be reviewed in conjunction with the company's Form 10-Q filed with the SEC. As a reminder, this conference call is being recorded for replay purposes. Please note that today's conference call may contain forward-looking statements which are not guarantees of future performance or results and involve a number of risks and uncertainties. Actual results may differ materially from those in the forward-looking statements as a result of a number of factors, including those described in the company's filings with the SEC.

Joining me on today's call will be Mark Gatto, CION Investment Corporation's Co-Chief Executive Officer, Greg Bresner, President and Chief Investment Officer, and Keith Franz, Chief Financial Officer. With that, I'd like to now turn the call over to Mark Gatto. Please go ahead, Mark.

Mark Gatto (Co-CEO)

Thank you, Charlie. Good morning, everyone, and thanks for joining our call today. I am pleased to report that CION continues to perform well, with strong results across the board in net investment income, NAV growth, capital deployment, and portfolio credit performance. I believe these results are particularly impressive, given what many lenders have described as a challenging market environment. I will discuss in more detail later, but I believe this quarter reflected CION's continued focus on deal selection and measured growth rather than buying the market, like many of our peers. CION reported $0.43 per share in quarterly net investment income, more than covering our recently increased quarterly base dividend. As you recall, last quarter, we recognized significant accretion from several structured yield-enhancing provisions and beneficial resolutions in our special situations investment portfolio. These tend to be transactional in nature and may not always recur every quarter.

We believe that CION's differentiated strategy of combining a conservatively positioned loan portfolio paired with opportunistic first lien investing in more complex special situations is a superior model for driving attractive risk-adjusted returns. Our net asset value grew modestly quarter-over-quarter to $16.08, driven by overearning our quarterly base dividend and ongoing accretive share repurchases, all set partially by unrealized and realized appreciation in the portfolio. This represents approximately 5% NAV appreciation compared to the same quarter last year. We remain laser-focused on the credit performance of our portfolio and closely monitor the underlying fundamentals of our borrowers. During the quarter, following a review process that includes both internal and external examinations of various borrower key metrics and fair value marks, we downgraded 3 loans, offset by upgrading 4 loans on our risk rating scale.

We also added one new loan to non-accrual status during the quarter, bringing the total non-accruals to 1.36% of the portfolio at fair value. In the aggregate, loans rated four or five comprised less than 1.5% of our total portfolio. We are pleased with the credit performance of our portfolio but remain conservatively positioned with a net leverage ratio of 1.13 times. We remained active repurchasers of our common stock in Q2, buying back approximately 235,000 shares at an average price of $11.37. Subsequent to the quarter end, we intend to renew our share repurchase authorization, which we believe preserves a strong alignment with CION shareholders.

I mentioned earlier that we are operating in a challenging market environment where there is an enormous amount of capital chasing a relatively small pool of new deal opportunities compared to prior years. The logical consequence of this dynamic is that new deals often have tighter credit spreads and looser protection for lenders. Amidst this backdrop, we remain highly selective in evaluating new deal opportunities, both in our traditional middle-market direct lending portfolio and in the lightly syndicated loan market. We believe this positioning is prudent given the macroeconomic environment, but at the same time, we remain nimble to adapt as needed as conditions evolve in the second half of the year. As Keith will discuss later, our recent amendment of our largest secured credit facility also reduces our cost of capital and provides increased operational flexibility as we navigate the current lending-...

We believe CION is uniquely positioned for this environment, given our middle-market direct lending focus, paired with our opportunistic strategy that can capture alpha in volatile and complex situations. With that, I will now turn the call over to Greg to discuss our portfolio and investment activity during the quarter.

Gregg Bresner (President and CIO)

Thank you, Mark, and good morning, everyone. Our Q2 net investment income benefited from a diverse combination of coupon income, dividends, origination and transaction fees, and yield-enhancing provisions such as MOICs and prepayment premiums. As Mark noted in his remarks, we remain highly selective with new investments as market conditions created a dynamic of capital-chasing transactions, resulting in lower coupon spreads, higher leverage attachment levels, and easing credit terms throughout the leveraged loan markets. We continue to strategically focus on first lien investing at the top of the capital structure and prefer to utilize secured yield enhancement provisions such as PIK features, call protection, make-whole provisions, and MOICs to incrementally enhance yields at the top of the capital structure, rather than reaching deeper into capital structures for mezzanine and equity co-investments.

We believe our continued investment selectivity and proportional deployment levels relative to our fund size helped us to invest in first lien loans at higher spreads when compared to the overall loan markets during the quarter. We also continued our highly selective focus on secondary investments, where we see attractive risk-return profiles or the opportunity to acquire lightly syndicated first lien loan tranches at significant discounts to par due to technical reasons, where we expect to have active roles in the processes that drive the refinancing or restructuring of the investments. Historically, we have been able to realize healthy recoveries on our 1L restructured, reorganized transactions, as our realized weighted average total recoveries have been in excess of the amortized cost of those investments at the time of restructuring.

The majority of our annual PIK income is strategically derived from highly structured situations, such as our litigation finance investments, where we can attain higher yields by matching flexible PIK timing features with strict cash flow sweeps upon collections, or through coupon structures where PIK is incremental to our cash interest. Over 60% of our PIK investments are in portfolio companies risk-graded either one or two, and 98% risk-graded three or better. As a result, we believe this PIK income may not compare to restructured PIK driven by a deterioration in credit. Turning now to our Q2 investment and portfolio activity. Our Q2 pipeline benefited from new M&A financing opportunities, as well as refinancing, add-on acquisition, and secondary activities through our portfolio companies.

We completed private direct first lien financings for new portfolio companies, including Voyager Global Mobility, Health-E Commerce, and Core Health & Fitness, where we acted as either a co-lead arranger or impactful club partner. We completed direct refinancings and add-on investments for portfolio companies, including OpCo Borrower, also known as Giving Home Health, OptioRx, David's Bridal, WorkGenius, StatLab, CenExel, Gold Medal Pools, and LGC. We completed secondary market first lien purchases for portfolio companies, including Abzena and Young Innovations, AHF Products, JP Intermediate, and PH Beauty. The weighted average coupon for total funded debt investments was approximately SOFR + 6.6% for the quarter and approximately SOFR + 7.1% for direct 1L investments in new portfolio companies. We opportunistically increased our common equity ownership in Longview Power through attractive restricted stock purchases.

During Q2, we made a total of $148 million in new investment commitments across 3 new and 16 existing portfolio companies, of which $137 million was funded. Approximately 39% were direct first lien loans to new portfolio companies, 54% primary first lien loans to existing portfolio companies, and 7% for secondary investments in existing portfolio companies. We also funded a total of $10 million of previously unfunded commitments. We had sales and repayments totaling $77 million for the quarter, which consisted of the refinancing of our first and second lien investments in Giving Home Health, the full paydown of our preferred equity holding in Yak Mat. As a result of all of these activities, our net funded investments increased by approximately $70 million during the quarter.

In terms of portfolio performance, our net asset value per share increased from $16.05 in Q1 to $16.08 per share in Q2. We saw increases in the value of our equity investments in Longview Power, Carestream Health, and CCS Medical, which were driven by increased earnings and cash flow performance at each of the companies, and our ability to acquire additional equity shares in Longview via secondary restricted stock, stock sales at attractive levels. We also had mark-to-market declines in value for portfolio positions, including our first lien investment in Trademark Global and our equity investment in TMK Trimark, based on LTM earnings performance, and our equity investments in David's Bridal, based on seasonal working capital borrowings. From a portfolio credit perspective, our non-accruals increased from 0.86% of fair value at the end of Q1 to 1.36% of fair value at the end of Q2.

We added one new name to non-accrual this quarter, our first lien investment in Naviga. As we gain more clarity on corporate development activities of the company and the expected pro forma business strategy going forward, we will continue to reevaluate the non-accrual status of this investment. On an absolute basis, non-accruals continue to be largely benign, and we are pleased with the continued credit performance of our portfolio, particularly in the current interest rate environment. During the quarter, we recognized GAAP realized losses of approximately $20 million, which resulted in only a $2 million negative impact to NAV, as they consisted largely of the final write-off of legacy, stub, and trust investments in Country Fresh, Deluxe Entertainment, and K&B Holdings that were valued at or near zero as of March 31, 2024.

This also included a $4.6 million realized loss based on the mark-to-market value of our H-W Acquisition first lien position at the time of restructure, which constituted $1.3 million of the total $2 million negative impact to NAV from GAAP realized loss transactions. We completed the exchange of H-W Acquisition first lien debt into new first lien debt, preferred and common equity, in order to drive recovery by providing the company with the financial flexibility to pursue new product introductions and growth initiatives. Overall, our portfolio remains defensive in nature, with 84% in first lien investments and 85% in senior secured investments. Approximately 99% of our portfolio remains risk rated 3 or better.

Our risk rated three investments, which are investments where we expect full repayment, but are either spending more engagement time and/or have seen increased risk since the initial asset purchase, declined from approximately 10.4% to 9.1% of the portfolio. I will now turn the call over to Keith.

Keith Franz (CFO)

Okay, thank you, Greg, and good morning, everyone. As Mark mentioned, we reported another quarter of solid financial results driven by a combination of income generated from our quarterly investment activity, including dividend income and yield-enhancing provisions realized within the portfolio. During the quarter, net investment income was $23 million, or $0.43 per share, compared to $32.6 million, or $0.60 per share, reported in the first quarter. A decrease of $9.6 million, or $0.17 per share. Total investment income was $61.4 million during Q2, as compared to $73.6 million reported in Q1. This decrease was driven by lower income recorded during Q2 relating to restructuring and prepayment activities and make-whole premiums earned in connection with the repayment of certain investments when compared to the first quarter.

On the expense side, total operating expenses were $38.4 million, as compared to $41 million reported in the first quarter. Decrease was primarily driven by lower advisory fees due to a decrease in total investment income when compared to the prior quarter. At June 30, we had total assets of approximately $2 billion and total equity or net assets of $861 million, with total debt outstanding of $1.07 billion and 53.5 million shares outstanding. At the end of the quarter, our net debt-to-equity ratio was 1.13 times, which is slightly higher than 1.03 times at the end of Q1. Our portfolio at fair value ended the quarter at $1.8 billion, up over $80 million from the first quarter, primarily reflecting an increase in net funded investment activity during the quarter.

The weighted average yield on our debt and other income producing investments at amortized cost was 12.9% at June thirtieth, which is consistent with the first quarter. At June thirtieth, our NAV was $16.08 per share, as compared to $16.05 per share at the end of March. The increase of $0.03 per share, or 0.2%, was primarily due to outearning our distributions and the accretive nature of our share repurchase program during the quarter, partially offset by price declines in our portfolio. We ended the second quarter with a strong and flexible balance sheet, with over $600 million in unencumbered assets, lower net leverage relative to our peers, a strong debt servicing capacity, and solid liquidity.

We had $93 million in cash and short-term investments and an additional $175 million available under our credit facilities to further finance our investment pipeline and continue to support our existing portfolio companies. Our current debt mix is about 60% in senior secured and 40% in unsecured, with over 85% in floating rate. During the quarter, the weighted average cost of our debt capital was about 8.4%, which is unchanged from the first quarter. In terms of our debt capital, we have recently amended and extended our senior secured credit facility with J.P. Morgan for an additional two years, with more constructive operating provisions and better economics. The effective credit spread was reduced by 45 basis points, which will help reduce our overall cost of debt capital in the second half of the year.

We believe these new terms will give us the flexibility needed to further diversify our debt mix and to continue to expand our group of lending partners. Now turning to distributions. During the second quarter, we paid total distributions to our shareholders of $0.41 per share, which includes a base distribution of $0.36 per share, which is an increase of $0.02 per share from $0.34 in Q1, and a mid-year supplemental distribution of $0.05 per share. We have now increased our quarterly base distribution 4 times since we listed back in October 2021, raising the base distribution by $0.10 per share, or 38%, from $0.26 per share to $0.36 per share.

As a result, the trailing twelve-month distribution yield through the second quarter, based on the average NAV, was 10.5%, and the trailing twelve-month distribution yield, based on the quarter-end market price, was 13.9%. As announced this morning, we declared our third quarter base distribution of $0.36 per share, which is the same as the second quarter. The third quarter base distribution will be paid on September 17 to shareholders of record on September 3. Okay, with that, I will now turn the call back to the operator, who will open the line for questions.

Operator (participant)

Thank you. The floor is now open for questions. If you would like to ask a question, please press star one on your telephone keypad at this time. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up the handset before pressing the star keys. Again, that's star one to register a question at this time. Our first question today is coming from Eric Zwick of Lucid Capital. Please go ahead.

Erik Zwick (Analyst)

Thanks. Good morning, everyone. Wanted to start first, you mentioned that spreads on new originations have been under pressure in the past few quarters, and that's pretty consistent with what we're hearing from, you know, others as well. Just curious, are you seeing any signs of those stabilizing, either in the latter part of 2Q or as you look at the pipeline going forward?

Gregg Bresner (President and CIO)

Hi, Eric, it's Greg. In the broader market, no. I think spreads are continuing to be tight, just based on supply and demand of money coming in and an investable universe that really hasn't grown accordingly. For us, we invested at SOFR 660 last quarter, which is consistent, you know, where we've been within previous quarters. We were able to maintain that premium. It really depends on your selectivity and your deployment level versus your fund size, and for us, it was a proportional quarter.

Erik Zwick (Analyst)

That's helpful. Thank you. Then a follow-up maybe on the pipeline, just in terms of, the mix between new and follow-on activity. Is that shifting at all or still pretty similar at this point, given the slow M&A market at this point?

Gregg Bresner (President and CIO)

I would say it's similar to what we experienced. The Q3 look is shaping up, we think, very consistent with what we saw in Q2, which was a balance, slightly higher portfolio investments in current portfolio companies. We still have a pretty robust new issue pipeline that we're looking at. I would say it from where we sit today, it'll be consistent with what we saw in Q2.

Erik Zwick (Analyst)

Then moving on to leverage, you noted that the net leverage increased slightly in the quarter. Just given that there's still, you know, a fair amount of uncertain outlook regarding the economy, just maybe refresh us on how you think about managing leverage, given the outlook and what's appropriate for the portfolio today and what the top end of that range would be based on what you see today.

Keith Franz (CFO)

Eric, it's Keith. How are you? Good morning. Yeah, you know, as we previously disclosed to the market, our target leverage range is about 1.25. We're currently at about 1.13. So yeah, leverage ticked up a little bit, but that was directly correlated to the net investment activity, the funding of the activity for the quarter.

Erik Zwick (Analyst)

Then last one from me. We're starting to see some, some anecdotal evidence of, of weakening in the U.S. economy, and just given your portfolio, what you're able to, to see, you've done a great job over the past year or so, working down the non-accrual levels and then not seeing any, you know, signs of, you know, acceleration, re-acceleration at this point, which is solid. As you look out across at the pipeline and, and deals you review, curious, are you seeing, you know, any of these signs of weakening? If so, are there any commonalities in terms of industry or geography? Just curious, given your seat and the, ability you have to look out what you're seeing at this point.

Gregg Bresner (President and CIO)

Hi, Eric, it's Greg. I would say it's a very similar to environment to what we've seen since the first quarter of 2023. I mean, we've been underwriting very defensively since then, and honestly, we haven't seen that much change. I think maybe perhaps other people are becoming more aware of it, but I think we, you know, we've been in this defence mode for a while. In terms of what we're seeing, I can't say there's any specific material change in the type of credit. It's really what we're seeing is in some of the universe, just the funds coming in or forcing people to be more aggressive with spreads and loosening documents, is more driving the credit outcome than the actual credit fundamentals of the borrower.

Erik Zwick (Analyst)

Greg and Keith, thank you both for the answers today. I appreciate the time.

Keith Franz (CFO)

Thanks, Eric.

Operator (participant)

Thank you. The next question is coming from Finian O'Shea of Wells Fargo Securities. Please go ahead.

Finian O'Shea (Analyst)

Hey, everyone. Good morning. Question on the buyback. Appreciating you extending and renewing that. First, can you remind us if that's a programmatic or discretionary plan? Then next, with your size, and assuming you'll no longer do those at some point, why not say, economically commensurate fee structure change that would be more lasting and allow you to maintain your scale? Thank you.

Mark Gatto (Co-CEO)

Hi, Finn, how are you? The program is programmatic at this stage, and we're, you know, using it wisely, and we'll continue to use it so long as the share price is undervalued. Will do that in a prudent way, and we think that's the most effective way to address the issue. The second part of your question, we're, you know, we'll take into consideration, but right now we're focused on managing the portfolio and continuing to perform. We think our performance is solid and the share price should reflect that, and hopefully that'll happen soon.

Finian O'Shea (Analyst)

Awesome. Thanks so much.

Mark Gatto (Co-CEO)

Thank you.

Operator (participant)

Thank you. Ladies and gentlemen, this brings us to the end of today's question-and-answer session. We would like to thank everyone for their participation, and I'd like to turn it over to Mr. Gatto at this time for closing comments.

Mark Gatto (Co-CEO)

In closing, we are focused on building a durable franchise at CION. Our investment team, which serves only the BDC, continues to source, underwrite, and execute attractive deal opportunities in the middle market direct lending space. Our credit performance reflects our ongoing portfolio management and our ability to navigate complex and opportunistic restructurings, enable CION to benefit from situations often overlooked by other capital providers. While this complexity may add another layer to the CION story, it has also produced a total return over the last 12 months that is in the top quartile of all publicly traded BDCs through the second quarter. Given this performance in an environment where broader BDC sector valuations remain near historical highs, we believe our discounted share price is unwarranted, and CION provides investors with a unique opportunity for both strong income and price appreciation potential.

Thank you all for your continued support of CION, and we look forward to speaking again next quarter.