Cion Investment - Earnings Call - Q4 2024

Transcript

Operator (participant)

Greetings and welcome to the CION Investment Corporation Q4 and Year-End 2024 Earnings Call. At this time, all participants are in a listen-only mode. A 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. Please note this conference is being recorded. I will now turn the conference over to your host, Charlie Arestia, Managing Director and Head of Investor Relations. Thank you. You may begin.

Charlie Arestia (Managing Director and Head of Investor Relations)

Good morning and welcome to CION Investment Corporation's fourth quarter and full year 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-K 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 Michael Reisner, CION Investment Corporation's Co-Chief Executive Officer, Gregg Bresner, President and Chief Investment Officer, and Keith Franz, Chief Financial Officer. With that, I would like to now turn the call over to Michael Reisner. Please go ahead, Michael.

Michael Reisner (Co-Founder and Co-CEO)

Thank you, Charlie. Good morning, everyone, and thanks for joining our call today. It's an exciting time here at CION, and we are verypleased with our 2024 results, especially against the backdrop of elevated competition and shifting expectations around both inflation and interest rates. Our BDC continues to generate a very attractive yield for our investors, which was enhanced this past year by our mid-year and special year-end distributions. We also had the pleasure of hosting both analysts and investors at CION's first Investor Day in January.

We took a deeper look at our differentiated investment strategy and our fundamental performance and track record, specifically against similarly valued publicly traded BDCs. We also highlighted several deal case studies across both our core and opportunistic investment strategies and hosted a panel discussion with several of our investing partners in both private credit and private equity.

This discussion covered the unique dynamics of club lending from both the lender and sponsor perspective, as well as our broader outlook for middle market investing in 2025. Lastly, we did a deep dive on our extensive valuation process, which utilizes both internal and external inputs to mark our portfolio assets.

Moving to our financial results for the quarter and full year of 2024, CION reported $0.35 in quarterly net investment income per share for the fourth quarter and $1.79 per share for the full year, exceeding our total 2024 distributions of $1.52 per share. Our net investment income reflects our diverse revenue base of interest income from our core lending strategy, as well as accretion from transaction fees and our opportunistic investments.

As Keith will describe in more detail, the modest decline in our quarterly net investment income was largely driven by the impact of repositioning of our balance sheet in the prior quarter. We anticipate that this effect will be mitigated as we redeploy into our deal pipeline over the coming quarters.

Our net asset value declined quarter over quarter to $15.43, down from $15.73 in the third quarter, driven primarily by fair value marks in our equity portfolio and the distribution of our year-end special dividend, somewhat offset by the accretion from share repurchases during the quarter. As discussed on our prior call, there is a seasonal impact on David's Bridal that creates volatility in our fair value marks during this time of year, as the company typically carries a higher debt load as it prepares for the upcoming selling season.

More broadly, we are optimistic on our equity positions heading into the year and believe the portfolio stands as a strong complement to our predominantly first-lien loan portfolio. The credit performance of our portfolio remains strong, and we are pleased with the fundamental trends we are observing in our portfolio companies, especially as base rates have remained elevated.

Following our regular valuation process and with inputs of our external valuation partners, we downgraded three loans on our internal risk-rating scale, offset by upgrading six loans. Overall, loans risk-rated four or five remain a small portion of our portfolio, comprising 1.7% of the book at fair value. We moved one loan, Homer City, back onto accrual status, which represents a material amount of the quarterly increase in our PIK income.

Gregg will provide additional context on this later in the call, but this asset was upgraded from a four to a two in conjunction with a redevelopment plan that allowed us to place the loan back on accrual status with visibility towards a potential exit in the coming quarters. In aggregate, non-accruals are generally benign and remain below many BDC peers, currently representing 1.41% of the portfolio at fair value.

We continue to be active repurchasers of our common stock, buying back approximately 171,000 shares at an average price of $11.74 a share. We believe our ongoing share buyback reflects our view that shares are undervalued, especially given our strong track record of shareholder returns. We see the buyback as an efficient use of capital and a strong signal to investors.

More broadly, we observe the continuation of trends we and other BDCs have noted from earlier in the year, particularly around spread compression and high levels of competition for deals. Consistent with last quarter, we have remained selective in this environment given these trends. While we see many peers highlighting record capital deployment numbers in recent quarters, we remain cautious on the earnings potential of this cohort in a compressed yield environment over the longer term.

We continue to see a healthy deal pipeline, but we also see strong opportunities in our existing portfolio. We believe our flexible and mostly unsecured funding structure positions CION well to remain nimble and adaptive in 2025. With that, I will now turn the call over to Gregg to discuss our portfolio and investment activity during the quarter.

Gregg Bresner (President and Chief Investment Officer)

Thank you, Michael, and good morning, everyone. We remained highly selective with new investments in Q4, as we were effectively at full investment during most of the quarter and successfully achieved our targeted net leverage level of 1.25x, while our loan repayment levels were less than typical. During the quarter, we passed on a historically higher percentage of potential investments based on credit and pricing considerations.

As Michael discussed in his remarks, market conditions remain very competitive as historic capital inflows continue to chase transactions in a relatively slow M&A environment. This resulted in lower coupon spreads, higher leverage attachment levels, and easing credit terms throughout the leveraged loan markets. We believe the 2024 cohort for new loan origination may eventually prove to be challenging for those who disproportionately ramp loans during the year.

As we presented at our inaugural Investor Day, when you look at the dynamics of the 2024 cohort versus the previous decade, monthly net cash inflows were at more than two times their average levels, and coupon spread levels for single-B, double-B, and triple-B loans finished 2024 at 15%-25% below historical average levels. We believe this dynamic may ultimately prove challenging for the total returns realized for the 2024 origination cohort.

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 PIC features, exit fees, and MOICs to drive 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 helped us to invest in first-lien loans at higher spreads when compared to the overall loan markets during the quarter.

The weighted average yield for our total funded first-lien debt investments for the quarter based on our investment cost was the equivalent of SOFR plus 7% and approximately SOFR plus 6.1% for direct 1L investments in new companies.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.

Our investments in the first-lien term loans of Innovative and Coinmach are representative of this strategy. This quarter, a significant increase in PIC income was primarily driven by our structured PIC term loan investment in Homer City Power.Given the significant redevelopment activities completed at Homer City, we have returned the loan to accrual status this quarter, which resulted in the recognition of past PIC interest that had not been previously accrued.

As we discussed in previous quarters and more specifically detailed at our inaugural Investor Day, the majority of our annual PIC income is strategically derived from highly structured situations such as our investment in litigation finance portfolios, where we can attain higher yields by matching flexible PIC timing features with strict cash flow sweeps upon collections or through coupon structures where PIC is incremental to our cash interest.

Approximately 64% of our PIC investments are in portfolio companies risk-rated either one or two and 98% risk-rated three or better. As a result, we believe this PIC income may not compare to restructured PIC driven by deterioration in credit.Turning now to our Q4 investment and portfolio activity. Our Q4 investment activity consisted of approximately 60% of add-on investments for existing portfolio companies and 40% for new company investments.

Approximately 80% of total fundings were completed on a private direct versus a secondary market basis. We closed direct first-lien financing for two new platforms, CrossLink Tax Solutions and Newbury Franklin Industrials. On the syndicated secondary side, we completed new first-lien term loan investments in ACCO, Grane, and Coinmach.

We completed add-on investments for portfolio companies including David's Bridal, HealthWay, Berlitz LP, Community Tree Service, Anthem Sports and Entertainment, Moss, Isagenix, Sleep OpCo, Adapt Laser, Innovative, Hollander, Homer City Power, and Juice Plus. During Q4, we made a total of $106 million in new investment commitments across five new and 15 existing portfolio companies, of which $100 million was funded. Approximately 96% were first-lien loans.

We have also funded a total of $12 million of previously unfunded commitments. We had sales and repayments totaling $47.8 million for the quarter, which consisted of the full paydown of investment tranches in H.W. Lochner, MedPlast, GSC Technologies, and Critical Nurse Staffing.

We also completed an exchange of a portion of our first-lien term loan in Playboy Enterprises into a convertible preferred investment in connection with the company's announcement of a strategic licensing and investment transaction with Byborg Enterprises. As a result of all of these activities, our net funded investments increased by approximately $64 million during the quarter.

As Michael referenced, our net portfolio decline was driven by declines in the unrealized mark-to-market value of our equity investments, including David's Bridal, HealthWay, K&N, Carestream, ARC Financial, URS Topco, and TriMark, and our first-lien term loan investment in Anthem Sports and Entertainment.

As we mentioned on previous quarterly calls, we expect to see significant quarter-to-quarter volatility in the marks of David's Bridal equity due to the larger overall relative size of our investment, as well as the highly seasonal nature of the company's operations and working capital profile.

The mark-to-market decline in David's Bridal for the quarter was driven by the seasonal increase in debt, as Q4 historically represents increased need for working capital to support merchandise inventory for the bridal season that traditionally kicks off in mid-January.

In addition, we invested incremental capital to accelerate the company's recently announced growth-oriented strategic transformation of the business to an increasingly asset-light, digitally and media-driven bridal marketplace business that expands the company's market power from the $4 billion wedding dress segment into the $65 billion-plus wedding industry.

The mark-to-market declines in HealthWay, K&N, ARC Financial, Anthem Sports and Entertainment, and TriMark were driven primarily by delays in expected revenue pipeline that impacted trailing EBITDA performance. In terms of unrealized marked gains, we had marked increases in the unrealized value of investments, including Longview Power, Homer City Power, CHC Medical, Palmetto Solar, and Berlitz LP based on stronger underlying performance trends.

From a portfolio credit perspective, our non-accruals decreased from 1.85% of fair value in Q3 to 1.41% in Q4. We added two new names to non-accrual this quarter: our term loan investment in Sequoia Healthcare and a second-lien investment in Securus Technologies. We also removed one name, our term loan investment in Homer City Power, and returned to accrual status, as I previously mentioned. Sequoia is a subsidiary investment within CarePoint Health, which is currently being restructured in a bankruptcy process.

Given the uncertainty of the process, we have elected to place Sequoia on non-accrual. Securus is evaluating strategic alternatives, including potential restructuring. Given the uncertainty, we have placed our second-lien investments on non-accrual until there is more clarity. On an absolute basis, non-accruals continue to be largely in line with historical experience, and we are pleased with the continued credit performance of our portfolio, particularly in the current interest rate environment.

Overall, our portfolio remains defensive in nature, with 86% in first-lien investments. Approximately 98% of our portfolio remains risk-rated three 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 11.8% in Q3 to 10.6% in Q4. I'll now turn the call over to Keith.

Keith Franz (Managing Director and CFO)

Okay. Thank you, Gregg, and good morning, everyone. As Michael mentioned, we are pleased with our strong performance for the full year in 2024, and we reported another quarter of solid financial results. During the quarter, net investment income was $18.7 million or $0.35 per share, compared to $21.6 million or $0.40 per share reported in the third quarter. The decrease of $0.05 per share was driven by a combination of lower SOFR rates on our investments and higher interest expense incurred on our borrowings during the quarter.

For the full year, total investment income was $252.4 million as compared to $251 million reported for the full year 2023. Even though we experienced a slight increase in total investment income year over year, total investment income during 2024 was impacted by higher transaction fees from our investment activities and lower SOFR rates earned on our investments.

Net investment income for the full year was $95.9 million or $1.79 per share as compared to $105 million or $1.92 per share for the full year 2023. The decrease of $0.13 per share was driven by higher interest expense on higher average borrowings outstanding during the year and higher amortization of debt issuance costs in connection with repositioning our debt capital during the second half of 2024.

At December 31st, we had total assets of approximately $1.9 billion and total equity or net assets of $821 million, with total debt outstanding of $1.1 billion and 53.2 million shares outstanding. At the end of the quarter, our net debt-to-equity ratio was 1.27 times, which is slightly higher than 1.18 times at the end of Q3. The increase in leverage was impacted by both an increase in the average debt outstanding and a decrease in NAV during the quarter.

During the quarter, total debt increased by $48 million due to the timing of funding new investment activities and add-on investments from our existing portfolio companies and lower than expected repayment activity near the end of the quarter. Our portfolio at fair value ended the quarter at $1.82 billion, up $67 million from the third quarter, reflecting an increase in quarterly investment activity.

The weighted average yield on our debt and other income-producing investments at amortized cost was 12.3% at December 31, which is flat from the third quarter. At December 31, our NAV was $15.43 per share as compared to $15.73 per share at the end of September.

The decrease of $0.30 per share or 1.9% was primarily due to mark-to-market price declines in our portfolio of $0.21 per share, mostly due to price volatility from our equity book, distributions in excess of our net investment income of $0.06 per share, mostly due to the year-end special distribution of $0.05 per share, all of which were partly offset by the creative nature of our share repurchase program during the quarter.

We ended the fourth quarter with a strong and flexible balance sheet with over $1 billion in unencumbered assets, a strong debt servicing capacity, and solid liquidity. We had over $70 million in cash and short-term investments and an additional $130 million available under our credit facilities to further finance our investment pipeline and continue to support our existing portfolio companies.

At December 31st, our debt mix is about 62% in unsecured and 38% in senior secured bank debt, with over 70% in floating rate. During the quarter, the weighted average cost of our debt capital was about 7.8%, which is down 40 basis points from the third quarter.

In terms of our debt structure during the quarter, we completed a public baby bond offering issuing $172.5 million of new unsecured 7.5% fixed-rate notes due 2029, which listed and commenced trading on the New York Stock Exchange under the ticker symbol CICB on October 9th. More recently, post-quarter end, we terminated our repurchase facility with UBS and entered into a new three-year $125 million senior secured credit facility with more constructive operating provisions and better economics.

The effective credit spread was reduced by 45 basis points.During the year, we were very active in the debt capital markets as we closed six debt transactions, effectively refinancing over 80% of our debt capital while extending the weighted average maturity wall by three years through 2027 and raised almost $300 million in new unsecured debt from new and existing institutional investors.

The increase in the unsecured debt mix to over 60% of our total debt capital, with over 70% in floating rate, brings additional strength and flexibility to our balance sheet, aligns well with our mostly floating rate investments, and expands our group of institutional lending partners while only slightly increasing our weighted average cost of debt capital when considering the benefits it brings to our balance sheet.

Now, turning to distributions, during the fourth 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 the same as Q3, and a year-end special distribution of $0.05 per share. For the full year 2024, we declared total distributions of $1.52 per share, which included a base distribution of $1.42 per share and supplemental distributions of $0.10 per share.

The trailing 12-month distribution yield through the fourth quarter based on the average NAV was 9.6%, and the trailing 12-month distribution yield based on the quarter-end market price was 13.3%. As announced this morning, we declared our first quarter base distribution of $0.36 per share, which is the same as the fourth quarter. The first quarter base distribution will be paid on April 11th to shareholders of record as of March 28th.Okay, with that, I will now turn the call back to the operator who will open the line for questions.

Operator (participant)

Thank you. At this time, we'll be conducting our question-and-answer session. If you would like to ask a question, please press Star 1 on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may press Star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the Star keys.

Once again, to ask a question now, press Star 1 on your telephone keypad. We'll pause for a moment while we pull for questions. Our first question comes from Finny O'Shea with Wells Fargo Securities. Please state your question.

Finny O'Shea (Director and Senior Equity Research Analyst)

Hi, everyone. Good morning. I want to start on David's Bridal. I know you mentioned the seasonality, but sort of if you can give color on what the add-on was really all about this quarter, because I do not think that comes every year. I think you mentioned a sort of strategic transformation as well. Maybe it is that, or is it just an overall more leveraged capital structure? Thanks.

Gregg Bresner (President and Chief Investment Officer)

Hi, Finny. It's Gregg. There are two components to it. The largest component is I would consider this more non-recurring in nature because this was our first year after the company emerged from bankruptcy in late 2023. This was our full merchandising season. The merchandise build was larger than usual because we had to stand the business back up, and this was the first full buying season. This season would be significantly larger than we would expect in the future.

There was also some incremental investment, which is more, again, non-recurring in nature as we invested in our new Pearl Marketplace, which is the new digital side of the business that we're in the beginning stages of a ramp. For us, which is a very exciting opportunity, the company did a big press release on it.It was unusually larger because of those two dynamics.

Finny O'Shea (Director and Senior Equity Research Analyst)

Okay. That's helpful. Should we expect this kind of fourth quarter investment and then maybe a paydown over the course of a year in normal course?

Gregg Bresner (President and Chief Investment Officer)

In the normal course, this was more of a one-time thing. I'd say going forward, what you'll see is a more significant paydown on the revolver side of the business. At some point, it would waterfall to the term loan, but initially, it would be a sweep down of the revolver.

Finny O'Shea (Director and Senior Equity Research Analyst)

Okay. I guess, sort of similar question or discussion on Homer City. I guess, can you expand? I think you touched a little bit on, but what was the sort of breakthrough there? You put in more debt. I think that loan still matures pretty soon. Maybe with whatever you can share, what's happening on the equity side, and do you anticipate refinancing that this quarter?

Gregg Bresner (President and Chief Investment Officer)

We have to be careful because it's a private company, but there's been significant redevelopment as it was a shuttered coal plant. That's now being redeveloped into a gas plant and other energy sources. We can't say too much, but you can assume that all the exciting things that are happening with data centers around the utility space is something that we are closely aligned with.

Finny O'Shea (Director and Senior Equity Research Analyst)

Okay. That's all for me. Thanks so much.

Operator (participant)

Thank you. Our next question comes from Eric Zwick with Lucid Capital Markets. Please state your question.

Justin Marca (VP of Equity Research)

Hey, guys. Good morning. Justin Marca for Eric today. Sounds like the pipeline remains healthy. Can you give us any detail on new versus add-on opportunities, and do you expect the increased competition for pricing and structure to kind of remain for the near term?

Gregg Bresner (President and Chief Investment Officer)

Our quarter, I think, was a pretty good illustration of what we expect in upcoming quarters. Roughly 60% of our investments were to existing portfolio companies. We do expect to see that trend continued because there's been a fair amount of add-on incremental acquisition activity. We do expect that to continue. As we stated in our talk, I mean, the market remains very competitive. We've been very selective and very careful about pricing and credit when we're making new platform decisions.

I do expect that 60%/40% type balance to continue. We do—and primarily driven by funds flow. I think you can see the competition in the market. I think we're going to continue on our current strategy. We do expect to have more significant activity, more towards portfolio companies than new platforms.

Justin Marca (VP of Equity Research)

Okay. I’d like to see the resolution on Homer City. Any sort of line of sight to additional resolutions for the credits that remain on non-accrual today?

Gregg Bresner (President and Chief Investment Officer)

Sorry, can you repeat the question?

Justin Marca (VP of Equity Research)

Just touching on non-accruals, any sort of line of sight into reaching additional resolutions for the credits that remain there?

Gregg Bresner (President and Chief Investment Officer)

I mean, I think it's too early to give good visibility, but there are a couple we're watching that could potentially go back on accrual, but we're not quite there yet. I think that's going to evolve over the year. There are a couple that we've seen some improvement, and it could happen, but it's a little early.

Justin Marca (VP of Equity Research)

Okay. Last one for me. We've heard a couple of companies talk about potential impacts of tariffs on portfolio companies. Have you guys started to analyze any of your portfolio companies, and has anyone kind of voiced concern about any potential outsized impact that they may be facing?

Gregg Bresner (President and Chief Investment Officer)

This is something we do actively talk with the portfolio companies about. David's Bridal is an example where we're closer to it. It's a relatively smaller portion of our portfolio because it tends to not be that much based on that kind of sourcing. In that example, and I think that's the general trend of what we're seeing across a few other portfolio companies, there have been efforts over the years to divert more production out of China into other Asian countries, which we've successfully done at Bridal.

I think the way most are planning to deal with it is more variability in where they're producing from, more diversification. The strategies we've seen are basically to divert more out of China in the short term, where they have that flexibility and reduce any tariff exposure.It is something we talk about every day, but candidly, it is not a big percentage of our portfolio, but that has been the common theme that we have seen.

Justin Marca (VP of Equity Research)

Great. Thanks for taking my questions.

Operator (participant)

Thank you. There are no further questions in queue. I will now turn the call back to Michael Reisner, CEO, for final comments.

Michael Reisner (Co-Founder and Co-CEO)

Great. Thank you, everyone, for joining our call today. We appreciate your continued support. We look forward to coming back to you next quarter with our Q1 results. Thank you, everyone.

Operator (participant)

This concludes today's conference. All parties may disconnect. Have a good day.