Cion Investment - Q3 2023

Transcript

Operator (participant)

Good morning, and welcome to CION Investment Corporation's Q3 2023 earnings conference call. An earnings press release was distributed earlier this morning before market open. A copy of the release, along with the 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.

Speaking 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 now like to turn the call over to Michael Reisner. Thank you. Please go ahead, Michael.

Michael Reisner (Co-CEO)

Thank you. Good morning, everyone, and thank you for joining us. As mentioned, I'm joined today by Gregg and Keith, as well as other members of senior management, including my co-CEO, Mark Gatto. I will start our call today with an overview of our Q3 results. Gregg will review our investment activity during the quarter, and Keith will provide additional detail on our financial results. After Keith's prepared remarks, we will open the call to questions. As we reported this morning, we had a very strong Q3, which saw a continued resilient credit profile, an over 3% increase to our net asset value quarter-over-quarter, and strong net income of $0.87 per share, an increase of 70.6% quarter-over-quarter and 45% year-over-year. Our net investment income of $0.55 per share continues to outperform our dividends.

As we did last year, we expect to be in a position to declare a year-end special dividend while keeping our base dividend steady for now. The special dividend would be in addition to the two supplemental dividends previously announced. We previously declared a supplemental dividend of $0.05 per share for both the third and Q4. Our net investment income of $0.55 per share is up 22% year-over-year and 27.9 sequentially, driven on balance by higher interest income from our floating rate loan assets, origination and other transaction fees, prepayment and other yield-enhancing features within the portfolio, and the reversal of non-accruals from restructured transactions. Our portfolio delivered resilient credit performance as a percentage of our portfolio on non-accrual fell to 1.03% of fair value, down from 1.69% the previous quarter.

Perhaps an even better indication of our credit performance, the percentage of names that we have risk rated 4 or 5 has remained consistent at around 1% of the portfolio, which compares favorably to many other BDCs. 99% of our book is risk rated 3 or higher. Again, a favorable benchmark when looking at our peers. Furthermore, interest coverage ratios and leverage ratios at the portfolio company level remains consistent quarter over quarter. On the financing side, we successfully issued $33 million of additional floating rate Series A unsecured notes in Israel this quarter, and just yesterday closed on a bilateral $100 million unsecured floating rate note with certain large institutional investors, which Keith will touch upon further.

The completion of these financings naturally matches the predominantly floating rate nature of our assets and allows us to continue to increase our percentage of unsecured debt relative to secured, to methodically increase our leverage towards our net leverage target of 1.25 times, provides us ample dry powder to take advantage of a favorable vintage of investments, and allows us the flexibility to increase the pace of our 10b5-1 share buyback program in coming quarters. At quarter end, we were still leveraged conservatively on a net basis at 1.03 times, but anticipate that now should increase in coming quarters as opportunities present themselves. Our net asset value increased $0.49 a share to $15.80, owing in part to the share repurchase program, as well as outearning our dividends and an increase in marks from our illiquid book.

During Q3, we repurchased approximately 168,023 shares at an average price of $10.71 per share, for a total repurchase amount of $1.8 million. We have repurchased a total of 2.5 million shares for a total repurchase amount of $24.1 million since the beginning of the repurchase program we put in place in August 2022 through the end of Q3, and intend to continue to be active repurchasing our shares in the coming quarters. Before I turn the call over to Gregg, I wanted to finish with some thoughts. Direct lending to support sponsors buying companies, albeit a proven business model, has become somewhat commoditized, with a lot of new entrants focused on the large cap segment of the market. Going deeper and cheaper is the name of that game to win market share.

Most BDCs historically lent to middle market companies, which was traditionally defined as those with an average EBITDA of $50 million. Those companies who had limited access to more borrower-friendly syndicated loan alternatives due to deal sizes and perceived tranche liquidity. The traditional middle market loans tended to be less borrower-friendly. With all the capital now flowing into private credit, $150 million EBITDA is the new $50 million EBITDA. The same participants now focused on scale and emphasizing that bigger is better. We're singing a far different tune a few short years ago. While we don't believe it's a bad thing, BDCs are taking market share from the investment banks, we are very proud that we continue to stick to our knitting of lending to truly middle market companies.... The median EBITDA of our portfolio is $33.7 million.

We believe investors are well-served sticking with BDCs that have established true middle-market ecosystems and have not engaged in deviations from their long-term focus and track record histories. In our 12 years of investing over $7.8 billion in predominantly middle-market loan assets, we are proud to have achieved a 3 basis points annualized loss rate. We believe we have demonstrated that we can drive shareholder returns by being highly diversified in predominantly senior secured floating rate first lien loans, while remaining conservatively levered. We have consistently demonstrated that our robust, unique, and diversified deal sourcing funnel is capable of originating high-quality senior secured investments to true middle-market companies. We have successfully and very strategically accessed the financing markets in a methodical, incremental manner to grow our portfolio and continue to increase our portion of unsecured versus secured.

We believe that through our predominant focus on first lien investments to companies with institutionally backed sponsors, we provide a higher quality of earnings with a superior risk-return profile than other BDCs that often have much higher portions of their portfolio in equity investments. At the end of Q3, we had 87.8% of our portfolio in senior secured loans and 11.3% in equity positions. Our portfolio benefits from EBITDA growth and financial support from equity sponsors. This, coupled with a robust deal pipeline, a conservative balance sheet, and the fact that our investing team's singular focus is on our BDC and not conflicted or distracted by competing strategies or products, makes us feel very good about our Q3 results and our position going forward. With that, I'll now turn the call over to Gregg.

Gregg Bresner (President and CIO)

Thank you, Michael, and good morning, everyone. Our Q3 net investment income benefited from a diverse combination of the direct pass-through of higher floating interest rates from our loan assets, origination and amendment fees, prepayment premiums, and other yield-enhancing provisions embedded with our primarily first lien portfolio. There remains a clear distinction between the large cap syndicated markets and the direct private credit market where we strategically focus. The private direct lending sector remains robust, which is consistent with what we are experiencing with our platform, as our private direct transaction sourcing remains strong. We are seeing many direct investment opportunities for which we remain highly selective. We have seen an increase in refinancing opportunities, particularly in conjunction with tack-on acquisitions, where additional debt capital is required when it's beyond the capacity of the incumbent lender groups.

In addition, we have benefited from technically driven disruptions in the syndicated loan market, where we continue to acquire lightly syndicated first lien loan tranches at substantial discounts to par due to issues such as ratings changes, maturity extensions, exchanges, or restructurings, which are not suitable for the existing syndicate holders. We remain highly selective with new investments as we are still cautious with respect to the US consumer, particularly in light of recent global developments. M&A activity remains relatively subdued, and we have seen a number of circumstances where valuation gaps and lengthy negotiations are not ultimately being converted into closed transactions. These dynamics have resulted in several of our planned investment closings slipping from Q3 to Q4. Turning now to our Q3 investment and portfolio activity.

During Q3, we continued our focus on higher yielding first lien opportunities in both the directly sourced and lightly syndicated loan markets. Our focus in the lightly syndicated markets remains targeted on higher yielding, illiquid opportunities, such as investments with valuation distress, where we expect to have active roles in the processes that drive the refinancing or restructuring of the investments. During the quarter, we completed an attractive mix of direct and lightly syndicated first lien investments, such as our lead arranger exit financing for David's Bridal, co-lead arranger financings for the sponsor acquisitions of Fluid Control and Stengel Hill Architecture, and the discounted purchases of the lightly syndicated first lien tranches of Avison Young, Juice Plus, and Yak Mat, and the incremental direct term loan upsizes to finance tuck-in acquisitions for Gold Medal Holdings and WorkGenius.

Overall, we have seen roughly a 100-150 basis point increase in spreads year-over-year for new direct investments that meet our investment criteria. During Q3, we made $97 million in new investment commitments across 3 new and 11 existing portfolio companies, of which $93 million was funded. These investments were diversified across direct and secondary opportunities. We also funded a total of $10 million of previously unfunded commitments. We had sales and repayments totaling $96 million for the quarter, which primarily consisted of the full repayment of our investments in CircusTrix, Fusion Connect, Pitney Bowes DMT, Analogic, and the DIP loan to Williams Industrial Services Group. As a result, net funded investment activity increased by $7 million during the quarter.

Our non-accruals decreased from 1.7% of fair value at 6/30/2023 to approximately 1% at 9/30/2023. We removed David's Bridal from non-accrual status this quarter as the result of our successful restructuring of the business, where we worked with Bank of America and David's Bridal management to lead the emergence of David's Bridal from bankruptcy in July. As a result of the transaction, we are now a secured lender and majority equity owner of David's Bridal. We added one new portfolio company, Williams Industrial, to non-accrual this quarter. We added the remaining residual amount of the first lien term loan of Williams Industrial to non-accrual, as the majority of the loan was repaid from the bankruptcy sale, and we expect to receive the remaining residual amount over an extended period of time from the bankruptcy estate.

We received full repayment of our Williams DIP loan. Overall, our portfolio remains defensive in nature with 88% in senior secured investments that are highly diversified across industries and issuers. I'll now turn the call over to Keith.

Keith Franz (CFO and Treasurer)

Okay. Thank you, Gregg, and good morning, everyone. As Michael mentioned, we reported another quarter of solid investment performance, driven by an increase in LIBOR and SOFR rates, fees generated from our quarterly investment activity, prepayment premiums, and other yield-enhancing features within our portfolio. During the quarter, net investment income was $30 million, or $0.55 per share, as compared to $23.4 million, or $0.43 per share, reported in the Q2, an increase of $6.6 million, or $0.12 per share. Total investment income was $67.5 million during Q3, as compared to $58.5 million reported during the Q2, an increase of $9 million or 15%. On the expense side, total operating expenses were $38 million, compared to $35 million in the Q2.

Total operating expenses reflect an increase in interest expense due to higher LIBOR and SOFR rates, as well as higher advisory fees when compared to the prior quarter. At September thirtieth, we had total assets of approximately $1.9 billion and total equity or net assets of $861 million, with total debt outstanding of $1 billion and 54.5 million shares outstanding. At the end of the quarter, our net debt-to-equity ratio was 1.03 times, which is slightly lower than our net debt-to-equity ratio of 1.04 times at the end of Q2. At September thirtieth, our NAV was $15.80 per share, as compared to $15.31 per share at June thirtieth.

The increase of $0.49 per share, or an increase of 3.2%, was primarily due to overearning our distribution, price increases in the portfolio, and the accretive nature of our share repurchase program during the quarter. We ended the quarter with a strong and flexible balance sheet, with over $500 million in unencumbered assets, lower net leverage relative to our peers, a strong debt servicing capacity, and solid liquidity. We had over $120 million in cash and short-term investments and an additional $100 million under our credit facilities to further finance our investment pipeline and continue to support our existing portfolio companies. During the quarter, the weighted average cost of our debt capital was about 8.3%.

In terms of our debt structure, as Michael mentioned, in October, we closed on a $33 million follow-on to the Series A unsecured floating rate notes to certain large Israeli institutional investors with the same terms as the existing notes. Yesterday, we completed a $100 million private offering of floating rate unsecured notes due 2027 to certain institutional investors. These notes pay interest at a floating rate equal to the 3-month SOFR, plus a credit spread of 475. The notes are rated investment grade by DBRS. After completing these two financing transactions, our debt mix will now be 60% in senior secured and 40% in unsecured. It also brings additional strength and flexibility to our balance sheet and aligns well with our mostly floating rate investments. Turning to distributions.

During the Q3, we paid distributions to our shareholders of $0.39 per share, which includes a base distribution of $0.34 per share and a supplemental of $0.05 per share. As announced this morning, we declared our Q4 base distribution of $0.34 per share. The Q4 distribution will be paid on December fifteenth to shareholders of record on December first. In addition, as we announced last quarter, we also declared a supplemental distribution of $0.05 per share for the Q4. The supplemental distribution for the Q4 will be paid on January fifteenth to shareholders of record on December twenty-ninth. Okay. With that, I'll turn the call back over to Michael for some closing comments.

Michael Reisner (Co-CEO)

Thanks, Keith. As a final thought, before we open the line, we would like to reiterate our message that we believe CION is well positioned to provide solid returns to its shareholders despite current market conditions. And with that, operator, we're ready to take any questions.

Operator (participant)

Thank you. We will now be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate that your line is in the queue. You may press star two to remove a question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment while we pull for questions. The first question comes from the line of Erik Zwick with Hovde Group. Please proceed with your question.

Erik Zwick (Equity Research)

Good morning, everyone. I wanted to first start on, you know, leverage. And you mentioned kind of a target range of a kind of a target level of 1.25%. In the past year or so, you've been around 1% or so. So just curious about, you know, if you need to see a change in market opportunities, comfort with the economy, you know, the outlook, or how you would think about kind of approaching that target range and over what timeframe?

Michael Reisner (Co-CEO)

Yeah. Thanks, Eric. It's Michael. So listen, we've always said we wanted to get to 1.25 times. We're just cautious in how we obtain the additional leverage. We wanted to be cognizant of not only rates and the environment, but also the mix between secured and unsecured.

... and we were happy that we were able to get this $100 million in unsecured and also floating. That was important to us to match the liabilities and assets, especially where rates are at this time.

Erik Zwick (Equity Research)

Got it. Thanks for the color there. And another one, just as I kind of look through the statistics that you provide on the portfolio companies, notice that the current median EBITDA at $33.7 million is down about 10% from the year-ago figure. But I also do see that the footnote indicates that those median figures are as of the EBITDA, the initial investment period. So curious, one, if the year-over-year decline is reflective of you may be kind of targeting some smaller companies, and I know in your prepared comments you said, you know, kind of going deeper into, you know, smaller middle market companies.

And if that is the case, curious if you could provide, you know, any kind of color or commentary over, you know, what the average year-over-year growth in actual EBITDA for your portfolio companies has been?

Gregg Bresner (President and CIO)

Yeah. So, Eric, this is Gregg. I think there are two issues. One, the median EBITDA number is more a reflection of portfolio in and out than it is any earnings profile. From an organic earnings point of view, our EBITDA is up. We're seeing single digit EBITDA growth in names that we've held over a quarter. So, what you're seeing in that movement really is a reflection of names coming in, names coming out. This quarter, we did a couple of new platforms that had about $17 million of EBITDA, so that brought the number down a bit, and we exited something that I have had over $100 million of EBITDA. So it's more pure math than it is any earnings or strategic decision.

Erik Zwick (Equity Research)

That makes sense. I appreciate the color there. That's all I had today. Thanks, guys.

Michael Reisner (Co-CEO)

Thank you, Eric.

Operator (participant)

At this time, there are no further questions, and I'd like to turn it back over to management for any closing comments.

Michael Reisner (Co-CEO)

Great. Well, thank you everyone who joined the call today. We appreciate your interest, and we look forward to speaking to you in early March, when we announce our Q4 and year-end results. Thank you, everyone.

Operator (participant)

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.