Investcorp Credit Management BDC - Q4 2023

Executive Summary

• Q4 FY2023 NII was $2.2mm ($0.15/share), with weighted average debt yield at cost of 12.45% and NAV/share of $6.09; gross leverage was 1.54x and net leverage 1.44x.
• The Board declared a base dividend of $0.12/share for the quarter ending September 30, 2023 and a $0.03/share supplemental (spillback), and management expects to cover the base distribution next quarter; base dividend was modestly reduced vs prior quarter ($0.13) and supplemental reduced ($0.05 → $0.03).
• Portfolio repositioning continued: 2 new and 2 follow-on investments ($15.1mm cost) with strong sponsor support; repayments totaled $8.7mm (realized IRR ~9.77%), nonaccruals increased to 6 as American Nuts Term Loan A & B were added.
• Management emphasized risk mitigation and diversification amid limited primary issuance, with expectations of improving deal flow and redeployment of expected repayments; the expanded platform (SMA + institutional fund) is a key sourcing and origination catalyst.

What Went Well and What Went Wrong

What Went Well

• High-yield deployment with sponsor-backed credits: 2 new and 2 existing investments totaling $15.1mm at a 15.48% weighted average yield at origination; repayments of $8.7mm realized ~9.77% IRR.
• Dividend policy visibility and coverage: base $0.12 plus $0.03 supplemental declared; management reiterated expectation to cover the base dividend next quarter (“We covered our June quarterly dividend with NII… expected to earn its dividend through the next quarter ending September 30”).
• Platform scale increased: acquisition of an SMA and initial close on an institutional fund doubled platform AUM, enhancing sourcing, origination, and cost spreading; “expanded team has already proved to be meaningful”.

Selected quote: “We continue to focus on managing the portfolio in this inflationary environment; specifically focusing on the diversity of our investments, reducing average position sizes, and working with borrowers and sponsors where covenant or liquidity issues exist.” — Michael C. Mauer.

What Went Wrong

• Yield compression vs prior quarter: weighted average yield on debt investments at cost fell to 12.45% from 13.36% in Q3; management noted continued portfolio risk management amid high-rate stresses.
• NAV and net assets down: NAV/share decreased $0.04 to $6.09; net assets fell by ~$0.5mm (0.6%) q/q; net increase in net assets from operations was $2.1mm ($0.14/share).
• Credit headwinds: nonaccruals increased to 6 (American Nuts added); primary issuance remained limited, constraining new deal activity and necessitating higher selectivity.

Transcript

Operator (participant)

The host just joined. You will now be placed into the conference. You are muted on this call. This call is being recorded.

Welcome to the Investcorp Credit Management BDC Incorporated scheduled earnings release of fourth quarter ended June 30. Your speakers for today's call are Mike Maurer, Suhail Shaikh, and Rocco DelGuercio. Operator assistance is available at any time during this conference by pressing zero pound. A question and answer session will follow the presentation. I would now like to turn the call over to your speakers. Please begin.

Michael Mauer (Chairman and CEO)

Thank you, operator, and thank you for joining us on our fourth quarter call today. I'm joined by Suhail Shaikh, my Co-CIO and President of Investcorp Credit Management BDC, and Rocco DelGuercio, our CFO. Before we begin, Rocco will give our customary disclaimer regarding information and forward-looking statements. Rocco?

Rocco DelGuercio (CFO)

Thank you, Mike. I would like to remind everyone that today's call is being recorded and that this call is the property of Investcorp Credit Management BDC. 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 icmbdc.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. Actual results may differ materially from these projections. We will not update forward-looking statements unless required by law. To obtain copies of our latest SEC filing, please visit our investor relations page on our website.

At this time, I would like to turn the call back over to our Chairman and CEO, Michael Maurer.

Michael Mauer (Chairman and CEO)

Thanks, Rocco. The June quarter marks the last quarter of our fiscal year. New deal activity in the primary markets, especially new LBOs and refinancings, remained limited during the quarter. High interest rates have discouraged sponsors from doing dividend recaps or acquiring new companies. As a result, our investment activity remained lower this quarter compared to previous periods. However, we expect the slowdown in primary deal activity to pick up the next few quarters, and we continue to see compelling investment opportunities in our pipeline. We made several investments this quarter in the secondary market. These opportunities were primarily borrowers we are familiar with and have exposure to in our other funds across our platform. During the quarter, we invested in two new portfolio companies and two existing portfolio companies.

The weighted average yield of our debt investments during the quarter decreased 12.5% from 13.4% at 3/31. We remain very focused on portfolio management and risk mitigation. We continue to diversify our investments into new borrowers, to reduce our average position sizes, and to work with borrowers who have covenant or liquidity issues in the current high interest rate environment. This quarter, we increased our number of borrowers and the number of GICS industries across our portfolio to 21 industries when compared to the previous quarter. As we look at our borrowers' operating performance, the credit quality of our portfolio remains stable. Our weighted average net leverage is relatively unchanged from the quarter ended 3/31 at 3.9 times. Additionally, our weighted average loan-to-value ratio for all debt investments is approximately 48%.

Looking forward, we expect to continue our theme of risk management and diversification. We are expecting repayments in both the current quarter and the fourth quarter this year, which we expect to deploy, redeploy across new borrowers in a smaller average size. While we suspect there is pent-up demand for primary issuance, we remain focused on secondary opportunities as well, where we can create positions with shorter maturities, convexity, and established track records of operating as leveraged borrowers. Suhail will now walk through our investment activity during the quarter and after quarter end. Rocco will go through our financial results. I'll finish with commentary on our non-accrual investments, our leverage, the dividend, and our outlook. As always, we'll end with Q&A. With that, I'll turn it over to Suhail.

Suhail Shaikh (Co-CIO and President)

Thank you, Mike. As Mike mentioned, this quarter's activity was characterized by secondary opportunities. Market estimates have direct lending volume in this quarter, down almost 50% year-over-year. However, we're beginning to see primary deal flow pick up after the summer slowdown. We're being highly selective in this credit environment, whether we are evaluating a primary or a secondary transaction. Our primary focus remains investing in high cash flow, operating high cash flow, generating businesses with enhanced structural protections and supported by experienced sponsors. During the quarter, we invested in two new portfolio companies and two existing portfolio companies, as Mike mentioned. We also fully realized our position in one of the portfolio companies. During the quarter, fundings for commitments and new investments totaled approximately $15.1 million at cost, with a weighted average yield of approximately 15.5%.

In the same period, the payments totaled approximately $8.7 million from one investment, with an IRR of approximately 9.8%. To talk you through the new investments, first, we made an investment in the first lien term loan of AMCP Clean Acquisition Company, also known as PureStar. This is a good example of an opportunistic secondary purchase of a credit that we had been tracking. PureStar is a portfolio company of Cornell Capital. It is one of the largest commercial laundry providers in the hospitality industry in the U.S. We invested in the first lien term loan and delayed draw term loan. Our yield at cost is approximately 16.5%. Second, we invested in the first lien term loan of American Auto Auction Group, also known as XLerate.

This is an example of an investment that we own another portfolio, and we're able to find an attractive opportunity to purchase in the secondary market. A Brightstar Capital portfolio company, XLerate Group, is a full service, used vehicle auction services provider for B2B customers. Our yield at cost is approximately 13.6%. Finally, we invested in the priority term loan of Bioplan. Bioplan provides packaging and sampling solutions to the beauty and fragrance industry. Our yield at cost is approximately 13.6%. During the quarter, we fully realized our position in Autumn Harp, which was refinanced. Our fully realized IRR was approximately 9.8%, as I mentioned above. After quarter end, we invested in one new portfolio company and one existing portfolio company. First, we invested in the first lien term loan of Axiom Global.

Axiom is a leading and global provider of expertise with talent, offering legal counseling and representation services. Axiom is a portfolio company of Permira. We have been an investor in Axiom for a few years in our other portfolios, and similar to XLerate, we were able to purchase it at an attractive price. Our yielded cost is approximately 10.1%. We also made a follow-on secondary investment in PureStar. Our yielded cost is approximately the same as our original investment of 16.5%. I'd like to note that the GICS standard was updated in May of this year. As such, our industry categorizations for existing portfolio companies have changed in some cases, and our industry ratings have also changed.

As of June 30, our largest industry concentrations were the following: trading companies and distributors at 16%, professional services at 12.8%, followed by IT services at 10.7%. Commercial services and supplies at 6.5%, and software at 6.2%. Our portfolio companies are in 21 GICS industries, as Mike mentioned, as of quarter end, including our equity and warrant position. I'd now like to turn the call back over to Rocco to discuss our financial results.

Rocco DelGuercio (CFO)

Thank you, Suhail. For the year ended June 30, 2023, our net investment income was $9.4 million, or $0.66 per share. The fair value of our portfolio was $220.1 million, compared to $221.3 million on March 31. Our net assets were $87.7 million, a decrease of 60 basis points from the prior quarter. Our portfolio's net increase from operations this quarter was approximately $2.2 million. Our debt investments made during the quarter had an average yield of 5.5%. Our realizations and repayments during the quarter had an average yield of 11.3%, and our average IRR was 9.8%. The weighted average yield on our debt portfolio was 12.5%, a decrease of 90 basis points from March 31.

As of June 30, our portfolio consisted of 36 portfolio companies. 89.2% of our investments were first lien. The remaining 10.8% is invested in equity, warrants, and other positions. 88.8% of our debt portfolio was invested in floating rate instruments and 0.4% in fixed rate investments. The average floor on our debt investments was 1.1%. Our average portfolio investment was approximately $6.1 million, and our largest portfolio company investment is Bioplan at $13 million. We had a gross leverage of 1.54x and a net leverage of 1.44x as of June 30, compared to 1.65x gross and 1.49x net, respectively, for the previous quarter.

As of June thirtieth, we had six investments on non-accrual, which included the three investments in 1888, the PGI revolver, and two investments in American Nuts. This is an increase of two investments related to American Nuts from the previous quarter. With respect to our liquidity, as of June thirtieth, we had approximately $9.2 million in cash, of which $8.1 million was restricted cash, with $28.1 million of capacity under our revolving credit facility with Capital One. Additional information regarding the composition of our portfolio is included in our Form 10-K filing, which will be filed later this week. With that, I'd like to turn the call over back to Mike.

Michael Mauer (Chairman and CEO)

Thank you, Rocco. As mentioned earlier, we remain focused on portfolio management and risk mitigation, especially in our borrowers that are experiencing periods of stress. We added two new positions on nonaccrual, American Nuts Term Loan A and Term Loan B positions. American Nuts sources, procures, and distributes nuts, seeds, and dried fruits, among other products. Their results have been challenged in the recent period. We are currently working with the sponsor and other co-lenders on the path forward. We continue to make progress rotating the portfolio and expected progress on the remaining nonaccruals over the next 12 months. Our NAV remained relatively unchanged, declining by 60 basis points. Our gross leverage was 1.54, above our guidance of 1.25x-1.5x. Our net leverage, at 1.44, was within the target range.

As mentioned last quarter, we expect to see our gross and net leverage converge. As of September 15, our gross and net leverage were 1.51 and 1.50. As we have previously stated, the advisor will waive the portion of our management fee associated with base management fees over 1 turn of leverage. We covered our June quarterly dividend with NII. The company is expected to earn its dividend through the next quarter, ending September 30. On September 14, 2023, the board of directors declared a distribution for the quarter ended June 30, 2023, of $0.12 per share, as well as a supplemental distribution of $0.03 per share, both payable on November 2, 2023, to shareholders of record as of October 12, 2023.

It is worth noting that the $0.03 supplemental distribution is related to fiscal year 2023 spillback. As previously mentioned, we doubled our platform AUM through the acquisition of an SMA and an initial close on our institutional fund, which resulted in the expansion of our investable assets and reduced the average expenses across the fund. Our expanded team has already proved to be meaningful in terms of sourcing and originating, and as a result, we expect our pipeline to remain healthy for the remainder of the year. As always, we remain increasingly focused on capital preservation and maintaining a stable dividend. We are continuing our work on rotating and diversifying the portfolio, all while focusing on mitigating risk in our borrowers experiencing short-term stress.

As we head into the back half of the year, we remain optimistic about our pipeline and our ability to deploy our capital in high-quality investments. This concludes our prepared remarks. Operator, please open the line for Q&A.

Operator (participant)

Ladies and gentlemen, at this time, we will conduct the question-and-answer session. If you would like to state a question, please press seven pound on your phone now, and you will be placed in the queue in the order received, or press seven pound at any time to remove yourself from the queue. Please listen for your name to be announced and be prepared to ask. All right, we our first question comes from Paul Johnson with KBW. Paul, go ahead, please.

Paul Johnson (VP and Equity Research)

Yeah, good afternoon, guys. Thanks for taking my questions. Just clarifying your comments on repayments for next quarter or this, the second half this year, I guess. You said you expect repayments. Do you expect, is this net repayments that you're talking about, you know, above what you're expecting to, to redeploy? Or is these just repayments that you have kind of line of sight on, for the rest of the year, not necessarily net repayments?

Michael Mauer (Chairman and CEO)

No, not net repayments, Paul. Thank you for, you know, taking the time today. These are payments that we have line of sight on today, that there will be some coming in, but we will be redeploying.

Paul Johnson (VP and Equity Research)

Gotcha. Okay, thanks for that. And then, my second question or, or possibly a follow-up to that, a little bit broader, but, just kind of taking a step back and, and looking at the quarter, I think, you know, in the context of, you know, the, the space, obviously, you know, this has been a pretty good year for BDCs so far, kind of despite, you know, what we expected earlier in the year. And a lot of BDCs, pretty much, you know, almost every BDC in this sector has benefited quite a bit from the rate hike cycle.

I'm just, you know, kind of curious, you know, your thoughts on the portfolio, you know, this year in particular, and why, I guess, that hasn't really, you know, worked to your benefit quite as much as the rest of the space. And then, I guess, in addition to that, you know, what are some of the things that you think you could do, you know, with the advisor to hopefully help, you know, improve performance? You mentioned a thing or two, you know, in terms of raising new funds, and potentially lowering costs, but anything to that end would be helpful.

Michael Mauer (Chairman and CEO)

Yeah, Paul, thank you. I know it's on your minds, it's on our minds every day: How do we continue to advance the platform? I think that's, and you hit on it, you know, we need to have a broader platform so we can originate more. We're making headway with that. We've done a first close, as you—we talked about on the last call, of a fund. That fund is bringing in additional money throughout this year. The second thing is we did bring in an SMA, we're in discussions on another. We are targeting an additional fund, first close, the first quarter of next year.

All of that not only spreads costs, and you touched on bringing down costs, but I think equally important, it generates more origination and better terms on origination as we have a bigger platform. We really just started getting traction on that earlier this year, and I expect that to continue to pick up. But those are the areas that we're really focused on, because I think you've seen a lot of big platforms that have some small funds, and they are the beneficiary of it.

Paul Johnson (VP and Equity Research)

Thanks, Mike, and, appreciate that. I mean, I guess, you know, I mean, at this point, you know, the, the advisor Investcorp, I think they came in, you know, roughly four years ago. I mean, do you see it as a case at this point where the equity base has essentially shrunk to a point where scale is just not quite possible with the size of the BDC, you know, being, you know, about, you know, roughly $90 million equity base BDC, one of the smaller, you know, smallest market cap BDC space, BDCs in the, in our coverage, at least? I mean, do you see that as, as a, I guess, inhibitor to, to pulling these levers?

I mean, what do you expect, I guess, out of this, the growth that you're kind of calling for in the next few years?

Michael Mauer (Chairman and CEO)

I don't think the BDC is an inhibitor. I think that there was a lot of time spent over the first two years looking at strategic ways to grow it, and those did not happen for a lot of different reasons I can't go into, but mostly our choice not to execute around a lot of that. We've been focused over the last 12 months on organic growth, and so the size of the external, publicly traded BDC has not been the inhibitor. Going forward, hopefully, it will be one of the beneficiaries.

Paul Johnson (VP and Equity Research)

Got it. Thanks. Appreciate you for taking my questions, and that's all for me.

Michael Mauer (Chairman and CEO)

Thank you very much, Paul. Appreciate it.

Operator (participant)

Thank you, Paul. Our next question comes from Robert Dodd with Raymond James. Robert, go ahead, please.

Robert Dodd (Director and Equity Research)

Hi, guys. First, a housekeeping one, if I can. I mean, there was a fairly sizable dividend in the fourth quarter. I mean, was that related to a one-time event, or is that a new position in, say, preferred equity or something? I.e., is it gonna continue or is that a one-off sort of thing?

Michael Mauer (Chairman and CEO)

That five cents that you're, I think, referring to was a one-time event. So we've got, you know, the base going forward at 12, and we'll have a supplemental to the extent that it makes sense, and we will, as, you know, we have in the past, we give visibility for the next quarter, and we've said we expect to cover the dividend for the next quarter.

Robert Dodd (Director and Equity Research)

I appreciate that color. My, I meant the, the income to the BDC. There was a $690,000 dividend in total investment income for the BDC this quarter. Is that sustainable number?

Rocco DelGuercio (CFO)

Oh, Rob, are you talking on the income statement, correct?

Robert Dodd (Director and Equity Research)

Yes. Yeah, yeah, yeah. Correct.

Rocco DelGuercio (CFO)

Yeah. Mike, he's talking about the technical loss, dividend that we got. Technical. I think, I think some of the equity positions pay a dividend. I don't think they're. I think they're one-offs.

Michael Mauer (Chairman and CEO)

Yeah, those are one-offs, the dividends coming in. I would not think about those as recurring dividends. We do think that we'll get them episodically, but not on a quarterly basis.

Robert Dodd (Director and Equity Research)

Got it. Got it. Appreciate that color. Then if I can, I saw you obviously amended the credit facility, and we spoke about that last quarter. That amendment does not, and I apologize for that one, like, hasn't changed the revolving period. So can you give us any color on what you're doing to extend that? Obviously, it's the revolving period currently expires all this next year. That's part of it. Also, in that, I do note that in the credit facility amendment, you've now added an advance rate bucket for broadly syndicated loans. Is it a plan to do more of that within the BDC in terms of more secondary purchases on BSLs, or is that just.

Paul Johnson (VP and Equity Research)

Yeah.

Suhail Shaikh (Co-CIO and President)

Yeah. Hi, Robert. This is Suhail. So I'll let Rocco pick up on the credit facility. The short answer is we didn't have an expiration coming due. I think we have amended the credit facility to allow for some, you know, financial flexibility in it. With respect to secondary positions, I think we are, you know, the big picture response is, you know, we're being very selective in this marketplace from a deal flow perspective. As you know, deal flow, primary deal flow for buyouts is down almost 50% year-on-year. So what we see is, frankly, a lot of that stuff we're passing on.

We're looking at secondary investments where either we know the credit or we can leverage the broader Investcorp platform, our private equity, or our liquid credit businesses to source ideas from. That's really the theory behind doing some of those investments. Because they are somewhat more liquid than your traditional middle market loans, we can, you know, move in and out of those when we have to, to make room for primary deals as they come through. Hopefully that answers your question.

Robert Dodd (Director and Equity Research)

Yeah. Yeah, that, that answers that question. Thank you. And then just on, on your, but you—there, there's no immediate maturity on the revolving credit facility or the, the credit facility, but the revolving period now has less than 12 months.

Suhail Shaikh (Co-CIO and President)

No.

Robert Dodd (Director and Equity Research)

To, to-

Suhail Shaikh (Co-CIO and President)

But, Robert, I wanna try and-

Rocco DelGuercio (CFO)

One of the plans on that front.

Michael Mauer (Chairman and CEO)

Being the revolver, the term-out goes further, the revolver ends.

Rocco DelGuercio (CFO)

The revolver, the Capital One facility ends in 2026.

Robert Dodd (Director and Equity Research)

Right, but the revolving, the reinvestment period ends in, in 2024.

Michael Mauer (Chairman and CEO)

We'll go back and review all that, but we've been working with Capital One ongoing, and all those relationships are very healthy. I'll double-check that, Robert, and we'll come back.

Rocco DelGuercio (CFO)

Yeah, I'm sorry, Robert. Yeah, don't have to-

Robert Dodd (Director and Equity Research)

Yeah, yeah, no, no worries. Appreciate it. Thank you for the answer very much.

Michael Mauer (Chairman and CEO)

Yep.

Robert Dodd (Director and Equity Research)

Sure.

Operator (participant)

Thank you very much. Our next question comes from Paul Johnson, again, with KBW. Paul, go ahead, please.

Paul Johnson (VP and Equity Research)

Yeah, thanks. Sorry, one more follow-up. Hey, during the remarks, you guys said that you expect to cover the distribution, I believe, next quarter. I just wanna make sure I'm clear. This are you talking about the full $0.15 distribution, or are we talking about just simply the base distribution of $0.12?

Suhail Shaikh (Co-CIO and President)

No, Paul, this is Suhail. It's the base distribution of $0.12. And to the extent there is any spillover or supplemental, that's gonna be on top of that.

Paul Johnson (VP and Equity Research)

Okay. Okay, thanks. That's all for me.

Operator (participant)

Thank you very much, Paul. I see no other questions in the queue. Go ahead.

Michael Mauer (Chairman and CEO)

Thank you. If there's no other questions, we'll talk to everyone next quarter. This was a long gap because of the year-end, but we'll be talking to everyone after the September quarter. Thank you very much.

Suhail Shaikh (Co-CIO and President)

Thank you.

Operator (participant)

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