CION Investment Corporation (NYSE:CION) Q2 2023 Earnings Call Transcript

CION Investment Corporation (NYSE:CION) Q2 2023 Earnings Call Transcript August 11, 2023

Operator: Thank you. Good morning and welcome to the CION Investment Corporation’s Second Quarter 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’d like to turn the call over to Michael Reisner. Please go ahead Michael.

Michael Reisner: 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 second quarter 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 yet another quarter of income exceeding our $0.34 a share dividend, which led to our announcing a supplemental dividend this morning of an additional $0.05 a share for the next two quarters. Net investment income was $0.43 a share, a 21.4% increase year-over-year.

While income from last quarter was higher due to a distribution from our EagleTree joint venture and other equity dividends from a deleveraging portfolio company, we are pleased that our income continued to outperform our dividend without the periodic dividends and a higher than anticipated cash balance throughout Q2. I will note that as previously advised, distributions from our EagleTree joint venture are expected to be periodic in nature and we believe there will be more meaningful income in the coming quarters from that entity. Therefore, the lack of a dividend this quarter is simply reflective of the structural construction of the portfolio in that entity. Additionally, as Gregg will discuss the quality of opportunities in our pipeline remains strong and the delays in closings we experienced during the quarter has subsided.

In fact, we have closed $54 million in new investments since the end of the quarter such that our investable cash balance for this current quarter will be more in line with our expectations as compared to the second quarter. Moreover, we believe that our cautious view of the economy over the last few quarters and underwriting on the basis that the economy was in or entering into a recession is a meaningful factor as to why the portfolio is performing well. We placed one new investment on non-accrual this quarter an additional investment with Jenny Craig was added and took three names off of non-accrual. The percentage of our portfolio on non-accrual fell to 1.69% of fair value, down from 3.47% from last quarter. The percentage of names that we have risk rated four or five decreased to less than 1% of the portfolio with 99% of our book now rated three or higher.

As we said last quarter, we believe the stressed names identified in Q1 were idiosyncratic in nature and limited to those in consumer-facing industries. On the financing side, we successfully extended our JPMorgan and UBS senior secured facilities. We continue to remain conservatively levered relative to our peers with a net debt-to-equity ratio of 1.04 times, and we’ll seek to increase leverage in the coming quarters to achieve our target of 1.25 times, but we’ll continue to do so in a prudent fashion. Our net asset value increased $0.20 a share to $15.31 from $15.11 last quarter owing in part due to our share buyback, as well as an increase in the illiquid portion of our portfolio and continuing to out earn our dividend. Regarding the share buyback, this month we expect to extend our repurchase plan for another year, which we will continue to utilize in a prudent fashion to drive long-term shareholder value.

In Q2, we repurchased approximately 328,600 shares at an average price of $9.81 per share for a total repurchase amount of $3.2 million. Through the end of Q2, we have repurchased shares totaling approximately 2.3 million for a total repurchase amount of $22.3 million since the beginning of the repurchase program was implemented in August 2022. We believe that despite media headlines discussing the decreased likelihood of a recession now is not the time to take unnecessary risk. We believe we have demonstrated that we have the ability to drive shareholder returns by being highly diversified and predominantly senior secured floating rate loans, while remaining conservatively levered. We remain highly diversified with our investment portfolio of $1.69 billion, spread across 112 distinct issuers with an average investment size of $15 million.

Our investment portfolio is 89.3% senior secured with 87% in first lien investments. The weighted average leverage or net debt to EBITDA of our portfolio companies decreased slightly to 4.83 times, as compared to 5.1 times in Q1. The weighted average interest coverage of our portfolio companies of two times was relatively in line with the prior quarter. With that, I will now turn the call over to, Gregg.

Gregg Bresner: Thank you, Michael and good morning everyone. Our Q2 net investment income benefited from a diverse combination of the direct pass-through of higher 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 continues to remain a clear distinction between the large-cap syndicated markets and the direct private credit market where we strategically focus. The private direct lending sector, continued to expand its market share with issuance and yield opportunities at the expense of the less active syndicated loan markets which has sharply lowered new issue volume to relatively lackluster LBO and M&A activity.

This is consistent with what we are experiencing with our platform as our current private direct transaction inflow remains strong. We are seeing many attractive direct investment opportunities for which we will remain highly selective. We have seen an increase in refinancing opportunities particularly in conjunction with add-on acquisitions where additional debt capital is required that is beyond the ability of the incumbent lender groups. In addition, we have benefited from the disruption in the syndicated loan market, where we have been able to acquire lightly syndicated first lien loan tranches, at substantial discounts to par due to the technical and fundamental headwinds from ratings downgrades as well as reduced CLO issuance outflows from loan mutual funds and ETFs. We remain highly selective with new investments, as we are still cautious with respect to the US consumer particularly in the middle and lower markets.

M&A activity remains well below the 2022 level, and we have seen a number of circumstances where valuation gaps and lengthy negotiations are ultimately not being converted into closed transactions. We are additionally seeing delays in regulatory approvals, due to elongated governmental review timetables. These dynamics have resulted in several of our planned investment closing slipping from Q2 to Q3. Turning now to, our Q2 investment and portfolio activity at the end of Q1 we were strategically preserving cash for our expected Q2 investment pipeline. Given the delays in transaction closings that I just referenced, we now expect most of our targeted investment pipeline to be largely funded by the end of August. During Q2, we continued our focus on higher-yielding first lien opportunities in both the directly sourced and lightly syndicated loan markets.

Our focus in the syndicated markets has been largely higher-yielding illiquid opportunities such as investment and — such as investment opportunities with valuation distress, due to either technical or capital structure-related situations where we expect to have active roles in the processes that drive the refinancing or restructuring of the investments. Also, during Q2, we completed an attractive mix of investments including our co-lead role in the newly issued private credit facility for PRA events the secondary purchase of the higher-yielding privately structured first lien tranche of R.R. Donnelley and the discounted purchases of the lightly syndicated first lien tranches of Avison Young, MedPlast and Florida Foods. Overall, we have seen roughly a 100 to 150 basis point increase in spreads, year-over-year for new direct investments that meet our investment criteria.

We ended the quarter with strong liquidity and a conservative net debt to equity profile of approximately 1.04 times slightly higher than at the end of Q1. We maintained strong liquidity for some new investments and maintained strong dry powder to invest in the growth and working capital needs of our portfolio companies. During Q2, we made $62 million in new investment commitments all of which were funded. These investments were balanced and diversified across direct and secondary opportunities. We also funded a total of $8 million of previously unfunded commitments. We had sales and repayments totaling $55 million for the quarter which primarily consisted of the full repayment of one investment and the successful restructuring of IPP, United Road and Isagenix into new debt and equity tranches.

As a result, net in funded — net funded investment activity increased by $15 million during the quarter. Our non-accruals decreased from 3.5% of fair value at 3/31/23 to 1.7% at 6/30/23. We removed Sequoia Healthcare, Independent Pet Partners and United Road from non-accrual status this quarter as we successfully utilized our secured loan positions to restructure our investments in these companies. In July, we worked with Bank of America and David’s Bridal management to help lead the successful restructuring and emergence of David’s Bridal out of bankruptcy. We successfully utilized our multiple, pre-petition secured holdings and extensive experience with the company and management to structure the purchase of substantially all assets of David’s Bridal out of bankruptcy.

As a result of the transaction, we are now a secured lender and majority equity owner of David’s Bridal and our pre-petition secured debt in David’s Bridal will be removed from non-accrual status in Q3. Overall, our portfolio remains defensive in nature, with 89% in senior secured investments that is highly diversified across industries and issuers. I’ll now turn the call over to Keith.

Keith Franz: Okay. Thank you, Gregg and good morning, everyone. As Michael mentioned, we reported another quarter of solid investment performance, driven by an increase in base rates and fees generated from a quarterly investment activity. During the quarter, net investment income was $23.4 million or $0.43 per share, as compared to $29.9 million or $0.54 reported in the first quarter. Total investment income was $58.5 million during the quarter, as compared to $65 million reported during Q1. On the expense side, total operating expenses were $35.1 million, which is consistent with the first quarter. Total operating expenses reflect an increase in interest expense due to higher LIBOR and SOFR rates, as well as lower advisory fees when compared to the prior quarter.

At June 30, we had total assets of approximately $1.8 billion and total equity for net assets of $836 million, with total debt outstanding of $985 million and 54.6 million shares outstanding. At the end of the quarter, our net debt-to-equity ratio was 1.04 times which is slightly higher than 1.02 times at the end of Q1. At June 30, our NAV was $15.31 per share as compared to $15.11 per share at March 31. The increase of $0.20 per share was due outearning of 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 $450 million in unencumbered assets, lower leverage relative to our peers, our strong debt servicing capacity and solid liquidity.

We had over $110 million in cash and short-term investments and an additional $125 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 71% in senior secured and 29% in unsecured, with 85% of floating rate. During the quarter, the weighted average cost of our debt capital was about 7.9%. We expect to continue to see the positive impact to net investment income, as we continue to deploy our available capital into new middle-market floating rate investments that typically pay a yield premium when compared to larger broadly syndicated deals. If interest rates continue to rise, we expect an increase to our net interest income of about $0.05 per share for the next 50 basis point increase to the current base rate as of June 30, and $0.10 per share for a 100 basis point increase to the base rate and that’s assuming no material changes to the investment portfolio or our debt structure.

In terms of our debt structure, as Michael mentioned, we have amended both of our senior secured facilities for an additional year with slightly better economics. We believe that both extensions will give us the flexibility to work towards something more strategic and longer term during the next year. Our objective is to further diversify debt mix between secured and unsecured and continue to expand our syndicate of lending partners. Now turning to distributions. During the second quarter we paid distributions to our shareholders of $0.34 per share. As announced this morning, we also declared our third quarter distribution of $0.34 per share. The third quarter distribution will be paid on September 15 to shareholders of record on September 1.

In addition this morning, we announced a supplemental distribution of $0.05 per share for both the third and fourth quarters, as we have consistently outearned our distribution and have a strong liquidity position. The supplemental distribution for the third quarter will be paid on October 16 to shareholders of record as of September 29. And the supplemental distribution for the fourth quarter will be paid on January 15 to shareholders of record as of December 29. Okay, with that, I will now turn the call back over to Michael for some closing remarks.

Michael Reisner: Thank you, Keith. Before that operator, I think we’re ready to take some questions.

Q&A Session

Operator: Ladies and gentlemen, at this time we will be conducting a question-and-answer session [Operator Instructions] Our first question comes from the line of Erik Zwick with Hovde Group. Please proceed with your question.

Erik Zwick: Thanks. Good morning, everyone. Wanted to just start on the supplemental dividend and curious kind of how you came up kind of the rationale to start instituting and paying one of those and how you think about the magnitude of that determining that $0.05 level?

Michael Reisner: Thanks, Erik. It’s, Michael. I think you’ve been following us now for some time. I think we’re pretty conservative by nature. I think our goal is that we want to be able to confidently grow into that supplemental dividend such that it will be permanent. I think we still want to see what happens with the economy over the next six to 12 months. And we also want to continue to try to, as we said before, increase our leverage to get to that target 1.25 until we’re 100% confident that the dividend level is sustainable.

Erik Zwick: That’s helpful. And then just thinking about the pipeline, I think if I heard the commentary correctly some of the expected activity in 2Q kind of pushed to 3Q in terms of maybe kind of closings and fundings and that is likely to be concluded by the end of August. So curious what the pipeline looks like beyond that and what the mix might look like in terms of new investment opportunities versus add-on opportunities.

Gregg Bresner: I’ll take that. Hi Erik, it’s Gregg. So the pipeline right now what we referred to for August was primarily Q2 that spilled over into Q3. Going forward, I would say, we have a very strong pipeline and we expect the balance to be largely new issue, new platforms with incremental from add-ons to existing portfolio companies. But it should be primarily primary in nature and skewed to new platforms for the remainder of Q3.

Erik Zwick: Got it. That’s perfect. Thanks. And last one for me just looking at slide 7 and I know you referenced this a little bit in the prepared remarks. But the improvement in the internal ratings in Q2, I wonder if you could just talk about some of the factors that drove that if it was broader market dynamics or more portfolio-level company specifics that helped that.

Gregg Bresner: I would say it was more the transitioning of some of the names that were challenged during the last quarter that we were working through transactions and getting those transactions completed. That’s really what drove primarily those changes in the risk ratings. It was really a couple of names that we had to work through. And the transactions went inter-quarter. So, we had to work through those. And once we worked through those, we were able to change the risk ratings pro forma for the restructuring.

Erik Zwick: Make sense. That’s all for me. Thanks for taking my questions this morning.

Michael Reisner: Thank you, Erik.

Operator: Our next question comes from the line of Finian O’Shea with Wells Fargo. Please proceed with your question.

Finian O’Shea: Hi. Good afternoon. First question on the improved outlook for EagleTree. Can you touch on the drivers there on what’s leading to the improved business conditions?

Michael Reisner: I’ll turn it over to Gregg. I’m not sure it’s improved. I think we’ve always kind of said nature of that portfolio, it would be lumpy distributions. So some quarters you’ll have income and soon, in some quarters you won’t. So I’m not sure there’s an improvement. I think that implies there’s something wrong with it. But I’ll let Gregg add a comment there.

Gregg Bresner: Yes. The only thing I would add to what Michael said is that, it’s really a portfolio-driven distribution stream. So it really depends on realizations and the function of new investments that translate to realization. So I really don’t think there’s a substantive change. It’s more — it’s a diversified portfolio. And as investments mature and realize, that will affect the pattern of distributions.

Finian O’Shea: Okay. Thanks. And a couple of names, I think Independent Pet and Sequoia correct me if I’m wrong, you were touching on some senior debt-driven restructures. Does that mean you are now the equity of the business or does that mean you drove a recap? Just looking to get color on the new profile of those investments? Thanks.

Gregg Bresner: So for IPP, it was a restructuring along with Main Street. So that was a conversion into equity. As a secured lender, we stayed with the process and then ultimately converted into equity post position. Sequoia, it was just an amending of the existing facilities. We added more capital into the hospitals, and as a result of that, the performance has been better. And we were able to take their name reverse it on a poll based on performance and specific factors going on there that have improved. But there, there was no transition to equity. It was just an improved situation.

Finian O’Shea: Great. Thanks. And one more. On David’s Bridal did you put equity into that as well, or was the markup on some performance improvements or just emerging-type valuation tailwind? Anything to see there?

Gregg Bresner: Yes. It was not new equity. It was the repositioning and emergence of the company and the utilization of the bankruptcy process to streamline operations which improved the fundamental outlook for the company.

Finian O’Shea: Very well. Thanks so much.

Michael Reisner: Thank you, Finian.

Operator: This concludes our question-and-answer session. I’d like to hand it back to management for closing remarks.

A – Michael Reisner: Thank you. And thank you everyone who joined the call today. We appreciate your interest in CION, and we look forward to speaking to you again in November when we announce our third quarter results. Enjoy the rest of the summer everyone.

Operator: Ladies and gentlemen, this does conclude today’s teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.