CION Investment Corporation (NYSE:CION) Q4 2023 Earnings Call Transcript

CION Investment Corporation (NYSE:CION) Q4 2023 Earnings Call Transcript March 14, 2024

CION Investment Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning. And welcome to CION Investment Corporation’s Fourth Quarter and Year End 2023 Earnings Conference Call. An earning press release was distributed earlier this morning before market opened. A copy of the release, along with the supplement 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. Please go ahead, Michael.

Michael Reisner: Thank you. Good morning, everyone, and thank you for joining us. As mentioned, I am joined today by Gregg and Keith, as well as other members of senior management. I will start our call today with an overview of our fourth quarter and year end 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 fourth quarter and 2023 overall, which saw a continued to demoted solid credit performance with an increase of almost 3% to our net asset value quarter-over-quarter and almost 2% year-over-year and net income of $0.94 per share, an increase of 8% quarter-over-quarter.

Our ROE was 23.4% for the quarter and 11% for the year. Our net investment income ROE was 10% for the quarter 12.1% for the year. Our net investment income of $0.40 per share once again out earned our base dividend. Because of our continued ability to out earn our base dividends, coupled with our ability to drive returns by our yield enhancing features and opportunistic buying of lightly syndicated deals at discounts, which Gregg will speak more about, we are announcing today our intention to declare a midyear supplemental dividend payable July 12th to shareholders of record as of June 28th. The exact amount of the supplemental dividends will be announced next quarter. Our portfolio continued to deliver resilient credit performance as the percentage of our portfolio on nonaccrual is now below 1% of fair value.

Perhaps an even better indication of our credit performance, the percentage of names that we have risk rated 4 or 5, which represents our higher credit risk names, is also below 1% of the portfolio at fair value, 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. At quarter end, we were still leveraged conservatively on a net basis at 1.1 times. Our net asset value increased $0.43 per share to $16.23 owing in part to mark-to-market adjustments to the portfolio as well as the accretive nature of our share repurchase program. Our NAV continues its recent improvement and is now back to where it was 2 years ago, despite the higher interest rate environment we have been operating in and compares favorably with the net asset values of our peers, which have mostly experienced decreasing to flat net asset values over the same period.

During Q4, we repurchased approximately 280,000 shares at an average price of $10.35 per share for a total repurchase amount of $2.9 million. We have repurchased a total of approximately 2.8 million shares for a total repurchase amount of $27 million since the beginning of the repurchase program we put in place in August 2022 through the end of 2023, and we intend to continue to be active for repurchasing our shares in the coming quarters. While many consider this the golden age of private credit, more or more of our BDC peers continue to depart from their traditional niche of lending to true middle market companies as banks retrenched in 2023. However, as banks start to resume lending activity, we believe that having a defensible niche in the middle market is paramount.

As I mentioned last quarter, many BDCs are going after larger companies where leverage is higher, spreads are lower, and covenants, if even presents, are looser. To that end, just recently, a Bloomberg article was titled Private Credit Cuts Pricing to Fend Off Wall Street Deal Grab as many large BDCs participated in a loan with a spread of only 475 basis points over the base rate with 1.5% OID, one of the cheapest private credit deals in recent memory. The company in question has an EBITDA of approximately $500 million. By comparison, the weighted average EBITDA of our portfolio is $34 million. We almost always receive meaningful lender protection and covenants, our weighted average spread is 750 basis points over the base rate, and our average OID is between 2% and 3%.

While there is nothing wrong in and of itself with the deal I referenced, we believe from a risk adjusted perspective, our style of lending is superior. At almost $2 billion in total assets, we are large enough to be an impactful player to borrowers in the middle market without being so large that we are forced to buy the market or sacrifice economics or borrower protections in an effort to put money to work. Finally, before I turn the call to Gregg, I wanted to announce that we are welcoming a new member to our senior management team this week as Charlie Arestia has joined us as a Managing Director and Head of Investor Relations. Charlie was previously part of IR team at Focus Financial Partners, and before that was an Analyst at JPMorgan.

With that, I’ll now turn the call over to Gregg.

Gregg Bresner : Thank you, Michael, and good morning, everyone. Our Q4 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 and other prepayment premiums and other yield enhancing provisions embedded within our primarily first lien portfolio. As Michael referenced, there remains a clear distinction between the increased levels of competition in the large cap markets between the larger asset management platforms and the middle market direct lending sector remains robust and continues to take market share from the lower rated single B syndicated markets, which is consistent with what we are experiencing with our platform as our private direct transaction sourcing remains vibrant.

We continue to see attractive direct investment opportunities for which we remain highly selective. While M&A activity remains subdued in Q4, we saw an increase in refinancing opportunities particularly in conjunction with add on acquisitions where additional debt capital was required that was beyond the capacity of the incumbent lender groups or the private equity sponsor chose to refinance to provide an additional 2 years to pursue M&A or sales strategies. We do expect M&A activity to increase in 2024 as we believe buyers and sellers are now accepting the higher for longer reality regarding interest rates. In addition, we continue to benefit from technically driven disruptions in the syndicated loan market where we acquired lightly syndicated first lien loan tranches at significant discounts to par due to issues such as rate exchanges which truly expansions, exchanges or restructurings that were not suitable for the exiting syndicate holders and where we can expect to have active role in the process that drive the refinancing or restructuring of the investments.

We remain highly selective with new investments as we’re still cautious with respect to the U.S. consumer particularly in light of recent global developments and the persistence of higher interest rates and inflation levels. We continue to strategically focus on first lien investing and prefer to utilize yield enhancement provisions such as PIK features, call protection, make whole provisions and MOICs to incrementally enhance yields at the top of the capital structure rather than reaching deeper into capital structures for mezzanine and equity co-investments to achieve incremental yield. Approximately 60% of our annual PIK income is derived from highly structured situations such as our litigation finance investments where we can attain higher yields by matching flexible pick timing features with strict cash flow sweeps upon collections or through coupon structures where PIK is incremental to our cash interest.

Approximately 85% of our PIK investments are in portfolio companies risk rated either 1 or 2 and 97% risk rated 3 or better. Turning now to our Q4 investment and portfolio activity. During Q4, we completed an attractive mix of first lien investments. We completed private direct first lien financing tranches for new platforms including Nova Compression, North Third Travel and Tactical Air Support where we acted as co-lead arranger. We also completed a number of first lien add on investments for portfolio companies including Work Genius, H.W. Lochner, David’s Bridal, USALCO and Moss. The weighted average coupon for our direct investments was approximately sulfur plus 8% for the quarter. We additionally continued our purchases of the lightly syndicated first lien tranches of companies such as PureStar, YAK MAT, Avison Young and Aveline at discounts.

These purchases proved to be attractive as PureStar, YAK MAT and Aveline have been recently refinanced and we have received significant investment income from OID acceleration in Q1 of this year. Avison Young announced the comprehensive recapitalization and deleveraging transaction that is expected to close in Q1 of 2024 and positions the company for future growth and investment. Upon closing, we expect to realize significant accretion to the blended cost of our first lien investment in Avison Young. During Q4, we made $152 million in new investment commitments across 5 new and 15 existing portfolio companies of which $147 million was funded. These investments were diversified across direct and secondary opportunities with approximately 72% in direct private investments.

We also funded a total of $7 million of previously unfunded commitments. We had sales and repayments totaling $83 million for the quarter, which primarily consisted of the full repayment of our investments in Cadence, Archer Systems, NWN and associated asphalt. As a result, net funded investment activity increased by approximately $71 million during the quarter. The repayment trend has continued into 2024 as M&A activity has fueled recent Q1 repayments that have resulted in significant OID acceleration and incremental investment income from yield enhancement provisions such as prepayment premiums, make holes and MOICs attached to our 1st lien portfolio. Our nonaccruals declined slightly from 1% of fair value at 9/30/23 to 0.9% of fair value at 12/31/23.

We added one new name, our second lien investment in TriMak Ambrosia with approximately $1.5 million of fair market value to nonaccrual this quarter. TriMark was in the process of a voluntary restructuring process in Q4 that did not close until January of 2024. As a result of the restructuring, we participated in the backstop group and received a package of backstop fee take back debt and equity for first lien and second lien positions in the company. Given the closing of the transaction, we expect to remove TriMark from nonaccrual status in Q1 of 2024. Overall, our portfolio remains defensive in nature with 85% in first lien investments and 87% in senior secured investments. 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 financial results, driven by the benefits of higher base rates on our mostly floating rate portfolio and fees generated from a quarterly investment activity. During the fourth quarter, net investment income was $21.8 million or $0.40 per share as compared to $30 million or $0.55 per share reported in the third quarter. For the full year, net investment income was $105 million dollars or $1.92 per share as compared to $88.2 million or $1.56 per share for the prior year. This is an increase of $0.36 per share with 23% year-over-year. On the expense side, total operating expenses were $38.2 million as compared to $37.6 million reported in the third quarter.

The increase was driven by higher interest expense under our financing arrangements due to an increase in our average debt outstanding when compared to the prior quarter. At December 31st, we had total assets of approximately $2 billion, and total equity or net assets of $880 million dollars with total debt outstanding of $1.1 billion and 54.2 million shares outstanding. At the end of the quarter, our net debt to equity ratio was 1.10 times, which is slightly higher than 1.03 times at the end of Q3. During the year, our total debt outstanding increased by $134 million or 14% from the prior year, reflecting the measured growth of our portfolio using additional debt capital. Our portfolio at fair value ended the quarter at $1.8 billion up $113 million from the third quarter, reflecting the combination of net funding and net unrealized gains from the portfolio.

The weighted average yield on our debt and other income producing investments and amortized cost was 13.4% at December 31st, which increased 36 basis points from 13.04% at the end of Q3, an increase over 100 basis points from the prior year end. At December 31st, our NAV was $16.23 per share as compared to $15.80 per share at September 30th, an increase of $0.43 per share or 2.7%. The increase was driven by mark-to-market price increases in our portfolio and the accretive nature of a share repurchase program during the quarter, which was offset by our year-end special and fourth quarter supplemental distributions totaling $0.20 per share. For the quarter, we experienced a significant mark-to-market price increase to the value of our common equity investment in David’s Bridal.

Given the overall largest size of this position relative to our other equity investments and the seasonal nature of its end markets, we do expect to have a higher than average mark-to-market price volatility in the fair market value of this investment on a quarter to quarter basis. Year-over-year, our NAV was up $0.25 per share or 1.6%, increasing from $15.98 per share at the end of 2022 to $16.23 per share at the end of 2023, reflecting the strong credit quality of our portfolio. We ended the quarter with a strong and flexible balance sheet with over $600 million in unencumbered assets, lower net leverage relative to our peers, a strong debt servicing capacity and solid liquidity. We have over $120 million in cash and short-term investments and access to an additional $150 million under our credit facility 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 8.5%. In terms of our debt structure, as we previously discussed, in October, we closed on a $33 million follow on to our Series A unsecured floating rate notes to certain institutional investors in Israel, with the same terms as the existing notes issued earlier in the year. And in November, we completed a $100 million private offering of floating rate unsecured notes to certain U.S. Institutional investors. The addition of these unsecured notes to our debt capital brings additional strength and flexibility to our balance sheet and aligns well with our mostly floating rate investments. After completing these two financing transactions, our debt mix is now about 60% in senior secured and 40% in unsecured with about 85% in floating rate.

Now turning to our distributions. During the fourth quarter, we paid total distributions to our shareholders of $0.54 per share, which includes a base distribution of $0.34 per share, a year end special distribution of $0.15 per share, and a previously declared fourth quarter supplemental distribution of $0.05 per share. For the full year 2023, we declared total distributions of $1.61 per share as compared to total distributions of $1.45 per share during 2022, an increase of $0.16 per share or 11% year-over-year. As a result, our distribution yield based on the year-end average NAV was 9.9% and our distribution yield based on the year-end market price was 14.2%. As announced this morning, we declared our first quarter base distribution of $0.34 per share, which is the same amount as the base distribution declared during the fourth quarter of 2023.

The first quarter distribution will be paid on March 28th to shareholders of record on March 22nd. Okay. With that, I will now turn the call back over to Michael for some closing remarks.

Michael Reisner : Thanks, Keith. As a final thought before we open the line for questions, we would like to reiterate our message that we believe CION is undervalued, continues to perform well, and is well positioned to continue to provide solid returns to its shareholders. And with that, operator, we’re ready to take any questions.

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Q&A Session

Operator: [Operator Instructions] Our first question is from Erik Zwick from Hovde Group.

Erik Zwick: I wanted to start with a question following the fourth quarter actions towards raising more unsecured debt. You noted that the mix is now kind of 60/40 secured versus unsecured. And curious, have you kind of reached your target mix there? Or do you anticipate potentially making some additional changes in the 2024?

Keith Franz: Good morning, Erik. This is Keith. So in terms of our debt capital, we continue to work with our commercial banking partners on extending our current arrangements. Those conversations continue to be had today, so we’ll probably have a better update for you over the next couple of weeks or months. And at the same time, we continue to explore opportunities in the debt capital markets, which would further diversify our mix between securities and unsecured, and also expand our lending partners that we do business with. So, yes, I don’t think we’re done. I think that we’ll continue to explore opportunities as they present themselves.

Erik Zwick: And switching gears, just curious if you could provide any commentary on the current pipeline maybe in terms of the mix of new versus add-on opportunities as well as any if you’re seeing any particular industries that are stronger and presenting maybe more attractive opportunities today?

Gregg Bresner: Hi, Erik. It’s Gregg. It really is diversified. There is no one specific industry focus from what we’re seeing B2B remains strong. So you will see that in our business services focus. We’re still seeing opportunities, niche opportunities in Healthcare and Industrial Services. So it’s pretty broad based. I wouldn’t say there’s one particular theme to it.

Erik Zwick: Thanks. And any thoughts on kind of the mix between new and add on opportunities today?

Gregg Bresner: Yes, we’re seeing both. It’s healthy on both sides. We do see platform M&A starting to pick up sales of companies, but we’re also seeing a lot of incremental add-on activity where we step in. So it really is a combination of both.

Erik Zwick: And then previously you mentioned that your portfolio companies kind of have been growing at a single digit EBITDA. Hearing just from anecdotal evidence and talking to some other BDCs that some are starting to see some slowdowns in certain pockets of the economy. So just curious if you could provide any kind of insight into what you’re seeing with your portfolio companies and whether they continue to grow and improve at this point?

Gregg Bresner: Yes, we’re still seeing the single digit growth. We haven’t seen any pronounced slowdown. It varies industry by industry, but I think that single digit measure still holds.

Erik Zwick: And then last one for me. Can you provide any comments on what drove the unrealized gains in this past quarter?

Gregg Bresner: Yes. So mark-to-market, obviously there was some spread compression which fit throughout our model. So we did see spreads tighten a bit. And also David’s Bridal was strong in this quarter and that had to do with really the purchase accounting adjustments associated with closing the transaction. The auditors had the time to perform the revalue inventory, merchandise and things like that. So you saw a mark-to-market increase based on that analysis.

Operator: Our next question is from Steven Martin with Slater Capital Management.

Steven Martin: Following up on your last response on David’s Bridal, can you talk is there any incremental information on its performance, its turnaround? I see you extended additional credit and I assume it’s current pay, etcetera?

Gregg Bresner: So, it’s really no not much material information we can share. Part of it too is you’re going through the selling season now. So, we’ll have a much better view in the next couple of quarters. The incremental debt this quarter was a synthetic letter of credit facility. So it wasn’t a general loan. It was more to back LCs to free up capacity under traditional ABL. So, it really wasn’t a corporate for use loan. It was really to help the company more efficiently on a cost of capital basis backstop standby LCs.

Steven Martin: Are they now complete with all the closings and restructurings that were discussed previously?

Gregg Bresner: Yes.

Steven Martin: This is probably something you talked about on the third quarter. Interest income from Q2 to Q3 to Q4 went from 57% to 64% and then back down to 64% — 56%. What was the anomaly in Q3 that accounted for that?

Keith Franz: Yes. Good morning. This is Keith. So in Q3 we had some make whole fees that we recognized as a result of some exits and some additional income recognized as a result of some restructuring transaction that brought back and recaptured some income.

Steven Martin: Yes. I figured you had mentioned it, but I just couldn’t find a note on it. Where do you stand on PIK sequentially and going forward?

Gregg Bresner: So, we discussed some in our conference today, our PIK income is diversified and it’s usually driven by structured situations where we’re picking up enhanced yield for the PIK flexibility. We do expect over time that number to come down as our current portfolio refinances or gets repaid in those structured situations. So, over time, we do expect it to come down. But again, it’s more opportunistic. What we’ve chosen strategically is we would rather for special situations be PIK secured at the top of the capital structure than do equity co invest in mezz which are junior securities where you have a lot more capital structure risk. So for us, we find it’s a good risk return trade-off.