Crescent Capital BDC, Inc. (NASDAQ:CCAP) Q3 2023 Earnings Call Transcript

Crescent Capital BDC, Inc. (NASDAQ:CCAP) Q3 2023 Earnings Call Transcript November 9, 2023

Operator: Good afternoon, ladies and gentlemen, and welcome to the Q3 2023 Crescent Capital Inc. Earnings Conference Call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct the question-and-answer session. [Operator Instructions] This call is being recorded on Thursday, November 9, 2023. I would now like to turn the conference over to Dan McMahon. Please go ahead.

Dan McMahon: Good morning and welcome to Crescent Capital BDC Inc’s third quarter ended September 30, 2023, earnings conference call. Please note that Crescent Capital BDC, Inc. may be referred to as CCAP, Crescent BDC or the company throughout the call. Before we begin, I’ll start with some important reminders. Comments made over the course of this conference call and webcast may contain forward-looking statements and are subject to risks and uncertainties. The company’s actual results could differ materially from those expressed in such forward-looking statements for any reason, including those listed in its SEC filings. The company assumes no obligation to update any such forward-looking statements. Please also note that past performance or market information is not a guarantee of future results.

During this conference call, we may discuss certain non-GAAP measures as defined by SEC Regulation G, such as adjusted net investment income or NII per share. The company believes that adjusted NII per share provides useful information to investors regarding financial performance because it’s one method the company uses to measure its financial condition and results of operations. A reconciliation of adjusted NII per share to NII per share, the most directly comparable GAAP financial measure can be found in the accompanying slide presentation for this call. In addition, a reconciliation of this measure may also be found in our earnings release. Yesterday, after the market closed, the company issued its earnings press release for the third quarter ended September 30, 2023, and posted a presentation to the Investor Relations section of its website at www.crescentbdc.com.

The presentation should be reviewed in conjunction with the company’s Form 10-Q filed yesterday with the SEC. As a reminder, this call is being recorded for replay purposes. Speaking on today’s call will be CCAP’s President and Chief Executive Officer, Jason Breaux; Chief Financial Officer, Gerhard Lombard, and Managing Director, Henry Chung. With that, I’d now like to turn it over to Jason.

Jason Breaux: Thank you, Dan. Hello, everyone, and thank you for joining our earnings call. We appreciate your continued interest in CCAP. I’ll begin the call by providing a brief overview of our third quarter results before discussing the current market environment in more detail. I’ll then turn it over to Henry to review our recent investing activity and portfolio performance. Gerhard will then review our financial performance for the third quarter. Before we begin, you will note the presentation format has changed. We trust the content remains helpful in providing an overview of CCAP’s performance. The revised format is Crescent’s brand refresh, which reflects the growth and consistency of our firm, investing in private and tradable corporate credit over the past 30-plus years.

Let’s begin. Please turn to Slide 6, where you’ll see a summary of our results. For the third quarter, we reported record net investment income of $0.59 per share, up from $0.56 per share in the prior quarter. This quarter’s net investment income continues to reflect the strength in the core earnings power of our portfolio as we over earned our regular dividend by 44%. We also paid our first supplemental dividend in September, which was $0.08 per share and announced on last quarter’s call. CCAP’s overearn of the combined dividend payments, coupled with unrealized appreciation in the portfolio on a net basis, resulted in net asset value per share of $19.70 as of quarter end, up 0.6% as compared to the prior quarter. For the third quarter, we are pleased to declare a supplemental dividend of $0.09 per share, $0.01 higher than last quarter’s supplemental dividend payable on December 15.

As a reminder, these supplemental dividends are calculated as 50% of net investment income in excess of our regular $0.41 per share dividend, subject to a measurement test. Our Board also declared a regular dividend of $0.41 per share for the fourth quarter payable on January 16, 2024, which represents the 20th consecutive quarter of CCAP paying a regular dividend of $0.41. Please turn to Slides 13 and 14 of the presentation, which highlights certain characteristics of our portfolio. We ended the quarter with approximately $1.6 billion of investments at fair value across a highly diversified portfolio of 185 companies with an average investment size of approximately 0.5% of the total portfolio. Our investment portfolio continues to consist primarily of senior secured first lien and unitranche first lien loans, collectively representing 89% of the portfolio at fair value at quarter end, unchanged from the prior quarter.

This speaks to our continued focus on maintaining a defensively positioned portfolio with greater downside protection and lower risk of loss compared to second lien and subordinated debt focused portfolios. We remain well diversified across 20 industries and continue to lend almost exclusively to private equity-backed companies, with 98% of our debt portfolio and sponsor-backed companies as of quarter end. In terms of industry composition, you can see on the right-hand side of Slide 14 that the majority of our investments continue to be in services-based businesses, with a particular focus on health care, software and commercial and professional services. This is by design as Crescent’s private credit team has always focused on underwriting free cash flow-generative businesses in what we deem to be more recession-resilient industries.

A few more credit trends to review. Performance ratings and nonaccrual levels. Our weighted average portfolio grade of 2.1 remains stable quarter-over-quarter. And on Page 17, you will see that the percentage of risk rated one and two investments the highest ratings our portfolio companies can receive accounted for 89% of the portfolio at fair value, up from 87% last quarter. As of quarter end, we had investments in 9 portfolio companies on nonaccrual status representing 2.3% and 1.8% of our total debt investments at cost and fair value, respectively. Moving to the current market backdrop. Activity levels have picked up in the second half of 2023, with new issuance in the third quarter, hitting its highest mark since the rate hike onset in Q1 2022.

During the third quarter, market pricing and terms continue to be attractive for new transactions. Credit spreads on new loans are above historical averages, leverage levels are lower and equity contributions are at historical highs. We’ve continued to see private credit to take share from the broadly syndicated market, which we believe, to some extent, is a more permanent structural shift. Looking ahead to the remainder of this year and 2024, we expect to see a continued uptick in M&A activity. On the demand side, private equity dry powder is at record levels and on the supply side, an increasing number of private companies are looking for potential exit opportunities with many backed by sponsors that may be seeking to monetize longer-held investments.

While these dynamics should lead to an acceleration of sponsor-to-sponsor portfolio company transactions, the current geopolitical situation, perceptions around a slowing economy and potential recession and a higher for longer rate environment continued to weigh on the deal environment. When activity does pick up further, we do believe that Crescent’s focus on sponsor-backed opportunities and our deep relationships in the space position us well to benefit. I’d now like to turn it over to Henry to discuss our Q3 investment activity. Henry?

Henry Chung: Thanks, Jason. Please turn to Slide 15 where we highlight our recent activity. Gross deployment in the second quarter totaled $45 million. As you can see on the left-hand side of the page, 99% was in senior secured first lien and unitranche investments. During the quarter, we closed on 3 new investments totaling $20 million with the remaining $25 million coming from incremental investments in our existing portfolio companies. The new investments during the third quarter were loans to private equity-backed companies with silver floors, attractive fees and a weighted average spread of approximately 590 basis points. Underscoring Jason’s earlier point about the historically attractive relative value we were able to achieve in the current market, the weighted average loan to value of our new investments for the quarter was below 30%.

The $45 million in gross deployment compares to approximately — in aggregate exits, sales and repayments. We continue to remain highly selective from a credit and risk-adjusted return perspective and maintaining a long-term strategic view on capital deployment that is insulated by our orientation of first lien credit risk in noncyclical industries. We remain focused on the continued rotation of the acquired First Eagle BDC assets and maintaining stable leverage levels and have progressed on both of these fronts during the third quarter. Balance sheet leverage is down quarter-over-quarter and as of last Friday, we had realized approximately 26% of the acquired First Eagle portfolio since closing in March. 100% of the aforementioned $62 million in aggregate exits during the third quarter were First Eagle names.

Turning to Slide 16. You can see that the weighted average yield of our income-producing securities at cost increased quarter-over-quarter from 11.7% to 11.9% and is up 240 basis points year-over-year, driven by the increase in the respective base rates. As of September 30, 99% of our debt investments at fair value were floating rate with a weighted average floor of 80 basis points which compares to our 66% floating rate liability structure based on debt drawn with 0% floors. Overall, our investment portfolio continues to perform well with strong year-over-year weighted average revenue and EBITDA growth. That being said, we have continued to closely monitor the impact of rising borrowing costs on our portfolio companies. The weighted average interest coverage of the companies in our investment portfolio at quarter-end held stable at 1.7 times.

It is important to note that we calculate our interest coverage ratio using annual interest expense that reflects the latest respective base rates in contrast to a trailing 12-month interest expense calculation, which would have resulted in an interest coverage ratio of 2 times. We believe this provides a more relevant metric when evaluating the ability of our portfolio companies to continue to service their respective interest obligations. We also continue to closely monitor how our portfolio companies are managing fixed operating charges in this environment. Our analysis demonstrates that our portfolio companies in the aggregate are well positioned to address fixed charges with operating cash flows and available balance sheet liquidity. At quarter end, approximately 64% of aggregate revolver capacity was available across the portfolio, an increase from 60% in the prior quarter, and we have not seen increasing aggregate revolver utilization during the third quarter.

Our private equity partners have been active in managing costs, particularly SG&A in this environment, and we are starting to see operating results that demonstrate the effectiveness of the actions that have been taken. A significant majority of our portfolio companies have grown both revenue and EBITDA on a year-over-year basis. Additionally, we have seen some improvement in margin pressures at our portfolio companies that resulted from COVID-related economic pressures particularly supply chain issues and elevated employee turnover. While the current rate environment and economic outlook present a challenging environment for our companies to navigate, we are encouraged by the results of the early actions to our sponsors and management teams have taken to date.

The strength of our portfolio continues to benefit from the substantial amount of equity invested in our companies. Most of it is applied by large and well-established private equity firms with whom we have long-standing relationships that have partnered with in multiple transactions. The weighted average loan-to-value in the portfolio at the time of underwriting is approximately 41%, which provides us a margin of safety from an enterprise value coverage perspective. Crescent’s track record of successfully managing through multiple economic and market cycles provides us a significant and relevant experience to navigate the challenges that the current environment brings with it. With that, I will now turn it over to Gerhard.

Gerhard Lombard: Thanks, Henry, and hello, everyone. Our net investment income per share of $0.59 for the second quarter of 2023 compared to $0.56 per share for the prior quarter. Total investment income of $48.2 million for the second quarter compared to $46.7 million for the prior quarter, representing an increase of approximately 3%. Recurring yield related investment income comprised of interest income, pick income, amortization and unused fees and dividend income from the Logan JV was up 2% quarter-over-quarter from $45.7 million to $46.7 million ultimately accounting for 97% of this quarter’s total investment income. PIK income continues to represent a modest portion of our revenue at 2% of total investment income, which, based on our analysis, is one of the lowest levels in the space given our focus on market-leading companies with strong margins and high free cash flow generation.

Our GAAP earnings per share or net increase in net assets resulting from operations for the second quarter of ’23 was $0.61, unchanged from the prior quarter. At September 30, our stockholders’ equity was $730 million, resulting in net asset value per share of $19.70 as compared to $726 million or $19.58 per share last quarter. Net investment excess of $17 million, offset by net portfolio appreciation contributed to total portfolio value of $1.6 billion as of September 30, down approximately $16 million quarter-over-quarter. Now let’s shift to our capitalization and liquidity. I’m on Slide 19. As of September 30, our debt-to-equity ratio was 1.18x down from 1.19x in the prior quarter. The weighted average interest rate on our borrowings was 7.01% as of quarter end.

As we’ve highlighted on the right-hand side of the slide, there are no debt maturities until 2026. Our liquidity position remains strong with $370 million of undrawn capacity, subject to leverage, borrowing base and other restrictions and $22.8 million of cash and cash equivalents as of quarter end. We believe this level of dry powder positions us well to selectively invest in new opportunities while continuing to support our existing portfolio company commitments. Finally, for the fourth quarter of 2023, our Board declared a $0.41 per share quarterly cash dividend, which will be paid on January 16, 2024, to stockholders of record as of December 29, 2023. Additionally, as Jason discussed, our Board declared a supplemental cash dividend of $0.09 per share, which will be paid on December 15, 2023 to stockholders of record as of November 30, 2023.

And with that, I’d like to turn it back to Jason for closing remarks.

Jason Breaux: Thanks, Gerhard. In closing, we’re pleased with our strong financial results for the quarter and believe CCAP remains well positioned to continue to deliver strong results going forward. Our portfolio is diverse and healthy, and we are in excellent financial condition to selectively capitalize on the current investment environment. On an annualized basis, we’re currently delivering $2 per share in total dividends, which translates into a 10.2% yield on CCAP’s current NAV and an over 12% yield on CCAP’s current stock price, which we view as highly attractive given our predominantly first lien focus and track record of NAV stability. As always, we appreciate you all joining us today, and we look forward to speaking with you next quarter. And with that, operator, we can open the line for questions.

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Q&A Session

Operator: [Operator Instructions] Your first question comes from the line of Robert Dodd from Raymond James. Your line is now open.

Robert Dodd: Congratulations on the quarter. Some questions. I mean, first, on the first you talked about, obviously, you realized 26% of the assets from that. So a quarter gone, three quarters left to go. Can you give us any color on kind of the mix. Obviously, the ones that are easiest to refinance usually the performance and then the struggles tend to get that went later. I mean OEMs still their load basis still there, et cetera, some historic problem names that aren’t a big PC of portfolio that could give us a headache. Can you give us any update on how the rotation of the more troubled names in that portfolio is going?

Jason Breaux: Robert, it’s Jason. Thanks for the question. You’re right. I would say the noncore bucket of the portfolio that we identified when we acquired the book is still in place. I think we feel comfortable about where we’ve generally marks those positions and underwrote those positions. Those are not positions that we need to rush to exit. And it was our expectation that those might take some time to further develop and ultimately monetize. So I think your observation is accurate. We have fully realized 20 names out of that 26%, but they all fall within the core bucket. I wouldn’t say that they are just all natural realizations. I think there has been some proactive sort of movement on our part to try to rotate some of those names.

Robert Dodd: And then on the — I think the LTV for the quarter was about 30%. And you mentioned in your opening remarks, leverage is down, equity checks are up. I mean on that 30%, can you give us — so I mean, obviously, if — for example, if the ARR loans, we expect them to be low anyway. Is that mix the type of businesses? Or is it just the firms writing bigger checks in order to underwrite to get lower interest or better interest coverage at the current market would imply otherwise.

Henry Chung: Yes. Thanks for the question. This is Henry. I’ll take that one. On the first part of your question, no, none of these are ARR loans. That’s just not an area that we focus on historically nor 1 that we intend to focus on here in the near term. They’re all — your typical renewal cash flow-based loans. I think you hit the nail on the head on the second point. We are seeing, especially in this rate environment, sponsors are very focused on capitalizing the businesses in a way that not withstand the current rate environment that we’re in. And oftentimes, especially with base rates where they are today, that’s going to be much more moderate levers than what we saw in a zero rate environment just a couple of years ago.

So I think part of it is certainly the — I think a thoughtful approach to capitalization from sponsors. I think the other side of that is also really disciplined on our end. There are certainly other sponsors that are out there that are still kind of trying to pursue what I would say, very full capital structures. And for us, credit is quite binary in terms of whether or not it fits our box. And if it doesn’t fit the profile that we’re looking for with respect to the amount of cash flow the business generates and its ability to cover its debt service. That’s just something that’s not going to work for our portfolio and one that will we just look to pass on versus stretch on and or price that risk.

Jason Breaux: The other thing I’d add to agree with everything Henry said is that, as you know, we’ve talked in the past, Robert, about PIK interest and that as a percentage of our portfolio and of our top line, which is something we really try hard to minimize. And so as Henry mentioned, when buyers, private equity firms or other buyers are looking to put in place more full aggressive cap structures, there’s — you’ll oftentimes find in this environment, a PIK component in those cash structures given where base rates are. And those are the types of deals that I think we obviously see them. We evaluate them. We’ll participate on a very selective basis, but we overall are trying to keep our PIK income at a very modest level in our top line.

Robert Dodd: If I can ask you to stretch the time line a little bit more to your point, sponsors are going to look to monetize more assets in 2024, right? It looks like currently, later is still going to be pretty high in 2024. So do you expect that kind of structures we see in 2024 to be more reminiscent of what you’re doing in the third quarter here or do you think there’s going to be some different evolution as we go through 2024, if monetization for funds does increase, but rates remain high. Same kind of — does Q3 apply to next year, I guess, is the question.

Jason Breaux: I think that’s a great question. It’s something we’re thinking a lot about. And I think we’re going to see segments of the market evolve a bit depending on, I would say, the risk profile of the buyers and the lenders attached to those buyers in a very low rate environment, which we experienced for several years, you saw secured debt continue to grow at a multiple of cash flow and that wasn’t necessarily surprising. Now we’re in a different reality and with where base rates where they’re at. I think what you’ll start to see more of are these conservative structures, as Henry outlined, for Q3 activity or potentially more aggressive leverage levels, but with maybe a more traditional first lien loan that’s cash pay and more junior oriented piece of paper that might have a pick toggle option or a portion of it as PIK to help owners manage their fixed charge burden in these acquisitions.

So I do think it’s something that we’re going to start to see more of in ’24 than we’ve seen in some time.

Operator: Your next question comes from the line of Ryan Lynch from KBW. Your line is now open.

Ryan Lynch: First question I had, kind of following up on the previous line of question with the loan to value 30% below 30% loan to value on kind of on the investments made this quarter. It seems like that in combination with — if I look at your overall weighted average spread on new investments, which was 5.9% versus 6.7% in the prior quarter. It feels like you guys are purposely sort of derisking on the new investments or your willingness on the level of safety you guys want on new investments. Is that fair to assume that that’s what’s happening? Or are the terms and structures on these new investments coming to market? Or are these just representative of kind of what’s coming to the market today?

Jason Breaux: Ryan, it’s Jason. Thanks for the question. I think it’s a little bit of both. I think we are certainly trying to be selective in our underwriting in this environment. Not to mention, we’re sort of at a leverage level on the overall fund that we’re comfortable at. And so we’re not looking to meaningfully lever up from where we are. The second point I would say is that because we are in a slower volume environment, albeit certainly a tick up from Q2 that slower deal flow combined with significant capital that’s been raised targeting private credit has forced pricing to tighten a bit. So I would say we’re generally probably 25 basis points to 50 basis points inside of where we were a quarter or so ago where unis now are in the, I would say, 5.50, 5.75 range.

And first liens, not stretch are in the 5.00 to 5.25 range today. So I think you’ve got a little bit of our conservative bias, but in addition to that, just a supply-demand imbalance, which we hope to even out and become more rational in ’24.

Ryan Lynch: The other question I had was, I think you said 26% of the FCRD portfolio has been realized at this point. I’m just curious, from an aggregate level of those investments exited, do you know what sort of value you guys got versus what you guys purchased those investments for? And then separately, on that point, it sounds like some of them were kind of exited in a normal course and maybe sounds like you’re proactive in some of those exits. If the M&A environment does pick up over the next — going into 2024, which it seems to be — do you think that, that would result in a higher correlation or some correlation of you being able to and actually exiting the FCRD portfolio at a faster clip or do you think a more active M&A environment doesn’t really have a high correlation with your ability to — and speed of exiting those investments?

Henry Chung: Thanks for the question, Ryan. This is Henry. I’ll take that one. The first question that you had on the fair value or the realized value relative to onboard cost basis. So we exited all the investments that we’ve realized either at or above cost — the respective cost basis that, that applies to the 20 investments that Jason referenced in an earlier question, with respect to where were those shook out at. On the second point, I think it’s an interesting 1 because we did see a similar dynamic with Alcentra. We closed Alcentra right before the onset of COVID-19. So we closed that portfolio over that acquisition into an environment where there is no deal activity. And then obviously, as we all recall, in 2021 and in the early part of 2022, M&A activity picked up quite dramatically.

And we saw a very, I’d say, fast acceleration in the rotation of that portfolio during that time frame as well. It’s a little analogous to what we’re seeing with First Eagle, where we closed First Eagle right before Silicon Valley Bank got taken over by the FDIC and I think we all know that the deal environment was quite anemic shortly thereafter. And we are starting to see activity pick up, albeit modestly and I think my expectation would be that as we see just M&A volumes pick up, given that almost all of these businesses that we have in the portfolio are sponsor backed. And if there’s an attractive opportunity for sponsors to be able to monetize assets, they’re certainly not going to be shy about doing so. I can certainly see that potentially happening again here.

Operator: [Operator Instructions] There are no further questions at this time. Please continue.

Jason Breaux: Thank you, operator. Well, once again, I’d like to thank you all for joining our earnings call today and appreciate the questions, and we look forward to speaking with you again soon.