Crescent Capital BDC, Inc. (NASDAQ:CCAP) Q4 2023 Earnings Call Transcript

Crescent Capital BDC, Inc. (NASDAQ:CCAP) Q4 2023 Earnings Call Transcript February 22, 2024

Crescent Capital BDC, Inc. 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 afternoon, ladies and gentlemen and welcome to the Crescent Capital BDC, Inc. Fourth Quarter Earnings Conference Call. [Operator Instructions] This call is being recorded on Thursday, February 22, 2024, and 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 fourth quarter and year ended December 31, 2023, Earnings Conference Call. Please note that Crescent Capital BDC, Inc. maybe 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 net investment income per share to net investment income 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 fourth quarter and year ended December 31, 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-K 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 Chief Executive Officer, Jason Breaux; Chief Financial Officer, Gerhard Lombard; and Managing Director, Henry Chung, who was recently appointed to serve as President of CCAP. 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 provide some fourth quarter and full year highlights, touch on our current portfolio and provide some commentary on what we are seeing in the market. 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 fourth quarter. Let’s begin. Please turn to Slide 7. The headline is that CCAP had an excellent quarter. After the market closed yesterday, we reported net investment income of $0.61 per share for the fourth quarter corresponding to an annualized NII ROE of 12.4%. The $0.61 per share of NII is up from $0.59 per share in the prior quarter, which culminated in a year of record net investment income of $2.30 per share.

These results largely reflect the continued strong credit performance of our portfolio, and the earnings benefits of higher market interest rates on our primarily floating rate portfolio. The strength of our earnings and positive valuation momentum in our portfolio also led to growth in our net asset value which increased 1.7% in the quarter and 1.1% year-over-year to $20.04 per share. Net income per share was $0.83 in the fourth quarter corresponding to an annualized ROE of 16.9%. Please turn to Slides 14 and 15 of the presentation, which highlights certain characteristics of our portfolio. We ended the year with approximately $1.6 billion of investments at fair value across a highly diversified portfolio of 186 companies with an average investment size of approximately 0.5% of the total portfolio.

We have deliberately maintained an investment portfolio that consists primarily of senior secured first lien and unitranche first lien loans, collectively representing 89% of the portfolio at fair value at year-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 portfolios with greater second lien and subordinated debt exposure. We have focused our investing efforts on non-cyclical industries with high free cash flow characteristics and remain well diversified across 20 industries. Our investments are almost entirely supported by well-capitalized private equity sponsors with 98% of our debt portfolio and sponsor-backed companies as of year-end.

We’ve been pleased with the fundamental performance of our portfolio, as indicated by our performance ratings and non-accrual levels. Our weighted average portfolio grade of 2.1 remained stable quarter-over-quarter, and on Page 18, you will see that the percentage of risk rated 1 and 2 investments, the highest ratings our portfolio companies can receive accounted for 87% of the portfolio at fair value. As of year-end, we had investments in 9 portfolio companies on non-accrual status, representing 2.0 and 1.9% of our total debt investments at cost and fair value, respectively. Moving to the market backdrop. Over the past year, we’ve largely operated in an environment, where the ongoing impact of higher interest rates and future rate uncertainty, have constrained new LBO activity.

These dynamics weighed on the deal environment for most of 2023 as evidenced by U.S. LBO transaction volume reaching its lowest level in 10 years and down nearly 40% from the trailing 10-year average. However, during the fourth quarter, we did see a meaningful improvement in deal volume relative to the first three quarters of 2023, and the consensus seems to be that this trend is going to continue. 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 back by sponsors that may be seeking to monetize longer-held investments. With motivated sponsor buyers and sponsor sellers, we are cautiously optimistic about deal volumes for 2024.

Given Crescent’s deep relationships with private equity sponsors that span in excess of 3 decades, we are well positioned to benefit from an increase in LBO activity. For the fourth quarter, we are pleased to declare a supplemental dividend of $0.10 per share, $0.01 higher than last quarter’s supplemental dividend payable on March 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. The increased supplemental dividend comes from a record earnings quarter and our maintained focus on aligning ourselves with our shareholders. While future supplemental dividend declarations are at the discretion of our Board of Directors, it is our intent and expectation that CCAP will continue to distribute quarterly supplemental dividends for the foreseeable future given base rates are above historical averages, and we have meaningful undistributed taxable income which is generated by earnings in excess of our dividends.

Our Board has also declared a regular dividend of $0.41 per share for the first quarter, payable on April 15, 2024, which represents the 21st consecutive quarter of CCAP paying a regular dividend of $0.41. Together with the $0.10 supplemental, these distributions correspond to an annualized dividend yield of 10.2% based on CCAP’s NAV per share as of December 31, 2023. I’d now like to turn it over to Henry to discuss our Q4 investment activity and portfolio commentary. Henry?

Henry Chung: Thanks, Jason. Please turn to Slide 16, where we highlight our recent activity. Gross deployment in the fourth quarter totaled $89 million. As you can see on the left-hand side of the page, 98% of which was in senior secured first lien and unitranche investments. During the quarter, we closed 10 new platform investments totaling $60 million, representing $81 million in commitments with the remaining $29 million coming from the incremental investments in our existing portfolio companies. The $89 million in gross deployment compares to approximately $87 million in aggregate exits, sales and repayments. The new investments during the fourth quarter were loans to private equity-backed companies with sulfur floors, attractive fees and a weighted average spread of approximately 600 basis points.

We continue to back well-capitalized borrowers with significant equity cushions and the weighted average loan to value of our new investments for the quarter was 36%. We remain highly selective from a credit and risk-adjusted return perspective and maintain a long-term strategic view on capital deployment that is insulated by our orientation to first lien credit risk and non-cyclical industries. Diving a bit deeper on the latter, I’d like to spend a few minutes on CCAP’s two most heavily weighted industry exposures, healthcare equipment and services and software and services. Let’s start with healthcare, which is CCAP’s largest industry exposure at approximately 26% of the portfolio at fair value as of year-end. We are mindful of our concentration of healthcare providers and view it as important to note that approximately half of our healthcare industry exposure or 13% of the overall portfolio, our investments in actual providers.

These businesses have stable demand drivers that are attractive from a credit perspective, but we are mindful of reimbursement and margin pressures that these businesses may face, particularly in this environment. This particular sub-sector has performed well with a weighted average risk rating leverage and fixed charge coverage ratios that are in line with the broader CCAP portfolio. We have deemphasized specialties and practice areas that have been most acutely affected by legislative changes, in particular, emergency services. Additionally, we are fully confident of the challenges facing healthcare provider rollout strategies that were popularized in the zero-interest rate environment and note that we have a de minimis amount of delayed draw commitments to our healthcare provider portfolio companies.

The other half of our healthcare industry exposure is in revenue cycle management, distributors medical equipment manufacturers and other service providers that are not generally subject to REC reimbursement from payers. With respect to our software investments, which is our second largest industry concentration at 21% of the overall portfolio, our investment focus is providing conventional cash flow-based leverage financing to mature sponsor-backed companies. We do not lend to free cash flow companies or originate annual recurring revenue-based loans and our underwriting to software businesses is the same as any other sector, whereby the cash flow to the company needs for our credit. Let’s shift gears. Next month marks one year since the closing of our acquisition of the First Eagle BDC.

When we announced the acquisition, we noted that we had established a successful playbook to onboard, monitor and appropriately monetize an acquired BDC portfolio given our acquisition of Alcentra in 2020. The remaining investments in the acquired First Eagle portfolio have largely performed to expectations to date with a weighted average risk rating of 2.3 unchanged since the time of acquisition. To date, we have rotated our 21 investments representing 27% of the First Eagle portfolio. As a result, the First Eagle portfolio represented 15% of CCaaS total investment portfolio as of year-end. First Eagle’s pre-2020 vintage legacy investments which were a key area of focus during our diligence accounted for 1.3% of CCAP’s combined portfolio at cost and fair value, respectively, as of year-end.

We will note that we acquired the subset of the portfolio at an over 70% discount to First Eagle respective cost basis at the time of the acquisition. Turning back to the broader portfolio. Please flip to Slide 17. You can see that the weighted average yield of our income-producing securities at cost remained flat quarter-over-quarter at 11.9% and is up 110 basis points year-over-year, driven by the increase in the respective base rates. As of December 31, 99% of our debt investments had a fair value of floating rate with a weighted average floor of 80 basis points, which compares to our 65% 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 helped save at 1.7x based on the latest annualized base rates. We also continue to closely monitor how our portfolio companies are managing fixed operating costs 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. As of year-end, approximately 64% of aggregate revolver capacity was available across the portfolio, unchanged from the prior quarter, and we have not seen an increase in aggregate revolver utilization during the fourth quarter.

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 and have partnered with in multiple transactions. And we note that the weighted average loan-to-value in the portfolio at the time of underwrite approximately 41%. With that, I will now turn it over to Gerhard.

Gerhard Lombard: Thanks, Henry, and hello everyone. Our net investment income per share of $0.61 for the fourth quarter of 2023 compared to $0.59 per share for the prior quarter and $0.52 per share for the fourth quarter of 2022. Total investment income of $50 million for the fourth quarter, the highest quarterly figure we’ve reported since inception compared to $48.2 million for the prior quarter, representing an increase of approximately 4%. Importantly, the quality of our income remains very strong. Recurring yield related income accounted for 96% of this quarter’s total investment income and PIK income continues to represent a modest portion of our revenue at less than 3% of total investment income. 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 income for the fourth quarter of 2023 was $0.83, an increase of 36% from the prior quarter. This was the result of net investment income outpacing the regular and supplemental dividends, coupled with $0.40 per share of net unrealized depreciation, largely a result of spread tightening. At December 31, our stockholders’ equity was $743 million, resulting in net asset value per share of $20.04 and as compared to $730 million or $19.70 per share last quarter. Now let’s shift to our capitalization and liquidity. I’m on Slide 20. We continue to maintain a conservative mindset to both balance sheet liquidity and BDC leverage, managing the company with a full economic cycle mentality. While this starts with our underwriting of new investment opportunities, it also applies to how we manage CCAP’s capitalization and liquidity, managing leverage to the lower end of our targeted range while ensuring strong balance sheet liquidity affords us the ability to invest in new platform companies even in periods of volatile capital markets when risk-adjusted returns can be particularly attractive.

As of December 31, our debt-to-equity ratio was 1.15x, down from 1.18x in the prior quarter. Our liquidity position remains strong with $330 million of undrawn capacity subject to leverage, borrowing base and other restrictions and $24.5 million in cash and cash equivalents as of year-end. The weighted average stated interest rate on our total borrowings was 7.02% as of year-end. And we’ve highlighted on the right side of the slide that there are no debt maturities until 2026. Finally, for the first quarter of 2024, our Board declared a $0.41 per share quarterly cash dividend, which will be paid on April 15, 2024, to stockholders of record as of March 29, 2024. Additionally, as Jason mentioned, our Board declared a supplemental cash dividend of $0.10 per share, which will be paid on March 15, 2024, to stockholders of record as of February 29, 2024.

In terms of our taxable income spillover, we currently estimate that we ended 2023 with approximately $35 million or $0.94 per share from 2023 for distribution to stockholders in future quarters. This level is more than 2x our current quarterly base dividend, which we believe is very beneficial to the stability of our dividend. And with that, I’d like to turn it back to Jason for closing remarks.

Jason Breaux: Thanks, Gerhard. Before we wrap up, I’d like to spend a minute on our public track record. I’m on Slide 5. This month marks the 4-year anniversary of CCAP’s public listing. A lot has changed in the world since February 2020. The administration in Washington, the global pandemic, 11 Fed rate hikes, a lot has changed at CCAP 2. Total book value has grown by over 80%. Our investment portfolio has grown by over 70%. Insider ownership of CCAP shares is up over 4x since Q4 of 2019. We’ve progressed on a number of technical fronts as well. Market capitalization has grown by approximately 30% and average daily trading volume has doubled, making it easier for investors to own our stock. What hasn’t changed is our focus on maintaining a defensively positioned portfolio that delivers a stable NAV profile with consistent dividend coverage.

Since listing, our NAV per share is up over 3%, the percentage of the portfolio that’s first lien is up from 85.5% to nearly 90%. Non-accruals are down. PIK interest remains a very low percentage of total investment income and we’ve delivered a 37% total economic return per share, measured as change in NAV plus total dividends. We believe our portfolio is diverse and healthy, and we are in excellent financial condition to selectively capitalize on the current investment environment. As always, we appreciate you all joining us today, and we look forward to speaking with you soon. And with that, operator, we can open the line for questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] First question comes from Robert Dodd from Raymond James. Please go ahead.

Robert Dodd: Hi, everyone. Congratulations on a really nice quarter. So a few questions. I want to start off with Jason. In your prepared remarks, I think you said Q4 volume was up. We’ve obviously heard that from others. The consensus was the trend would continue. I mean do you agree with the consensus? Or do you have a different opinion or any thoughts on what you think about the forward trend and what’s in the pipeline, for example, would be appreciated.

Jason Breaux: Hi, Robert, thank you for the question. It’s Jason. I would say I think the term I used in the prepared remarks was cautious optimism for 2024. However, what I would say that we had a pretty active January and I would say, things have slowed down a bit here in February, which is interesting and curious potential explanations maybe for the slower start to the year, at least what we’re seeing right now are some of the recent Fed comments around the time line pushing out for future rate decreases. Certainly, the macro uncertainties that are out there around the world as well and the continued challenge of getting to purchase price equilibrium between buyers and sellers. I will still say, we are optimistic that deal flow will increase in 2024, certainly.

And maybe it’s perhaps a bit more back-end weighted, but given the combination of a significant amount of private equity dry powder that needs to be put to work and the pressure on sponsors from LPs to return capital we are optimistic for volumes over the course of ‘24.

Robert Dodd: Got it. I appreciate that. And then I will cut to the latest, I mean in Q4, I mean activity did pick up fairly significantly versus earlier in the year 2023, yet your weighted average spread on new investments was remarkably stable. I mean it was 600 bps in the fourth quarter was from that 519 bps despite a pickup in activity. So, do you think the spreads on the kind of deal you are doing, obviously, like-for-like house, have they stabilized here, or do you think there is prospectively more pressure could happen, but right now, they kind of hang in this kind of 600 bps?

Jason Breaux: I would say pricing has tightened a bit here over the last six months and maybe a bit more recently. But certainly, private credit continues to carry an attractive premium relative to the syndicated market. The tightening in the syndicated market has resulted in the average premium in the private market over BSL rising to over 200 basis points in January, which is a six-month high and up from a little over 100 basis points a year ago. That spread, that 200 basis points, I think will tighten again over time. But because of that tightening in the BSL market, that’s really put, I would say, more pressure on the upper bid market in private credit. So, call it, a couple of hundred million of EBITDA and larger which is oftentimes a BSL replacement option versus the tightening that we are seeing in the core and lower-mid market, which is where Crescent spends most of its time, core-mid market, I would say, is sort of 50 to 150 and lower-mid market is 10 to 50.

We are seeing a bit of tightening there, but I would say it’s not as acute as what the upper-mid market is currently experiencing. The other pressure on the upper-mid market besides sort of comping to BSL is the amount of inflows coming in that’s chasing that opportunity, particularly from some sizable institutional products, but also from the significant capital that’s coming in on the non-traded BDC side of things from the retail market. If I were to characterize pricing today, I would say, for unis in the lower-mid market, I would say, we are still in the 50, 75, up to 625 million range in the core-mid market, probably 550, 575, and then in the upper-mid market, I think it’s tighter than that, probably 525 to 550.

Robert Dodd: Got it. Thank you. That is incredibly helpful. Thank you and congratulations for very solid quarter.

Jason Breaux: Thank you.

Operator: [Operator Instructions] Next question comes from Paul Johnson from KBW. Please go ahead.

Paul Johnson: Yes. Good afternoon guys. Thanks for taking my questions. You guys are at the lower end of sort of your target range here, net leverage, and you are obviously generating a very strong ROE. Do you think going forward this year, kind of in this more uncertain environment, holding back on originations a little bit, maybe even kind of de-risking the BDC is something that you would be looking to do, or is it more about just kind of the activity, I guess that you have in front of you? And what’s obviously the attractive set of opportunities that you are evaluating?

Jason Breaux: Hey. Thanks Paul for the question. This is Jason. I would say that we have been operating with a leverage profile that I think is already sort of conservatively minded. We have been operating in an uncertain environment around rates in the economy. Certainly a year ago, I think the consensus was that we were going to be in recession in 2023. That obviously didn’t happen. But because of sort of that mentality and that caution, we have tried to – post-acquisition of the First Eagle transaction, we have really tried to maintain to slightly de-lever relative to our target range so that we are operating kind of on the lower half of our target stated debt to equity range. And I think that’s a range – that’s a level that we are comfortable with in this environment.

Henry Chung: And Paul, I think – this is Henry speaking. One other thing to note here is the rotation of the First Eagle assets that is still currently in process. So, as those assets monetize, we would seek to reinvest those in directly originated loans from the Crescent platform here. So, if you look at the Q4 activity on a net basis, we were up modestly on a quarter-over-quarter basis. But if you look at the overall activity here, there is a fair amount of realizations just due to the rotation of that book relative to new deployment within the quarter.

Paul Johnson: Got it. That makes sense. And I appreciate the color there. Now, I was just wondering if you could maybe, if it’s possible, just touch on any sort of fundraising efforts the advisor has outside of the BDC, it’s possible to provide any sort of numbers or targets that you are looking to potentially raise and will these assets be, I guess in line with CCAP’s core strategy?

Jason Breaux: Yes. Hey Paul, it’s Jason again. Thanks for the question. I think what I can say is CCAP overall – or Crescent overall is a $40-plus billion platform, of which $30 billion of that is in private credit. If you think about CCAP, that’s just under a couple of billion of that $30 billion. So, we have got some fairly significant affiliated institutional funds that CCAP sits alongside at Crescent that focuses on private credit, whether it’s lower-mid market or core-mid market U.S. and Europe. And so I think what I could say is that we are regularly in the market with institutional funds focused on private credit and certain segments of private credit. That’s nice for CCAP because as a $1.6 billion portfolio, we can maintain really nice diversification within our portfolio and still be very relevant in the marketplace because as we participate alongside the larger institutional funds that we sit next to, CCAP might commit $10 million or $20 million to a given transaction and Crescent as a whole might commit a couple of hundred million dollars to that transaction.

So, it’s certainly an attractive benefit for the BDC to be attached to these larger institutional pools of capital.

Paul Johnson: Thanks for that. And last one for me. You guys, obviously, this quarter as well as for the full year, last year, pretty significantly over-earned the dividend even with the supplemental framework in place. I am just curious if the Board in addition to the supplementals has been evaluating any sort of potentially specials or if you are just comfortable with the current level of spillover that you have built up?

Jason Breaux: It’s Jason again, and maybe Gerhard might have something to add here. But I would say that we are comfortable with where we are at the moment. We talk about the dividend regularly, internally and with our Board. As you know, Paul, having covered us for some time, we really, since inception have prioritized earning our dividend and have never cut our dividend, which are two sort of, I would say, key priorities for us going forward. And as we think about the ongoing environment and what’s going to happen to rates, we certainly run sensitivities around that and around the performance of the portfolio. And I would just say, we want to be in a position where years from now, when rates are down meaningfully potentially from where they are today, we can say that we continue to maintain our base dividend at $0.41 and have hopefully shared a lot of the upside from the higher base rate environment with our shareholders in the form of the supplemental.

Paul Johnson: Appreciated. That makes sense. Helpful answers and congrats on a very good quarter.

Jason Breaux: Thanks Paul.

Operator: Thank you. There are no further questions. I will turn the call back over for closing comments.

Jason Breaux: Okay. Well, thank you everyone for joining the call here today. We are appreciative of your interest and your time that you have invested in CCAP, and we look forward to further conversations with you all.

Operator: Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and we ask that you please disconnect your lines.