Crescent Capital BDC, Inc. Q2 FY2023 Earnings Call

Good morning and afternoon, everyone, and welcome to the Q2 2023 Crescent Capital BDC, Inc. Earnings Conference Call. I would now like to hand the conference over to Dan McMahon. Please proceed.

Good morning and welcome to Crescent Capital BDC, Inc.'s Second Quarter ended June 30, 2023 Earnings Conference Call. Please note that Crescent Capital BDC 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 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 second quarter ended June 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.

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 second quarter results before discussing the current market environment in more detail. I'll then touch on our dividend policy before turning it over to Henry to review our recent investing activity and portfolio performance. Gerhard will then review our financial performance for the second quarter. Let's begin. Please turn to Slide 6, where you'll see a summary of our results. For the second quarter, we reported record net investment income of $0.56 per share, up from $0.54 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 base dividend by 37%. This over-earned amount, coupled with unrealized appreciation in the portfolio on a net basis, resulted in net asset value per share of $19.58 as of quarter-end, up 1% as compared to the prior quarter. Please turn to Slides 14 and 15 of the presentation, which highlight certain characteristics of our portfolio. We ended the quarter with nearly $1.6 billion of investments at fair value across a highly diversified portfolio of 187 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 being sponsor-backed companies as of quarter-end. We generally believe that private equity sponsors can provide operational and financial support to strengthen their portfolio companies for long-term value creation. In terms of industry composition, you can see on the right-hand side of Slide 15 that the majority of our investments continue to be in service-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-generating businesses in what we deem to be more recession-resilient industries. A few more credit trends to review include performance ratings and non-accrual levels. Our weighted average portfolio grade of 2.1 improved from 2.2 last quarter, and the percentage of risk-rated 1 and 2 investments, which are the highest ratings our portfolio companies can receive, accounted for 87% of the portfolio at fair value, up from 85% last quarter. As of quarter-end, we had investments in 8 portfolio companies on non-accrual status, representing 2.2% and 1.7% of our total debt investments at cost and fair value, respectively, a decrease from the prior quarter. Moving to the current market backdrop, transaction activity in the second quarter was lighter compared to the prior year, albeit busier than what we witnessed during the first quarter, given the challenges in the regional banking space. We've seen direct lending continue to gain share from the syndicated markets, with approximately 85% of new issue LBO financing in the U.S. completed by direct lenders in Q2. A lack of CLO issuance and volatility in the BSL market have made certainty of execution and depth of capital in the direct lending space increasingly attractive for issuers. Valuation expectations between buyers and sellers have remained apart for much of 2023 thus far, driving a decline in overall M&A volumes. That said, 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. Looking ahead to the remainder of the year and beyond, as buyers and sellers acclimate to the new market environment, we see early signs that LBO volume has picked up, despite overall economic uncertainties that continue to exist. Before I turn it over to Henry, I'd like to touch on our dividend policy. On our call in May, we announced our intent to implement a variable supplemental dividend program beginning this quarter, which is the first full quarter of combined results following our acquisition of First Eagle BDC in March. For the second quarter, we're pleased to declare an inaugural supplemental dividend of $0.08 per share, payable on September 15. As detailed on Slide 7 of our earnings presentation, it is calculated as 50% of net investment income in excess of our regular $0.41 per share dividend, subject to a measurement test. CCAP's NII per share has been comfortably outpacing the base dividend for some time, which we have seen accelerate in recent quarters as higher underlying reference rates have resulted in higher portfolio yields, given our 99% floating rate portfolio. Looking at the current shape of the forward curve, however, we do expect rates will come down over time, which will impact the entire BDC sector's earnings profile. We believe the formulaic framework offered by our supplemental program ultimately strikes the right balance of increasing total distributions to our stockholders while preserving the stability of our NAV over time, across different base rate outlooks. Total dividends of $0.49 per share for the second quarter represent a 10% annualized yield based on our June 30 NAV. I'd now like to turn it over to Henry to discuss our Q2 investment activity.

Thanks, Jason. Please turn to Slide 16, where we highlight our recent activity. Gross deployment in the second quarter was $38 million, as you can see on the left-hand side of the page, all of which was in senior secured first lien and unitranche investments. During the quarter, we closed on 2 new investments totaling $24 million, with the remaining $14 million coming from incremental investments in our existing portfolio companies. The new investments during the second quarter were loans to private equity-backed companies with SOFR floors, attractive fees, and an average spread of approximately 660 basis points. The $13 million in gross deployment compares to approximately $28 million in aggregate exits, sales, and repayments. 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. In the near term, 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 those fronts during the second quarter. Balance sheet leverage is down quarter-over-quarter. And as of last Friday, we had realized approximately 16% of the acquired First Eagle portfolio since closing in March. Turning to Slide 17, you can see that the weighted average yield of our income-producing securities at cost increased quarter-over-quarter from 11.4% to 11.7% and is up 340 basis points year-over-year, driven by the increase in the respective base rates. As of June 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. This situates us well to benefit from increases in base rates above our average floors, as was the case this quarter with continued growth in our net interest margin. 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 in our portfolio companies. The weighted average interest coverage of the companies in our investment portfolio at quarter-end held stable at 1.7x. It is important to note that we calculate our interest coverage ratio using annualized 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 2.1x. 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 operating fixed 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. As of quarter-end, approximately 60% of aggregate revolver capacity was available across the portfolio, and we have not seen an increase in aggregate revolver utilization during the second quarter. The strength of our portfolio continues to benefit from the substantial amount of equity invested in our companies, most of which is applied by well-established private equity firms with whom we have long-standing relationships and 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 with 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.

Thanks, Henry, and hello, everyone. Our net investment income per share of $0.56 for the second quarter of 2023 compares to $0.54 per share for the prior quarter. Total investment income of $46.7 million for the second quarter compares to $39.3 million for the prior quarter, representing an increase of approximately 19%. Driven by rising base rates and adjusting for the impact of the First Eagle acquisition, recurring yield-related investment income comprised of interest income, PIK income, amortization and unused fees, and dividend income from the Logan JV was up 19% quarter-over-quarter from $38.5 million to $45.7 million, ultimately accounting for 98% of this quarter's total investment income. PIK income continues to represent a modest portion of our revenue at 1.8% of total investment income. Our portfolio is a combination of a substantial majority of recurring investment income paired with modest noncash PIK-based income, which provides the basis for a high-quality income stream that benefits CCAP stockholders. Our GAAP earnings per share or net increase in net assets resulting from operations for the second quarter of 2023 was $0.61, which compares to $0.24 per share for the prior quarter. At June 30, our stockholders' equity was $726 million, resulting in net asset value per share of $19.58, as compared to $718 million from $19.38 per share last quarter. The positive net deployment of $11 million in the second quarter, coupled with net unrealized depreciation on our investments, ultimately led to modest portfolio growth and a total investment portfolio at fair value of $1.6 billion as of June 30, up approximately $15 million quarter-over-quarter. Turning to Slide 18, our internal portfolio ratings at the end of the second quarter were largely consistent with prior quarters, with 87% of the portfolio rated 1 or 2, our highest rating categories. Now let's just go to our capitalization and liquidity. I'm on Slide 20. As of June 30, our debt-to-equity ratio was 1.19x, down from 1.23x in the prior quarter. The weighted average stated interest rate on our total borrowings was 6.73% as of quarter-end. In May, we completed a private offering of $50 million aggregate principal amount of 7.54% senior unsecured notes due July 28, 2026. These notes became effective upon the repayment of the 2023 notes at their maturity on July 30. Adjusted for this activity, and 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 $315 million of undrawn capacity subject to leverage, borrowing base, and other restrictions, with $21.5 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 third quarter of 2023, our Board declared a $0.41 per share quarterly cash dividend, which will be paid on October 16, 2023, to stockholders of record as of September 30, 2023. Additionally, as Jason discussed, our Board declared a supplemental cash dividend of $0.08 per share, which will be paid on September 15, 2023, to stockholders of record as of August 31, 2023. And with that, I'd like to turn it back to Jason for closing remarks.

Thanks, Gerhard. In closing, we're pleased with our strong financial results for the quarter and believe CCAP remains well positioned to deliver strong results going forward. Our portfolio is diverse and healthy, and we're in excellent financial condition to selectively capitalize on this volatile yet attractive investment environment. 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.

And your first question will be from Ryan Lynch at KBW.

Nice quarter. My first question just has to do with now that you guys are fully integrated with the FCRD acquisition in your portfolio. I would just love to hear how the initial performance of that portfolio has been specifically. And obviously, you guys bought some of those assets at a discount. What's your sort of outlook for potential turnover in that portfolio? And is there any upside on any of those investments? Or how is it just performing at least initially?

Thanks for the question, Jason here. I can start off and perhaps Henry will add some insights. Now that we’ve officially been integrated for about four to five months, I can say that the diligence we conducted on the portfolio has mostly been validated. The team did a commendable job assessing the credits before we had direct access to the company. Now that we do have direct access to the companies and the sponsors, there haven't been any major surprises regarding the underwriting of the book. Henry mentioned in the prepared remarks that we are seeing realizations running around 15% to 16% on the FCRD portfolio as of last week.

Yes. And just to comment on the second part of your question regarding the outlook around the rotation and upside here. The names that we rotated out through the second quarter and the beginning part of July, we've been able to realize that cost for better. So we are making good progress initially on that front as well. I think it's a little too early to say if we see meaningful upside from our cost basis in the remaining names that are in the portfolio. But to Jason's point, we have been able to see that our diligence has proven out initially here in terms of what we expected in the assets that we onboarded.

Okay. That's helpful. If I consider both the realized and unrealized movements in the portfolio, I know that sometimes a realized loss can lead to an unrealized gain. You reported an overall net gain of $2 million this quarter. Was this mainly due to one investment or a small number of investments, or was it a broader improvement across the portfolio that contributed to the gains this quarter?

Ryan, it's Gerhard. Nothing really stood out. I think we saw kind of movement across the portfolio, and that's kind of contributed to that number you called out.

Okay. I have one last question regarding the dividend and dividend policy. You have introduced a supplemental dividend program that appears to be performing well. Given the increase in earnings due to rates, which may eventually decrease, but with the supplemental dividend, earnings remain significantly higher than the total dividends. Is this the level of dividend coverage you aim for, or would you consider increasing the core dividend or adjusting the payout ratio from the 50% excess? I would like to hear your thoughts on this.

Yes. Thanks, Ryan. Jason again. We spent a lot of time thinking about our dividend policy over the last several quarters. And as you know, we've really consistently prioritized earning our dividend, which we've done every quarter. We believe that the supplemental dividend framework certainly ensures our stockholders will benefit from earnings generated in excess of the regular dividend, but it will also provide us with preserving a stable NAV for our stockholders as well. With SOFR hovering around 5%, 5.5% over 300 basis points increase relative to a year ago, certainly, the earnings for the sector are up meaningfully, including for CCAP. That being said, if you look at the curve, which is what the market at least is suggesting, we could see an initial decline in rates in the first half of '24. As we think about this, we try to take a long-term approach to it, and we really want to be in a position, 5-plus years from now, where we can continue to say that we've earned our dividend. We've delivered the stable $0.41 a share each and every quarter and that our stockholders have been able to participate in a lot of the upside along the way during the significant over-earned quarters. So we're really trying to take a long-term view on this. And right now, I think we're comfortable with the approach.

Next question will be from Mitchel Penn at Oppenheimer.

Good quarter, guys. A couple of questions on your weighted average loan-to-value. You guys said it's 41% at origination. What's it today for the portfolio?

We haven't seen that metric increase significantly. We're still in the low 40% range in total across the portfolio.

And what percent of the portfolio is greater than 70%?

70% loan-to-value? I don't know if we've got that at our fingertips right now, Mitch. Let us do a little bit of work on that and we can circle back to you.

Okay. Great. What is the average interest coverage ratio of the portfolio?

Yes. Henry said in the remarks that it's 1.7x, and that's on an annualized interest expense figure for current base rates.

Got it. And what percent are below 1?

Let us circle back to you on that as well. I don't think we've talked about that on prior calls.

And your next question will be from Sean-Paul Adams at Raymond James.

Regarding your credit facilities, I know in the Q, you guys disclosed both facilities maturing in 2026, but I didn't see any mention of when the revolving period for either of those facilities ends. I was hoping if you could provide some details on that as well as if you're looking at adding any additional unsecured debt. I know you guys just added an additional note for 2026, but just need a little bit more clarification on that.

Thank you for the question. This is Gerhard. I will address the second part first. We feel confident about our current capital structure, with over $300 million available through our credit facilities. While we monitor the market closely, we're not considering adding more unsecured debt in the near future, partly due to the relatively high cost of debt at this time. Regarding the first part of your question, the two revolving facilities we have typically have revolving periods of around 2 to 3 years. We maintain regular communication with our lenders, and we manage these facilities through annual or biannual extensions of the reinvestment periods to avoid reaching a maturity deadline. Therefore, as you think about our capital structure, particularly for CCAP, you can expect that we will continue to amend and extend these facilities as we near the end of the reinvestment periods for both the SPV and the SMBC revolving credit line.

And at this time, it appears that we have a follow-up from Ryan Lynch.

One more question I had. What is your guys' long-term outlook for First Eagle's Logan JV? I know in the past, it seems that you guys did not necessarily want to operate these JVs. Obviously, you inherited this with the acquisition. What should we expect from this long term?

Yes, Ryan, it's Jason here. We conducted thorough due diligence on that joint venture. The majority of the assets are within a CLO, which is a relatively new investment vehicle created about a year ago under First Eagle's management. It was priced quite competitively, and from an income perspective, it offers an attractive yield to equity. Additionally, it's a well-diversified CLO with approximately two years remaining in the reinvestment period. For now, we believe it will maintain a steady performance and we expect it to continue doing well over the next several quarters.

Okay. It makes sense. I appreciate the follow-up.

Thank you.

And at this time, gentlemen, it appears we have no other questions registered. Please proceed with any closing remarks.

Okay. Thank you, operator. Thank you all for joining the call today. We appreciate your continued interest and support in CCAP. And we look forward to speaking with you all again next quarter, if not sooner.

Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. At this time, we ask that you please disconnect your lines.