Investcorp Credit Management BDC, Inc. Q3 FY2020 Earnings Call

Welcome to the Investcorp Earnings Conference Call. Your speakers for today's call are Mike Mauer, Chris Jansen, and Rocco DelGuercio. A question-and-answer session will follow the presentation. I'll now turn the call over to your speakers. Gentlemen, you may begin.

Thank you, operator, and thank you all for joining us this afternoon. I am joined by Chris Jansen, my Co-Chief Investment Officer; and Rocco DelGuercio, our CFO. Before we begin, Rocco will give our customary disclaimer regarding the information and forward-looking statements. Rocco?

Thanks, Mike. I would like to remind everyone that today's call is being recorded and that this call is the property of Investcorp Credit Management BDC. Any unauthorized broadcast of this call in any form is strictly prohibited. Audio replay of the call will be available by visiting our Investor Relations page on our website at icmbdc.com. I would also like to call your attention to the Safe Harbor disclosure in our press release regarding forward-looking information and remind everyone that today's call may include forward-looking statements and projections; actual results may differ materially from these projections. We will not update forward-looking statements unless required by law. To obtain copies of our latest SEC filings, please visit our Investor Relations page on our website. At this time, I would like to turn the call back to our Chairman and CEO, Michael Mauer.

Thanks, Rocco. I want to begin by recognizing the extraordinary times we live in today. The COVID-19 pandemic has caused incredible suffering all over the world and the secondary economic effects have been devastating for both businesses and individuals. We count ourselves among the fortunate in that our team is all safe and healthy and we have been able to seamlessly transition our business to a work-from-home environment. Our work to reposition and diversify our portfolio over the past few years has strengthened our position in the midst of this pandemic. We have derisked the portfolio through smaller average-sized positions and an increase in the number of industries we align to and an increase in our number of borrowers. Still, our credit standards have not wavered. By being cautious underwriters, we hope to minimize the number of our borrowers that are distressed, even in the current environment. We have avoided some of the sectors that have been hardest hit by the pandemic, such as hospitality, restaurants, and retail. We have also been fortunate on occasion with the repayments, including a substantial one from Montreign, which vastly improved our position as lenders, at the same time that the casino was closed. The vast majority of our borrowers have ample liquidity, are less exposed than the average corporation, and should not violate loan covenants. We aren't perfect; we do have four borrowers in the energy sector. Another, Techniplas, has struggled with the unprecedented disruption of the auto supply chain in the U.S. and Europe. These are reasons to be cautious, but on balance, we are optimistic that our portfolio is well-positioned through this volatile business cycle. As usual, Chris will discuss our investment activity during and after the quarter, and then Rocco will walk through our financial results. I'll conclude with some commentary about a few of our investments and conclude my prepared remarks with commentary on our levers, Investcorp's share purchases, our dividends, and our outlook for the next few months. As always, we'll end with Q&A. With that, I'll turn it over to Chris.

Thanks, Mike. We invested in six portfolio companies this quarter, including four new portfolio companies. All of our investments were first lien. These additions were made between early January and early March. We also had two full realizations during the quarter and three partial realizations. After quarter end, we made two investments in existing portfolio companies, one of which was simply funding under an existing revolving commitment. First, our additional investments in existing portfolio companies: we invested opportunistically in RPX, which has been one of our best-performing borrowers. RPX repaid a majority of its term loan via an asset sale in December 2019, and we purchased some of the loans to hold a better-sized position. The yield on this new purchase was approximately 8.1%. ACProducts refinanced its debt facilities in February. We had a full realization of our existing position and made an investment in the new term loan. Our IRR under realization was approximately 14.3%. Our yield at cost on the new loan is lower at 7.8%. As I mentioned on our last call, we also invested in Alta Equipment Group. Alta is the largest integrated equipment dealership platform in the United States that was acquired by SPAC. Our first lien loan yields approximately 12.2% of cost. We invested in a first lien loan for Pixelle Specialty Solutions, a portfolio company of Lindsay Goldberg, which backed the acquisition of two paper mills from Verso. Pixelle is a leading producer of specialty grade papers, and our yield to cost is approximately 8.3%. We also participated in a club deal for Gexpro Services, which is owned by Luther King Capital. This first lien loan appears in our schedule of investments as GS Operating. Gexpro is a distributor of sea parts, which includes fasteners, valves, fittings, plastic parts, and other high SKU count, low value parts. Our yield to cost is approximately 8.9%. Our fourth new portfolio company investment is Allsup's, which you will see in our statement of investments listed as BW Gas & Convenience. Allsup's is a convenience store and gas station operator, and our yield to cost on this first lien loan is approximately 8.3%. We have had two full realizations during the quarter. I already mentioned the repayment of our loan to ACProducts. The second realization was TouchTunes, which is a second lien investment, and our fully realized IRR was 11.7%. We have three loans restructured during the quarter: Fusion Connect, 4L Technologies, and Montreign, also known as Empire Resorts. Fusion exited bankruptcy in January. We had a realization of our position in the dip loan, which generated an IRR of approximately 33.2%. As discussed last quarter, we are a lender under the new first out first lien term loan. This quarter, we received our pro-rata portion of the second out loan in exchange for our pre-petition term loan position. The yield on the second out first lien was approximately 12.6%, although I would note that the majority of the coupon is paid in kind. We also hold a position in Fusion's equity. 4L Technologies, now known as Clover Technologies, also emerged from bankruptcy this quarter. The exit loan yields approximately 9.6%. Like Fusion, we also hold the position in Clover's equity. Finally, Montreign's loan also restructured during this quarter. Unlike Fusion and Clover, it was not a Chapter 11 process, but rather a very positive partial refinancing and exchange of our prior position. We received a significant pay down of approximately 70% and a new one-year loan, which yields 3.9%, with a substantially improved collateral and guarantee package. Despite the decrease in yield, we are very pleased with our position here, especially in light of the COVID pandemic, which has shuttered the casino for an indefinite amount of time. Since quarter end, we made a small loan to Techniplas. This was to provide liquidity in advance of the company filing for bankruptcy, which occurred earlier this month. Mike will discuss Techniplas later in the call. Using the GICS standard, as of March 31, our largest industry concentration was energy, equipment, and services at 11.2%, followed by construction and engineering at 11%, professional services also at 11%, media at 6.8%, and trading companies and distributors at 6.1%. Our portfolio companies are in 26 GICS industries as of quarter end, including our equity and warrant positions. As of March 31, our portfolio company count was 38 versus 35 at December 31. These counts are unchanged today. I'd now like to turn the call over to Rocco to discuss our financial results.

Thanks, Chris. For the quarter ended March 31, 2020, our net investment income was $3.4 million or $0.25 per share. The fair value of our portfolio was $274.9 million compared to $305 million at December 31. Our portfolio's net decrease from operations this quarter was approximately $24.2 million. Our new investments during the quarter had an average yield of 9.1% and investments exited during the quarter had an average yield of 11.2%, and a realized average IRR of 11.6%. The average yield of our portfolio was 10.05%, a decrease of 36 basis points from December 31. As of March 31, our portfolio consisted of 38 portfolio companies; 84.3% of our investments were first lien, 11.3% of the portfolio was second lien investment, and 3.7% was in unitranche investments. 98.1% of our debt portfolio was invested in floating rate loans and 1.9% in fixed rate investments. Our average portfolio company investment was approximately $7.2 million, and our largest portfolio company investment was Endemol at $14.9 million. We were 1.64x levered as of March 31 compared to 1.23x levered as of December 31. Finally, with respect to our liquidity, as of March 31, we had $11 million in cash, $21.1 million in restricted cash, and $18.3 million of capacity under our revolving credit facility with UBS. Subsequent to quarter end, we reduced the term loan by $20 million, and as of today, we have $16.3 million in cash, $2.1 million in restricted cash, and are fully drawn on our $30 million revolver. Additional information regarding the composition of our portfolio is included in our Form 10-Q, which was filed after. With that, I'd like to turn the call back over to Mike.

Thank you, Rocco. I want to update you on some of our portfolio investments. The significant disruption in the oil and gas markets has affected several of our investments. Since January, the U.S. onshore rig count has fallen by over 50%, and the price of WTI oil has slid from $60 down to the $20s due to a sharp decline in global demand and the well-known conflict between Saudi Arabia and Russia. This decline in drilling and production has impacted our borrowers in the fracking sector, namely Liberty and ProFrac, along with Oilfield Water Logistics and 1888. Starting with our fracking companies, we're encouraged that both Liberty and ProFrac took early and proactive steps to enhance liquidity and control costs. Liberty has a very low debt level and sufficient liquidity to endure a prolonged downturn. The company has announced significant cost-cutting measures and expects to maintain some risk-free assets while staying cash flow positive, even in this market. Discussions with ProFrac's management give us high confidence that they are navigating the present conditions well, and we expect them to remain stable with enough liquidity moving forward. Additionally, the Wilks family, owners of ProFrac, have shown they are ready to support the company with extra equity. Similarly, both companies have frac fleets that have asset values exceeding their current and projected debt levels, which provides us with added security as first lien lenders. 1888 is facing the same difficult conditions as Liberty and ProFrac, primarily because of the drop in the rig count. With operations in the Permian Basin coming nearly to a standstill, they are concentrating on cutting costs and nurturing key relationships. They are also benefiting from funds through the PPP loan program, which will help cover some operational costs. Current forecasts suggest that 1888 will have adequate liquidity throughout 2020 at these oil price levels. We believe they are making the right moves to navigate these challenges. As for Oilfield Water Logistics, there is minimal additional drilling necessary to sustain the business, as the revenue primarily comes from water removal associated with existing wells. OWL’s management is postponing capital expenditures and cutting costs until there is more clarity in the market. We are confident that the revenue from existing wells, to which the company is directly connected, will be sufficient to support operations under current market conditions. Like Liberty and ProFrac, OWL's strong asset base gives us additional assurance. Regarding Techniplas, we currently have one investment on non-accrual. Techniplas has been severely affected by work stoppages, particularly as the auto supply chain in the U.S. and Europe came to a halt. This occurred right as the company was nearing a transaction that would have brought in significant capital. Consequently, the company filed for bankruptcy last week, and the noteholder group is providing liquidity to help the business through this process via debt financing. We anticipate that as the case concludes, a subset of noteholders, including us, will also support exit financing. In the long run, we believe Techniplas has a solid franchise and that the additional funding will enhance our recovery on the notes and yield attractive returns once the business rebounds and auto production resumes. Over the last several years, we've shifted our portfolio focus to first lien investments and sought to diversify across industries and the number of portfolio companies. These strategies have proven beneficial in our current market environment. Our leverage target is set between 1.25x to 1.5x. Last quarter, we fell slightly below that target due to changes in our portfolio's fair value, but this quarter we are just above the upper end of our range. In the December quarter, we covered our dividends with an IRR. As previously stated, we waived the current portion of our management fee related to base management fees over one turn of revenue. Our Board of Directors has declared a distribution for the quarter ending June 30, 2020, of $0.15 per share, payable on July 10, 2020, to shareholders of record as of June 19, alongside a supplemental dividend of $0.03 per share. While it is disappointing to reduce our dividend, we believe that in light of the economic turmoil caused by the global pandemic, it's prudent to do so while adding a variable supplemental component. Investcorp has made two separate commitments to purchase shares of ICMB. The first involves open market purchases under a 10b5 program, acquiring 113,200 shares from January 1 to March 31 and 272,134 shares since the program's inception. The second commitment involves a purchase of shares at NAV, with 113,500 shares bought between January 1 and March 31 and a total of 227,000 shares so far. COVID-19 has disrupted all markets, and while we cannot predict what will happen next, our portfolio management team, positioned at the top of the capital structure within a diverse range of more resilient sectors, makes us feel fortunate. We do not have investments in restaurants, hotels, traditional retail, transportation, early-stage technology, software, or structured products. We recognize that the market volatility we've seen in recent months may persist, and we expect it to continue. We will remain disciplined, prioritizing the preservation of shareholder capital as we manage our portfolio. Now, operator, please open the line for questions.

Our first question comes from Christopher Nolan.

Mike, what is the plan in terms of lowering the leverage ratio going forward?

Yes, Chris. First, I'd like to apologize to everybody. I assume you had the same quality I had, and I apologize for that. So to the extent that anything wasn't audible, please chime in and ask me to clarify because, at least on my end, it was not as clear as it has been historically. On leverage, Chris, we are targeting to be more in the 1.2x, not the 1.5x in our 1.2x to 1.5x. We're at 1.6x and change because of the write-downs in NAV. That also dovetails with you heard we had paid down some of the revolver. We're using the term loan, and we're now using the revolver because we don't need as much between term and revolver when we were targeting a little more leverage. In the current environment, we will continue to run at the lower end. That having been said, we're at a higher multiple today because of the write-downs. We'll be prudent around that. We're not going to sell just to sell, but we're going to manage that down.

So is it fair to say that the priority right now would be lowering the leverage as opposed to and not growing the portfolio?

I would say, yes, but let me say it's slightly different, which is the priority is to manage the existing portfolio, not to grow it, to make sure we preserve capital selectively. As we get any repayments, we may redeploy, but it is not targeted on growing the portfolio today.

Great. And then Techniplas, was that a new non-accrual in the second quarter since April?

Yes. So technically, Techniplas was not non-accrual at 3/31; it is today. So when we say we have one non-accrual, that's today. They paid their interest through the March quarter, and it was about to have a very nice influx of capital from a sponsor. When COVID happened, all of that fell apart, and we are in bankruptcy restructuring it now. So it was not non-accrual before.

Our next question comes from Robert Dodd.

On the dividends, obviously, you cut the base to $0.15. And then the $0.03 supplement, any color you can give us on whether that supplemental is going to be formulaic Board discretion? I mean, everything is Board discretion. But in terms of how the two components are going to interact going forward versus NII as well, right?

Yes, Robert. We spent a lot of time around this. I'm not sure there's a right way to do it. We think we're doing it the right way. We know that over the next six months, and hopefully, it's not 18 months that the global economies and the U.S. economies are going to recover at some pace; we are being somewhat prudent in expecting that to be a slow pace. We hope it's quicker. With all that having been said, we are looking at NII and managing the portfolio. We want to have a base level that we're comfortable will be covered, and that's the $0.15. We believe there should be some above that where that will play out with time, and we will reassess that quarterly. The supplemental will be formulaic. It is meant to be a proxy for what we expect that to be at each quarter end. It may be a little above or below, but it will be formulaic of expected NII.

Got it. Appreciate that. And then on liquidity, not the portfolio companies, I mean thank you for all the color you provided on the energy investments and on Techniplas as well. If we look beyond that into the rest of the portfolio, could you give us any assessment of how much the remainder of the portfolio beyond those called-out assets has what you would call a low, moderate or maybe high risk exposure to COVID, and some combination of operational exposure versus liquidity? Obviously, if a business has no revenue but has 24 months of liquidity, it's less worrying than another. So any color you can give us around that kind of thought process?

Yes. Robert, it's Chris. We've done some really detailed analysis on the portfolio, as you would expect. We look at about 25% to 30% of our portfolio as being more severely impacted by COVID, including all of our oil and gas exposure, and there's an argument about how much of that is COVID and how much is not. Of those, we have probably about half of that amount as lower liquidity, so roughly 15% of the portfolio. Some of that was including Techniplas, which as Mike mentioned, has filed for bankruptcy last week, and the bondholder group is supporting that through the bankruptcy process.

Got it. I appreciate that information.

And Robert, just to add to that, I don't know if this is part of your question. When we think about requests for relief from covenants, we have just shy of 40 investments, and less than a handful of them have asked for covenant relief, where almost two-thirds, 60%, plus or minus, have covenants. So we are not sitting with a 90% covenant light basket here. We've got the vast majority under covenant, and we've only had a handful of requests. I'd expect we will see more requests for some covenant relief as we go further out, but we have not seen people coming with a lot of amendments and ask for liquidity to date.

Got it. I appreciate that. And then on your side, so I mean your liquidity, $16 million in cash today, right, and the fully drawn revolver. I presume you think that's sufficient to fund any liquidity requests that do come in from portfolio companies, even if you do not get additional repayments. But what's the margin of error there in terms of if you do get more requests for the relief, requests for liquidity, if this situation drags on longer, what are your resources to incrementally add liquidity to your own balance sheet?

Yes. There are two or three ways that we have thought about that. Number one is revolver claims on up. It's $2 million, $3 million of revolver claims that are truly outside of our control as the lender group. The other ones have a lot of gating, a lot of requirements, or discretion on the lenders. So we do not have significant revolver exposure by design in our portfolio. That's number one. Number two is, when we think about self-help and other things, I've included what we know about in that number. Number three is, we do expect that there will be at least $10 million to $20 million of repayments over the near term, i.e., before 6/30. We will assess liquidity needs over that period of time and whether or not we pay down the revolver and keep some extra liquidity there. Lastly, UBS, as you know, is our liquidity provider, and they basically said they want to talk to us about extending and other things. We’re kind of waiting, and I think it will probably be mid-summer before we get into those discussions because of a lot of other disruption away from the BDC sector, actually. It's not even in the corporate; it's more in a lot of the mortgage sector. So we think we've got more than adequate liquidity today. We've got cushions on top of that in our leverage facility with UBS that we think are adequate, and we have some liquidity coming.

Our next question comes from Paul Johnson.

One more on the credit facility. As far as your availability goes today, I think you said you had about, correct me if I'm wrong, $21 million drawn today on the revolver in the second quarter. Is the capacity completely available there for you to draw on, or are there any sort of borrower restrictions in the facility that limit the availability?

Just to clarify, I think as of today, what we've done is we have drawn our revolver at the BDC and paid down our term loan. So we are drawn under the revolver. There's not additional capacity there. We've got about $15 million of cash on top of other buffers that we've got, but the actual cash is about $15 million that we have. So there is not additional revolver capacity, and we don't think we need it.

Okay. Thanks for that. And then as far as fair value marks this quarter, I'm just curious if you could talk a little bit about your process. When you were going through this process of marking these companies, did you incorporate any sort of forward-looking projections, or were these primarily based off of more historical performance plus market spread adjustments?

Yes, Paul. It's Chris Jansen. We did more of the latter. It's really difficult. The crystal ball gets a little foggy, depending on how companies come back. So when we first started hearing rumblings of this, we did some really thorough analysis on what we felt the liquidity of our individual investments had. We didn’t really look at enterprise value, but we said, right, what do companies have in their coffers to sustain themselves against this? And from there, we went on to say, okay, which companies do we think are going to be most impacted and why? Given that as a backdrop, we went through the portfolio and said we did more of our traditional valuation analysis to say the companies that we felt very confident would make it through this, which was the vast majority of them. We did some spread widening and more or less where the market spreads had widened versus where we think companies will be performing in the new COVID environment. So it was pretty similar to what we've been doing before, but with our COVID analysis and liquidity analysis as a backdrop.

Sure. Okay. And I guess the last question I had just had to do more with the broader platform. I'm curious as we entered this crisis, and we're entering potentially what's very likely to be a recession, how have you guys shifted any resources at the firm to focus on potentially your highest liquidity need companies or credit trouble in the portfolio? Or basically just how are you shifting those personnel around or resources to help support your portfolio today?

Yes. I think it's a great question. We are a team of about 10 people. We all get involved. We do take specialists by industry and by restructuring expertise. And given that the portfolio is less than 40 names, we're not dealing with 150, 200 names. We're able to take the people who have the industry expertise, and the senior members, Chris and myself, are involved literally down to minutiae in each and every name that is having any type of discussion around whether it's amendment, restructuring with advisers, lawyers, etc. So we are nimble enough that we can shift based upon industry and restructuring expertise.

And a good example of that is 1888 where Mike literally rolls up his sleeves on that credit more than anybody else on the team. So Mike has vast experience in things like refinancings from his prior career, so I think he understates his ability to do that.

Our next question comes from David Rothschild.

As far as your market price is so far below your net asset value and I know you talked here a lot about your credits. Does your guys' line of credit allow you to buy back more shares, and if so, why aren't you doing that at this kind of discount?

So from our line of credit, we're borrowed against that. And so liquidity is very important, Mr. Rothschild around all the investments. At this point, I think it's important to make sure that we're maintaining the overall portfolio. I understand your question about the trading level versus the NAV. I'd say we've got a lot of company across the BDC sector in discount, whether or not you are at $0.30 or $0.60, you are at a deep discount. I think part of it is making sure that you maintain the liquidity to keep your investments. The second is the next stage beyond that is for a rebound and to appreciate the NAV, and I think if we do that right, we should get our trading levels back up into that 60, 70, 80-plus range. That's really the primary. And we absolutely are focused on the share price, but buying back stock right now is not a good use of our liquidity.

Yes. It seems like a 50% return is a good return.

At this time, we have no further questions.

Thank you, everyone. We appreciate your time and look forward to talking to you in the future.

This concludes today's conference call. Thank you for attending.