CION Investment Corporation (CION) Q1 2023 Earnings Call Transcript
Good morning, and welcome to CION’s Investment Corporation’s First Quarter ended March 31, 2023 Earnings Conference Call. An earnings press release was distributed earlier this morning before market open. A copy of the release, along with the supplemental earnings presentation, is available on the company’s website at www.cionbdc.com in the Investor Resources section and should be reviewed in conjunction with the company’s Form 10-Q filed with the SEC. As a reminder, this conference is being recorded for replay purposes.
Please note that today’s conference call may contain forward-looking statements, which are not guarantees of future performance or results, and involve a number of risks and uncertainties. Actual results may differ materially from those in the forward-looking statements as a result of the number of factors, including those described in the company’s filings with the SEC.
Speaking on today’s call will be Michael Reisner, CION Investment Corporation’s Co-Chief Executive Officer; Gregg Bresner, President and Chief Investment Officer; and Keith Franz, Chief Financial Officer.
With that, I would now like to turn the call over to Michael Reisner. Please go ahead, Michael.
Thank you. Good morning, everyone and thank you for joining us. As mentioned, I’m joined today by Gregg and Keith as well as other members of senior management, including my Co-CEO, Mark Gatto.
I will start our call today with an overview of our first quarter results. Gregg will review our investment activity during the quarter, and Keith will provide additional detail on our financial results. After Keith’s prepared remarks, we will open the call to questions.
As we reported this morning, we had yet another strong quarter, marking the fifth consecutive quarter we’ve exceeded The Street’s expectations with total investment income increasing 17% sequentially quarter-over-quarter and net investment income increasing 25% quarter-over-quarter and 53% year-over-year. We believe that our continued ability to substantially outearn our dividend demonstrates the resilience of our business model and our ability to drive returns through a strategy laser-focused on senior secured floating rate loans originated from our diverse sourcing strategy.
Presumably, for the first quarter, our net investment income of $0.54 per share ou5earned $0.34 per share dividend we declared for the first quarter of 2023 and the net investment income of $0.43 per share we earned last quarter. Besides an increase in base rates, our income during the quarter was driven by equity dividends from deleveraging companies, realized earnings from our EagleTree joint venture, prepayment premiums and other yield-enhancing provisions embedded within our primarily first lien portfolio.
On the financing side, we have agreed in principle with our two senior secured lenders on expanding the facilities that are set to mature within the next year. JPMorgan has agreed in principle to extend its facility for 1 year at the same spread, and we have agreed in principle with UBS to extend its facility for 1 year at a slightly tighter spread. In addition, as part of this process, we received several indications of interest from other lenders. We are pleased with the support we have received from our existing financing partners, and we believe the additional interest received is an indication of the strength and credit quality of our portfolio.
Last quarter, we saw an increase in our non-accrual rate, which now stands at 3.5% of fair value. We would note, however, that two of the names have been restructured post quarter and placed back on performance status in Q2. And the third name is likely to reverse as well. Gregg will add more on this in his remarks. Our net asset value did decrease last quarter as well, owing in part to previously disclosed and stressed names in our portfolio. However, we believe approximately two-thirds of the net asset value decline is reflective of current market conditions and mark-to-market adjustments as these investments consist of performing names and companies that were recently successfully restructured, and we are optimistic the value should rebound.
We believe that despite increasingly challenging economic conditions, our portfolio is well structured for the current environment. We are highly diversified with our investment portfolio of $1.66 billion spread across 109 distinct issuers with an average investment size of $15 million. Our investment portfolio is 91% senior secured with 89% in first lien investments.
The weighted average leverage or net debt to EBITDA of our portfolio companies decreased slightly to 5.11x as compared to 5.30x in Q4. The weighted average interest coverage of our portfolio companies decreased to 2.07x as compared to 2.31x in the fourth quarter of 2022. We would note that 85.2% of our portfolio is risk rated 2 or higher compared to 82.9% in Q4 2022 and only 3 investments that make up only 0.33% of our portfolio were downgraded from a risk rated 2 to a 3 during this quarter. We believe that any credit weakness we experienced in Q1 was mostly limited to a few names that were already risk rated 3 or lower and undergoing stress in prior periods and primarily in consumer-facing industries. Again, Gregg will discuss this in more detail as well as our recent new deal activity.
As a reminder, we remain conservatively levered relative to our peers with a net debt-to-equity ratio at 1.02x and, given recent repayments and the support of our existing lenders, are well positioned to take advantage of what we believe will be a great vintage for direct lending and private credit in the next few months. We further note that unlike some others that solely rely on a sponsor coverage deal sourcing strategy that is heavily contingent on M&A activity, our diversified sourcing capabilities that does not rely solely on covering sponsors has provided us with the most robust deal flow in recent memory, thereby allowing us to remain highly selective.
Finally, we also continued our share repurchase program this quarter, repurchasing approximately 338,000 shares at an average price of $10.63 per share for a total repurchase amount of $3.6 million. We repurchased approximately 2 million shares since the beginning of the repurchase program we put in place in August 2022.
With that, I will now turn the call over to Gregg.
Thank you, Michael, and good morning, everyone. Our strong Q1 net investment income benefited from a diverse combination of the direct pass-through of higher interest rates from our primarily floating rate first lien loan assets, equity dividends from deleveraging companies, realized earnings distributions from our EagleTree joint venture, prepayment premiums and other yield-enhancing provisions embedded within our primarily first lien portfolio. Our defensive strategic positioning also contributed to our ability to declare a nearly 10% increase to our base quarterly dividend to our shareholders for the first quarter of 2023 compared to the fourth quarter of 2022.
On the macroeconomic environment, the recent banking failures with SVB, Signature Bank and First Republic and the resulting reduced access to financing have more than dampened what seemed to be early signs of optimism in February. The clearest signs in Q1 seem to be the negative impact to the U.S. consumer, particularly in the middle and lower markets, and sharply reduced M&A activity or initial indications of interest and value are not being converted into closed transactions.
Thus, our total return to investors for Q1 was down 3.3%, driven by a 5.4% decline or $56 million in unrealized mark-to-market valuation. Of this $56 million, approximately two-thirds represent performing or recently restructured investments, where valuations were more reflective of current market conditions and market multiples as opposed to our longer-term exit value expectations where we still believe that we will retrieve the full amortized cost basis of our investment.
Most of the remaining one-third of our mark-to-market declines were from first lien investments that were valued at 3/31 based on the status of current issues or restructuring processes at that particular date and not necessarily our expected realized values after exercising our priority position and other rights and remedies as a first lien lender subsequent to quarter end.
Turning now to our Q1 investment and portfolio activity, there continues to remain a clear distinction between the syndicated and the direct private credit markets where we strategically focus. As syndicated market conditions continued to deteriorate in 2022 through the first quarter of 2023 with declining new issue activity, our volatility and spread widening, private direct lending continued to expand its market share with robust issuance and yield opportunities. This is consistent with our platform as our current transaction inflow and potential investment opportunities are among the highest we have seen.
We continue to maintain a highly selective approach in pursuing new investments given the strong economic headwinds and the need for greater liquidity in cushion within the capital structures of the potential new issuers we are considering. We are strategically preserving capital for investment in the strong pipeline we see ahead within our current portfolio, particularly for attractive strategic tuck-in acquisitions.
Overall, we have seen roughly a 100 to 150 basis point increase in spreads over the last year for new direct investments that meet our investment criteria. We continue to be highly focused on first lien investment opportunities in both the directly sourced and lightly syndicated loan markets. Our focus in the first lien syndicated loan markets has been largely on investment opportunities with valuation distress due to technical or capital structure-related situations, where we expect to have active roles in the processes that drive the refinancing or restructuring of those investment tranches. A recent example would be our successful investment in the first lien term loan of Y.A.C. Holdings, where the company completed a voluntary restructuring that, in our view, greatly enhanced the balance sheet and future prospects of its recovery.
We ended the first quarter with strong liquidity and a conservative net debt to equity profile of approximately 1.02x slightly higher than at the end of 2022. As of 3/31, we maintained strong liquidity for our targeted investment pipeline with $162 million of cash and equivalents and $100 million of undrawn availability under our credit facilities, which positions us well to selectively pursue new investments and maintain strong dry powder to invest in the growth and working capital needs of our existing portfolio of companies.
During Q1, we made $15 million in new investment commitments, of which $14 million was funded as of quarter end. We also funded a total of $9 million of previously unfunded commitments during the quarter. Notwithstanding the micro – the macro challenges in the market, we continue to have sales and repayments totaling $66 million for the quarter. This was primarily driven by the full repayment of foreign investments and the selective sale of 3 lower-yielding names. As a result, net funded investment activity decreased by $43 million during the quarter.
As with our market peers, we were not immune from the macro environment and have experienced some movements in our overall portfolio credit metrics. We added 5 new names to non-accrual status this quarter. Our non-accrual status at fair value increased from 1.3% at 12/31/22 to 3.5% at 3/31/23. This increase was driven primarily by the intra-quarter restructurings of our first lien investments in IPP and United Road, both of which closed in early April after quarter end, and the weakened performance of several of our first lien investments in retail-facing consumer names.
Pro forma for the successful in-court restructuring of IPP and out-of-court restructuring of United Road in early April, our investments on non-accrual status at fair value would have been 2.5% as opposed to 3.5% as of 3/31. As a first lien lender in both IPP and United Road, we work closely with our co-lenders to complete restructurings where we retain pro rata debt and equity positions that vastly improved the companies’ balance sheets and position the companies to drive enterprise value growth going forward. The remaining 2.5% of non-accrual names are largely first lien positions concentrated among retail-facing consumer companies, such as David’s Bridal, Jenny Craig, Lucky Bucks and NBG. Several have sought bankruptcy court protection to reorganize their operations.
To provide overall context, retail-facing consumer companies represented approximately 10% of our total portfolio as of 3/31 across 13 companies. These remaining 2.5% investments on non-accrual status are primarily first lien positions where we continue to work actively to utilize our secured priority rights, investment flexibility and the extensive restructuring experience of our senior professionals to help maximize our realizations. From inception, our net recovery rate on nonperforming investments has been approximately 90%. We currently expect that one or more of these investments will be removed from non-accrual status in Q2 as we work through various potential transactions.
For Q1, our PIK income represented approximately 10% of our total investment income. We strategically utilized PIK for our structured financial investments as well as for yield enhancement that is secured at the top of the capital structure as opposed to common equity warrants, equity co-invest or other subordinated kickers.
Overall, our portfolio remains defensive in nature with approximately 90% in first lien investments and is highly diversified across industries and issuers. Our portfolio is not immune to the high inflation environment, as we do maintain a relatively small exposure to capital goods, packaging, chemicals and plastics, automotive and transportation sectors that have been significantly impacted by inflationary pressures. Our combined exposure to these sectors represents approximately 9% of our total portfolio as of the end of Q1.
I will now turn the call over to Keith.
Okay. Thank you, Gregg, and good morning, everyone. As Michael mentioned, we reported another quarter of solid investment income. Total investment income increased by 17% during the quarter to $65 million when compared to $55.5 million during the fourth quarter. Net investment income was up by 25% to $29.9 million or $0.54 per share as compared to $23.9 million or $0.43 per share reported in the fourth quarter.
On the expense side, total operating expenses were $35.1 million compared to $31.6 million during the fourth quarter. The increase was primarily driven by an increase in interest expense under our financing arrangements due to higher LIBOR and SOFR rates as well as higher advisory fees when compared to the prior quarter.
At March 31, we had total assets of approximately $1.9 billion and total equity or net assets of $830 million with total debt outstanding of $1 billion and 54.9 million shares outstanding. At the end of the quarter, our net debt-to-equity ratio was 1.02x, which is slightly higher than our debt-to-equity ratio of 0.98x at the end of Q4.
Total debt outstanding increased by $53 million since year-end primarily due to the unsecured public bond offering completed during February. At March 31, our NAV was $15.11 per share compared to $15.98 per share at December 31. The decrease of $0.87 per share was primarily due to price declines in our portfolio. This was partially offset by overearning our distribution and the accretive nature of our share repurchase program during the quarter.
We ended the quarter with a strong and flexible balance sheet with over $400 million in unencumbered assets lower leverage relative to our peers, our strong debt servicing capacity and solid liquidity. We have over $160 million in cash and short-term investments and $100 million available under our credit facilities to further finance our investment pipeline and continue to support our existing portfolio of companies.
Our current debt mix is 72% in senior secured and 28% in unsecured. During the quarter, the weighted average cost of our debt capital was 7.5%. We expect to continue to see the positive impact to net investment income as we continue to deploy our available capital into new and existing middle market floating rate investments that typically pay a yield premium when compared to larger broadly syndicated deals. If interest rates continue to rise, we expect an increase to our net interest income of about $0.09 per share for the next 100 basis point increase to the base rate as of March 31; and $0.18 per share for a 200 basis point increase to the base rate, and that’s assuming no material changes to the investment portfolio or our debt structure.
In terms of our debt structure, as Michael mentioned, we have agreeable terms with both of our senior secured lenders to extend our facilities for an additional year with slightly better economics. We believe that both extensions will give us the flexibility to work towards something more strategic and longer term during the current economic environment. Our objective is to further diversify our debt mix between secured and unsecured and continue to expand our syndicate of lending partners.
During the quarter, we also raised about $81 million in series A unsecured bonds through a public offering in Israel, which was 1.3x oversubscribed. The bond was priced at SOFR plus a spread of 3.82% per year. This offering continues to strengthen our balance sheet and aligns well with our mostly floating rate investments while, at the same time, further diversifying our financing sources.
Now turning to distributions. During the first quarter, we paid distributions to our shareholders of $0.34 per share, which is an increase of $0.03 per share or about 10% from Q4. As announced this morning, we declared our second quarter distribution of $0.34 per share, which is the same as the first quarter. The distribution will be paid on June 15 to shareholders of record on June 1.
Okay. With that, I will now turn the call back over to Michael for some closing remarks.
Thanks, Keith. A final thought before we open the line for questions. We would just like to reiterate our message, but we believe CION is well positioned to provide solid returns to its shareholders despite current market conditions.
And with that, operator, we’re ready to take any questions.
Great. Well, thank you, everyone, who joined the call today. We appreciate your interest in CION. We look forward to speaking to you again in early August when we announce our second quarter 2023 results. Take care.
Thank you. That concludes today’s conference. All parties may disconnect. Have a good day.