CION Investment Corporation (NYSE:CION) Q3 2022 Earnings Conference Call November 10, 2022 11:00 AM ET
Company Participants
Michael Reisner – Co-Chief Executive Officer
Gregg Bresner – President and Chief Investment Officer
Keith Franz – Chief Financial Officer
Conference Call Participants
Casey Alexander – Compass Point
Operator
Operator
Good morning, and welcome to the CION Investment Corporation’s Third Quarter Ended September 30, 2022 Earnings Conference Call. An earnings press release was distributed earlier this morning before market opened. A copy of the release, along with a 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 call 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 that involve a number of risks and uncertainties. Actual results may differ materially from those in the forward-looking statements as a result of a 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.
Michael Reisner
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 third quarter results. Gregg will review our investment activity during the quarter, and Gregg will provide additional detail on our financial results. After Keith’s prepared remarks, we will open the call to questions.
As reported this morning, we had another solid quarter in our financial performance, as we reported higher investment income, net investment income and net asset value as compared to the second quarter of 2022. This was due to the successful execution of the plan we have previously laid out and have consistently communicated, which is to organically grow our portfolio through a measured strategy, aiming to provide excellent risk-adjusted returns to our shareholders by focusing on senior secured first lien loans to quality companies, while remaining disciplined and not reaching for yield.
As we communicated to you all since our listing in October 2021, when we felt like we were headed into a recession, we worked hard to build an investment portfolio to expand these turbulent times and are quite pleased how we outperformed to-date, notwithstanding the challenging macroeconomic environment in which we find ourselves.
In terms of credit quality, our high quality portfolio continued to improve in the third quarter, with one name coming off nonaccrual status and no new names being placed on nonaccrual. Nonaccruals, in general, were relatively low when compared to the total fair value of our investment portfolio and accounted for just 0.4% and 1.7% of the overall portfolio at fair value and amortized costs at quarter end.
Our credit quality metrics remained solid in the face of the challenging market environment. The weighted average or net debt-to-EBITDA of our portfolio companies increased to 4.97x as compared to 4.67x on June 30. The weighted average interest coverage of our portfolio companies decreased to 2.67x as compared to 3.29x in the second quarter.
While we continue to significantly outearn our distribution, with our net investment income of $0.45 per share, we are being conservative and holding our distribution steady at this time, but are announcing our intention to declare a special distribution before year-end that should be consistent with our special distribution declared in the fourth quarter of last year in an amount of not less than $0.20 per share.
Over the third quarter, we continue to deploy our capital into quality deals. At September 30, we had 119 companies in our portfolio, with a median EBITDA of $37.3 million across 22 industries. We had new investment commitments of $134 million, of which we funded $127 million and funded previously unfunded commitments totaling $14 million, while sales and repayments totaled $155 million.
We funded six new portfolio companies and funded follow-on commitments to five existing portfolio companies. We believe that the quality of our performing floating rate investments, which at September 30 accounted for 89.1% of our total portfolio, should further positively affect our net investment income in the coming quarters.
During the third quarter, the weighted average yield on our performing loan portfolio increased by 147 basis points to 10.98% compared to 9.51% during the second quarter. Our deal pipeline continues to be active with quality first lien investments. We remain focused on first lien debt investments, and we’ve been able to maintain a level of approximately 90% over the last two years, a significant improvement from 82% of our portfolio at year-end 2020.
Our pipeline continues to be extremely robust, as Gregg will discuss, and we believe that being modestly levered compared to our peers will position us well to continue to grow into what we believe will be an opportunistic market for the rest of this year and as we head into next year.
As we’re getting closer to the end of the year, the year-to-date financial performance and the condition of our portfolio gives us the confidence to believe that we are well positioned to take advantage of sound investment opportunities, a rise from this environment without deviating from our core investment strategy.
Now I’d like to turn it over to Gregg for an overview of the investment market and our investment activity for the quarter.
Gregg Bresner
Thank you, Michael, and good morning, everyone. The challenging bifurcated market conditions of the leverage finance ecosystem that we experienced in Q2 of this year continued into Q3. There remained a clear distinction between the syndicated and direct investing markets.
As syndicated market conditions continue to deteriorate, with declining new issue activity, higher volatility and spread widening, private direct lending continued to expand its market share with robust issuance and yield opportunities. U.S. leveraged loan issuance plummeted in Q3, as the plethora of economic and geopolitical challenges, such as surging inflation, rising interest rates and loan outflows, directly impacted primary market activities.
The $21.4 billion in institutional loan issuance was the lowest amount since the fourth quarter of 2009 when the loan market ground to a halt in the aftermath of the great financial crisis. The total return on the composite Morningstar LSTA U.S. Leveraged Loan Index increased 1.4% during Q3, but cumulatively declined 3.25% on a year-to-date basis through September 30, 2022.
Average bid pricing for secondary loans finished at 92.23% on September 30, down from 92.39% on June 30 and 98.71% on December 31, 2021. The yield to maturity increased over 400 basis points from 4.2% at 12/31/21 to 8.47% on September 30, 2022.
Liquidity has clearly tightened in the syndicated loan market. Cash outflows to prime loans totaled $14.6 billion in Q3. With additional $5.8 billion in outflows in October 2022, the year-to-date cumulative total is now $5.3 billion of cumulative outflow, a sharp reversal from the nearly $25 billion of inflows from January to April of 2022 and the seemingly ends inflows of previous years.
It was markedly different for direct private lenders as firms such as ours took advantage of the dislocation in the syndicated market to continue to build and expand market presence and take advantage of the increased pricing and spread opportunities.
There were a number of noticeable inflection points. According to LCD, the estimated new issuance of direct lending deals exceeded the combined total of syndicated loans and high yield. In addition, larger private lenders appeared more reticent to take down entire loan commitments and pivoted to clubbing transactions with syndicates to reduce concentration and unfunded exposure. This is a strategy CION has employed for many years.
As we have discussed in our past several quarterly calls, we continue to have a cautionary and defensive outlook for the next 12 to 18 months. As a predominantly first lien, highly diversified and floating rate lender, we believe our portfolio is well positioned to deal with the challenging economic headwinds that lie ahead.
As with our peers, we are not in the macroeconomic and geopolitical factors affecting our portfolio holdings, such as supply chain issues, tight labor markets, increases in credit spreads, downward mark-to-market pressures and overall volatility. Irrespective, our portfolio performance for the third quarter and year-to-date remain solid.
CION’s compounded total return to investors for the third quarter of 2022 and year-to-date were 4.3% and 4.8%, respectively. This compares favorably to year-to-date total returns of negative 3.25% for the composite S&P/LSTA Leveraged Loan Index and negative 0.27% for the S&P/LSTA Middle Market Index.
Turning now to our portfolio and investment activity. We entered the third quarter with strong liquidity, a conservative net leverage profile of less than 1x and the continued ability to be highly opportunistic with respect to new investment opportunities in both directly sourced and syndicated markets.
Despite the highly volatile market environment, our new investment activity remained strong in Q3, but we also maintain a prudent approach in preserving capital during this challenging economic environment. New investment portfolio and repayment activities resulted in solid fee and yield income realizations for the quarter as our investors benefited from the myriad of protective, prepayment, restructuring exit and other yield-enhancing features we have in our portfolio. Two transactions of note for the quarter were Carestream Health and Longview Power.
In the $1-plus billion Carestream Health restructuring, we had a highly active role in various committees and used our financial and structural flexibility in the prepackaged restructuring and related DIP and equity rights offerings to disproportionately increase our equity ownership in the company upon emergence, while, at the same time, realizing significant income and substantially reducing the total enterprise value needed at exit to achieve the full recovery of our investment costs. The Carestream transaction was completed equally across the CION and CION/EagleTree entities, with the assistance of our JV partners at EagleTree.
With respect to Longview Power, which we actively helped to restructure several years ago, we received a loan principal paydown at a significant exit premium to par. CION has achieved success with past DIP investments, and it continues to be an important strategic investment focus for us going forward.
As Michael mentioned, during Q3, we made $134 million new investments across six portfolio companies. Of the $134 million in new investment commitments made during the quarter, $127 million was funded. We also funded a total of $14 million of previously unfunded commitments. Additionally, we had sales and repayments totaling $155 million for the quarter, which were primarily driven by the full sale or repayment of investments in eight portfolio companies.
As a result, net funded investment activity decreased by $14 million during the quarter, and the number of portfolio companies decreased from 121 as of the end of Q2 to 119 at the end of Q3. At quarter end, total fair value of our portfolio was about $1.8 billion. The investment portfolio was comprised of 92% senior secured loans, including 89.8% in first lien investments. Approximately 89.1% of the performing loan portfolio was in floating rate investments.
As of September 30, the yield on our performing loan portfolio increased to a gross annual yield before leverage of 10.98%, up materially from 9.51% at the end of the second quarter of 2022 and 9.16% at the end of 2021, with a weighted average purchase price of 97.19% at par and an average investment size of about $15 million per portfolio company as of 9/30.
We had a robust new investment quarter in Q3 as we closed on four new direct investments, two of which are expected to be significant acquisition platforms and four direct investments to existing portfolio companies. In a number of the transactions, we’re a highly impactful investor with substantial roles in the various processes. This is reflected in our solid fee income for the quarter.
We also opportunistically took advantage of the lower quota levels and widening spreads in the syndicated loan markets via the secondary acquisition of nearly $20 million of loans at a price of approximately 84% at par with an unlevered yield to call of approximately 19.32%.
While we continue to carefully evaluate secondary market opportunities, we have passed in many cases as the high overall leverage profile and loose nature of the credit documents, associated with the borrowers, more than offset the attractive yield offer. We were able to sustain our ability to originate new first lien debt investments at a significant premium to the average 9% yield to cost of the S&P Middle Market Loan Index. During Q3, the weighted average yield at cost of our new investments was approximately 10.76%.
We believe our portfolio companies continue to deliver strong overall performance and is well positioned given our predominantly first lien portfolio to weather future market challenges. During this quarter, we completed a number of amendments as several of our portfolio companies completed acquisitions or requested greater covenant flexibility in conjunction with new cash equity contributions.
Some additional portfolio activities slipped into the fourth quarter. Two notable portfolio examples are Vericast, which completed amended in October that resulted in a deleveraging event for first lien holders such as us and Vesta Holdings, where we work to complete a DIP financing and bankruptcy filing in October that we believe was necessary for legal reasons.
As Michael mentioned, at September 30, investments on nonaccrual status declined to 0.4% and 1.7% of the total investment portfolio at fair value and at amortized costs, respectively, compared to 1.5% and 3.6%, respectively, at the end of the second quarter.
During the third quarter, we added no new investments to nonaccrual status and removed one investment, STATinMED, from nonaccrual status as of the end of Q2 as we completed a restructuring of our debt and raised the new equity financing round from the equity sponsor on July 1.
Our investments with internal risk ratings of 4 and 5 comprise 0.5% of the total portfolio as compared to 1.5% at the end of Q2 and 0.7% at the end of 2021. Of note, those investments rated two or higher increase from upping 85% at year-end to approximately 88% at the end of Q3. Approximately 11.4% of our investments were risk-rated three at quarter end, which was up from 8.4% in Q2 as we have become more actively involved in several names.
It is important to note that our definition of a rated three investment is one that indicates a higher risk to our ability to recoup the cost of such investment has increased since origination or acquisition, but a full return of principal and interest or dividend is expected. A portfolio company with an internal risk rating of three requires more active monitoring.
I will now turn the call over to Keith.
A – Keith Franz
Okay. Thank you, Gregg, and good morning, everyone. As Michael mentioned, we reported another quarter of strong financial results, driven by an increase in LIBOR and SOFR rates and additional fees generated from our quarterly investment activity.
During the quarter, net investment income was $25.6 million or $0.45 per share, an increase of $6.3 million or $0.11 per share as compared to $19.3 million or $0.34 per share reported in the second quarter. Total investment income was $54.2 million, an increase of $10.6 million or 24% when compared to $43.6 million reported during Q2.
On the expense side, total operating expenses were $28.6 million compared to $24.3 million in the second quarter. The increase in operating expenses was primarily driven by an increase in interest expense under our financing facilities due to higher LIBOR and SOFR rates and an increase in advisory fees when compared to the prior quarter.
At September 30, we had total assets of approximately $1.9 billion and total equity or net assets of $915 million, with total debt outstanding of $958 million and 56.3 million shares outstanding. As a result, at the end of the quarter, our debt-to-equity ratio was 1.05x, which is consistent when compared to the June quarter.
At September 30, our NAV was $16.26 per share as compared to $15.89 per share at June 30. The increase was largely due to mark-to-market changes in our portfolio, overearning our distribution during the quarter and the accretive nature of our stock buyback plan during the period.
During the quarter, as part of our previously announced $60 million share repurchase plan, we began purchasing shares in the open market. As a result, during the quarter, we purchased about 695,000 shares of our common stock at an average price of $9.65 per share for a total cost of $6.7 million.
Following our shareholder approval to reduce the asset coverage ratio from 200% to 150% back in December of 2021, we have taken steps to increase our debt capacity by $150 million, which enhanced our liquidity and supported the growth of our portfolio during the year.
We ended the quarter with a strong and flexible balance sheet with over 400 million in unencumbered assets, low leverage, a strong debt servicing capacity and solid liquidity. The weighted average cost of our debt capital was 5.4%, with the majority of our senior secured facilities maturing in 2024 and all of our unsecured term loans maturing in 2026 and beyond.
We had over $53 million in cash and short-term investments and access to an additional $72 million under our facilities to finance our investment pipeline. Our current debt mix was 79% in senior secured and 21% in unsecured. At September 30, about 89% of our performing loans were in floating rate, of which 85% had a LIBOR or SOFR floor, with a weighted average floor of 105%.
We should continue to see the positive impact to net investment income as we continue to deploy our available capital into new middle-market floating rate investments that typically pay a yield premium when compared to broadly syndicated deals.
As interest rates continue to rise, we expect an increase to our net interest income of about $0.12 per share to the next 100 basis point increase to the base rate as of September 30 and $0.25 per share for a 200 basis point increase to the base rate, assuming no material changes to the investment portfolio or our debt structure.
Since the beginning of the year, we paid three quarterly cash distributions to our shareholders amounting to $0.28 per share for the first and second quarters, followed by $0.31 per share in the third quarter. As we have announced this morning, our fourth quarter base distribution will remain unchanged at $0.31 per share, and all of our distributions for the year have been fully covered by our taxable income.
Even though we have consistently overearned our distributions during the year, as Michael mentioned earlier, it is our intent to declare a special distribution before year-end in a range consistent with the special distribution declared in the fourth quarter of last year.
Okay. With that, I will turn the call back over to Michael for some closing remarks.
Michael Reisner
Thank you, Keith. As a final thought before we open the line for questions, we’d like to reiterate our message, and we believe CION is well positioned to provide higher returns to its shareholders despite the concerns we discussed regarding current market conditions.
And with that, operator, we’re ready to take any questions.
Question-and-Answer Session
Operator
Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question is from Casey Alexander with Compass Point. Please proceed with your question.
Casey Alexander
Yes. Hi, I noticed that the leverage ratio stayed stable quarter-over-quarter. What would you like to get the leverage ratio to? And I see that your liabilities have a relatively low percentage of unsecured debt relative to your overall liability stack. Would you like to increase that percentage or at the current level of unsecured rates? Do you feel like that’s just too high of a rate to fix that and you’d rather just leave it inside the credit facility? How do you feel about that?
Keith Franz
Hey Casey, it’s Keith. So in terms of our target leverage, we’re looking at about 1.25x. I think that’s where we have communicated previously. And in terms of the secured/unsecured mix, we’re currently about 22% unsecured. Clearly, we would like to bring that up over time, but we’re going to take on new financing transactions very responsibly.
Casey Alexander
All right, thank you. On the expiration date on the share repurchase program, because you did a little over 10%, I think, of the total authorization, and if there’s only three quarters left to it, would it be your expectation that you would be accelerating it from here or is this kind of the tempo and the pace of it that we should expect?
Michael Reisner
Casey, it’s Michael. I think it’s probably the pace you should expect at this time.
Casey Alexander
Great, that’s all my questions. Thank you.
Operator
[Operator Instructions] There are no further questions at this time. I’d like to turn the floor back over to management for any closing comments.
Michael Reisner
Great. Thank you, Paul, and thank you, everyone, who joined the call today. We appreciate your interest in CION. We look forward to speaking to you in early March when we announce our 2022 full year results. Take care, everyone.
Operator
This concludes today’s conference. You may disconnect your lines at this time and log off your computer. Thank you for your participation.
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