On September 6, 2017 after the close, CM Finance (CMFN) announced the results of its fiscal fourth quarter and full year ended June 30 2017 in a press release, and filed a 10-K. The BDC Reporter has read both documents. Here are the highlights, as well as analysis of the earnings and portfolio, and the BDC Reporter’s view of where the BDC is headed in the coming year, and our own investment approach:
Highlight numbers had Net Asset Value Per Share increasing from $11.90 at fiscal year-end 2016 to reach $12.41 at June 2017, which was up from $12.32 the prior quarter.
However, NAV Per Share remains substantially below FY 2014 – when CMFN came to market at $15.00 a share – which ended at $14.65.
Net Investment Income Per Share was $1.15 for the year, but was trending downward, with the last 2 quarters at $0.25.
At its peak two years ago, CMFN’s annual Net Investment Income Per Share was $1.48.
Portfolio assets continued a two year slide, dropping to $255mn at June 30 2017 from $330mn 2 years previously.
Debt To Equity, which had been approaching BDC regulatory limits in the past two years, eased back to 0.74 to 1:00 this fiscal year.
There were 23 companies in the loan portfolio at June 30, 2017, generating a portfolio yield of 9.73%, compared to 22 companies and a 9.80% yield the year before.
A year before that CMFN’s portfolio yield was 10.91%.
At June 2017 there was one loan on Non-Accrual, representing 3.0% of the portfolio at fair value.
Last year, CMFN’s own debt rating system suggested $53mn in DEBT investment were under-performing, or 19.4% of the total. See page 65 of the 10-K.
This year, total under-performing debt assets remaining amounted to $43mn, or 16.5% of the total at FMV.
However, the dollar value and the percentage of the total of the loans in the two lowest risk categories (4 & 5) were hardly changed from year to year.
In FY 2017, CMFN recorded a Realized Loss of ($11.8mn) for the year, which was offset by an Unrealized Gain of $19.7mn.
The latter reflected the reversal of the Realized Losses and the write-up of several investments.
From a distribution standpoint, the BDC’s $0.3516 quarterly distribution level lasted for 4 payments before being reduced (see page 55) half way through the year to $0.25.
The BDC’s liquidity consists of $10.6mn in Cash, $22.6mn in Restricted Cash and $50mn of “capacity” under its Revolver.
The CEO summed up the fiscal year in the press release as follows:
Mr. Michael C. Mauer, the Company’s Chief Executive Officer, said, “During the current period of tightening spreads, declining new issue credit metrics, and increasing uncertainty, we have focused our origination efforts on lower-risk secured opportunities. We are also pleased to have lowered the risk profile in the portfolio by increasing diversification, reducing our average position size, and exiting one of our most highly levered investments.”
FY 2017 saw a huge amount of portfolio turnover at CMFN, as well as numerous restructuring and re-positioning of investments.
During the twelve months ended June 30, 2017, we added 28 new investments [7 in the IVQ] , totaling approximately $134.3 million [$53.2mn in IVQ]. 15  of these investments were in new portfolio companies and 13 were existing portfolio companies. Of these new investments, 63.3% consisted of first lien investments, 36.7% second lien investments, 0% unsecured investments and 0% in equity, warrants, and other investment. [Page 64]
Essentially half the BDC’s portfolio assets are new in the year, and two-thirds in the last 24 months.
That’s high even in the frequent turnover world of leveraged lending and with a BDC that has not had new capital to deploy.
Notwithstanding the CEO’s comments above, the risk profile of the portfolio remains unchanged if we use the loan categorization as a guide.
At cost, Second Lien loans increased from $139mn to $144mn in FY 2017.
First Lien loans dropped from $165mn to $124mn. See page 65 of the 10-K.
Second lien and equity investments at cost exceed First Lien and are 50/50 on a FMV basis.
Last year First Lien assets were in the majority in both categories.
No wonder that the portfolio yield was essentially unchanged on the year.
Compare And Contrast
Credit quality has been a problem with Realized Losses equal to 75% of Net Investment Income on the year.
By contrast, the Investment Advisor received $1,289,927 in Incentive Fees and waived $249,071.
Waived fees equaled 2% of Realized Losses.
Had the Investment Advisor waived all Incentive Fees, Net Investment Income would have been 8 cents a share higher or 7%.
Looking forward, CMFN is going to be hard pressed to maintain its current earnings level.
Loan pay-offs are continuing, as is the “spread compression”. Just look at the press release for the most recent evidence:
During the [FY 2017 IVQ] quarter, we made investments in seven companies, including six new portfolio companies. Five of our seven investments were in 1st lien term loans. These seven investments totaled $53.2mm at cost, and were made at a weighted average yield of 8.25%.
Not helping matters is higher LIBOR resets increasing the cost of its principal debt financing. As of June 2016, CMFN was paying 2.84%. In June of 2017 that was up to 4.1%.
The BDC’s total interest bill increased by 30% last year while Investment Income dropped (8%).
The biggest Wild Card for CMFN- and every BDC – is credit.
As of September, the only non-accrual on the books (Bird Electric) was restructured. Judging by what the press release says about the new instrument created, CMFN might not be counting on any cash income from this source for awhile:
The Company’s investment in Bird Electric Enterprises, LLC was restructured on September 1, 2017, resulting in the elimination of $15 million of principal and replaced with 10 Class C Units. The Class C Units are a non-voting class of preferred equity with a $10mm liquidation preference that accretes at a 10% rate until such time as certain EBITDA targets are met, after which the units are paid a 10% cash dividend.
By our count – with our BDC Credit Reporter hat on – 5 other under-performing or potentially under-performing companies remain.
Admittedly, we are a skeptical observer when BDC credit issues are concerned because being too optimistic can leave a mark.
In this case, we still carry on our Watch List companies which CMFN has “restructured” until we’re fully satisfied that a fundamental change in the business is confirmed.
Otherwise, today’s fully valued investment is tomorrow’s re-defaulting loan.
Permanent Change ?
AAR Intermediate Holdings falls in that category. This was a company which two years ago was in default and whose first lien debt had been written down 45% by several BDC lenders.
After a debt for equity restructuring, CMFN values its $9.8mn of loans at $12mn. (Medley Capital has a similar valuation).
However, should conditions in the oil patch change for service companies, so could these numbers.
Ditto for a similarly restructured U.S. Well Services LLC. Its first lien debt was written down by (24%) in September 2016, but is now – following a rejigging- valued at par.
Nonetheless, we maintain the company on our Watch List.
Also there is another energy company – which has not been restructured and remains current – Caelus Energy Alaska, which is carried at a modest discount to cost by CMFN.
Like Deja Vu All Over Again
From a risk standpoint, we remain concerned that the Investment Advisor has decided to stick with an energy heavy portfolio after all the heartache caused to the BDC’s NAV the first time round.
Between them Oil & Gas and Oil Field Services investments account for $40mn at FMV, and 18% of the total portfolio and nearly a quarter of net assets.
Where CMFN, “fool me twice” where energy investments are concerned and shareholders could take a shellacking.
Back To Our List
Otherwise on our Watch List there is Trident USA Health Services whose $21.8mn second lien loan has been written down to $17.065mn, or (22%). Last quarter that percentage was (15%).
Then there’s a $19mn loan to AP NMT Acquisition, which has been under-performing since the IVQ of 2015.
From what we’ve been able to determine the media company involved was downgraded by Moody’s in both 2016 and 2017. If we’re correct, the 2022 debt which CMFN owns is in the Highly Speculative category.
Not even on our Watch List but previously resident there is exposure to PR Wireless (Puerto Rico and wireless carriers should be enough code words to explain why BDC Credit Reporter has the company in its records) and YRC Worldwide, a trucking company, that was carried at a (14%) discount back in March 2016.
Good Things Can Happen
However, we should stress that CMFN may very well be able to avoid any impact from the 6 companies on our Watch List (which includes Bird Electric) or the $43mn in under-performing assets by their own count.
Even then the relentless economics of an over-supplied leveraged debt market is likely to squeeze earnings below the distribution.
However, if just one or two existing credits go sour the impact on earnings – and thus the sustainability of the current distribution- will be palpable.
Nicholas Marshi is the Editor-In-Chief of the BDC Reporter