Crescent Capital BDC, Inc. (NASDAQ:CCAP) Q1 2023 Earnings Call Transcript

Crescent Capital BDC, Inc. (NASDAQ:CCAP) Q1 2023 Earnings Call Transcript May 11, 2023

Operator: Good afternoon, ladies and gentlemen, and welcome to the Q1 2023 Crescent Capital BDC, Inc. Earnings Conference Call. [Operator Instructions] Also note that this call is being recorded on Thursday May 11, 2023. And I would like to turn the conference over to Dan McMahon. Please go ahead.

Dan McMahon: Good morning, and welcome to Crescent Capital BDC Inc.’s first quarter ended March 31, 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 not 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 first quarter ended March 31, 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.

Jason Breaux: 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 first quarter results before discussing the current market environment in more detail. I’ll then provide an update on our dividend policy, before turning it over to Henry to review our recent investing activity. Gerhard will then review our financial performance for the first quarter. Let’s begin. Please turn to Slide 6, where you’ll see a summary of our results. On March 9, we closed on our acquisition of First Eagle BDC, so first quarter results reflect approximately three weeks’ worth of combined company P&L. Earnings per share metrics are based on weighted average shares outstanding for the period.

For the first quarter, adjusted net investment income increased 10% to $0.54 per share from $0.49 per share for the prior quarter. This increase was driven primarily by rising base rates and higher spreads. Our net asset value per share ended the quarter at $19.38, down 2.3% as compared to year-end. This decline was attributable to two things: one, transaction costs related to our acquisition of First Eagle BDC; and two, unrealized losses we took to reflect wider credit spreads in the market, which were modestly offset by net realized gains. We tend to focus more on realized gains and losses, which we believe is a more important metric in grading our performance than unrealized gains and losses, which has meaningfully less impact on our longer-term results.

Please turn to Slides 13 and 14 of the presentation, which highlights 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 less than 1% 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, which compares to 90% as of year-end. And we remain well diversified across 20 industries and continue to lend almost exclusively to private equity-backed companies, with 98% of our debt portfolio in sponsor-backed companies as of quarter end.

In terms of industry composition, you can see on the right-hand side of Slide 14 that the majority of our investments continue to be in services-based businesses with a particular focus on healthcare, software, commercial and professional services. This is by design, as Crescent’s private credit team has always focused on underwriting free cash flow generative businesses in what we deem to be more recession-resilient industries. With respect to software, our investment focus is providing conventional cash flow-based leverage financing to more mature sponsor-backed companies. We are not participants in loans to free cash flow or annual recurring revenue-based loans. This approach has led to the consistent payment of principal and interest from our borrowers, with portfolio companies representing over 99% of our total debt investments at fair value, making full payment in the first quarter, a figure that’s remained stable for some time.

As highlighted in our previously released supplemental materials, the acquisition of First Eagle BDC has not resulted in material changes to the credit quality, investment type or industry focus of our portfolio. A few more credit trends to review: performance ratings and nonaccrual levels. Our weighted average portfolio grade of 2.2 compares to 2.1 last quarter, and the percentage of risk rated one and two investments, the highest ratings our portfolio companies can receive accounted for 85% of the portfolio at fair value, down modestly from 87% last quarter. As of quarter end, we had investments in eight portfolio companies on nonaccrual status representing 2.7% and 2.0% of our total debt investments at cost and fair value, respectively. Moving to the current market backdrop.

The volatility we experienced in the financial markets in the latter half of 2022, continued during the first quarter of 2023, especially with the challenges in the regional banking space. We believe that the banks remain constrained on new activity due to capital and liquidity concerns, which improves the opportunity set for direct lenders. For example, while M&A activity remained muted for the first quarter, for those deals that did get done, we continued to see a growing preference for surety of execution from sponsors and management teams alike. This is highlighted by the fact that in the first quarter, over 90% of new LBO financings by count were completed by private capital providers, a market traditionally weighted towards the broadly syndicated channel.

Additionally, the opportunities we have seen in recent quarters have demonstrated economic and structural terms that are favorable to prior years. On the topic of regional banks, less than 3% of our portfolio at fair value has top line exposure to regional bank customers. While we believe Crescent has and will continue to benefit from its position as a tenured solutions provider to middle market companies, given the breadth of our origination capabilities and the experience of our team, in the immediate to near term CCAP is primarily focused on the rotation of our existing portfolio and maintaining leverage in the lower half of our target range and therefore, we’ll be highly selective on new deployment opportunities. The new investment opportunities the platform is seeing are quite compelling in terms of attractive pricing, enhanced call protection and lower overall leverage levels for high-quality companies.

Spreads on new originations are approximately 100 basis points higher compared to a year ago. Switching gears. Before I turn it over to Henry, I want to touch on our dividend policy. As CCAP has continued to scale since its inception in 2015, net investment income and the quarterly base dividend have grown alongside. Following a dozen dividend increases, which began in the second half of 2015, we’ve paid the current $0.41 per share base dividend every quarter, since the beginning of 2019, which represents an 8.5% annualized dividend yield based on our March 31 NAV. We have consistently prioritized earning our dividend and note that we have earned our dividend in every quarter since inception. Following the Fed’s rate hikes beginning last year, our NII per share has begun to more comfortably outpace the base dividend, as was evident over the past few quarters.

Because of this dynamic, beginning in the second quarter, we intend to implement a variable supplemental dividend program. The supplemental dividend will be variable each quarter, calculated as 50% of NII in excess of our regular dividend rounded to the nearest penny and subject to a measurement test. The measurement test will cap the supplemental dividend such that any decline in NAV over the prior two quarters, plus the supplemental dividend, will be no more than $0.15 per share. For purposes of the initial second quarter calculation, the change in NAV component will only look back one quarter to March 31, which is the first reporting period following the First Eagle BDC acquisition. For all future periods, the prior two-quarter methodology will be applied.

The supplemental dividends will be approved by our Board, announced with quarterly results and paid in the following quarter. We believe this formulaic framework strikes the right balance of increasing total distributions to our stockholders, while preserving the stability of our NAV over time. For the second quarter of 2023, our Board declared a $0.41 per share, quarterly cash dividend, which will be paid on July 17 2023, to stockholders of record as of June 30 2023. Assuming we over-earned $0.41 per share in the second quarter, and are not constrained by the measurement test, we’ll announce the amount of our first supplemental dividend in conjunction with next quarter’s results. I’d now, like to turn it over to Henry, to discuss our Q1 investment activity.

Henry?

Henry Chung: Thanks, Jason. Please turn to Slide 15, where we highlight our recent activity. Gross deployment in the first quarter was $29 million as you can see on the left-hand side of the page, which consisted of three add-on and several follow-on revolver and delayed draw fundings. The $29 million in gross deployment compares to approximately $54 million, in aggregate sales and repayments during the quarter. Inclusive of the $335 million First Eagle BDC investment portfolio that we acquired, which is not highlighted on this side of the slide, total investments at fair value increased by 24% quarter-over-quarter. Moving to the right-hand side of the page, you’ll see our first lien investments including unitranche investments continue to account for the lion’s share or 89% of our total portfolio at fair value.

Given that majority of the acquired First Eagle portfolio was in traditional senior secured first lien loans as opposed to unitranche loans that component of the combined portfolio increased from 24% to 28% quarter-over-quarter. Turning to slide 16. You can see that the weighted average yield of our income-producing securities at cost increased quarter-over-quarter from 10.8% to 11.4% on the heels of the Federal Reserve’s continued interest rate hikes and is up 390 basis points year-over-year. This was driven primarily by an increase in base rates. As of March 31st, 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 is the case this quarter with continued growth in our net interest margin. Overall, our investment portfolio continues to perform well with strong double-digit year-over-year weighted average revenue and EBITDA growth. While a higher rate environment is certainly beneficial from an earnings perspective, we are also cognizant of the fact that it is generally correlated with a slower US economy, which together can create more stress in the portfolio. We have been particularly focused on the impact to our portfolio from rising wages and interest rates. We have seen a sustained outpacing of revenue growth relative to EBITDA growth driven primarily by margin pressures resulting from labor inflation in select top sectors.

While our portfolio companies has demonstrated an ability to pass-through certain price increases due to their respective market positions and customer value propositions this dynamic continues to be one that our management teams and private equity partners are actively managing. We have yet see broad-based revenue pressure at the portfolio or even sector level and declines that we have witnessed have tended to be company specific particularly companies that were outsized beneficiaries from COVID-19 stay-at-home mandates where we are now observing a reversion to the mean. With respect to rising rates, using market interest rate levels at quarter end and adjusting for last week’s Fed rate hike, weighted average interest coverage for the total portfolio is 1.8 times.

We continue to closely monitor how our portfolio companies are managing fixed charges in this environment and believe that our companies in the aggregate are capitalized as sufficient available liquidity. As of quarter end, approximately 70% of aggregate revolving capacity was available across the portfolio, which we view as a very manageable figure. We have not seen a material increase in revolver utilization rates across the portfolio in recent quarters and recent draws have been driven largely by the routine operational needs of the respective businesses. The strength of our portfolio continues to benefit from the substantial amount of equity invested in our companies. The weighted average loan-to-value in the portfolio at time of underwriting was approximately 41%, which provides us a margin of safety from both an enterprise value perspective as well as capital risk from sophisticated partners beneath our tranche that is available to support our investments.

Crescent’s track record of successfully managing through multiple economic and market cycles provides us with significant and relevant experience to navigate what could potentially be a challenging environment in 2023 and beyond. With that I’ll now turn it over to Gerhard.

Gerhard Lombard: Thanks, Henry, and good afternoon, everyone. Our adjusted net investment income per share of $0.54 for the first quarter of 2023 compares to $0.49 per share for the prior quarter and $0.41 per share for the first quarter of 2022. Total investment income of $39.3 million for the first quarter compares to $34.5 million for the prior quarter, representing an increase of approximately 14%. Driven by rising base rates and the impact of three weeks of earnings from First Eagle, recurring yield-related investment income comprised of interest income, PIK income, amortization and unused fees was up 10% quarter-over-quarter from $32.5 million to $35.8 million, ultimately accounting for over 90% of this quarter’s total investment income.

PIK income continues to represent a modest portion of our revenue at approximately 2% of total investment income. Our GAAP earnings per share or net increase in net assets resulting from operations for the first quarter of 2023 was $0.24 per share, which compares to $0.08 per share for the prior quarter. At March 31st, our stockholders’ equity was $718 million resulting in net asset value per share of $19.38 as compared to $613 million or $19.83 per share last quarter as we issued approximately 6.2 million shares during the first quarter as part of the consideration for the net assets acquired from First Eagle BDC. The unrealized component of this quarter’s NAV decline is not in our view a reflection of deteriorating credit quality in our portfolio, but rather the widening credit spread environment, which affected marks.

This dynamic is evidenced by our internal portfolio ratings at the end of the first quarter, largely consistent with prior quarters with 85% of the portfolio rated one or two our highest rating categories. This is also in line with our expected risk ratings resulting from the First Eagle BDC acquisition. We believe this is an important distinction to highlight for shareholders in a volatile market environment. Now, let’s shift to our capitalization and liquidity I’m on Slide 19. As of March 31, our debt-to-equity ratio was 1.23x up from 1.08x at year-end, which is in line with our expectations given the leveraging impact of the First Eagle acquisition. The weighted average stated interest rate on our total borrowings was 6.52% as of quarter end.

As you can see on the right-hand side of the slide, we have a low level of debt maturities over the next few years with one $50 million maturity related to our 5.95% unsecured notes coming due in July. As you may have seen disclosed in the 10-Q we filed yesterday evening we completed a private offering of $50 million aggregate principal amount of 7.54% senior unsecured notes due July 28, 2026. These notes will become effective upon the repayment of the existing 2023 notes at their maturity at the end of July. Adjusted for this activity there are no near-term maturities until 2026. It’s also worth highlighting that in January we upsized our SMBC Corporate Revolving Facility by $35 million to $385 million. And in March, we upsized our SPV asset facility by $150 million to $500 million and extended the maturity from June 2026 to March 2028.

Additionally, we assumed First Eagle’s 5% unsecured notes due 2026 which provides for enhanced funding flexibility and improves our unsecured debt mix to approximately 33% of total drawn debt as of quarter end. Our liquidity position remains strong with $297 million of undrawn capacity subject to leverage borrowing base and other restrictions and $34.5 million in cash and cash equivalents as of quarter end. We believe the increase in our dry powder positions us well to continue to support our existing portfolio company commitments as well as selectively invest in new opportunities in the current investing environment where we will remain highly selective. Finally, for the second quarter of 2023, our Board declared a $0.41 per share quarterly cash dividend which will be paid on July 17, 2023 to stockholders of record as of June 30, 2023.

And with that, I’d like to turn it back to Jason for closing remarks.

Jason Breaux: Thanks, Gerhard. In closing, while we continue to monitor the potential for economic challenges that may lie ahead, we believe that we are well positioned to navigate these conditions. We’ve built a defensively positioned portfolio and benefit from the Crescent platform and highly seasoned team who’ve collectively managed through numerous challenging times and cycles. 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.

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Q&A Session

Operator: Thank you. [Operator Instructions] And your first question will be from Sean-Paul Adams. Please go ahead.

Q –Unidentified Analyst: Hey, guys. Good morning. I only have one question and that’s how much of your total investment income or your NII was from the accretion from the FCRD acquisition?

Q –Unidentified Analyst: Thank you for that color. I really appreciate it.

Operator: Thank you. Next question will be from Ryan Lynch at KBW. Please go ahead.

Operator: Thank you. [Operator Instructions] And your next question will be from Finian O’Shea at Wells Fargo Securities.

Operator: Thank you. At this time, I would like to turn the call back over to Mr. McMahon, for closing remarks.

Dan McMahon: Thanks, everyone. Appreciate your interest in CCAP and the thoughtful questions. We look forward to speaking with you, next quarter, if not sooner.

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