CION Investment Q4 2023 Earnings Call Transcript

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March 14, 2024

Key Takeaways

  • Scion reported a 3% QoQ and 2% YoY NAV increase in Q4, core EPS of $0.94 (up 8% QoQ), and an ROE of 23.4% (11% FY), with net investment income of $0.40 per share exceeding its base dividend and prompting a planned midyear supplemental distribution.
  • Credit quality remained robust with non‐accruals below 1% of fair value, 99% of assets risk‐rated 3 or higher, conservative net leverage of 1.1x, and NAV restored to two‐year levels while peers’ NAVs were flat or down.
  • The board repurchased ~280,000 shares at an average of $10.35 in Q4 (~$2.9M) and has bought back ~2.8M shares for $27M since August 2022, with share repurchases set to continue.
  • Scion emphasized its niche in middle‐market first‐lien lending, targeting yield‐enhancing features with average spreads of ~750bps and 2–3% OID, as opposed to lower‐spread large‐cap deals, to deliver superior risk‐adjusted returns.
  • The balance sheet mix is ~60% secured/40% unsecured debt (85% floating rate) at an 8.5% average cost, backed by over $600M of unencumbered assets, $120M+ in cash, and $150M of undrawn credit capacity.
AI Generated. May Contain Errors.
Earnings Conference Call
CION Investment Q4 2023
00:00 / 00:00

There are 7 speakers on the call.

Operator

and welcome to Scion Investment Corporation's 4th Quarter and Year End 2023 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 company's website at www.scionbdc.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 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 and involve a number of risks and uncertainties.

Operator

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 Reznor, Dione Investment Corporation's Co Chief Executive Officer Greg Bresner, President and Chief Investment Officer and Keith France, Chief Financial Officer. With that, I would now like to turn the call over to Michael Reznor. Please go ahead, Michael.

Speaker 1

Thank you. Good morning, everyone, and thank you for joining us. As mentioned, I am joined today by Greg and Keith, as well as other members of Cigna Management. I will start our call today with an overview of our Q4 year end results. Greg will review our investment activity during the quarter, and Keith will provide additional detail on our financial results.

Speaker 1

After Keith's prepared remarks, we will open the call to questions. As we reported this morning, we had a very strong Q4 and 2023 overall, which saw us continue to demonstrate solid credit performance with an increase of almost 3% to our net asset value quarter over quarter and almost 2% year over year and net income of $0.94 per share, an increase of 8% quarter over quarter. Our ROE was 23.4% for the quarter and 11% for the year. Our net investment income ROE was 10% for the quarter and 12.1% for the year. Our net investment income of $0.40 per share once again out earned our base dividend.

Speaker 1

Because of our continued ability to out earn our base dividends, coupled with our ability to drive returns by our yield enhancing features and opportunistic buying of lightly syndicated deals at discounts, which Greg will speak more about, we are announcing today our intention to declare a midyear supplemental dividend payable July 12 to shareholders of record as of June 28. The exact amount of the supplemental dividend will be announced next quarter. Our portfolio continued to deliver resilient credit performance as the percentage of our portfolio on non accrual is now below 1% of fair value. Perhaps an even better indication of our credit performance, the percentage of names that we have risk rated 4 or 5, which represents our higher credit risk names, is also below 1% of the portfolio at fair value, which compares favorably to many other BDCs. 99% of our book is risk rated 3 or higher, again a favorable benchmark when looking at our peers.

Speaker 1

At quarter end, we were still leveraged conservatively on a net basis at 1.1x. Our net asset value increased to $0.43 per share to $16.23 owing in part to mark to market adjustments to the portfolio as well as the accretive nature of our share repurchase program. Our NAV continues its recent improvement and is now back to where it was 2 years ago, despite the higher interest rate environment we have been operating in and compares favorably with the net asset values of our peers, which have mostly experienced decreasing to flat net asset values over the same period. During Q4, we repurchased approximately 280,000 shares at an average price of $10.35 per share for a total repurchase amount of $2,900,000 We have repurchased a total of approximately 2,800,000 shares for a total repurchase amount of $27,000,000 since the beginning of the repurchase program we put in place in August 2022 through the end of 2023, and we intend to continue to be active for repurchasing our shares in the coming quarters. While many consider this the golden age of private credit, more and more of our BDC peers continue to depart from their traditional niche of lending to true middle market companies as banks retrenched in 2023.

Speaker 1

However, as banks start to resume lending activity, we believe that having a defensible niche in the middle market is paramount. As I mentioned last quarter, many BDCs are going after larger companies where leverage is higher, spreads are lower and covenants, if even presents, are looser. To that end, just recently a Bloomberg article was titled Private Credit Cuts Pricing to fend off Wall Street Deal Grab as many large BDCs participated in a loan with a spread of only 4 75 basis points over the base rate with 1.5% OID, one of the cheapest private credit deals in recent memory. The company in question has an EBITDA of approximately $500,000,000 By comparison, the weighted average EBITDA of our portfolio is $34,000,000 We almost always receive meaningful lender protection and covenants. Our weighted average spread is 7.50 basis points over the base rate, and our average OID has been between 2% 3%.

Speaker 1

While there is nothing wrong in and of itself with the deal I referenced, we believe from a risk adjusted perspective, our style of lending is superior. At almost $2,000,000,000 in total assets, we are large enough to be an impactful player to borrowers in the middle market without being so large that we are forced to buy the market or sacrifice economics or borrower protections in an effort to put money to work. Finally, before I turn the call to Greg, I wanted to announce that we are welcoming a new member to our senior management team this week, as Charlie Orestia has joined us as a Managing Director and Head of Investor Relations. Charlie was previously part of IR team at Focus Financial Partners and before that was an analyst at JP Morgan. With that, I'll now turn the call over to Greg.

Speaker 2

Thank you, Michael, and good morning, everyone. Our Q4 net investment income benefited from a diverse combination

Speaker 3

of

Speaker 2

the direct pass through of higher floating interest rates from our loan assets, origination and amendment fees and other prepayment premiums and other yield enhancing provisions embedded within our primarily 1st lien portfolio. As Michael referenced, there remains a clear distinction between the increased levels of competition in the large cap markets between the larger asset management platforms and money center banks and the direct middle market The middle market direct lending sector remains robust and continues to take market share from the lower rated single B syndicated markets, which is consistent with what we are experiencing with our platform as our private direct transaction sourcing remains vibrant. We continue to see attractive direct investment opportunities for which we remain highly selective. While M and A activity remains subdued in Q4, we saw an increase in refinancing opportunities, particularly in conjunction with add on acquisitions where additional debt capital was required that was beyond the capacity of the incumbent lender groups or the private equity sponsor chose to refinance to provide an additional 2 years to pursue M and A or sales strategies. We do expect M and A activity to increase in 2024 as we believe buyers and sellers are now accepting the higher FOLONGA reality regarding interest rates.

Speaker 2

In addition, we continue to benefit from technically driven disruptions in the syndicated loan market where we acquired lightly syndicated 1st lien loan tranches at significant discounts to par due to issues such as ratings changes, maturity extensions, exchanges or restructurings that were not suitable for the existing syndicate holders and where we can expect to have active roles in the processes that drive the refinancing or restructuring of the investments. We remain highly selective with new investments as we are still cautious with respect to the U. S. Consumer particularly in light of recent global developments and the persistence of higher interest rates and inflation levels. We continue to strategically focus on 1st lien investing and prefer to utilize yield enhancement provisions such as PIK features, call protection, make whole provisions and MOEX to incrementally enhance yields at the top of the capital structure rather than reaching deeper into capital structures for mezzanine and equity co investments to achieve incremental yield.

Speaker 2

Approximately 60% of our annual PIK income is derived from highly structured situations such as our litigation finance investments where we can attain higher yields by matching flexible PIC timing features with strict cash flow sweeps upon collections or through coupon structures where PIK is incremental to our cash interest. Approximately 85% of our PIK investments are in portfolio companies risk rated either 1 or 2 and 97% risk rated 3 or better. Turning now to our Q4 investment and portfolio activity. During Q4, we completed an attractive mix of 1st lien investments. We completed private direct 1st lien financing tranches for new platforms including Nova Compression, North Third Travel and Tactical Air Support where we acted as co lead arranger.

Speaker 2

We also completed a number of 1st lien add on investments for portfolio companies including Work Genius, H. W. Lochner, David's Bridle, Uselco and Moss. The weighted average coupon for our direct investments was approximately sulfur plus 8% for the quarter. We additionally continued our purchases of the lightly syndicated 1st lien tranches of companies such as PureStar, YakMAT, Avison Young and Aveline at discounts.

Speaker 2

These purchases proved to be attractive as PureStar, Yakmat and Aveline have been recently refinanced and we comprehensive recapitalization and deleveraging transaction that is expected to close in Q1 of 2024 and positions the company for future growth and investment. Upon closing, we expect to realize significant accretion to the blended cost of our 1st lien investment in Avison Young. During Q4, we made $152,000,000 in new investment commitments across 5 new and 15 existing portfolio companies, of which $147,000,000 was funded. These investments were diversified across direct and secondary opportunities with approximately 72% in direct private investments. We also funded a total of $7,000,000 of previously unfunded commitments.

Speaker 2

We had sales and repayments totaling $83,000,000 for the quarter, which primarily consisted of the full repayment of our investments in Cadence, Archer Systems, NWN and associated asphalt. As a result, net funded investment activity increased by approximately $71,000,000 during the quarter. The repayment trend has continued into 2024 as M and A activity has fueled recent Q1 repayments that have resulted in significant OID acceleration and incremental investment income from yield enhancement provisions such as prepayment premiums, make calls and MOICs attached to our 1st lien portfolio. Our non accruals declined slightly from 1% of fair value at ninethirtytwenty 3 to 0.9 percent of fair value at Twelvethirty Onetwenty 3. We added one new name, our second lien investment in TriMas Ambrosia with approximately $1,500,000 of fair market value to non accrual this quarter.

Speaker 2

TriMark was in the process of a voluntary restructuring process in Q4 did not close until January of 2024. As a result of the restructuring, we participated in the backstop group and received a package of backstop fee, take back debt and equity for our 1st lien and second lien positions in the company. Given the closing of the transaction, we expect to remove TriMark from non accrual status in Q1 of 2024. Overall, our portfolio remains defensive in nature with 85% in 1st lien investments and 87% in senior secured investments. I'll now turn the call over to Keith.

Speaker 3

Okay. Thank you, Greg, and good morning, everyone. As Michael mentioned, we reported another quarter of solid financial results, driven by the benefits of higher base rates on our mostly floating rate portfolio and fees generated from a quarterly investment activity. During the Q4, net investment income was $21,800,000 or $0.40 per share as compared to $30,000,000 or $0.55 per share reported in the Q3. For the full year, net investment income was $105,000,000 or $1.92 per share as compared to $88,200,000 or $1.56 per share for the prior year.

Speaker 3

This is an increase of $0.36 per share with 23% year over year. On the expense side, total operating expenses were $38,200,000 as compared to $37,600,000 reported in the 3rd quarter. The increase was driven by higher interest expense under our financing arrangements due to an increase in our average debt outstanding when compared to the prior quarter. At December 31, we had total assets of approximately $2,000,000,000 and total equity or net assets of 880,000,000 dollars with total debt outstanding of $1,100,000,000 54,200,000 shares outstanding. At the end of the quarter, our net debt to equity ratio was 1.10x, which is slightly higher than 1.03x at the end of Q3.

Speaker 3

During the year, our total debt outstanding increased by $134,000,000 or 14% from the prior year, reflecting the measured growth of our portfolio using additional debt capital. Our portfolio at fair value ended the quarter at $1,800,000,000 up $113,000,000 from the 3rd quarter, reflecting the combination of net fundings and net unrealized gains from the portfolio. The weighted average yield on our debt and other income producing investments and amortized cost was 13.4% at December 31, which increased 36 basis points from 13.04% at the end of Q3 and increased over 100 basis points from the prior year end. At December 31, our NAV was $16.23 per share as compared to $15.80 per share at September 30, increase of $0.43 per share with 2.7%. The increase was driven by mark to market price increases in our portfolio and the accretive nature of a share repurchase program during the quarter, which was offset by our year end special and 4th quarter supplemental distributions totaling $0.20 per share.

Speaker 3

For the quarter, we experienced a significant mark to market price increase to the value of our common equity investment in David's Bridal. Given the overall largest size of this position relative to our other equity investments and the seasonal nature of its end markets, we do expect to have a higher than average mark to market price volatility in the fair market value of this investment on a quarter to quarter basis. Year over year, our NAV was up $0.25 per share or 1.6 percent, increasing from $15.98 per share at the end of 2022 to $16.23 per share at the end of 2023, reflecting the strong credit quality of our portfolio. We ended the quarter with a strong and flexible balance sheet with over $600,000,000 in unencumbered assets, lower net leverage relative to our peers, a strong debt servicing capacity and solid liquidity. We have over $120,000,000 in cash and short term investments and access to an additional 150,000,000 dollars under our credit facility to further finance our investment pipeline and continue to support our existing portfolio companies.

Speaker 3

During the quarter, the weighted average cost of our debt capital was about 8.5%. In terms of our debt structure, as we previously discussed, in October, we closed on a $33,000,000 follow on to our Series A unsecured floating rate notes to certain institutional investors in Israel, with the same terms as the existing notes issued earlier in the year. And in November, we completed a $100,000,000 private offering of floating rate unsecured notes to certain U. S. Institutional investors.

Speaker 3

The addition of these unsecured notes to our debt capital brings additional strength and flexibility to our balance sheet and aligns well with our mostly floating rate investments. After completing these two financing transactions, our debt mix is now about 60% in senior secured and 40% in unsecured with about 85% in floating rate. Now turning to our distributions. During the Q4, we paid total distributions to our shareholders of $0.54 per share, which includes a base distribution of $0.34 per share, the year end special distribution of $0.15 per share and a previously declared 4th quarter supplemental distribution of $0.05 per share. For the full year 2023, we declared total distributions of $1.61 per share as compared to total distributions of $1.45 per share during 2022, an increase of $0.16 per share or 11% year over year.

Speaker 3

As a result, our distribution yield based on the year end average NAV was 9.9% and our distribution yield based on the year end market price was 14.2%. As announced this morning, we declared our 1st quarter base distribution of $0.34 per share, which is the same amount as the base distribution declared during the Q4 of 2023. The 1st quarter distribution will be paid on March 28 to shareholders of record on March 22. Okay. With that, I will now turn the call back over to Michael for some closing remarks.

Speaker 1

Thanks, Keith. As a final thought before we open the line for questions, we would like to reiterate our message that we believe Scion is undervalued, continues to perform well and is well positioned to continue to provide solid returns to its shareholders. And with that, operator, we're ready to take any questions.

Operator

Thank you. We will now be conducting a question and answer session. Our first question is from Eric Siouc from Hovde Group.

Speaker 4

I wanted to start with a question following the Q4 actions towards raising more unsecured debt. You noted that the mix now kind of sixty-forty secondured versus unsecured. And curious, have you kind of reached your target mix there? Or do you anticipate potentially making some additional changes in the 2024?

Speaker 3

Good morning, Eric. This is Keith. So in terms of our debt capital, we continue to work with our commercial banking partners on extending our current arrangements. Those conversations continue to be had today. So we'll probably have a better update for you over the next couple of weeks or months.

Speaker 3

And at the same time, we continue to explore opportunities in the Get Capital Markets, which would further diversify our mix between secured and unsecured and also expand our lending partners that we do business with. So, yes, we I don't think we're done. I think we'll continue to explore opportunities as they present themselves.

Speaker 4

Thanks, Keith. And switching gears, just curious if you could provide any commentary on the current pipeline, maybe in terms of the mix of new versus add on opportunities as well as any if you're seeing any particular industries that are stronger and presenting to be more attractive opportunities today?

Speaker 2

Eric, it's Greg. It really is diversified. There is no one specific industry focus. From what we're seeing, B2B remains strong. So you will that in our business services focus.

Speaker 2

We're still seeing opportunities, niche opportunities in healthcare and industrial services. So it's pretty broad based. I wouldn't say there's one particular theme to it.

Speaker 4

And any thoughts on kind of the mix between new and add on opportunities today?

Speaker 2

Yes, we're seeing both. It's healthy on both sides. We do see platform M and A starting to pick up sales of companies, but we're also seeing a lot of incremental add on activity where we step in. So it really is a combination of both.

Speaker 4

Thanks. And then previously you mentioned that your portfolio companies kind of have been growing at a single digit EBITDA. Hearing just from anecdotal evidence and talking to some other BDCs that some are starting to see some slowdowns in certain pockets of the economy. So just curious if you could provide any insight into what you're seeing with your portfolio companies and whether they continue to grow and improve at this point?

Speaker 2

Yes, we're still seeing the single digit growth. We haven't seen any pronounced slowdown. It varies industry by industry, but I think that single digit measure still holds.

Speaker 4

And then last one for me. Can you provide any comments on what drove the unrealized gains in this past quarter?

Speaker 2

Yes. So mark to market, obviously, there was some spread compression, which fit throughout our model. So we did see spreads tighten a bit. And also, David's Bridal was strong in this quarter and that had to do with really the purchase accounting adjustments associated with closing the transaction. The auditors had the time to perform the revalue of inventory, merchandise and things like that.

Speaker 2

So you saw a mark to market increase based on that analysis.

Speaker 4

That's helpful. Thanks for taking all my questions today.

Speaker 3

Thank you.

Speaker 5

Thank you, Eric.

Operator

Our next question is from Stephen Martin with Slater Capital

Speaker 6

Management. Following up on your last response on David's Bridle, can you talk is there any incremental information on its performance, its turnaround? I see you extended additional credit and I assume it's current pay, etcetera?

Speaker 2

So, it's really no not much material information we can share. Part of it too is you're going through the selling season now. So, we'll have a much better view in the next couple of quarters. The incremental debt this quarter was a synthetic letter of credit facility. So it wasn't a general loan.

Speaker 2

It was more to back LCs to free up capacity under traditional ABL. So it really wasn't a corporate for use loan. It was really to help the company more efficiently on a cost of capital basis backstop standby LCs.

Speaker 6

Got it. And were are they now complete with all the closings and The just and this is probably something you talked about on the Q3. Interest income from Q2 to Q3 to Q4 went from 57 to 64 and then back down to 64 56. What was the anomaly in Q3 that accounted for that?

Speaker 3

Yes. Good morning. This is Keith. So in Q3, we had some make whole fees that we recognized as a result of some exits and some additional income recognized as a result of some restructuring transactions that brought back and recaptured some income.

Speaker 6

Yes. I figured you had mentioned it, but I just couldn't find a note on it. Where do you stand on PIK sequentially and going forward?

Speaker 2

So we discussed some in our conference today, our PIC income is diversified and it's usually driven by structured situations where we're picking up enhanced yield for the PIC flexibility. We do expect over time that number to come down as our current portfolio refinances or gets repaid in those structured situations. So over time, we do expect it to come down. But again, it's more opportunistic. What we've chosen strategically is we would rather for special situations be PIK secured at the top of the capital

Speaker 6

Okay. And last on you did a good job on the nonperformings and non accruals. Are there any prospective restructurings that would reduce that further after the quarter this quarter or next quarter?

Speaker 5

No. This is Michael. Other than TriMark, as Greg mentioned, which we expect to take off this quarter. Nothing else we know right now.

Speaker 6

Okay. Thanks a lot. Good quarter, guys.

Speaker 5

Thank you, Steve.

Operator

Thank you. There are no further questions at this time. I'd like to hand the floor back over to management for closing

Speaker 5

comments. Great. Well, we thank everyone for tuning in today and we look forward to talking to you in a couple of months after the close of the Q1. Take care everyone. Thank you.

Operator

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.

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