Business Context and Reporting Period
Company: CM Finance Inc (CMFN)
Filing Type: Form 10-K (Annual Report)
Reporting Period: Fiscal year ended June 30, 2018
Business Overview: CM Finance is an externally managed, non-diversified closed-end management investment company regulated as a Business Development Company (BDC). It invests primarily in the debt of U.S. middle-market companies, focusing on unitranche loans, first and second lien loans, and selectively in unsecured debt and equity. The company is managed by CM Investment Partners LLC.
Key Financial Metrics
| Metric | 2018 | 2017 |
|---|---|---|
| Total Investment Income | $40.8 million | $31.0 million |
| Net Investment Income | $19.0 million | $15.7 million |
| Net Increase in Net Assets from Operations | $15.6 million | $23.6 million |
| Net Asset Value (NAV) per Share | $12.57 | $12.41 |
| Portfolio Fair Value | $293.6 million | $254.9 million |
| Weighted Average Yield (at cost) | 11.19% | 9.73% |
| Total Assets | $314.5 million | $296.0 million |
| Total Liabilities | $143.0 million | $126.1 million |
| Senior Securities Outstanding | $119.8 million | $102.0 million |
| Asset Coverage Ratio | 243% | Not explicitly stated (implied >200%) |
Material Changes vs. Prior Period
- Investment Income Growth: Total investment income increased 31.5% to $40.8 million, driven primarily by dividends received from wholly-owned subsidiaries (Bird Electric Blocker, LLC and U.S. Well Services Blocker, LLC).
- Expense Increase: Total expenses rose to $21.8 million from $15.3 million, attributed to higher income-based incentive fees and a new tax provision related to subsidiary dividends.
- Realized Losses: The company recorded a net realized loss of $9.9 million, primarily due to the restructuring of Bird Electric, LLC and the sale of Dayton Superior Corporation. This compares to a $11.8 million loss in 2017.
- Unrealized Appreciation: Net change in unrealized appreciation was $6.5 million, an improvement from the $19.7 million appreciation in 2017, reflecting mixed performance across portfolio companies.
- Portfolio Expansion: The portfolio grew to 25 companies with a fair value of $293.6 million. The weighted average yield increased to 11.19%.
Guidance, Outlook, Risks, and Unusual Items
Recent Developments and Capital Markets
- Notes Offering: On July 2, 2018, the company closed a public offering of $34.5 million in 6.125% Notes due 2023 (including over-allotment), netting approximately $33.2 million.
- Dividend: The board declared a quarterly distribution of $0.25 per share for the quarter ended September 30, 2018.
- Leverage Capacity: The board approved an increase in leverage capacity, lowering the asset coverage requirement from 200% to 150%, effective May 2, 2019.
Risks and Contingencies
- Concentration Risk: The portfolio is concentrated in specific industries, notably Energy Equipment & Services and Oil, Gas & Consumable Fuels (approx. 19.2% combined), which face commodity pricing and regulatory risks.
- Asset Quality: As of June 30, 2018, 6.8% of the portfolio (by fair value) was rated 4 or 5 (performing substantially below expectations), compared to 5.6% in 2017. No investments were on non-accrual status.
- Liquidity: The company relies on financing facilities (Term Financing and Revolving Credit) and cash flows from operations. A default on these facilities could force asset sales at disadvantageous prices.
- LIBOR Transition: The company faces uncertainty regarding the phase-out of LIBOR by 2021, which could impact the valuation and cash flows of its floating-rate debt portfolio.
Investor Verification Checklist
- Verify Asset Coverage: Confirm the current asset coverage ratio remains above the 200% threshold (or 150% post-May 2019) to ensure compliance with the 1940 Act and ability to pay dividends.
- Review Subsidiary Tax Impact: Assess the sustainability of the tax provision ($2.6 million) related to dividends from taxable subsidiaries and its impact on future Net Investment Income.
- Monitor Energy Sector Exposure: Evaluate the credit quality of the ~19% portfolio exposure to energy-related sectors given commodity price volatility.
- Check Incentive Fee Waivers: Note that the Adviser waived $527,000 of incentive fees in 2018; verify if future waivers are expected to support dividend yields.
- Confirm Liquidity Position: Review the status of the $50 million UBS Revolving Facility (currently $17.8 million drawn) and the $102 million Term Financing to ensure adequate liquidity for new originations.