Business Context and Reporting Period
Company: CM Finance Inc (formerly CM Finance LLC)
Filing Type: Form 10-K (Annual Report)
Period Ended: June 30, 2014
Business Overview: CM Finance Inc is an externally managed, non-diversified closed-end management investment company regulated as a Business Development Company (BDC). The company invests primarily in the debt of U.S. middle-market companies, focusing on unitranche loans, standalone first and second lien loans, and selectively in mezzanine loans and equity warrants. The company completed its Initial Public Offering (IPO) on February 5, 2014, and merged with CM Finance LLC immediately prior to pricing.
Key Financial Metrics
| Metric | Year Ended June 30, 2014 | Year Ended June 30, 2013 |
|---|---|---|
| Total Investment Income | $21,134,061 | $6,772,816 |
| Total Expenses (Net of Fee Waiver) | $5,135,934 | $630,686 |
| Net Investment Income | $15,998,127 | $6,142,130 |
| Net Increase in Net Assets from Operations | $16,176,034 | $7,996,171 |
| Net Asset Value (NAV) per Share | $14.65 | N/A (Pre-IPO) |
| Portfolio Fair Value | $273,710,465 | $119,209,284 |
| Total Assets | $308,759,998 | $186,938,136 |
| Total Liabilities | $108,543,177 | $99,687,499 |
| Total Net Assets | $200,216,821 | $87,250,637 |
| Weighted Average Yield on Debt | 10.44% | 10.72% |
| Number of Portfolio Companies | 24 | 11 |
Debt and Liquidity: As of June 30, 2014, the company held $85.6 million in debt obligations (comprising a $76.5 million term loan and $9.1 million drawn on a revolving facility). Cash and cash equivalents totaled $24.7 million. The asset coverage ratio was 3.34x.
Material Changes vs. Prior Period
- Portfolio Growth: The portfolio fair value increased by approximately 130% from $119.2 million to $273.7 million, driven by the IPO proceeds and new investment originations ($278.9 million invested during the year).
- Revenue Expansion: Total investment income more than tripled to $21.1 million, primarily due to the significant increase in invested assets.
- Expense Increase: Total expenses rose to $5.1 million from $0.6 million, largely due to interest expense on the Financing Facility and increased operating costs associated with the larger portfolio.
- Capital Structure: The company transitioned from a private LLC to a public BDC, issuing 13.67 million shares of common stock. It utilized a portion of IPO proceeds to repay $39.8 million in debt owed to original investors.
- Industry Diversification: The portfolio composition shifted. While Telecommunications remained the largest sector (19.35%), the company increased exposure to Healthcare (17.83%) and Oil & Gas (16.39%), reducing concentration compared to the prior year.
Guidance, Outlook, and Risks
Management Commentary & Outlook: Management believes the current environment offers compelling opportunities in middle-market debt due to reduced capital availability from traditional banks. The company intends to maintain a disciplined underwriting approach, targeting investments with favorable risk-adjusted returns. The company expects to continue investing in unitranche and second lien loans with an emphasis on floating-rate debt.
Dividend Policy: The company intends to elect to be treated as a Regulated Investment Company (RIC) to avoid corporate-level taxation. To support this, the Investment Manager has agreed to waive fees to support a minimum quarterly dividend yield of 9.0% for 2014, 9.25% for 2015, and 9.375% for 2016.
Key Risks:
- Leverage Risk: The company uses borrowed funds to finance investments. A decline in asset values could magnify losses and restrict the ability to make distributions.
- Credit Risk: Investments are in private, middle-market companies that are often highly leveraged and unrated. Defaults could lead to significant losses.
- Interest Rate Risk: While 89% of the portfolio is floating-rate, rising rates increase the cost of capital. A 1% increase in rates would decrease net interest income by approximately 1.2%.
- Valuation Uncertainty: Most investments are Level 3 assets valued by the board of directors using unobservable inputs, creating potential volatility in reported NAV.
- Conflicts of Interest: Significant relationships exist with the Investment Manager, Stifel (15.9% owner), and Cyrus Funds (27.9% owner), which may create conflicts regarding deal allocation and fee structures.
Investor Verification Checklist
- Fee Waiver Sustainability: Verify the terms and duration of the management fee waivers required to support the 9.0% dividend yield and assess the impact on net income once waivers expire.
- Asset Coverage Ratio: Monitor the 200% asset coverage requirement under the 1940 Act to ensure the company can maintain distributions and avoid forced asset sales.
- Portfolio Concentration: Review the exposure to the Oil & Gas and Telecommunications sectors, which together represent over 35% of the portfolio, for industry-specific downturn risks.
- PIK Interest Impact: Assess the proportion of Payment-in-Kind (PIK) interest income ($1.7 million for the year) and its effect on taxable income versus cash flow available for dividends.
- Financing Facility Terms: Review the covenants and maturity dates of the $76.5 million term loan (maturing May 2016) and the $50 million revolver (maturing Dec 2015) to evaluate refinancing risks.