Business Context and Reporting Period
Company: CM Finance Inc (CMFN), a closed-end, externally managed Business Development Company (BDC) regulated under the Investment Company Act of 1940.
Reporting Period: Quarterly period ended December 31, 2015 (Six months ended December 31, 2015).
Investment Strategy: The Company invests primarily in debt and related equity of privately held lower middle-market companies, focusing on unitranche, first lien, second lien, and mezzanine loans to fund acquisitions, growth, or refinancing.
Key Financial Metrics
| Metric | Six Months Ended Dec 31, 2015 | Six Months Ended Dec 31, 2014 |
|---|---|---|
| Total Investment Income | $19,827,296 | $17,068,220 |
| Net Investment Income | $11,183,605 | $9,225,000 |
| Net Realized Gains | $301,924 | $920,475 |
| Net Change in Unrealized Appreciation/Depreciation | $(26,714,703) | $2,531,909 |
| Net Increase (Decrease) in Net Assets from Operations | $(15,229,174) | $12,677,384 |
| Net Asset Value (NAV) per Share | $12.17 | $14.41 (Beginning of Period) |
| Total Assets | $333,748,518 | $360,458,841 (June 30, 2015) |
| Total Debt (Notes Payable, net) | $144,152,799 | $148,516,424 (June 30, 2015) |
| Cash and Restricted Cash | $26,098,200 | $24,969,196 (June 30, 2015) |
| Asset Coverage Ratio | 2.14x | 2.44x (June 30, 2015) |
Material Changes vs. Prior Period
- Significant Unrealized Losses: The Company recorded a net unrealized depreciation of $26.7 million for the six months ended December 31, 2015, compared to a net unrealized gain of $2.5 million in the prior year period. This decline was primarily driven by fair value reductions in investments in Bird Electric Enterprises, LLC, AP NMT Acquisitions, AAR Intermediate Holdings, LLC, Caelus Energy Alaska 03 LLC, North American Lifting Holdings, Inc., AM General, LLC, Trident USA Health Services, LLC, and YRC Worldwide, Inc.
- Portfolio Composition: The investment portfolio decreased from $330.3 million (fair value) at June 30, 2015, to $292.8 million at December 31, 2015. The number of portfolio companies decreased from 26 to 22.
- Asset Quality Deterioration: The investment in Bird Electric Enterprises, LLC was placed on non-accrual status effective December 31, 2015. Additionally, 6.6% of the portfolio was rated as "Investment Rating 4" (substantially below expectations, some loss of return expected) at period end, up from 2.0% at June 30, 2015.
- Expense Fluctuations: Total expenses increased to $8.6 million for the six months ended December 31, 2015, from $7.8 million in the prior year, driven by higher interest expense on borrowings and increased operating expenses, despite a decrease in incentive fees due to fee waivers.
Guidance, Outlook, Risks, and Unusual Items
- Dividend Policy and Fee Waivers: The Adviser has agreed to permanently waive portions of the incentive fee for 2015 and 2016 to support an annualized dividend yield of 9.25% and 9.375%, respectively, based on the IPO price of $15.00. A quarterly distribution of $0.3516 per share was declared on February 2, 2016.
- Liquidity: As of December 31, 2015, the Company held $16.4 million in cash and $9.7 million in restricted cash. It had approximately $5.6 million of remaining capacity under its $50.0 million revolving credit facility.
- Financing Structure: The Company utilizes a $102.0 million term facility and a $50.0 million revolving facility with UBS. These facilities are collateralized by a Special Purpose Vehicle (SPV) holding a portion of the portfolio. The Company uses Total Return Swaps (TRS) to manage the economic exposure of these financings.
- Risks: The filing highlights risks related to the credit quality of portfolio companies, the impact of interest rate fluctuations on floating-rate assets, and the potential for further declines in fair value of Level 3 investments due to market conditions.
- Unusual Items: The significant unrealized depreciation was a non-cash item driven by fair value adjustments. The Company also recorded $960,603 in Payment-in-Kind (PIK) interest income for the six-month period.
Investor Verification Checklist
- Asset Quality: Verify the status and recovery prospects of the Bird Electric Enterprises, LLC investment, which was placed on non-accrual status.
- Valuation Methodology: Review the specific unobservable inputs (Level 3) used to value the portfolio, particularly for the investments that experienced significant fair value declines (e.g., AP NMT, AAR Intermediate Holdings).
- Debt Covenants: Confirm compliance with the Asset Coverage Ratio (2.14x) and other covenants in the UBS Financing Facility, which could restrict future distributions.
- Fee Waiver Sustainability: Assess the long-term sustainability of the dividend yield supported by the Adviser's fee waivers, which are scheduled to expire or change in 2016.
- Portfolio Concentration: Note that the top 5 investments (American Gaming Systems, Land Holdings I, A.S.V., Inc., PR Wireless, and Trident USA Health Services) represent a significant portion of the portfolio fair value.