Investcorp Credit Management BDC, Inc. annual report, Q2 FY2016

Business Context and Reporting Period

Company: CM Finance Inc (CMFN)
Filing Type: Form 10-K (Annual Report)
Period Ended: June 30, 2016
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 (unitranche, first lien, second lien) and related equity of privately held lower middle-market U.S. companies. The company is managed by CM Investment Partners LLC.

Key Financial Metrics

Metric 2016 (Year Ended June 30) 2015 (Year Ended June 30)
Total Investment Income $35.58 million $36.92 million
Net Investment Income $19.85 million $20.22 million
Net Increase (Decrease) in Net Assets from Operations $(9.34) million $15.43 million
Net Asset Value (NAV) per Share $11.90 $14.41
Total Assets $319.96 million $360.46 million
Total Liabilities $157.21 million $163.51 million
Portfolio Fair Value $272.11 million $330.32 million
Weighted Average Yield on Debt 9.80% 10.91%
Asset Coverage Ratio 2.23x 2.31x
Outstanding Debt (Term + Revolving) $132.48 million $150.85 million

Material Changes vs. Prior Period

  • Operating Loss: The company reported a net decrease in net assets from operations of $9.34 million in 2016, compared to a net increase of $15.43 million in 2015. This reversal was primarily driven by a net change in unrealized depreciation of $29.48 million.
  • Portfolio Valuation: Portfolio fair value declined by approximately $58.2 million (17.6%) year-over-year. Significant unrealized depreciation was recorded for investments in Bird Electric Enterprises, LLC, AAR Intermediate Holdings, LLC, and YRC Worldwide, Inc.
  • Asset Quality: As of June 30, 2016, two investments were placed on non-accrual status, representing 6.2% of the portfolio. In the prior year, no investments were on non-accrual. The percentage of the portfolio rated "Investment Rating 5" (expected loss of principal) increased to 6.2% from 0% in 2015.
  • Investment Income: Total investment income decreased by $1.34 million, largely due to the non-accrual status of two portfolio companies.
  • Debt Reduction: The company reduced its revolving credit facility drawdown from $48.8 million in 2015 to $30.5 million in 2016, while the term loan remained constant at $102.0 million.

Guidance, Outlook, and Risks

  • Dividend Policy: The company declared a quarterly distribution of $0.3516 per share for the quarter ended September 30, 2016. The Adviser has agreed to waive incentive fees through December 31, 2016, to support an annualized dividend yield of 9.375% based on the IPO price.
  • Liquidity: As of June 30, 2016, the company held $18.4 million in cash and $18.0 million in restricted cash, with approximately $19.5 million of capacity remaining under its revolving credit facility.
  • Key Risks:
    • Credit Risk: Concentration in the entertainment/leisure (19.5%) and telecommunications (11.0%) sectors exposes the portfolio to industry-specific downturns.
    • Valuation Uncertainty: All investments are classified as Level 3 assets, meaning valuations are based on unobservable inputs and management judgment, creating potential volatility in NAV.
    • Leverage: The company utilizes a $102 million term facility and a $50 million revolving facility. A decline in asset values could trigger asset coverage ratio violations, restricting further borrowing or distributions.
    • Fee Waivers: Current dividend levels are partially supported by fee waivers from the Adviser, which are not guaranteed to continue indefinitely.

Investor Verification Checklist

  • Non-Accrual Assets: Verify the specific performance and recovery prospects of the two portfolio companies currently on non-accrual status (representing 6.2% of the portfolio).
  • Unrealized Depreciation: Review the specific valuation adjustments made for Bird Electric Enterprises, AAR Intermediate Holdings, and YRC Worldwide to understand the drivers of the $29.5 million unrealized loss.
  • Fee Waiver Sustainability: Assess the company's ability to maintain the 9.375% dividend yield without the Adviser's incentive fee waivers in future periods.
  • Asset Coverage Ratio: Monitor the 2.23x asset coverage ratio to ensure it remains well above the 2.00x regulatory minimum required to maintain BDC status and make distributions.
  • Revolving Facility Expiry: Note that the $50 million revolving credit facility expires in December 2016; verify refinancing plans or repayment strategies.