Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended December 31, 2013, for CM Finance Inc (formerly CM Finance LLC). The company is an externally managed, non-diversified closed-end management investment company that elected to be regulated as a Business Development Company (BDC) under the Investment Company Act of 1940. The filing reflects the financial position immediately prior to the company's merger with CM Finance Inc and its subsequent Initial Public Offering (IPO) in February 2014.
Key Financial Metrics
| Metric | Six Months Ended Dec 31, 2013 | Three Months Ended Dec 31, 2013 |
|---|---|---|
| Total Assets | $217.8 million | $217.8 million |
| Investments at Fair Value | $203.7 million | $203.7 million |
| Members' Capital | $139.9 million | $139.9 million |
| Total Investment Income | $9.0 million | $5.2 million |
| Net Investment Income | $7.2 million | $4.1 million |
| Net Realized and Unrealized (Loss) Gain | ($1.6 million) | ($1.0 million) |
| Net Increase in Members' Capital | $5.6 million | $3.1 million |
| Total Debt (Notes Payable) | $76.5 million | $76.5 million |
| Cash and Restricted Cash | $7.7 million | $7.7 million |
Portfolio Composition: As of December 31, 2013, the portfolio consisted of 16 investments. By fair value, 53.1% were Senior Secured First Lien Term Loans, 46.4% were Senior Secured Second Lien Term Loans, and 0.5% were Warrants. The largest industry exposure was Oil and Gas (28.4%), followed by Healthcare-Products/Services (15.7%).
Material Changes vs. Prior Period
- Portfolio Growth: Total investments at fair value increased from $119.2 million at June 30, 2013, to $203.7 million at December 31, 2013, driven by $112.4 million in new purchases during the six-month period.
- Revenue Expansion: Total investment income for the six months ended December 31, 2013, rose to $9.0 million from $2.0 million in the same period in 2012, primarily due to portfolio expansion.
- Expense Increase: Total expenses increased to $1.8 million for the six months ended December 31, 2013, from $150,000 in the prior year period. This increase was driven by interest expense on the Financing Facility and higher legal and professional fees.
- Realized Losses: The company recorded a net realized loss of $1.1 million for the six months ended December 31, 2013, compared to a net realized gain of $42,000 in the prior year. This was primarily due to a loss on the sale of an investment in YRC.
- Unrealized Depreciation: The portfolio experienced a net change in unrealized depreciation of $579,000 for the six months ended December 31, 2013, contrasting with unrealized appreciation of $153,000 in the prior year.
Outlook, Risks, and Subsequent Events
Subsequent Events: On February 5, 2014, CM Finance LLC merged with CM Finance Inc. On February 11, 2014, the company completed its IPO, selling 7,666,666 shares at $15.00 per share for gross proceeds of $115.0 million. Proceeds were used to repay the Cyrus Funds Debt. Post-period, the company made six new investments totaling $67.3 million.
Financing Facility: The company maintains a $76.5 million term financing facility with UBS (maturing May 2016) and a $50.0 million revolving facility (maturing December 2015). As of December 31, 2013, the revolving facility was undrawn.
Risks and Contingencies:
- Industry Concentration: Significant exposure to the Oil and Gas (28.4%) and Healthcare (15.7%) sectors creates vulnerability to industry-specific downturns.
- Valuation Uncertainty: All investments are classified as Level 3 in the fair value hierarchy, relying on unobservable inputs and management judgment, which introduces valuation risk.
- Liquidity and Distributions: The company intends to qualify as a Regulated Investment Company (RIC) to avoid corporate-level taxes, requiring the distribution of at least 90% of taxable income. However, covenants in the Financing Facility may restrict the ability to make distributions.
Investor Verification Checklist
- Fee Structure Post-IPO: Verify the impact of the new Investment Advisory Agreement (1.75% management fee and 20% incentive fee) on future net investment income, noting the fee waivers agreed upon to support minimum dividend yields.
- Debt Covenants: Review the specific asset coverage and distribution restrictions within the UBS Financing Facility to assess liquidity constraints.
- Portfolio Credit Quality: Confirm the current status of the 16 portfolio companies, particularly the concentration in Oil and Gas, to evaluate credit risk exposure.
- Valuation Methodology: Scrutinize the Level 3 valuation inputs (e.g., illiquidity discounts, PIK discounts) given that 100% of the portfolio relies on unobservable inputs.
- Capital Deployment: Monitor the deployment of the $115 million IPO proceeds and the repayment of the Cyrus Funds Debt to ensure alignment with the stated investment strategy.