Chenavari Toro Income Fund Limited (TORO.L) Earnings Call Transcript & Summary

Good afternoon, ladies and gentlemen. I'm glad to welcome you to the quarterly update of the Chenavari Toro Income Fund. And I'd like to invite you to open the supporting slides, which are available on the website, www.chenavaritoroincomefund.com in the Report section. The agenda for today's call is to provide an update on the strategy and prospective return to shareholders. And before we start, I will read the following compliance statement. Certain statements made during this conference call may be forward-looking statements, projections and therefore, are subject to a variety of risks and uncertainties that could cause the company's actual results to differ from its expectations, estimates and projections. Consequently, you should not rely on these forward-looking statements as predictions of future events cannot be relied upon when making investment decisions. Statements made during this conference call are made as of 30th of September and the company undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. [Operator Instructions] And let me hand over to Fred for an update on the performance of the Chenavari Toro Income Fund for the third quarter.

Thank you very much, Guy, and thanks, everyone, for attending the call. I hope you guys are fine, and I'm glad to be with you for this quarterly update of the Chenavari Toro Income Fund. The purpose of the presentation is to update shareholders on the performance of the company in the third quarter and on its strategy and outlook for the foreseeable future. We can start the presentation by looking at Slide 2 and 3, which provide you an update on Chenavari and remind our prospective shareholder and existing shareholder of our meaningful experience and excellent track record investing in ABS and CLOs as well as managing CLOs. The Chenavari Toro Income Fund is our listed vehicle to capitalize on that excellent track record. As we remind you on Slide 4, we have defined 3 key pillars for the fund: a clear investment strategy, attractive return targets and maximizing shareholder value. The purpose of this call is also to update shareholders on each of these points. So we can start with the investment strategy. As you know, our investment strategy is to invest in European asset-backed securities and CLO across the capital structure through 2 main strategies that we can see on Slide 5. ABS/CLO risk retention and public ABS/CLOs. And on Slide 6, we give you an update on the allocation per different strategy at the end of the third quarter, 45.4% on ABS/CLO risk retention and 44.9% in public ABS/CLO and 4.3% in SpRED. So as we can see from the allocation number, during the third quarter, we have reduced the exposure in both ABS/CLO risk retention and public ABS/CLO, while increasing the level of cash from 0% to 5.4%. This was an active process to reduce risk to be able to reallocate during Q4. Finally, we continue to reduce the exposure to SpRED, which now stands at 4.3% of NAV. So as we mentioned previously, we still believe there is to be a very attractive investment opportunity in ABS and CLO for the next 12 to 24 months. And so we continue to expect to add to that strategy over the next few quarters. Going forward, we will continue to invest in ABS/CLO risk retention strategy and public ABS/CLO, while progressively exiting the exposure in SpRED.

Thank you very much Fred for this. And what about the performance this quarter and the attribution across the different strategies?

Yes, Guy. So you can see on Slide 7 that unfortunately, the fund was down during the third quarter by 2.55% gross. And this growth performance can be broken down by strategy as follows: so ABS/CLO risk retention was down 3.04% gross, while public ABS/CLO contributed positively with a positive performance of plus 0.54%. And SpRED was marginally down at minus 5 bps. As we can see from Slide 8, despite this negative performance this quarter, the last 12 months net performance is still plus 12.4%, above our annualized NAV return target of 10%. In the meantime, we have continued to deliver on the dividend policy of 2.5% of NAV per quarter, leading to a last 12 months dividend yield on the share price of 10.4%. Moving to Slide 9. We can see here the stability of the dividend yield for the past 5 years as well as the magnitude of the cumulative distribution we have made since the IPO. The last 12 months dividend coverage stands at 1.35x. On Slide 10 and 11, we can see that the company has outperformed both crossover and European high yield since inception and especially since September 2020 to reflect the post-COVID environment. In particular, it's worth outlining the very strong share price performance of the company, up close to 150% since inception and more than 150% in the last 5 years. On Slide 12, we give our shareholder and prospective shareholder a summary of the prospective gross returns by strategy in accordance to our base case assumption. So 10.6% for the invested portfolio, and overall, 10.3%, if one consider the current discount of the share price to NAV showing that we are currently on track to continue to deliver on the second pillar of attractive return targets. In details on that slide, you can see that the ABS/CLO risk retention strategy has a prospective return of 12.7% and the public ABS/CLO strategy has a prospective IRR of 8.8% under our base case assumption.

That's great, Fred. And now moving on to the CLO risk retention performance in the third quarter. Could you also give us details on this?

Yes. Sure, Guy. So as we mentioned, the CLO risk retention strategy was down during the quarter, and we'll explain why. First of all, the ABS/CLO risk retention strategy distributed strong cash flow in the quarter, paying a combined total of EUR 6.1 million, which on an annualized basis represents a return of 40% over the market value of the position. But despite this distribution, the return of that strategy was negative, as I just mentioned, because the position were marked down more than those cash flows. And so in order to understand why it was marked down, we can move to Slide 13, where we get a good summary of the horizontal and vertical risk retention held in Toro's and the different metrics on the loan and on the most junior cushion and the equity now, right? All of this will explain a bit better why we have those markdowns. So on Slide 14, on the graph, you can see that the overall prices of loans in Toro's were down a full percentage points during the quarter from 96% to 95%. And the decline in the weighted average price is mainly due to the performance of some of the weaker credits. And you can see that the percentage of loans trading below 85 increased from 5.8% to 9.1%. And the percentage of loan trading below 17 increased from 2.6% to 5.4%. And this resulted in the equity NAV declining from 29.2% to 19.6% during the third quarter. So the credit performance in the European leverage loan market continued to be a tale of 2 stories. So stability and positive performance in the better credits, while the weaker ones underperformed further. Given the underperformance of the weaker credits, there was a deterioration in the most junior coverage test in the portfolio of retention equity. As we can see from Slide 16, the cushion over the most junior trigger declined by 0.2% in average during the quarter, sitting between 1.7% and 4.5% across the different TCLO and Bosphorus vintages. So while in most deals, the buffer should allow for a continued distribution of cash flow in the coming quarters, it's true to say that the probability of such cash flow is lower this quarter than it was the previous quarter and especially the deal where the cushion stands below 2.5% will require monitoring. We've always stated that the main risk for the strategy is an increase in the default risk, and that is why we are constantly focused on mitigating that risk. And so in order to do that, during the quarter, we have exited the exposure in underlying names in which we believe that there is a material restructuring or default risk and in which we anticipate the recovery could be lower than the current market price. On top of that, we have increased our default assumption under the same simple and base case scenario to reflect this higher idiosyncratic risk environment.

Thank you, Fred. That was very detailed, very useful. And could you also share more about the public ABS and CLO strategy?

Sure. So as mentioned before, the public ABS/CLO strategy was up 0.54% during the third quarter. If we move to Slide 17, we can see that generic CLO spreads were stable to marginally tighter during the third quarter. AAA and AA were stable at 120 basis points and 185 basis points, respectively. And on the other hand, single A, BBB, BB and single B were marginally tighter at, respectively, 220 basis points, 330 basis points, 590 basis points and 875 basis points. So this more or less stability in CLO spread, together with the growing activity in risk retention financing, as we can see from Slide 18. So we can see that this activity that we started in 2023 has been growing nicely, and we have now done 41 transactions and financed EUR 743 million. And so yes, this has contributed to the positive performance this quarter. Also, if we move to Slide 19, important to say that the growing activity in risk retention financing is helping to increase the amount of fees that make part of the return of the fund. So as of the 30th of September, we have now over 20% of the fund that has been coming from fees. On Slide 21, we provide our shareholder and prospective shareholder with our updated expected return under simple base and stress scenario for exposures through ABS/CLO risk retention and public ABS/CLO. So given the deterioration witnessed in the weaker credit that we mentioned before, we have increased our peak default rate for the base case to 4% and our recovery assumptions are unchanged at 50% for the higher default rate period and 65% for the normalized period. So under the base case, our forecasted return for the risk retention strategy is 12.7% and 8.8% for the public ABS/CLO strategy. Under the stress scenario, the gross return dropped, but are still positive for public ABS/CLO at 4.7% while they are slightly negative at minus 1.3% for the ABS/CLO risk retention strategy. So that's regarding prospective return, right? Also, what we monitor is the risk of the portfolio. So if we move to Slide 22, we can see that this is what basically where we stress the portfolio for a 0 IRR and to see what default rates -- a couple of default rate and recovery rate the portfolio can withstand, and we do that for our portfolio, but also across the AAA down to equity universe in the CLO market. And so from that chart, we can see that we stand still between single B and equity in terms of risk. And so this continue to demonstrate that the Chenavari Toro Income Fund offer a CLO equity-like return with better than CLO equity risk. Moving to Slide 23 for our investor, remembering them that we have a robust ESG investment process, and this slide updates you on our ESG journey.

Great. Thank you. Fred, finally, you will make a comment on Spanish real estate project, SpRED.

Yes, Spanish real estate development, SpRED. So if we move to Slide 24, you can see where we stand on that investment. So currently, 4.3% of NAV. As of the 30th of September 2025, we have sold 95% of the units built since inception. The third quarter was a bit slower than the second quarter, typical seasonal slowdown given summer months as usually lower real estate activity. During the quarter, we sold 2 flats and 3 parking spaces. We have now 18 flats and 42 parking spaces left to sell. During the quarter, we distributed EUR 1.1 million to the fund, so 0.5% of NAV. All the flats in Barcelona have been sold, and there are now in Barcelona only 23 parking spaces that we expect to sell by the end of the year. So the main exposure, therefore, is now located in Gerona. As you know, we have 2 developments in Gerona, Gerona Barcelona and Gerona Belmirall. One, Gerona Barcelona, we've sold 86% of the flat, and we only have 4 flats left to sell, and we believe we should sell them within the next 3 to 9 months. On the other hand, the other development for Belmirall, we haven't sold any flats yet. We still have 14 flats left to sell. As you know, we moved from trying to sell the development in bulk to selling it flat by flat. So it's just been done this quarter. We have seen some interest, but no actual sales so far. So on SpRED, our aim is still to finalize the overall sale process within the next 12 to 18 months, as we can see from Slide 25, with a gross investment IRR of 5% on the transaction, assuming an exit of the remaining unit in the next 12 months at a level 10% below our current target sales price. After a successful exit of the private asset-backed finance, exiting the SpRED exposure remains a key priority for us in the next 12 to 18months.

Great. Thank you, Fred. So good progress on that front as well. I think you'd probably like to comment on the third pillar for maximizing shareholder value.

Yes, definitely. So if we move to Slide 26. As you know, for us, maximizing shareholder value is delivering on the NAV performance target, pay the dividend, which has been done, but also monitor the discount to NAV. So the good news this quarter is like we're seeing the discount to NAV reduce further, now standing at minus 1.54%, so the shares are trading very close to NAV now. So this reduction in the discount to NAV has contributed to the very strong share price performance in the last 12 months, 39.94% including dividend reinvested. And in the last 5 years, 154.8%, as we mentioned before. So this is great news. And this positive performance, we should try to capitalize on it and continue to do what we've been doing, which is the performance, the dividend and the marketing of the strategy. And ideally, we can see the discount stabilized around 0, let's say, right? So no discount basically and/or even ideally, maybe we could get the fund to trade at a small premium to NAV.

Excellent. Do you want to add anything, Fred, in conclusion?

Yes. Thank you, Guy. So I think in conclusion, I want to stress that despite the negative performance this quarter, the last 12 months net performance still stands at 12.4% above our 10% annualized return target, that's under our revised default rate assumption because of the rising idiosyncratic risk. We believe the portfolio should deliver positive return around our return target of 10% of NAV in the base case and marginally positive in the stress case. Given the current market, we anticipate significant investment opportunities in European ABS and CLO in the next few quarters and the rising activity on risk retention financing shall provide very attractive opportunity in that respect and also raise the share of fees that are contributing to the fund returns. Therefore, we believe that the Chenavari Toro Income Fund represents an attractive investment in European ABS and CLO, including the risk-adjusted return provided by the CLO retention and also the new vertical risk retention financing strategy. The dividend policy is still 2.5% of NAV per quarter. So the share price provides for an attractive dividend play with currently 10.4% dividend yield as of the 30th of September share price. If we move to Slide 32, we can see that the combination of an attractive investment portfolio and the discount to NAV allow us to target a gross IRR between 2.5% and 11.5% between the stress and the base case. As our investors know, we have a very strong important shareholding in the fund, and this ensures a strong alignment of interest with investor. We've constantly reinvested in the fund since December 2020 and showing we believe in the company. Finally, the discount to NAV -- the discount to NAV is now getting closer to -- for the fund to close almost trade at NAV. And hopefully, we can get it stabilized around here or maybe even trade at a small premium.

Great. Thank you very much for this presentation. Well, I think we'll now move to Q&A.

[Operator Instructions] And Fred, I'll start with the first question. Following the recent deterioration in the credit quality, you mentioned and across some segments of the loan universe, especially in chemicals and among several French issues, do you expect this trend to remain contained within these specific names or could it spread more broadly across other sectors? And have you taken any actions within the portfolios in response?

Yes. Thank you, Guy. Very good question. I mean I think this is the most important question for the European loan market and the CLO market. To be fair, it's difficult to forecast, right? So for now, it's really idiosyncratic stories, but the number of them has been increasing. But for now, it's not spreading, but it requires our full attention. And so what we believe in this case is like we can only prepare for the worst basically, right? And so that means being even more conservative in our name selection and also by selling the credit in which we anticipate a high risk of restructuring with a lower recovery than the current market price.

And given this weakening credit quality within affluent markets, how long do you expect equity tranches to continue cash flowing at the current levels? And has this dynamic encouraged you to favor more vertical over horizontal retention?

Yes. Thank you, Guy. One, for the time being, as we mentioned in the presentation, on most of our CLO equity risk retention, there's still a decent headroom on the OC cushion. So as long as there is this headroom, we should still be getting some cash flows in the coming quarters. However, as we mentioned in the presentation, the OC cushion has declined. And so that in itself means there's a lower probability of those cash flow. And especially, as we mentioned, the one that has less than 2.5% cushion are worth monitoring. On horizontal versus vertical, if you remember, we've done our last transaction in March, TCLO 10, where we did horizontal, but we haven't done any new CLO since then. And so our split between vertical and horizontal has remained unchanged. It is true to say like you're kind of saying in the question that on risk management, it would be probably smarter to do vertical now than horizontal. But also sometime investing in CLO equity during these periods of weakness is potentially to substantial returns. I mean, to be fair, we think the situation is not clear for now. And so we will stay cautious for now and see how the situation evolves.

Very good. The next question to you, Fred. If you hit par, will you try to issue new shares?

It's a good question. It's a question for us as a manager, but also for the Board to consider. I think from the feedback from investors, from the Board and from discussion with people have been liking the fund because it provides a very strong dividend yield, liking the fact that we are very aligned, right, with the share of the manager. On our side, on the investment side, we are constrained in a way, right? So the size of the fund, we always have more capacity in terms of investment than what we're actually investing. So we would benefit from having a higher asset base, right, by raising new shares. And also investors have been mentioning that some investors say the fund is a bit small for them to invest. And if it was bigger, they could invest. So overall, I think there would be arguments to increase the size of the fund if we were trading above NAV.

Thank you very much, Fred. And one investor asking what were the holdings in TCLO 6, which caused the decline in junior cushion to 1.7%? So maybe if you can show the Slide 13, I think this participant is referring to.

So I mean, we had -- we usually manage the different CLO passthrough each of them because they are not priced at the same time and the portfolio has some small difference, but most of the name are in common between CLO. So it's not that TCLO 6 had more difficulty with names than the other. It's more linked to where does TCLO 6 stand in its life, right? And so it's basically passed its reinvestment period. The AAA is amortizing. And so it's a bit of a technicality to have 1.7% there. There was an amount of cash that will repay the AAA. And so should rebuild a bit of the OC cushion in TCLO 6 going forward. To answer the question in principle, we had some exposure to First Brands, right? So that was, as you know, and we've put in the presentation, a very allegation of fraud. Is it fraud or allegation of fraud, right? But the loans have dropped very sharply in September from EUR 0.95 to EUR 0.35 in a very quick fashion. So that was one of the credits that affected TCLO 6, but not only TCLO 6. And then as we mentioned in the presentation, certain of the chemical names we had like Ineos, right, has been dropping in price. We also had Colisee at the beginning of the quarter, which is a French company, it has been a default basically. So the names in which we have suffered are present across all the different TCLO platform. TCLO 6 is in particular because it's not reinvesting. And so that's why the OC test was a bit lower than the rest of the [indiscernible].

Very good. Thank you, Fred. One question in regards the part of the capital structure, you currently find most attractive from a risk/reward perspective?

Sure. I mean on our side, we continue to believe that the rated part of the CLO market from AAA down to BB is quite attractive. In particular, I think we mentioned that last quarter, the potential change in solvency capital ratio for insurer could be a strong tailwind for the CLO markets and the spread of the rated CLO tranches. And so yes, that's where we focus most of our investment activity these days. And the vertical risk retention strategy, the financing, right, provide us with an interesting way to capture that investment opportunity.

And moving on to our next question. Does the current environment, Fred, call for a degree of derisking or does it instead present compelling entry points?

Well, as I mentioned before, Guy, sometimes it's -- in times of trouble, it's sometimes good to invest and can lead to significant returns. But as it stands, we think the situation is not clear enough to materially increase risk taking in CLO equity, if we're speaking about that. And so for now, we prefer to increase our exposure to CLO rated tranches.

All right. Now looking ahead to 2026, how do you view the balance between maintaining yield through the CLO equity exposure and protecting the downside risk?

Well, I mean, from my point of view, the current portfolio is a balanced portfolio between CLO rated tranches in the public ABS/CLO and CLO equity tranches through ABS/CLO risk retention in which I want to remind investor, we have the position, but we also get fee rebates, right? So this helps lower the downside of the strategy and increase the prospective return. So I think this balance and the way the portfolio is constructed today has a good probability of achieving a return target of 10% in the base case and breakeven in the stress case. So I think for us, we will continue to try to build the portfolio this way. And again, as things evolve, right now, probably more investing in rated tranches. But if we start to see that this is the moment to increase equity, we'll do it at that time. I think at this time, we don't see it yet, but it could be the case that in 2026, we see it, and then we will do that.

Excellent. Well, I think -- I don't think we have any more questions coming. So probably that concludes our call. Thank you very much, Fred, and thanks, everyone, for joining the call.

Thank you, Guy, and thanks, everyone, for attending the call. Bye-bye.