Crescent Capital BDC, Inc. (CCAP) Earnings Call Transcript & Summary

Good day, and thank you for standing by. Welcome to the Crescent Capital BDC, Inc.'s Third Quarter ended September 30, 2022, Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today Dan McMahon, Head of Investor Relations. Please go ahead.

Good morning, and welcome to Crescent Capital BDC, Inc.'s third quarter ended September 30, 2022 earnings conference call. Please note that Crescent Capital BDC, Inc. may be referred to as CCAP, Crescent BDC, or the company throughout the call. Before we begin, I'll start with some important reminders. Comments made over the course of this conference call and webcast may contain forward-looking statements and are subject to risks and uncertainties. The company's actual results could differ materially from those expressed in such forward-looking statements for any reason, including those listed in its SEC filings. The company assumes no obligation to update any such forward-looking statements. Please also note that past performance or market information is not a guarantee of future results. During this conference call, we may discuss certain non-GAAP measures as defined by SEC Regulation G, such as adjusted net investment income or NII per share. The company believes that adjusted NII per share provides useful information to investors regarding financial performance because it's one method the company uses to measure its financial condition and the results of operations. A reconciliation of adjusted net investment income per share to net investment income per share, the most directly comparable GAAP financial measure, can be found in the accompanying slide presentation for this call. In addition, a reconciliation of this measure may also be found in our earnings release. Yesterday after the market closed, the company issued its earnings press release for the third quarter ended September 30, 2022, and posted a presentation to the Investor Relations section of its website at www.crescentbdc.com. The presentation should be reviewed in conjunction with the company's Form 10-Q filed yesterday with the SEC. As a reminder, this call is being recorded for replay purposes. Speaking on today's call will be CCAP's President and Chief Executive Officer, Jason Breaux; Chief Financial Officer, Gerhard Lombard; and Senior Vice President, Henry Chung. With that, I'd now like to turn it over to Jason.

Thanks, Dan. Hello, everyone, and thank you for joining our earnings call. We appreciate your continued interest in CCAP. Today, I'll highlight our third-quarter results, discuss our current portfolio, and provide some thoughts on the current market backdrop. Then Henry will review our recent investing activity, and Gerhard will cover our financial results in more detail. So let's begin. Please turn to Slide 6, where you'll see a summary of our results. We reported an adjusted net investment income for the third quarter of $0.42 per share. Total investments and total investment income both reached their highest level since inception, and recurring yield-related investment income continues to grow in both absolute dollars and as a percentage of our total revenue, which Gerhard will provide more color on. On a GAAP basis, our third-quarter net investment income was $0.52 per share. The difference relates to a $0.10 per share non-cash reversal of our capital gains-based incentive fees on net realized and unrealized capital appreciation. Our net asset value per share ended the quarter at $20.16, down 2.5% as compared to the prior quarter. The majority of the decline relates to unrealized losses we took to reflect wider credit spreads in the market as volatility within the leveraged finance and equity markets persisted during the third quarter. Additionally, we wrote down a 0 cost basis legacy Alcentra investment that contributed approximately 1/3 of the NAV decline, which Henry will touch on in his comments. As the Federal Reserve has continued to raise rates to fight inflation, the resulting volatility has created an increasingly complex operating environment for many companies as many anticipate a general slowdown and softening demand. Despite this, the fundamental performance of our portfolio remains solid, given our focus on market-leading companies in resilient industries with strong margins and high free cash flow generation. And while certain of our companies have experienced some margin pressure from increases in labor and input costs, to date, they have largely been able to pass through certain cost increases to maintain healthy profitability. Given our track record through COVID, 7-plus years of investing in growing CCAP, and over 30 years since making our first private credit investment at Crescent, we feel well-positioned to navigate the uncertain macro environment and take advantage of the opportunity set that it presents. Please turn to Slides 13 and 14 in the presentation, which highlights our diversified portfolio. We ended the quarter with our largest portfolio since inception, with nearly $1.3 billion of investments at fair value across 136 portfolio companies with an average investment size of less than 1% of the total portfolio. Our investment portfolio continues to consist primarily of senior secured first lien and unitranche first lien loans, collectively representing 89% of the portfolio at fair value, up from 88% in the prior quarter. And we remain well diversified across 18 industries and continue to lend almost exclusively to private equity-backed companies, with 98% of our debt portfolio in sponsor-backed companies as of quarter end. We generally believe that our private equity partners provide operational and financial support to strengthen their portfolio companies for long-term value creation, which is particularly valuable during periods of heightened volatility. For the third quarter, 133 out of our 136 (sic) [ 123 out of our 126 ] debt investment portfolio companies, representing over 99% of total debt investments at fair value, made full scheduled principal and interest payments. 90% of our debt investment portfolio today is marked above $0.95 on the dollar, with an average mark of approximately 97%. 2 more credit trends are outlined on Slide 17. Continued strong performance ratings and low nonaccrual levels. Our weighted average portfolio grade of 2.1 was unchanged as compared to the past few quarters, and a percentage of risk-rated 1 and 2 investments, the highest ratings our portfolio companies can receive, remains unchanged at 89% of the portfolio at fair value. As of quarter end, we had investments in 4 portfolio companies on nonaccrual status, representing 2.0% and 1.3% of our total debt investments at cost and fair value, respectively. I'd now like to turn it over to Henry to discuss our Q3 investment activity. Henry?

Thanks, Jason. Please turn back to Slide 15 where we highlight our recent activity. Gross deployment in the third quarter was $90 million, as you can see on the left-hand side of the page, over 90% of which was in senior secured first lien and unitranche investments. In total, we closed on 7 new and 9 follow-on investments totaling $46 million and $4 million, respectively, with the remaining $40 million coming from revolver and delayed draw to our loan activity. All of the new investments were private equity-backed loans with silver or LIBOR floors, attractive fees or OIDs, and a weighted average spread of approximately 620 basis points. In addition, loan-to-value levels remain attractive, averaging 46% for the transactions closed this quarter. The $90 million in gross deployment compares to approximately $60 million in aggregate exits, sales, and repayments in the quarter, inclusive of a $10 million liquidating return of capital from our joint venture, which we are in the process of winding down. It is also worth highlighting that CCAP's total commitment for the aforementioned new deals represented about 6% of the over $1.1 billion total check size committed across Crescent accounts, highlighting the breadth of Crescent's platform. Moving to the right-hand side of the page, you'll see that our net investment activity has led to unitranche first lien becoming a more prominent percentage of our total portfolio. This increase from 53% a year ago to 64% today is by design, as it allows us to offer even greater certainty of execution to our private equity sponsors, especially in this market environment and enabled us to enhance our yield opportunity while remaining at the top of the capital stack. Turning to Slide 16. You can see that the weighted average yield of our income-producing securities at cost increased quarter-over-quarter meaningfully from 8.3% to 9.5% on the heels of the Federal Reserve interest rate hikes. As of September 30, 99% of our debt investments at fair value were floating rate with a weighted average floor of 83 basis points, which compares to our 73% floating rate liability structure with no floors. This echoic us well to benefit from increases in base rates above our average floors as of the case this quarter with growth in our interest income line item. As Jason noted during his comments, an item worth highlighting as it relates to our portfolio is our investment in Solar Technical Institute, or STI, which we acquired through the Alcentra merger at a cost basis of 0. Following the close of the merger, the portfolio company had several positive developments that resulted in us realizing over $2 million in total cash proceeds over the course of our investment. We increased the fair value above our initial 0 cost base due to positive investment performance. However, due to recent regulatory changes that impacted the portfolio company, we reduced the unrealized fair value of the position back down to 0 this quarter. This drove $0.17 per share, or approximately 1/3 of this quarter's reduction in net asset value. Before I turn it over to Gerhard to discuss our results in more detail, I wanted to spend a minute on our announced acquisition of First Eagle BDC. On the public call we hosted in early October, we reviewed the strategic merits of the transaction, including expected net investment income accretion, improved portfolio positioning, enhanced scale, and investment capacity. First Eagle reported their third-quarter results earlier this week, and with 84% of their book invested in senior secured first lien loans, 93% sponsor-backed, and 97% floating rate debt investments, we continue to believe that we are adding a highly complementary portfolio to CCAP. We continue to work in close conjunction with the First Eagle team, particularly as it relates to what we deem to be noncore investments that represent 9% of the First Eagle portfolio as of September 30 or approximately 2% of the pro forma combined TCAP portfolio and we believe will provide opportunities for near-term rotation into directly originated first lien investments. With that, I will now turn it over to Gerhard.

Thanks, Henry, and good morning, everyone. Our adjusted net investment income per share of $0.42 for the third quarter of 2022 compared to $0.41 per share for the prior quarter. Total investment income of $29 million for the third quarter, the highest quarterly figure we've reported since inception, compared to $26.8 million for the prior quarter, representing an increase of approximately 8%. Importantly, we consider recurring yield-related investment income comprised of interest income, fixed income, amortization, and unused fees was up 18% quarter-over-quarter from $22.8 million to $26.8 million, a record figure for us, driven by rising base rates and a growing portfolio. This recurring revenue ultimately accounted for 93% of this quarter's total investment income. We generated significant investment income in the form of fees, dividends, and accelerated amortization of OID from the realization of the Alcentra portfolio over close to the last 2 years. That nonrecurring income is now being replaced by recurring yield-related income from Crescent-originated assets. I'd also note that [ SIK ] income continues to represent a modest portion of our revenue at approximately 2% of total investment income. We expect revenue growth to continue and our net interest margin to expand due to tailwinds from rising rates and a larger income-producing portfolio. And because we're investing in largely first lien and unitranche-focused assets, having largely rotated out of legacy Alcentra names and our broadly syndicated [ Lancome ] joint venture, we expect to generate a higher quality of top-line revenue, primarily consisting of interest income. We have provided details on our sensitivity to interest rate movements in this quarter's Form 10-Q for those on to further examine these potential impacts. Holding all else equal, we expect approximately 85% of the portfolio to reset through higher base rates during the fourth quarter, which will provide additional lift to our fourth quarter revenue, partially offset by higher fourth quarter financing costs. Generally, by virtue of having the asset side of our balance sheet reset monthly or quarterly and a portion of our outstanding debt on a daily basis means that there is about a 1 quarter delay between the beneficial impact of higher base rates on interest income versus the more immediate impact of higher borrowing costs in a rising rate environment as we are currently experiencing. This should translate to modestly higher NII during the fourth quarter with additional upside potential in 2023 from base rate increases combined with the accretion from projected cost synergies and scale benefits associated with our pending acquisition of the First Eagle BDC. Turning back to this quarter's earnings. Our GAAP earnings per share or net decrease in net assets resulting from operations for the third quarter of 2022 minus $0.08. And which compares to minus $0.03 per share for the prior quarter. Our GAAP earnings included net realized and unrealized losses on investments of $0.59 per share as well as our fourth and final $0.05 per share special dividend. At September 30, our stockholders' equity was $623 million, resulting in a net asset value per share of $20.16 as compared to $639 million or $0.69 per share last quarter and $596 million of $21.16 per share at September 30, 2021. The positive net deployment of $30 million in the third quarter was partially offset by unrealized mark-to-market losses on our investments, ultimately, leading to modest portfolio growth and a total investment portfolio at a fair value of $1.3 billion as of September 30, 2022, up approximately $8 million quarter-over-quarter. Henry reviewed SDI's impact on our NAV this quarter, and the remainder of this quarter's NAV decline is not, in our view, the reflection of deteriorating credit quality in our portfolio but rather the widening credit spread environment, which impacted more. This dynamic is evidenced by our internal portfolio ratings at the end of the third quarter, consistent with prior quarters with roughly 90% of the portfolio rated 1 or 2, our highest trading categories. We believe this is an important distinction to highlight for shareholders in a volatile market environment. Now let's shift to our capitalization and liquidity. I'm on Slide 19. As of September 30, our debt-to-equity ratio was 1.11x, up modestly from 1.03x at June 30 and on the low end of our target range. The weighted average stated interest rate on our total borrowings was 5.31% as of the quarter's end. We expect that near-term full deployment activity will be financed by our attractively priced secured facilities. As you can see on the right-hand side of the slide, we have a low level of debt maturities over the next few years with no maturities this year and $150 million maturity related to our 5.95% unsecured notes in July of 2022. After that, there are no remaining maturities until -- from a liquidity perspective, as of quarter end, we had $197 million of undrawn capacity, subject to leverage, borrowing base, and other restrictions, and $22 million in cash and cash equivalents. Additional expected proceeds from the continued wind-down of our joint venture will provide for some incremental liquidity. Finally, for the fourth quarter of 2022, our Board declared a $0.41 per share quarterly cash dividend, which will be paid on January 17, 2023, to stockholders of record as of December 30, 2022. And with that, I'd like to turn it back to Jason for closing remarks.

Thank you, Gerhard. We continue to believe that CCAP remains well-positioned to navigate the economic and market uncertainty ahead. While we do anticipate further market volatility and the potential for spread widening as the cycle progresses, we feel good about our current portfolio and our ability to lean into attractive opportunities created during periods of dislocation while, of course, maintaining the same rigorous underwriting standards we've always implemented. We would like to thank all of you for your continued support and time today. We'll be happy to take your questions, and please understand that we may be limited in certain answers due to the ongoing First Eagle transaction. And with that, operator, please open the line for questions. I just want to make one clarifying remark before we start Q&A. I just wanted to say that 123 out of our 126 debt investment portfolio companies, representing over 99% of total debt investments at fair value, made full scheduled P&I payments in the third quarter. I believe I said 133 out of 136 earlier in my remarks. With that, operator, you can go ahead and open up the Q&A. Thanks.

[Operator Instructions] I'm showing no questions in the queue at this time. I'd like to turn the call back over to Mr. Jason Breaux, President, and CEO, for closing remarks.

Thank you, operator. We thank you all for joining this call today. We appreciate your attention and your support of CCAP, and we look forward to speaking with you soon.

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.