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CM Finance: Two Issues In The Annual Proxy

BDCs:
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NEWS

On August 31, 2018 CM Finance (CMFN) filed a preliminary Annual Proxy.

The document – which is attached – envisages that shareholders will vote on 2 key items at a meeting to be held on November 6, 2018.

(Curiously – as of late September 3 2018, the SEC filing was not available on the BDC’s own website).

First, two Directors are up for re-election for a period of 3 years: Messrs Jansen and Wagner.

The former is a so called “Interested Director” and serves as the BDC’s President.

The latter is an “Independent Director”, and like Mr Jansen, has been on the Board since 2013.

Second, the BDC is requesting shareholder approval – if deemed necessary by the Board – to issue new shares below book value.

The authorization would last one year from the approval date.

CMFN would be allowed to issue a maximum number of shares equal to 25% of all stock outstanding at the time of the issue.

There is no stated limit on the discount that new shares might be sold at.

The Proxy also contains standard disclosures about the ownership holdings of insiders, as well as director compensation and the expenses associated with the independent auditor.


ANALYSIS

As is the case with many BDCs, CMFN has a “staggered” Board approval process for its six members, with two being voted upon every year.

This is a standard protection against “activist” shareholders.

The 4 “independent” Board members are paid between $97,500 and $102,500 annually, depending on duties undertaken.

All Board members have been in place since 2013.

The BDC went public in February 2014, selling 7.666mn shares at $15.00 a share.

At March 31, 2014 the BDC reported 13,666,666 shares outstanding.

At August 31, 2018 CMFN’s closing price was $9.20, a 39% drop in four and a half years.

During that period, the BDC has incurred $25.142mn in Realized and Unrealized Losses, or 13% of equity capital raised at par.

CMFN reported 13.690mn shares outstanding at March 30, 2018.

To the best of our knowledge, the BDC has never issued any shares at a discount to book value since going public.


VIEWS

Ownership Disclosure

We are not shareholders in CMFN and will not be voting in the annual meeting.

Our View

However, wearing our BDC Shareholder hat – one of the features of the BDC Reporter – here is our view of the agenda items:

First, we see no objection to voting with the Board and approving the re-election of the current directors.

Caveat

However, for investors who like to see significant share ownership by insiders that’s not the case here, as the Proxy shows.

The “independent” director – Mr Wagner has purchased only 5,365 shares in CMFN.

Those shares have a value of just under $50,000, equal to less than 10% of directors fees received over the 2013-2018 period.

Mr Jansen and his family owns a more encouraging 87,769 shares, with a value of $807,475.

As a group, the insiders at CMFN own in aggregate 1.86% of shares outstanding.

Other Holders

However, big positions are owned by investment banking firm Stifel and affiliates of investment manager Cyrus Capital, both in the BDC and in the Investment Adviser as spelled out in the Proxy:

The Company is party to an investment advisory agreement (the “Investment Advisory Agreement”) with our Adviser, in which certain of the Company’s directors and executive officers have ownership and financial interests. Messrs. Mauer and Jansen, together, hold a 42% interest in our Adviser. Stifel, a wholly-owned subsidiary of Stifel Financial Corp., holds a 20% interest in our Adviser and approximately 16% of our total outstanding common stock. The Cyrus Funds, managed by Cyrus Capital, also hold, in the aggregate, a 38% indirect economic interest, but no voting interest, in our Adviser and approximately 28% of our total outstanding common stock.

Anyone interested in the web of relationships between the parties should review pages 16-17 of the Proxy.

Both Sides Now

Shareholders may be reassured by the very substantial stock positions in CMFN held by Stifel and Cyrus, which aggregate 44% of the total.

However, the possibility exists that the two parties may divest themselves of a goodly portion of their CMFN holdings.

In June 2018, the BDC registered all the shares held by Stifel and Cyrus (6mn) for sale.

To date, from what we can gather, no material dispositions have occurred.

Selling Shares Below Book

The second item – issuance of new shares below NAV – is a common request amongst BDCs.

The BDC Reporter does not favor these blank cheque arrangements, even if they are common.

Here’s why:

Reasons Against

In the case of CMFN such a license seems even more unnecessary as the Board has already given permission to raise additional debt capital.

Back in May 2018 the Board agreed to allow the BDC in a year’s time to adopt the lower asset coverage rules allowed under the Small Business Credit Availability Act.

Effectively, that will render faR easier meeting BDC regulatory leverage requirements cited as one of they reasons to raise additional equity capital, even if at a discount.

Moreover, at March 31, 2018 net debt to equity was a moderate 0.7x and the BDC’s credit portfolio was in good shape with only 1 company under-performing, according to our analysis.

Finally – as the numbers mentioned in the Analysis section above demonstrate – management’s credit performance since inception has been underwhelming, and ROE mediocre.

Of course to issue new shares at a discount would probably depress even further long term returns at this smaller sized BDC.

Alternatively

As always in these situations, the request would be more palatable if accompanied by any commitment by the insiders to co-invest in any such emergency capital raise or make some other concession.

Given that CMFN charges a 1.75% of assets Management Fee and a 20% Incentive Fee – which are on the high side in this universally expensive sector – such a commitment  would be reassuring.

No such commitment has been forthcoming from CMFN.

(Nor, to be fair, has any other BDC requesting shareholder waiver of this key protection under BDC regulations offered any type of concession).

Pragmatically Speaking

On the other hand, we have little reason to expect that the insiders who control the BDC will take advantage of shareholder approval of the below NAV stock issuance, if given.

The approval was given by shareholders last year and no untoward action was taken by the BDC.

Shareholders are likely to sign this blank cheque but it’s unlikely to be cashed even as it sits in the CFO’s desk drawer till November 2019.


SUMMARY

  • We recommend voting in favor of the two director appointments.
  • We recommend voting against the sale of shares below book value, both on the grounds of principle and necessity.
  • Even if the second proposal gets voted through, CMFN is unlikely to pull the trigger.
  • We suggest that current or future shareholders seek regular updates as to the intentions of Stifel and Cyrus towards their ownership holdings in CMFN, and the reasons for any dispositions.
  • Shareholders may also want to inquire for full details about the BDC’s balance sheet expansion plans which could – in theory – result in a nearly 75% increase in total assets and a 164% increase in borrowings.
  • CMFN’s annual earnings release is scheduled for after the close on August 4, 2018. 
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