MidCap Financial Investment Corp (MFIC) 2014 Q2 法說會逐字稿

Good morning and welcome to Apollo Investment Corporation's earnings conference call for the period ending September 20, 2013. At this time, all participants have been placed in listen-only mode. The call will be open for question-and-answer session following the speakers' prepared remarks.

(Operator Instructions)

I will now turn the call over to Elizabeth Besen, Investor Relations Manager for Apollo Investment Corporation.

Thank you, operator, and thank you, everyone, for joining us today. With me today are Jim Zelter, Chief Executive Officer; Ted Goldthorpe, President and Chief Investments Officer; and Greg Hunt, Chief Financial Officer. I would like to advise everyone that today's call and webcast are be being recorded. Please note they are the property of Apollo Investment Corporation and that any unauthorized broadcast in any form is strictly prohibited. Information about the audio replay of this call is available in our earnings press release.

I would also like to call your attention the customary Safe Harbor disclosure in our press release regarding forward-looking information. Today's conference call and webcast may include forward-looking statements. Forward-looking statements involve risks and uncertainties, including but not limited to statements as to our future results, our business prospects, and the prospects of our portfolio companies. You should refer to our registration statement and shareholder reports for risks that apply to our business and may adversely affect any forward-looking statements we make. We do not undertake to update our forward-looking statements or projections unless required by law. To obtain copies of our SEC filings, please visit our website at www.apolloic.com.

I would also like to remind everyone that we've posted a supplemental information package on our website which contains information about the portfolio as well as the Company's financial performance. At this time, I would like to turn the call over to Jim Zelter.

Thank you, Elizabeth. This morning we issued our earnings press release and filed our quarterly report on Form 10-Q. I'll begin my remarks with some financial highlights for the quarter followed by some other recent highlights. Following my comments, Ted will provide a brief overview of the market environment and will review our investment activity for the quarter, and finally, Greg will discuss our financial results in greater detail. We then will open the call to questions.

Starting with our financial highlights, we reported net investment income per share of $0.22 for the September quarter, which reflects stable recurring interest income and an elevated level of prepayment income, offset by lower dividend income and origination related fees. Net asset value per share was $8.30 at the end of September, compared to $8.16 at the end of June, a 2% increase driven by broad-based appreciation across our portfolio. In today's benign credit environment with tightening credit spreads, we are focused on derisking the portfolio by monetizing select higher risk assets. We are pleased with the current combination of our portfolio, and we are disciplined in our approach and favor security over incremental yield as we continue to reposition the portfolio into secured debt. Although our broad outlook for the credit markets has not changed dramatically, we do see some signs that drive us to be more conservative and, therefore, we remain cautious and selective while making new investments. Turning our attention to our dividend, the Board of Directors approved a $0.20 dividend per shareholders on record as of December 19, 2013. Based on our closing share price yesterday and annualizing the current dividend, our stock offers a dividend yield of approximately 9.5%.

With that, I will turn our call over to Ted to discuss the current market environment and our investment portfolio in greater detail.

Thanks, Jim. The credit markets were firmer in the September quarter as interest rate volatility subsided and credit spreads tightened, rallying in mid-September following the Federal Reserve's surprise decision to maintain its pace of quantitative easing. Although underlying fundamentals remain sound, we believe the abundance of liquidity and search for yield continues to result in the mis-pricing of risk. So we are focused on derisking the portfolio by selectively deploying capital and monetizing higher risk assets. During the September quarter, we invested $412 million in 12 new and 18 existing portfolio companies. Since early 2012, we have been focussed on investing in secured debt, which we believe continues to offer the most attractive, risk-adjusted returns in today's environment.

Accordingly, $285 million of investments made during the period were secured debt and at the end of September, secured debt accounted for 52% of the total portfolio, up from 48% last quarter and up from 32% when we started to reposition the portfolio approximately 1.5 years ago. We also received $284 million of proceeds from selected sales and $186 million from repayments. Additionally, in anticipation of continued rate volatility and our expectation of an ultimate rise in rates, we have also been focused on increasing our exposure of floating rate debt which accounts for 38% of our debt portfolio at the end of the quarter, up from 33% at the end of June on a fair value basis.

From a yield standpoint, the weighted average yield in our debt portfolio at cost declined approximately 30 basis points to 11.3% at the end of September, compared to 11.6% at the end of June. This decline reflects our continued focus on investing in secured debt and the repayment of a few of our higher yielding positions. The yield on debt investments made during the period was 10.4%, and we believe there are signs of stabilization as the yield on new investments was relatively flat quarter over quarter, and the spread between new and sold investments tightened. The yield on debt investments sold was 10.3%, and the yield on debt repayments was 13.4%. Investments that were repaid during the quarter included Angelica Corporation, Denver Parent, and Clean Earth.

I will now discuss some specific portfolio activity for the quarter. During the quarter, we committed approximately $75 million in asset based revolving credit facility to Unitech Global Services. Unitech is a provider of engineering construction management and installation fulfillment services to companies specializing in the telecommunications, broadband cable, wireless, two-way radio, transportation, public safety, and satellite industries. We also made a $15 million investment in Renaissance Umiat, a global energy company that engages in the exploration, development, and production of conventional and unconventional oil and gas reserves. And our aircraft leasing subsidiary, Merx Aviation, purchased three aircraft in two transactions.

Moving to sales during the quarter, we sold our investment in the student loan portfolio we made last quarter for a $6.1 million gain as we received an offer in excess of our target price. As discussed on last quarter's call, volatility during the June quarter provided us with an attractive opportunity to deploy capital in the secondary markets. We used some strength in credit markets in the September quarter to monetize some of these investments, as well as some higher risk positions. These higher risk positions, including the partial sale of our investments in Altegrity and IPC Systems, and our complete exit of our investment in TXU.

I will now review some general portfolio statistics for September 30. We continue to be diversified by issuer and industry with 93 portfolio companies invested in 30 different industries. The Company's total investment portfolio had a fair market value of $3 billion, with 52% in secured debt, 34% in unsecured debt, and 6% in structure products and other, and 8% in preferred equity, common equity, and warrants. Lastly, with respect to credit quality, we believe that the repositioning into more secured debt has made the portfolio better able to withstand market and economic volatility as evidenced by declining attachment points and improving interest coverage. Based on the portfolio at the end of September, the weighted average net leverage of investments made in the first 9 months of the calendar year 2013 was approximately 4.5 times, compared to 6.1 times for the investments made in 2010.

The weighted average cash interest coverage was approximately 2.6 times for investments made in the first 9 months of 2013, up from 2.1 times in 2010. The weighted average net leverage and interest coverage for the portfolio at September 30 was 5.2 times and 2.4 times. In addition, the weighted average risk rating of our portfolio, based on our 1 to 5 risk rating scale, with 1 representing the least amount of risk, declined to 2.2 at the end of September, compared to 2.3 at the end of June, measured at cost. The weighted average risk rating of our portfolio measured at fair value declined to 2.1 at the end of September, compared to 2.2 at the end of June. We continue to be pleased with the performance of our portfolio companies.

And with that, I will turn the call over to Greg who will discuss our financial performance for the second quarter.

Thank you, Ted. I would like to remind everyone that in addition to our 10-Q, we have posted a financial supplement presentation on our website. I will now discuss Apollo's Investment Corporation's financial performance for the quarter ended September 30, 2013. Beginning with operating results, total investment income for the September quarter was $93.7 million, a 3% decrease from the June quarter but a 12% increase from the year-ago quarter. Net investment income was $49.6 million or $0.22 per share for the September quarter. This compares to $52.4 million, or $0.25 per share, for the June quarter, and $44.5 million, or $0.22 per share, for the September 2012 quarter. The decrease, quarter to quarter, is primarily attributable to lower dividend income and origination related fees partially offset by higher prepayment income.

Included within interest income for the quarter is $9 million of prepayment income, compared to $7.8 million for the June quarter, and $1.6 million for the September 2012 quarter. While early repayments impact future interest income, we endeavor where appropriate to structure our investments with call protection, which generates income in periods of elevated prepayment activity. As of today, prepayment activity has slowed materially, which, should it continue, would result in lower prepayment income for the December quarter. The decrease in dividend income was primarily related to the unwinding of our First Data position within our credit opportunity fund, and a one-time special dividend received from one of our portfolio companies during our June quarter. Expenses for the September quarter totaled $44.1 million. This compares to expenses of $44.3 million for the June quarter, and $39.4 million for the September 2012 quarter. The slight decrease in expenses, quarter to quarter, was due to lower incentive fees, partially offset by higher quarterly interest rate, reflecting the impact of our management of the right side of our balance sheet with the issuance in late June of 30-year senior unsecured notes at 6.875%.

For the quarter, the net gain on the portfolio totaled $26.8 million, or $0.12 per share, compared to a net loss of $33.6 million, or $0.16 per share, for the June quarter, and a net gain of $28.6 million, or $0.14 per share, for the year-ago quarter. The net gain was the result of the improved credit market and the broad-based appreciation acrossed our portfolio, including our investments in Garden Fresh, our equity value in Merx Aviation, offset by several holdings such as Inventive Health and Allied Nevada. In total, our quarterly operating results increased net assets by $76.4 million, or $0.34 per share, compared to an increase of $18.8 million, or $0.09 per share, for the June quarter, and an increase of $73 million, or $0.36 per share, for the year-ago quarter. Our total investment portfolio had a fair value of $3 billion at the end of September and at the end of June, comparatively.

Net assets for the quarter totaled $1.86 billion, with a net asset value per share of $8.30, compared to net assets of $1.83 billion, or a net asset value per share of $8.16 at the end of June. On the funding side of the balance sheet, we continue to focus on improving our capital structure. During the September quarter, we amended and restated our senior secured revolving credit facility, increasing the facility size to $1.25 billion, extending the maturity by 2 years to August 2018, and reducing our interest costs by 25 basis points. As of quarter end, we had $312 million outstanding under the facility.

We had $1.1 billion of total debt outstanding at the end of the quarter, down slightly from the prior quarter. And the Company's debt to equity was 0.58, down from 0.61 at the end of June. The net leverage ratio, which includes the impact of cash and unsettled transactions, was 0.62 at the end of September, down from 0.66 at the end of June. Lastly, at the end of September, there was 1 company with 2 investments on nonaccrual, unchanged from the end of June, representing less than a 0.5% of our portfolio on a fair value basis.

With that, operator, we would like to open up the call to questions.

(Operator Instructions)

Rick Shane of JP Morgan.

Hello, guys. And I apologize, I'm a little confused at the moment by my own model, so I may misstate this question. But it looks to me like there were some realized losses on the quarter as you exited some things.

Just curious where those investments had been marked at the end of the June quarter, so we understand what was going through the reversal of the unrealized losses line?

Rick, I think to compare the June to September, we can, we'd have to go through on the exact components of it. But I think from -- when we look at our, the drivers for the losses overall, the net losses for the quarter, as we indicated we had Allied Nevada in our inventive health losses in the quarter that drove some of it at this point. (multiple speakers)

Rick, I think the key point is, a lot of the realized losses were us making decisions to monetize higher risk positions. Probably the best example is TXU. So, yes, we fully exited our TXU position which wasn't a material NAV or unrealized, there wasn't a massive unrealized change between June and the end of the quarter, but there was a realized loss because we monetized the position.

Great, that is exactly what I was asking. I understood why you did it, I was just trying to figure out where those exits were in relation to the June marks. And so we could figure out the impact on NAV was.

Doug Mewhirter of Sun Trust.

Hello, good morning. I apologize if I, if you have already mentioned, I missed the very first part of the call. I was wondering if you could give an update on, if you haven't already given it, on your energy group and your also your aircraft leasing group? The activity there and the general investing environment as well?

I think we continue to be very, very excited about both verticals. Our aircraft, we closed on a couple aircraft transactions this quarter. We continue to have a pretty robust pipeline there, and we continue to believe that the risk reward of that opportunity is very compelling. I think our energy business, we actually did originate a decent amount of energy transactions during this quarter.

I would say that our pipeline is probably not as robust as what it was six months ago, but again, it is an episodic business. So we continue to see very, very good risk reward on both. In both sectors, if they are really good, they are really good sectors for us. Asset rich, massive amounts of demand for capital, and reasonably limited supply of capital creates what we think is a pretty good competitive dynamic.

Just following on the energy, things might have flattened out a little bit on the investment activity, is that, do you think it is related to oil prices? Or it is some other, just a general, cyclical, animal spirits going up and down, so to speak?

I don't think it is either. It is an originated business. So we hit on some things and we don't hit on others. This past quarter, we had a couple large energy deals fall through for various reasons.

And so I don't think it is related to energy prices. I think it is more related to, it is an episodic business. Which is, it is not a constant stream of opportunities, it is a relatively lumpy and idiosyncratic business.

Okay, Thanks for that. And my last question, dealing with the -- looking at all the healthcare reform and the Affordable Care Act, has that changed your appetite for making healthcare investments?

Or is it at viewed, made you view your any existing portfolio companies where you might be wanting to either put more or less in, or maybe have an early exit? Or, and do you think it will be a net positive or a net negative for how you look at the space?

Yes, that is a great question. So there is two parts to ACA. Impact on our existing portfolio companies. Obviously, a lot of companies are spending a lot of time on this. And our general sense is it is not going to have a material impact on our portfolio.

And the flip side on our healthcare investments, we typically shy away from reimbursement risks. We just feel like it is really, really hard to handicap. And so there are some people out there who are good at it, and who have -- I just feel like from our perspective, just given we are making debt investments with capped upside to take material reimbursement risk in any of our portfolio companies, we just don't love to do that.

So we kind of analyze the types of healthcare investments we have. I don't think a lot of them will have a material positive or negative impact from ACA. There's a lot of healthcare businesses that are going to get a lot of tailwinds from ACA for various reasons. We will probably not be a huge beneficiary of it for all the reasons I said before.

Okay, great. Thanks for that answer. That's all my questions.

Terry Ma of Barclays.

Hello, thanks for taking my questions. So just looking at this Renaissance investment you guys made this quarter, it looks like a nonqualified 30% asset and it is also a non-income producing. Can you give us a little color on that?

Yes. So I would say a couple of things on that. It is a relatively short-term investment. It is backed by a tax receivable, which is why it counts as a 30% asset. I think we feel really, really good about the risk return.

It is a mid-teens type return for what we think is 90 to120 days of risk with very little, there is really no commodity price risk in the investment. So it is a little bit of a different investment. But it was obviously sourced off our energy platform. We obviously have a lot of experience in the region where this was originated. So we feel very good about it.

Okay, great. I think in the past you guys mentioned you wanted to better optimize that 30% bucket? Is this a signal of some sort of move more toward 30% assets in any way? Can you give us some color there?

I think that this is somewhat an idiosyncratic investment. When we think about our strategic goals and what we laid out a year and a half ago, we have accomplished many of them. One of which we are still very focused on is increasing the overall yield of our 30% bucket. So that is still a to be achieved in terms of our long-term goals.

Saying that, however, we recognize the market that we are in right now. And we don't want to be reaching for yield at the wrong time. So certainly, this was what an idiosyncratic investment, as Ted mentioned, really benefits our energy platform.

But to your answer your broader question, we still, one of our strategic goals is to continue to make sure we are increasing the overall yield on that 30% bucket.

Okay, great. Thanks.

Greg Mason of KBW.

Great, thanks. My first question was right along those lines. Also talking about the 30% bucket and the CLO, just kind of thinking, wanted to get your thoughts on what you are seeing in the CLO equity markets and any opportunities for investments there? Or perhaps another Kirkwood type of investment?

Yes, so we think about our CLO investments in two forms. One is strategic partnerships, like the one we pursued with Madison. And you look at our CLO equity, the vast preponderance of our CLO equity is in those two transactions. I think in the generic CLO equity market, as we sit here today we are not sure that is necessarily the best use of our capital.

And our exposure to generic CLO equity today is pretty de minimis as a percentage of the overall portfolio. So I think we are seeing opportunities in structured products. We saw this Sallie Mae transaction we did last quarter, which we monetized this quarter.

So I think you may see us do more structured products on a go-forward basis, they would be much more strategic and proprietary nature than just buying generic either new issue or secondary CLOs.

Okay, great. And then one last question, could you tell us how much, sometimes you have some trading opportunities? How much of your originations were in and out this quarter to try to get a better feel for longer term originations and sales?

Yes, I mean I'll answer the question this way, which is 79% of our investments this quarter were primary origination. So what you saw last quarter was higher, that was just an idiosyncratic, opportunistic event that we leveraged the platform.

We had wound some of those transactions this quarter. This quarter that we are in today, again, as well as this past quarter, the vast, vast, vast majority of what we are doing, the core to our business, is primary origination.

Great. Thanks. I appreciate it.

Finian O'Shea of Raymond James.

Hello, guys. Good morning and thank you. Just to wrap-up, can you talk about, you talked about how today's opportunities are less compelling. Could you give us maybe what you see on say fee structure and covenants for the newer originations out there?

Yes. I think, I bifurcated to, one is we have seen yield stabilization this quarter. And I know six weeks does not make a trend. But, and we can't tell whether if it is just the level of activity, level of activity as, a lot of our peers have said, has really picked up this quarter.

But what I would say is the liquid markets, or the liquid origination markets, meaning quartered securities, it has condition to go tighter, and we are not seeing a lot of compelling value there. I think we continue to focus on proprietary origination away from the liquid markets and we continue to find value there.

So I think originations, we are not that worried about it. The flip side, as Jim said, we are just very, very focused on risk return and we're just not seeing great risk return in either the secondary markets or primary origination, like the broadly syndicated primary origination markets.

Okay. Thank you.

Jon Bock of Wells Fargo.

My apologies. I thought I had logged in. Thank you very much for taking my questions. Greg real quickly, I think you mentioned there was about $9 million of prepayment or accelerated, we'll call it fees, in this quarter number, correct? About $0.04?

Yes.

Okay. So as we start to look forward, you mentioned that there is the potential for repayment fees to perhaps decline. Can you give us a sense of where the renewed confidence in slower repayments is coming from? Only because as we hear M&A activity or all in financing activity is likely to increase in the fourth quarter, I'm just curious as to how repayments can slow and the fee line decline?

Jon, I'm sorry this is Ted. The last quarter, the vast majority of our income was generated by only a few repayments. We've seen repayments come way down, and I think a lot of it has to do with a lot of our previous repayments were people refinancing older vintage opportunities, or people repricing existing opportunities.

A lot of the new, a lot of the activity we are seeing today is more new activity, net new activity, M&A and other things. And we just haven't seen the impact on our portfolio. And when we look at our portfolio, we try to model out and schedule forward repayments, and we usually have a good window into it. And we are seeing repayment activity coming down.

Okay. So if repayment activity does come down, and we just say that $0.04 this quarter there was that positive benefit, Ted, can you talk about how you view the use of leverage in this current environment and perhaps your willingness to leverage the portfolio to bridge the gap that is left as fee income subsides?

I mean, listen, the repayment income, if you have less repayment income, there is a benefit which is your portfolio yields typically are more stable or go higher. So your core NII, as you would describe it, should be more stable or potentially higher, right? So that offsets repayment income. Repayment income is episodic versus core recurring NII.

And number two is, you don't necessarily just need to take up leverage to make up that difference. There's other things you can do in your business, origination fees, there is a lot of other things you can do to bridge the gap if repayment income comes down, which is increase core NII, and other origination related activities that generate fees for us.

So I mean, listen, our leverage coming out of this past quarter was right in the middle of the range. We have provided everybody where we're, Greg and Jim and myself, feel comfortable. So I feel like we don't really need to take up leverage in order to feel really, really good where our dividend is.

Great answer. And then I guess a quick follow on that is, you could keep leverage constant two ways. You could effectively churn the syndicated or what we'll call it the opportunistic assets that you originated previously and churn those into higher yielding investments that are proprietary, which is a great and understood.

Or one could effectively grow the portfolio and issue equity. Do you have a preference between either of those choices?

Yes, I think it is definitely the former. We still have opportunities in our portfolio, to high grade the portfolio. We still have opportunistic purchases we made in the last quarter that we could potentially monetize.

And I think, as we sit here today, I don't think it is our intention to do any kind of material equity offerings until we see changing environment.

Much --

And I would --

Go ahead, Jim.

I would just add, Jonathan, and you have great insight to the dynamics of these markets. But right now, we felt it was very wise to issue debt early this year. We think that is the better way, as we think long term about a dynamic capital structure, it was more prudent for us to issue some debt, issue some equity earlier in the year.

But as Ted said, there is enough to do with our portfolio right now, with leverage and the liquidity we have in it, that raising equity is not a front burner opportunity that we are focused on today.

Appreciate that. Thank you for the color.

At this time, there are no further questions. I will now return the call to Jim Zelter for any additional or closing remarks.

Well, once again, the management team are very appreciative of the time everyone has spent today, and then the support from our shareholders and all the folks who cover us. Thank you very much for your time and we look forward to catching up next quarter.

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