MidCap Financial Investment Corp (MFIC) 2024 Q1 法說會逐字稿

Good morning, and welcome to the earnings conference call for the period ended March 31, 2024 for MidCap Financial Investment Corporation. (Operator Instructions)

I will now turn the call over to Elizabeth Besen, Investor Relations Manager for MidCap Financial Investment Corporation. Please go ahead.

Thank you, operator, and thank you, everyone, for joining us today. Speaking on today's call are Tanner Powell, Chief Executive Officer; Ted McNulty, President; and Greg Hunt, Chief Financial Officer; Howard Widra, Executive Chairman, as well as additional members of the management team are on the call and available for the Q&A portion of today's call.

I'd like to advise everyone that today's call and webcast are being recorded. Please note that they are the property of MidCap Financial 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 press release.

I'd also like to call your attention to the customary safe harbor disclosure in our press release regarding forward-looking information. Today's conference call and webcast may include forward-looking statements, and you should refer to our most recent SEC filings, our most recent filings with the SEC for risks that apply to our business and that 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 either the SEC's website at www.sec.gov or our website at www. midcapfinancialic.com.

I'd also like to remind everyone that we posted a supplemental financial information package on our website, which contains information about the portfolio as well as the company's financial performance throughout today's call, we will refer to MidCap Financial Investment Corporation as either MFIC or the BDC, and we will use MidCap Financial to refer to the lender headquartered in Bethesda, Maryland.

At this time, I'd like to turn the call over to Tanner Powell, MFIC's Chief Executive Officer.

Thank you, Elizabeth, and thank you, everyone, for joining today's call. I will begin today's call with a summary of our results and will also provide our perspective on the current environment. I will then provide an update to our proposed merger with Apollo Senior Floating Rate Fund Inc. and Apollo Tactical Income Fund, Inc.

Ted will then cover our investment activity and provide an update on the investment portfolio and credit quality. Lastly, Greg will review our financial results in greater detail. Yesterday, after market close, we reported solid results for the March quarter, which included a slight increase in net asset value per share, relatively stable credit performance and continued de-risking of the portfolio.

Net investment income per share for the March quarter was $0.44, which corresponds to an annualized return on equity or ROE of 11.4%. Results for the quarter reflect solid recurring interest income from our predominantly floating rate portfolio and strong fee and prepayment income. GAAP EPS for the March quarter was $0.39.

Similar to last quarter, we continued to improve the risk profile of our portfolio by reducing our exposure in Merx, our aircraft leasing portfolio company as well as our second-lien exposure. At the end of March, corporate lending and other represented 92% of the total portfolio, of which 97% was first lien on a fair value basis, up from 96% in last quarter.

With the repayment of one of our few remaining second-lien positions, our second lien and other debt exposure is now only about 0.7% of the total corporate lending portfolio.

We believe MFIC has one of the most senior corporate lending portfolios among BDCs as evidenced by our weighted average attachment point of essentially zero. We believe we have constructed a corporate lending portfolio that will perform well even during a potential economic downturn. Overall, we feel good about the health and quality of our corporate lending portfolio as our underlying borrowers have largely been able to handle higher borrowing costs.

We have not seen any significant signs of credit weakness across the portfolio. We are, of course, closely monitoring our portfolio and mindful of the potential impacts of a higher for longer rate environment.

I would now like to provide our perspective on the current environment. Despite high interest rates, elevated inflation and geopolitical uncertainty, US economy has proven to be resilient and continues to display strong growth. At the beginning of 2024 investors expect expected the Federal Reserve to cut rates multiple times during the year.

However, as the quarter progressed, Subrah and inflation has pushed out the expectation for the start of rate cuts and the market generally believes that we are in a higher for longer scenario. Apollo's Chief Economist believes that there's a reasonable chance that the Fed may not cut at all in 2024, while the market is currently pricing and only one cut this year.

Specific to the lending market, during the first quarter, there has been an increase in activity in the syndicated loan market. MFIC is focused on the middle market, which is less susceptible to competition from the syndicated loan market. Although spreads in our market have decreased. The decline has been less than what we have observed in liquid loan market.

Spreads in our market are still healthy by historical standards, and we continue to believe risk return in the middle market remains compelling and ARM in our market today, a typical deal with price with a spread of around 500 basis points to 550 basis points.

As, MFIC is squarely focused on the core middle market, MidCap Financial, which was founded in 2029 has a long track record, which includes closing on approximately $114 billion of lending commitments since 2013. This origination track record provides us with a very large dataset of middle market company financial information across all industries, and we believe makes MidCap Financial, one of the most informed and experienced middle market lenders in the market. Apollo's affiliation with MidCap Financial is a significant competitive advantage for MFIC.

In short, we believe the core middle market offers attractive investment opportunities across cycles and does not compete directly with either the broadly syndicated loan market or the high-yield market.

Next, let's turn to the dividend. Approach to dividend seeks to provide shareholders with an attractive current yield while also retaining some earnings for NAV stability and growth. To that end, our Board of Directors declared a dividend of $0.38 per share, consistent with our prior year prior quarter dividend to shareholders of record as of June 11, 2024, payable on June 27, 2024.

A $0.38 dividend represents an annualized yield of approximately 9.9% based on NAV per share as of March 31. Our dividend continues to be well covered by net investment income.

Before handling the call over to Ted, I would like to provide a brief update on MSIC's proposed mergers with AFT and AIF. We remain excited about these proposed mergers, and we believe that their consummation, which is subject to receipt of certain stockholder approvals and satisfaction of other customary closing conditions will create a stronger combined company.

We look forward to realizing the potential benefits of a larger combined company, including enhanced returns for all stockholders, greater scale and enhanced portfolio diversification after close.

As a reminder, if one or both of these mergers closed MFIC will pay a one-time cash dividend of $0.2 per share to all stockholders. Following the closing, the exact record date for this dividend will be determined by MFIC's Board of Directors based on the timing of the closing. We filed a definitive joint proxy statement [slash] prospectus related to the mergers on April 4.

And the special meeting for the stockholders of all three funds to vote on the merger proposals had been scheduled for May 28. We have officially commenced the proxy solicitation process related to these proposals, and we kindly request that any stockholders of MFIC, AFT, or AIF, who have not yet cast their votes on these proposals do so in the coming days, please note that we will not be able to answer any questions related to the current vote count on today's call.

With that, I will turn the call over to Ted.

Thank you, Janet, and good morning, everyone beginning with investment activity. As a reminder, MFIT. is focused on investing in loans sourced by MidCap Financial, which provides MFIC with a large pipeline of investment opportunities. Market Lender with one of the largest direct lending teams in the US with close to 200 investment professionals.

On last quarter's call, we mentioned we were seeing a noticeable pickup in pipeline activity. We're pleased to report that this has led to a strong level of closings during the March quarter.

MidCap Financial was active during the March quarter, closing approximately $5.1 billion in new commitments, an increase of approximately 31% from the December quarter. During the March quarter, MFIC's new investment commitments totaled $149 million of new first lien commitments across 16 different borrowers for an average new commitment of 9.3 million as we continue to focus on diversification by borrower.

38% of new commitments were made to existing portfolio companies. Although, we are seeing some pricing compression in the market, the weighted average spread of our new commitments in the quarter was relatively unchanged at 624 basis points, one basis point lower than commitments made during the December quarter the weighted average OID for new commitments was approximately 211 basis points.

The spread in OID translates into a very attractive online levered asset yield of around 12%, assuming a 5% base rate. The weighted average net leverage of new commitments was 3.9 times. We believe the risk return on these new commitments is very compelling. Our pipeline of investment opportunities remains strong.

In terms of funded investment activity. Gross fundings for the corporate lending portfolio, excluding revolvers, totaled $129 million. Sales and repayments totaled $95 million. Net corporate lending revolver paydowns were $14 million, and we received a $4 million paydown from Merck's.

In aggregate, net fundings for the quarter totaled $16 million. Our portfolio turnover continues to drive a positive shift in the composition of our portfolio. Sales and repayments included the exit of a $15 million second lien position, which reduced our already low second lien and other debt exposure by half to just $13.8 million, or 0.7% of the total corporate lending portfolio at fair value.

We believe this negligible amount of non-first lien exposure highlights the very senior nature of our corporate lending portfolio.

Turning to our investment portfolio. We have built a well-diversified senior corporate lending Board. At the end of March, our portfolio had a fair value of $2.35 billion and was invested in 154 companies across 23 different industries.

Corporate lending and other represented approximately 92% of the total portfolio, and Merck's accounted for 8% of the total portfolio. On a fair value basis, the average funded corporate lending position was $14.6 million or approximately 0.7% of the total corporate and other lending portfolio.

97% of our corporate lending portfolio was first lien, up from 96% last quarter and over 99% of our corporate lending debt portfolio on a cost basis at one or more financial covenants and 88% of our corporate lending portfolio is backed by financial sponsors who we know well and with whom MidCap Financial has long-standing relationships.

Despite the higher for longer interest rate environment, our portfolio companies continue to exhibit strong fundamental performance and meet our expectations on a median basis. For the quarter, portfolio company revenue and EBITDA both increased by mid single digits year-over-year.

The growth in revenues attributable to organic expansion, while improvements in margins are due to borrowers optimizing their cost structures. We believe the sustained positive improvement as an encouraging indicator of the portfolio's underlying strength.

The weighted average yield at cost of our corporate lending portfolio was 12.1% on average for the March quarter, down slightly from 12.2% in the December quarter. At the end of March, the weighted average spread on the corporate lending portfolio was 621 basis points, down 2 basis points compared to the end of December.

Turning to credit quality. Our focus on true first lien top of the capital structure of middle-market loans has resulted in what we consider to be strong and resilient credit metrics. Given the second lien repayment I mentioned, the weighted average attachment point for our corporate lending portfolio was essentially zero or to be more precise, 0.04 times.

This metric means that there is no senior debt to our positions, illustrating that our corporate lending portfolio is indeed first lien. We believe it is key to look at this metric as not all debt labeled first lien is actually top of the capital structure, as its name would suggest. At the end of March, the weighted average net leverage of our corporate lending portfolio was 5.36 times, up from 5.27 times last quarter.

Moving to interest coverage. The weighted average interest coverage ratio remained at 1.9 times, unchanged, with four companies below one times. We're closely monitoring these situations and believe they are manageable, as the companies have strong current liquidity, good underlying business performance or have strong financial sponsor support.

The median EBITDA of MFIC's corporate lending portfolio was approximately $47 million. We have not seen a meaningful increase in covenant breaches or a pickup in amendment activity. We believe our credit quality has benefited from MidCap Financial, strong sourcing and underwriting capabilities.

Our underwriting on MidCap sourced loans has proved to be sound based on data since mid 2016, which is the approximate date upon which we began utilizing our co-investment order, our annualized net realized and unrealized loss rate is around two basis points on loans sourced by MidCap Financial. We think this performance data shows how well the strategies performed.

Although we added our $12 million investment in Naviga to non-accrual status during the quarter. Investment on investments on nonaccrual remain very low, totaling $14.4 million, or 0.6% of the total portfolio at fair value across three names.

Naviga is currently in a sales process and initial bids are reflected in our market. We believe the stable credit metrics reflect the way in which we've constructed our portfolio and is the direct result of focus on sourcing assets from MidCap Financial, one of the leading middle market lenders.

Importantly, MFIC benefits for MidCap Financial's large dedicated portfolio management team of over 60 investment professionals, which helps identify and address issues early. It is also important to note that MidCap Financial leads and serves as administrative agent on the vast majority of our deals, which provides meaningful downside protection.

As an agent, were an access active dialogue with the borrower and have enhanced information flow, which allows us to be proactive in resolving problem credits.

Moving on to Merck, as discussed previously, we are focused on reducing our investment in our aircraft, leasing and servicing businesses. While we don't expect paydowns to occur evenly. We believe aircraft sales and servicing income should allow for the paydown of third party debt and MFIC's investment in Merck over time.

As of March 31, our investment in Mark's totaled approximately $190 million, representing approximately 8% of the total portfolio at fair value during the March quarter, Merx paid MFIC approximately $5.9 million, which included $1.9 million of interest and a $4 million return of capital.

For that, I will now turn the call over to Greg to discuss our financial results in detail.

Thank you, Ted, and good morning, everyone. Beginning with our financial results, net investment income per share for the March quarter was $0.44, which reflects solid recurring interest income as well as strong fee and prepayment income. For the quarter, prepayment income was $2.2 million and fee income was $1.7 million.

PIK income remains very low, representing approximately 3% of the total investment income for the quarter. GAAP net income per share for the quarter was $0.39, which reflects a $0.05 loss on the net on our investment portfolio. Results for the quarter correspond to an annualized return on equity based on net investment income of 11.4%, an annualized ROE based on net income of 10.1%.

MFIC's NAV per share at the end of March was $15.42, up $0.01 over the prior quarter, which reflects net investment income of $0.44, which is $0.06 above the $0.38 distribution and a $0.05 per share loss on the portfolio.

As Ted mentioned, the vast majority of our corporate lending portfolio continues to have strong fundamental performance. Additional details on the change in unrealized gains and losses by strategy are shown on slide 17 in the earnings supplement deck.

Net expenses for the quarter was $39.8 million, down $2.4 million compared to the prior quarter, primarily due to lower general administrative expenses as well as lower interest expense and lower incentives. We recruited of de minimus amount of excise tax in March compared to approximately $1.1 million this September quarter.

The weighted average interest rate on our debt for the quarter was 7.09%, up from 6.94% last quarter, which reflects a full quarter impact of the CLO notes and the baby bonds, which both closed during the December quarter. As stated on last quarter's call. We intend to continue evaluating and monitor capital raising transactions going forward. Management fees totaled $4.4 million for the March quarter, essentially flat compared to the prior quarter.

As a reminder, MFIC's base management fee was reduced to 1.75% on equity beginning January 1, 2023, and is one of the only listed BDC's to charge management fees on equity, which we believe provides greater alignment and focus on net asset value.

Incentive fees totaled $6 million for the March quarter. As a reminder, our incentive fee on income is 17.5% and includes a total return hurdle. The 12-quarter look back. Our current estimate of undistributed will taxable income or spillover income at the end of 2023, it was $67.3 million or $1.3 per share.

Moving to our balance sheet, MFIC's net leverage was 1.35 times at the end of March compared to 1.34 times at the end of December, reflecting $17 million of net fundings during the quarter.

This concludes our prepared remarks. Operator, please open the call to request.

(Operator Instructions) Mark Hughes, Truist.

Yeah, thank you. Good morning. To perceive much in the way of competitive moves. So say, given the broadly syndicated markets, a little more activity there. We've seen some lenders get down more into the middle market and impacting spreads and maybe along with that, I think you talked about 500 basis points to 550 basis points spread today.

Has that been relatively stable lately? Or has that been moving through the quarter? How would you say it is kind of the trend?

Tanner, let me I'll comment on that. As Howard. The odds are not so immediately on, and that's really because, obviously, you may see large sponsors that are covered by and doing larger deals occasionally get down in the middle market. But in order to cover the middle market, you need to have a comprehensive coverage effort, our which is a and continuity in the market with a lot of those sponsors.

And so you just don't see the capability of the people who are focused on the larger market competing directly probably syndicated with the capabilities to sort of to step into that market holistically doesn't mean it doesn't happen on occasional deals.

I mean, as a separate matter there's capital being created in the middle market all the time, and then either those teams may or may not have comprehensive coverage as well. So there is definitely competition that's causing compression, but it's not really the result of the broadly syndicated market. The middle market is one of the strengths of it as being sort of insulated from those that variation.

And then any comment on the trajectory of spreads this year to think about where they were in January to where we are today?

Happy to take that. So Mark, I would say that. So your mark, I would I would call your attention to we alluded to the fact that deals are between $500 million and $550 million. And in the quarter, we actually executed at $624 million. And that has to do with what we talked about a lot, there's a gestation period for deals getting done. And that reflects a lot of subsidies that have been commenced last year. And so that pretty significant tightening that we see.

What we are seeing is some modicum of stability as at this juncture unit post December, where there are some conditions improved and you saw some of the spread tightening and rally in markets more broadly, those sale processes are hitting are now at a point where we're able to create new credit assets and our pipelines are very full.

So I would say, certainly that my initial comment there reflects the tightening overall that we've seen in the middle market, but seeing some stability now that down sale prices have added an opportunity to run their course and the opportunity for new credit asset creation.

Thank you for that. One more in since you probably addressed this, but I wonder if you could update us on the kind of the seniority profile you can emphasize that our focus on first lien once you do the merger with the other Apollo funds, how will that look roughly speaking?

Yeah. It will look similarly on those funds and which is obviously publicly available, have some more on our broadly syndicated type loans, but predominantly first lien. And then, Mark, as we've talked about and both in our prepared remarks and in the filings, as well as also on our investor decks that the intention is obviously over time is as those loans mature or we can sell out of them to obviously reposition them into our core strategy of MidCap loans. First lien floating rate loans that we source for they're sourced by the MidCap platform.

Thank you very much.

Kyle Joseph, Jefferies.

Yeah great, thanks for taking my questions and sorry if I missed this on some earlier this morning, but did you give the center pro forma leverage or ballpark area post-merger?

It will be somewhere around on between 1.15 times and 1.2 times levered.

Okay. Got it. Helpful. And a good segue to my next. Over the last couple of years, you guys have been focused on reducing core and lowering our leverage and now, especially with the merger where we can have at the point where you can think about more transitioning to kind of the offensive side if that's fair to ask?

So Kyle, I mean, certainly, we're really excited by the prospect. Should it should we be successful of having an opportunity to come. We deploy even more capital.

Yes, I wouldn't attach the offense and defensive Valence to it per se because, our strategy since we got the ability to go up in leverage has been 100% focused on sourcing or sorry, participating in or investing in loans that are originated at MidCap and so our approach doesn't change.

I think this is just a very elegant opportunity to do even more of it and to kind of create the even bigger percentage of the portfolio with those MidCap source loans.

Got it. Very helpful. And then one follow-up for me. Probably, Greg, on this where we are on rates, I'm not going to ask you to predict where rates are going to go, but just how you're thinking about the right side of the balance sheet in the mix between floating rate and fixed rate liabilities. And that's it for me. Thanks, guys.

Okay. I mean, I think that, from our point of view, we do have our $350 million 10-year note coming due in March of '25, which is fixed rate. I do think we did our baby bond, which was fixed rate. And we on you didn't swap it because we have a two year call option on it. I do think that as we go out, we'll match our on liabilities were our assets.

Great. Thanks for taking my question.

(Operator Instructions) Robert Dodd, Raymond James.

Good morning. On our credit quality, obviously looks really good and picks up going up now with getting paid down, et cetera. Have you seen or heard any initial increased discussion from sponsors?

I mean, it was five months ago, looks like they were going to be six cuts and we may have sponsors could afford to sit on their hands, so to speak, and weight may be interest coverage that's still above one, but again, I'm moving might resolve itself, if I put it in one way.

But we've got the possibility of no cuts, but you never could say one, the high interest cost for the mid to longer in the portfolio. So has there been any change in what sponsors are doing proactively?

I said there was increase in amendment requests yet? Are there any preliminary discussions there? Or any color you can give on what the outlook is given, it looks like rates are going to stay extremely high for quite a lot longer at this point?

Yes, yes. Happy to take that. So there's a couple of things going on. One, over the you're kind of, I would say, economic environment over the last few years, the sponsors and the companies have focused on really becoming more efficient so that they could prepare for a longer term hold if necessary.

And then as you alluded to when there was a view that they're going to be in oh five rate cuts on people got excited about doing M&A. So with the prospect of rate cuts going away, I think we can at least kind of fall back from a fundamental performance standpoint that the companies are doing well.

And then secondly, if you think about the technicals of the private equity market, you still have a lot of dry powder that needs to be put to work. Are you still have a number of sponsors that need to return capital in order to be able to raise their next fund.

So that's going to drive that's going to drive transactions. And there's going to be a period of time like anytime that there is volatility and on rate expectations or market valuations for the bid ask to come together. And so I think that's happening and then that'll take a little bit of time to play out.

And then the third thing that we're seeing is more and more continuation vehicles were sponsors and we have companies within their funds and they need to hold on to those longer to really realize the multiples that they're looking for.

And then I guess, finally, the last thing I would say is that in terms of discussions with sponsors about other alternatives, there are some early conversations around extensions on repricings, where they're coming back and saying, we thought we were going to monetize this year, but it is we're going to look to next year.

They're not at the point in their fund where they need to do a continuation vehicle or they don't feel the pressure to return capital. And so there are very constructive discussions around on the lending groups, extending the maturity and addressing the overall structure. So on that note, I would say those are kind of the four dynamics at play.

That's really helpful. Thank you. I mean, quick follow up to that one. At this stage, a continuation vehicle constitute a change in control in the mandatory financing. I mean, does that get you refinanced out or is automatic that you get ported across to the vehicle with the existing loan?

Yes. So it is typical that that would be a change of control, but it's also typical in the direct lending space that you don't just show up one day at your desk and get a notice that it's going to happen, right? There's an ongoing dialogue about what the strategy is, what the financing is going to be.

And there's some visibility around on the sponsor will come and say, hey, do you want to support this going forward? And sometimes we say yes, and sometimes we say no, at which point they launch a financing process that aligns with their continuation vehicles.

Got it. Thank you. And then one more if I can take hypothetically that the merger's close sometime in the not-too-distant future hosted the something would change in the competitive environment out there, BSL et cetera. Has that changed your plan about how fast you would use to churn the assets within those acquired vehicles if they were to close?

Thanks, Robert, I think on, I would say no, I think that you should rely on us or expect us to always be evaluating risk reward in the context of the market environment, what makes sense? And then furthermore, as you're faced with as we as we think about investing, we're always cognizant of vintage and wanting to do things with a measured approach.

And that would be the same If hypothetically These were to close. And so if we are confronting an environment such as what we do today, we would be evaluating the market in a similar fashion and evaluating risk-reward and our intention would has always been to not take outsized exposure to any one particular vintage, and I would expect to conduct ourselves in a similar manner should the merger be successful.

Got it. Thank you.

Thank you. We show no further questions at this time. I would like to turn the call back to management for closing remarks.

Thank you, operator. Thank you, everyone, for listening to today's call. On behalf of the entire team, we thank you for your time today. Please feel free to reach out to us with any other questions, and have a good day.

This does conclude today's call. We thank you for your participation. You may disconnect your line at this time, and have a.