Monroe Capital Corp (MRCC) 2023 Q3 法說會逐字稿

Welcome to Monroe Capital Corporation's third-quarter 2023 earnings conference call. Before we begin, I would like to take the moment to remind our listeners that remarks made during this call today may contain certain forward-looking statements, including statements regarding our goals, strategies, beliefs, future potential, operating results and cash flows.

Although we believe these statements are reasonable based on management's estimates, assumption and projection as of today, November 9, 2023, these statements are not guarantees of future performance. Further, time-sensitive information may no longer be accurate as of the time of any replay or listening.

Actual result may differ materially as a result of risk, uncertainty or other factors, including but not limited to the risk factor described from time to time in the company's filings with the SEC. Monroe Capital takes no obligation to update or revise these forward-looking statements.

I will now turn the conference -- the call over to Ted Koenig, Chief Executive Officer of Monroe Capital Corporation. Please go ahead.

Good morning and thank you, everyone, who has joined our earnings call today. I am here with Mick Solimene, our CFO and Chief Investment Officer; and Alex Parmacek, our Deputy Portfolio Manager.

Last evening, we issued our third-quarter 2023 earnings press release and filed our 10-Q with the SEC. I am pleased to report that for the 14th consecutive quarter, our adjusted net investment income in the quarter covered our dividend. Our adjusted net investment income was $5.5 million or $0.25 per share, compared to $6.1 million or $0.28 per share last quarter.

We also reported NAV of $207.6 million or $9.58 per share as of September 30, 2023, compared to $213.2 million or $9.84 per share as of June 30, 2023. The decline in NAV was primarily attributable to net unrealized losses on the portfolio attributable to a few specific portfolio companies that were affected by idiosyncratic factors as well as a decrease in value at SLF, which was driven by unrealized mark-to-market losses.

The value of the remaining portfolio increased modestly. During the quarter, MRCC's debt-to-equity leverage increased from 1.54 times debt to equity to 1.60 times debt to equity. The increase in leverage was primarily driven by the aforementioned decrease in NAV.

Before I turn the call over to Mick and Alex, I would like to share some insights to the economic environment and current market, in the face of an uncertain economic outlook that continues to be an exciting time to deploy capital in direct lending where there are consistently attractive risk-adjusted returns.

Direct lenders such as Monroe Capital remain the preferred solution to middle market companies seeking financing with an emphasis on providing a higher certainty of execution on new transactions and demonstrating ongoing support for portfolio companies.

The volatile macroeconomic environment has resulted in lower new deal activity than in prior years. Yet our new investment pipeline remains robust heading into the fourth quarter. This includes a steady flow of lower risk incumbency lending opportunities, which relate to add-on financings, which has allowed us to maintain a highly selective approach when assessing and underwriting new investment opportunities.

In order for the Fed to manage inflation, the interest rate environment will likely be higher for longer. Given GDP expansion, job growth statistics and wage inflation, we see no signs of interest rate cuts on the horizon. At the same time, private equity and other middle market investors are facing heightened pressure to deploy dry powder and LP capital. This has led to an uptick in M&A and loan activity despite the higher cost of financing as direct lending volumes in the sponsored middle market increased 12% in the third quarter relative to the second quarter per Refinitiv.

These dynamics provide compelling tailwinds to the private credit direct lenders as transactions being completed at lower leverage levels, more conservative attachment points and with historically higher equity contributions. We believe this trend will continue in this fourth quarter and into 2024.

We remain focused on capitalizing on these attractive market fundamentals and the growing opportunity set within private credit. Throughout 2023, the economy has shown more resiliency than many had anticipated. In turn, we have seen solid overall financial performance across our borrowers, and our portfolio maintains a healthy average mark of nearly 97% as of the end of the quarter.

Our portfolio companies have demonstrated strong top-line growth with continued EBITDA growth, although at a slightly lower margin. Our companies continued to adapt their business models to combat the lingering impacts of inflation and begun to realize those benefits. The portfolio's overall interest coverage remains sound with sufficient cushion to weather an extended period of elevated interest rates and potentially a more challenging economic environment.

Looking ahead, we anticipate that some combination of an economic slowdown, a higher -- the long-term interest rate environment, heightened volatility in the capital markets, and geopolitical uncertainty around the globe seems inevitable. Companies are facing higher borrowing costs against a potential challenging economic environment. In addition to leaning on our defensive and diversified portfolio construct, we continue to emphasize our portfolio management and focus on capital preservation.

We believe that our defensive portfolio was well positioned to navigate a potentially prolonged economic downturn. We have nominal exposure to highly cyclical industries that our portfolio is predominantly comprised of first-lien senior secured loans at conservative loan-to-value attachment points. [That] portfolio's modest average loan to value and portfolio company leverage provides comfort given the meaningful equity value cushions below our debt.

Complementing the portfolio's risk-averse current position is our deep and highly experienced portfolio management team. Our portfolio team continues to actively monitor real-time performance and cash flows at our portfolio companies, while regularly engaging with the management teams to stay informed on key operating and industry trends.

Our portfolio management playbook, which has been time tested over the course of nearly two decades, allow us to identify challenges early and to proactively develop strategies to maximize our outcomes. We believe that the portfolio stands to benefit from tailwinds in the private credit and lower middle market segment. MRCC enjoys a strong strategic advantage in being affiliated with a best-in-class, middle-market, private credit asset management firm with nearly $18 billion in assets under management and approximately 240 employees with over 100 dedicated investment professionals as of September 30, 2023.

We continue to focus on generating adjusted net investment income that meets or exceeds our dividend and restoring the portfolio to positive long-term NAV performance. I am now going to turn the call over to Mick, who will walk through our financial results in greater detail.

Thank you, Ted. As of September 30, 2023, our investment portfolio totaled $518.3 million, an increase of $2.9 million from $515.4 million as of June 30, 2023. At the end of the quarter, our investment portfolio consisted of debt and equity investments in 99 portfolio companies unchanged from the end of the prior quarter.

During the quarter, we made an investment in one new portfolio company, funding $2 million at an effective interest rate of 12.6%. We also made a nominal equity investment in this new portfolio company. Further, we have revolver or delayed draw fundings and add-ons to existing portfolio companies totaling $10.7 million. We received one full payoff for a nominal amount and incurred normal course paydowns totaling $6.7 million.

At the end of the third quarter, we had total borrowings of $331.1 million, including $201.1 million outstanding under our floating rate revolving credit facility and $130 million of our 4.75% fixed rate 2026 notes. Total borrowings outstanding increased nominally during the quarter. The revolving credit facility had $53.9 million of availability subject to borrowing base capacity.

Now turning to our financial results. Adjusted net investment income, a non-GAAP measure, was $5.5 million or $0.25 per share this quarter compared to $6.1 million or $0.28 per share in the prior quarter. Our weighted average portfolio effective yield increased from 12.2% as of June 30 to 12.5% as of September 30.

The positive effect from this increase in portfolio yield on adjusted net investment income was offset by a $1 million reversal of previously accrued fee income associated with our former loan investment in IT Global Holdings alone that was fully paid off in 2022. This incremental fee income was to be paid in conjunction with a future liquidity event of the company.

However, unforeseen circumstances resulted in the company's filing for Chapter 11 prior to a sale where we would have monetized that fee income. We have $512,000 of remaining accrued fee income from IT Global, and we are actively monitoring the bankruptcy process to assess the likelihood of recovery for this exposure. Excluding this onetime reversal of previously accrued fee income, our investment income increased by $300,000 from last quarter.

Further, adjusted net investment income would have been $0.29 per share, up from $0.28 per share last quarter, due to an increase in portfolio yield driven by rising interest rates. At this level, our dividend coverage would have been nearly 1.2 times.

When considering current leverage levels, the interest rate environment and the favorable percentage of our funded leverage at a fixed rate, we believe that on a run rate basis, our adjusted net investment income will continue to cover the current $0.25 per share quarterly dividend, all things being equal -- all other things being equal.

As of September 30, 2023, our net asset value was $207.6 million, which decreased from $213.2 million of NAV as of June 30, 2023. And our corresponding net asset value per share decreased by $0.26 from $9.84 per share to $9.58 per share.

The decline in net asset value this quarter was a result of net unrealized losses attributable to a few specific portfolio companies that were affected by market conditions and various idiosyncratic factors. The balance of the decrease to net asset value was the result of net mark-to-market unrealized losses that negatively impacted the value of SLF.

I will now turn the call over to Alex, who will provide more details on our third-quarter operating performance.

Thank you, Mick. Looking to our statement of operations, total investment income totaled $15.6 million during the third quarter of 2023, down from $16.3 million in the second quarter of 2023. As Mick mentioned, excluding the reversal of the $1 million of previously accrued fee income related to the former IT Global investment, investment income increased by $300,000 compared to the last quarter due to a higher average portfolio yield driven by the rising interest rate environment.

While the rising interest rate environment will continue to improve the yield on our investment portfolio and increase investment income, fee income and prepayment gains and losses are tied to transactions which can cause volatility in our investment income. Fee income and prepayment gains were not significant contributors to investment income over the last two quarters.

As of September 30, 2023, we had four investments on non-accrual status, representing 1.2% of the portfolio at fair market value, a slight decrease from 1.3% of the portfolio at fair market value as of June 30, 2023. In the third quarter, we did not place any new investments on non-accrual.

Now, shifting over to the expense side, total expenses slightly decreased from $10.2 million in the third quarter of 2023, from $10.4 million in the second quarter. The $200,000 decrease in expenses during the quarter was primarily driven by a decrease in incentive fees from lower net investment income and a decrease in excise taxes. These decreases were partially offset by an increase in interest and other debt financing expenses driven by rising interest rates.

Our net loss for the third quarter of 2023 was $5.7 million compared to a net loss of $10.3 million for the second quarter of 2023. Net realized and unrealized losses on investments were $5.7 million for the quarter. This net loss on investments was primarily attributable to unrealized mark-to-market losses of a few specific portfolio companies and the slight decline in valuation of our SLF investment.

As of September 30, the SLF had investments in 53 different borrowers, aggregating to $148.2 million of fair value with a weighted average interest rate of 10.9%. The SLF's underlying investments are loans to middle market borrowers that are generally larger and more sensitive to market spread movements than the rest of the MRCC's portfolio, which is focused on lower middle market companies.

In the quarter, the SLF portfolio decreased in value by approximately 2.1% from 91.5% of amortized costs as of June 30 to 89.4% of amortized costs as of September 30. Consistent with the prior quarter, MRCC received income distributions from SLF of $900,000. As of September 30, 2023, the SLF had borrowings under its nonrecourse credit facility of $107.9 million and $2.1 million of available capacity, subject to borrowing base availability.

At this point, I will turn the call back to Mick for some closing remarks before we open up the line for any questions.

Thank you, Alex. To conclude, we remain confident in the overall quality of the portfolio and its ability to navigate prospective economic headwinds. Portfolio management remains top of mind, and we continue to actively engage with our portfolio companies and their management teams, especially in this volatile environment.

While we are mindful of the potential challenges that might -- may lie ahead, prior similar periods of volatility have created some of the very best vintages in private credit. Further, our average effective yield of approximately 12.5% on our predominantly first-lien portfolio pretends well for the remainder of 2023 and into 2024.

MRCC continues to deliver stable and consistent dividends for our shareholders. We have a long-standing dividend track record. And as Ted highlighted earlier, this quarter marked the 14th consecutive quarter where our net investment income has met or exceeded our dividend. Our dividend yield is at an attractive 14.3% as of November 7, 2023.

We believe that Monroe Capital Corporation, which is affiliated with an award-winning, best-in-class, external private credit manager with nearly $18 billion in assets under management, provides a very attractive investment opportunity to our shareholders and to other investors.

Thank you all for your time today. And that concludes our prepared remarks. I am now going to ask the operator to open up the call for questions.

Thank you. The floor is now open for your questions. (Operator Instructions)

Christopher Nolan, Ladenburg Thalmann.

Hi guys. On the SLF, given the decline in valuations, I know 2% [is so] small. But if it continues to decline, do the provisions of the SLF require you and your partner to -- JV partner to put in more capital?

The provisions of the JV agreement do not require us to put in new capital. And at this point, we don't anticipate that any capital will be required for the vehicle.

Got you. And then on the question of leverage. And by the way, congratulations on the asset quality, I mean, holding the line on that. And I think a lot of the efforts that you guys put in the past in terms of addressing those has really paid off. But going forward, given the uncertain environment that you guys outlined, should we view leverage as being one of those things that as you get more cautious about the asset quality environment that would you see leverage going down in the BDC?

Yeah, it's a really good question, Chris. Our leverage at the end of the third quarter was, as we pointed, out 1.6 times, increased slightly quarter over quarter. We have slightly higher debt levels associated with a slight increase in portfolio size and in conjunction with the decline in NAV.

We're comfortable at today's leverage levels, and we'll guide you towards that in the near term. We feel comfortable around our leverage levels given the first-lien weight of our portfolio and our average in our market, nearly $0.97 and our portfolio risk rating distribution, which didn't change over the course of the quarter.

Okay, final question. The fair value marks that you do in your portfolio, how has the rise in short-term interest rates affected those marks? I'm specifically thinking about discount rates on DCFs.

Yeah. It's a really good question, Chris. And as you know, we mark every one of our portfolio names with third-party marks on a quarterly basis. Discount rates have gone up that has affected the yield calculations when we do our fair market value calculations. The impact this quarter was relatively flat as we have looked at our portfolio companies, which have considerable enterprise value coverage cushion in that context.

Okay. Thanks, Mick. That's it from me.

Thanks, Chris.

(Operator Instructions) Robert James, Raymond James.

Hi, guys. On IT Global -- and thank you for the clarity on that. On the remaining income, I think you said $512,000 previously accrued fee income. What's the -- what do you think the timeframe is when you'll be able to evaluate whether that should be reversed or kept? I mean, is that likely to be a one quarter event or could it be prolonged given there's a bankruptcy [part]?

Yeah. Thank you for that question, Chris. I think we'll have more clarity around this IT Global receivable in the fourth quarter. It could slip into the first quarter. But just as way of background, this was a loan that was about $14.4 million in MRCC. The loan was made in 2018, was repaid in full in 2022.

The loan exclusive of that fee event had an IRR of around 12.4% and a MOIC of around 1.35 times. That incremental fee had to do with a future liquidity event related to the sale of the company, the company that the future fee event was related to filed for Chapter 11 in the third quarter when a significant tax liability got in the way of a sale process. And hence, the company filed for Chapter 11.

So we are monitoring that process to see what the results of the emergence from the proceeding might be. And that will influence, pursuant to a waterfall analysis, the ultimate treatment of that, roughly $500,000 receivable.

Got it. Thank you for that. Then on the credit quality, obviously for non-accruals, stable versus Q3, so congratulations on that. I mean, you talked about the markdowns in the quarter being a couple of handful of idiosyncratic issues with companies?

And can you give us any more -- I mean, was that just operational issues? Was that something completely out of left field unrelated to operations? I mean, can you give us any color? Because obviously, if it's operations, that that's beginning to -- [underperformance is] a little bit more concerning [than if it's] just some wildcard event of some sort. So can you give us a lot on --?

Yeah, good question, Robert. So as I look at -- as we look at the unrealized loss change quarter over quarter and we look at the idiosyncratic factors that have affected it, in one case, the idiosyncratic, that was really right -- the factors outside the control of the management team. And the management team had to -- and the management team is in the process of reacting to that and up -- and reassessing their business model to it.

And in the case of the other matter, that was the subject of an idiosyncratic event. It was really the same setup. There was an external event that really impacted the company. Company took and is taking quick charge of the situation to make sure it they can adapt. It's planned to deal with that. So that explains the idiosyncratic events that impacted a couple of names during the course of the quarter.

Yeah, and Robert, to your point, I mean, not so much focused on the actual operations of the business, as Mick noted, very much kind of factors, either unforeseen or not, but outside of the nuts and bolts of the operation.

Got it. Thank you. That's it for me. Thanks a lot.

Thank you, Robert.

There are no further questions at this time. Mr. Solimene, I turn the call back over to you.

Thank you, operator, and thank you for everyone for joining us this morning. We look forward to speaking with you again next quarter.

This concludes today's conference call. You may now disconnect.