Q2 2023 MidCap Financial Investment Corp Earnings Call
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Good afternoon, and welcome to the earnings Conference call for the period ended September 32022 from mid cap financial investment Corporation. At this time, all participants have been placed in a listen only mode. The call will be open for question and answer session. Following the speakers prepared remarks.
I'd like to ask a question at that time simply press star one on your telephone keypad. If you would like to withdraw your question. Please press star two I will now turn the call over to Elizabeth Besen Investor Relations manager for Midcap Financial Investment Corporation.
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, We address 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 every.
One that todays call and webcast are being recorded. Please note that they are the property of a mid cap 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 on <unk>.
That may include forward looking statements you should refer to our most recent SEC. 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 our website at www Dot midcap.
Financial IC Dot Com I would also like to remind everyone that we've posted a supplemental financial 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 our Chief Executive Officer Tanner Powell.
Thank you.
Good afternoon, everyone and thank you for joining us today I'll begin today's call with some comments about the market environment, while we believe our corporate lending portfolio is well positioned and well constructed for a challenging market environment.
First I will highlight our results for the quarter provide an update on <unk> and then I will discuss the increase to our quarterly dividend.
Following my remarks, Ted will discuss our investment activity, including the meaningful cash pay downs. We received from several investments we are seeking to reduce Ted will also cover the portfolio's credit quality, including how our portfolio companies are performing in the current environment Lastly, Greg will review our financial results in detail. We will then open the call to questions throughout <unk>.
This call we will refer to the company.
C or the BDC and we referred to the Bethesda based lender, which sources senior secured middle market investment opportunities for Apollo managed capital, including the BDC at Midcap financials.
Beginning with the current environment, the public credit markets remain volatile as the fed reiterated its commitment to tighter financial conditions in order to combat inflation.
Secondary price rally in the leveraged loan and high yield markets in the first half of the quarter were all better rates in the second half as investor sentiment.
Investor sentiment was dampened by the elevated interest rate environment and recession recessionary concerns during the quarter credit spreads continued to widen U S leveraged loan issuance plummeted to the lowest level since the fourth quarter of 2009, driven by a pullback from CLO investors banks continue to struggle to offload financing commitments made prior to.
The current more volatile environment, although deal activity has slowed borrowers continue to turn to the private credit market, which offer certainty of execution and general periods of economic stress and broader market volatility creates better opportunities for direct lending.
Amid this broader market volatility, we have seen improved lender terms and spreads for private direct win for the private direct lending market, which continues to experience strong demand from financial sponsors and companies. We would expect terms to continue to tighten and spreads to widen.
Continue to widen should economic stress continue or worsen for scaled capital providers like mid cap financial we believe that there are opportunities to lend to high quality companies with attractive pricing and terms Midcap financial was relatively active during the September quarter with $3 3 billion of new origination.
In the first nine months of 2022, Midcap financials, new originations totaled $12 5 billion. Additionally, we expect a tougher environment tougher economic environment should lead to an increase in ABL opportunities an area, where mid cap financial has a large and successful franchise in the face of significant market volatility our corporate lending portfolio continues to perform well, which we.
Believed demonstrates the value of our senior secured investment strategy and the quality of our portfolio our.
Our underwriting process contemplates the potential for macroeconomic headwinds as the macro environment continues to become more challenging we believe the strength of our underwriting and the quality of our portfolio will become more apparent.
We have constructed what we believe to be a well diversified portfolio of true first lien floating rate corporate loans invested in less cyclical industries with granular position size sizes.
At the end of September our corporate lending loans were 94% first lien with a weighted average attachment point of 0.2 times a metric with demonstrates that we are invested in the most senior part of the capital structure.
Yeah.
Moving to our financial results net investment income was 35 per share for the quarter, which reflects an increase in interest income due to higher base rates as well as strong fee and prepayment income partially offset by a slight decline in income from <unk> as we continue to reduce side of size of this investment amid the challenging market conditions, we are able to generate.
<unk>, we were able to generate considerable cash pay downs from several investments, which we are seeking to exit which Ted will discuss later during the call overall, given the volatile market environment. We recorded a net loss of $6 6 million on our portfolio given the total return feature in our incentive fee structure incentive fees accrued during the quarter were below the full rate.
We ended the period with net asset value per share of $15 45.
Yes.
Moving on as discussed previously we are focusing on reducing our investment in merck's, our aircraft leasing portfolio company by selling aircraft and deemphasizing the servicing business. During the September quarter, Merck's continued to make progress by selling two aircrafts, reducing the number of claims and its owned fleet from 62 to 60.
Which allowed <unk> to prepay 14 million to MFC in conjunction with the pay downs of MFC and the aircraft sales, we converted $111 million of nurses revolver into equity accordingly at the end of September our investment in merck's totaled $266 million, representing 11% of the total.
Folio, consisting of $150 million revolver with a 10% interest rate at $116 million of equity.
The pay down and conversion of debt to equity will reduce the amount of interest that merged tasty myc from approximately $6 million in the September quarter to approximately $3 8 million per quarter going forward. Despite the broader uncertain macroeconomic environment. There are no signs of slowdown in daily Global flight activity and we continue to focus on reducing our exposure.
Now, let me switch to our dividend policy given the impact of higher rates on our net interest income the strong performance of our corporate lending portfolio and considering the upcoming reduction in our fee structure. We are pleased to announce that we are raising our regular quarterly base dividend by 15, 6% from 32 per share to <unk>.
<unk> 37 per share payable to shareholders of record as of December 19, 2022, as a reminder, on our last conference call. We made several important announcements, including the establishment of what we consider to be the industry, leading fee structure. Among listed Bdcs recall, the Bdcs base management fee.
Permanently reduced to 175% on equity among listed Bdcs Mfc's management fee as the lowest and is the only one to charge management management fees on equity.
The incentive fee on income was permanently reduced from 20% to 17, 5% the changes to the fee structure will be effective for the period. Beginning January one 2023, we are raising the dividend to a level, which we believe reflects the current earnings power of our portfolio, including some of the permanent benefit.
Of our reduced fee structure, which is not yet reflected in our financial results when the new fee structure becomes effective we expect to significantly out earned <unk> 37.
This dividend and we will reevaluate our dividend at that time with that I will turn the call over to Ted to discuss our investment activity.
Thank you Tanner, beginning with investment activity, given our focus on reducing the fund's net leverage <unk> new investment activity was limited during the quarter <unk>, new corporate lending commitments totaled $21 million across three companies for an average new commitment of $7 million. The new commitments were first lien floating rate loans with a weighted average.
<unk> of 639 basis points and a weighted average net leverage of four five times, excluding revolvers gross fundings for the quarter totaled $67 million in sales and repayments totaled $154 million net revolver fundings were approximately $5 million in aggregate net repayments for the quarter totaled $83 million.
Repayments for the quarter included 101 from corporate lending positions $14 million for merck's and $39 million from other investments, including some shipping and oil and gas positions post quarter end, we exchanged 50% of our non income generating investment in carbon free at our September 30, Mark for $7 5 million cash and $12 five.
Interest bearing note.
Net leverage at the end of the at the end of September was one four times given our visibility into additional repayments in the coming months, we are well positioned to make new commitments. During what we believe will be an attractive vintage characterized by relatively wider spreads and lower leverage levels and tighter documentation.
Turning to the overall portfolio, our investment portfolio had a fair value of $2 $4 6 billion at the end of September across 136 companies in 26 different industries corporate loans and other represented 89% of the total portfolio and merck's represented 11% of the portfolio at fair value now.
94% of our corporate loans were first lien.
Weighted average spread on our corporate loans was 613 basis points at the end of September .
In general despite an environment of heightened uncertainty we've seen minimal negative impact in the fundamental performance of our corporate lending portfolio companies, while we're cognizant that borrowers will likely face increased challenges over the coming months due to inflationary pressures higher interest rates and potential headwinds from an economic slowdown we believe we are.
And our corporate lending portfolio to be defensive and perform well during periods of increased stress. We believe <unk> has one of the most senior secured portfolios among bdcs as evidenced by our low attachment point of 0.2 times.
Our corporate lending portfolio consists of granular position sizes with our average position of $16 $9 million, our credit metrics remained relatively stable during the quarter at the end of September the weighted average net leverage of the corporate lending portfolio was 552 times compared to 545 times last quarter.
The weighted average interest coverage ratio was two seven times compared to $2 eight last quarter.
These weighted average interest coverage ratios are based on company data from the last 12 months looking at the most recent quarter. We did observe some pressure on this metric as expected the weighted average interest coverage ratio was two two times based on company data from the June quarter.
Our second lien term loan in Cana, and which had a fair value of $14 2 million at the end of September and which was originated in 2016 was placed on non accrual status during the quarter at the end of September investments on non accrual status totaled $23 6 million or 1% of the total portfolio at fair value.
With that I will now turn the call over to Greg to discuss our financial results in detail.
Thank you Ted and good afternoon, everyone getting with our statement of operations total investment income was $58 9 million for the quarter of 10, 3% quarter over quarter recurring interest income rose due to the impact of higher base rates fee and pre payment income was strong.
Payment income was $2 9 million up from $1 9 million last quarter and fee income was approximately $1 $5 million up from 500000 last quarter dividend income was essentially flat quarter over quarter.
Weighted average yield at cost.
On our lending portfolio was eight 9% at the end of September up from 8% at the end of June the increase in yield was primarily due to higher base rates net expenses for the quarter totaled $36 2 million up $6 3 million quarter over quarter due to higher interest expense related to our credit facility.
Which bears a floating rate interest rate and higher incentive fees as a reminder, <unk> incentive C. On income includes a total return hurdle with a rolling 12 quarter look back given the net loss of $6 6 million for the quarter incentive fees during the quarter totaled approximately.
$4 million up from one $4 million last quarter net investment income per share for the quarter was 35.
During the quarter, we recorded a net loss on the portfolio of $6 6 million or <unk> 10 per share.
When you look at our corporate loan book and you exclude the impact of Chiron and can earn our spreads.
<unk>.
Began.
And considering our spreads began to widen during the quarter. Our corporate loan book was slightly down on page 16 in the earnings supplement we disclosed the net gain or loss by strategy over the past five quarters NAV per share at the end of September was $15 45.
Seven cents.
Core <unk>.
Half a cent.
Decrease quarter over quarter. The decrease is primarily attributable to the 10 cent loss on the portfolio, partially offset by <unk> net.
Net investment income relative to our dividend.
Moving on.
Our liquidity position remains strong with undrawn revolver capacity well in excess of unfunded commitments to borrowers we are well positioned to benefit from higher rates.
Put some color around the potential for near term earnings impact based on quarter end rates, we estimate that 100 basis point and a 200 basis point increase in reference rates would result in annual incremental earnings of approximately <unk> 26, respectively.
Stock was repurchased during the quarter.
Lastly, I wanted to mention and MSI see we'll be changing its fiscal year end from March 31.
To December 31, effective December 31 2022.
Accordingly, <unk> will file its annual report on Form 10-K for the fiscal year ended December 31 2022 in late February 23. This concludes our prepared remarks, operator, please open the call to questions.
At this time, if he would like to ask a question. Please press star one on your Touchtone phone, we will take our first question from Kenneth Lee with RBC capital markets. Please go ahead.
Hi, good afternoon, and thanks for taking my question.
Wondering if you could just talk a little bit about key drivers for the unrealized losses that you still have the merck's business in the quarter. Thanks.
Yes sure Thanks, Ken.
So when we look at <unk>, we are evaluating.
Each plane.
<unk>.
Its prospects with impending lease maturities and more specifically the slight write down that we saw in this particular quarter pertained to.
Our view on the resolution of a number of planes as we're working through at least maturities, but nothing nothing other than.
No no no broader the broader point there other than marketing to reflect our current view on those particular particular situations.
Gotcha.
And one follow up.
If I may.
Okay can you go back to the <unk>.
<unk> or driver of why so.
So much was converted to equity.
And then sort of to follow on Ken's question.
On the right down.
Can you reconcile that too.
The proportionally.
Steeper decline in the quarterly interest payments that will system works.
The 6 million and.
And unrealized March today versus the I think a couple of million dollars a quarter.
Correct me, if I'm wrong, they're uninteresting come.
Okay. This is this.
This is Howard just I you know I I think you know, which we said we should look at mercs.
Liquidating mercs can we have a combined mark of you know and the 250 million dollar range, we gotta pay down when we got that paid down we felt like guys were liquidating and we expect to see you know additional cash coming in over the next quarter's I. It was better to just have less income come.
Being off of the combined position and so we recast it it.
It really wasn't there was nothing behind sort of the underlying value of the changed we just felt like the you know the less capital that comes out out of it the more capital goes to return to basis and because.
Earning power as sort of we show it you know in our dividend raising are expected earnings. We you know we felt like we were well positioned to be in that and to be in that position. So so the first thing is we do expect to get additional pay down. Although you know it can be lumpy, but we're focused on it and and Ernie and.
In the throes of making that happen and recast is just really towards the intent of having you know as much capital go to basis as possible.
Okay. Thank you and just the small follow on there how much of an issue.
Is.
Net investment income.
Leases or maybe splatter stagnant and.
LIBOR base rates are going up or is that an item or are you hedged there.
Well you know we have we have leases set so they're not based off you know rates.
Basically fixed.
Mhm, and then and then.
<unk>, Yeah, we have a fixed rate that in our in our securitization. So we're not really impacted by that.
Okay helpful. Thanks, so much.
And we'll take our next question.
Please go ahead.
A mid afternoon. Thanks for taking my question and I, followed a couple of <unk> cover this but obviously, so originations or light I think you guys talk to that battles and on purpose to the level of the balance sheet that can you give us a sense for you know your.
Pipeline and then also kind of spreads you're seeing on on any new deals and how that compares to the portfolio.
Yeah sure I'd have to take it take dot com.
So the.
Like you said.
There was some deleveraging into particular quarter when we look at the current market environment.
Clearly M&A has slowed we are very fortunate and benefit from the wide funnel that mid cap financial that the debates lender affords us and interestingly as we look forward and as we alluded to in our prepared remarks across the various product areas in particular at Yale is one one.
<unk>, where we see increasing opportunity so our our outlook is.
Broadly lower M&A.
But it's still a nice level of opportunity and what I would say to add to that is well certainly as things are moving so quickly and valuation expectations had been recalibrated. That's certainly one of the drivers for limited M&A opportunity on the sponsor side, we are still seen a.
Good pipeline of add on acquisitions and that's both in the form of funding our existing delay draws as well as also new commitments to existing borrowers.
As as those small relatively smaller add ons are more and more palatable and this opportunity in this market environment and that's and that's another nice opportunity for us.
And the environment.
Yeah.
Oh, sorry thousand hits spreads sorry.
So we look at if we look at it spreads and even ignore obviously the the effect of the base rate.
And right now versus call at the beginning of the year, we're seeing spreads.
100 to 200 basis points wider and that's not just an spread we're seeing.
If you think the average deal that we are doing it about a year ago was 575, we're seeing.
650 to 675 and importantly also.
Seeing more <unk> come from a greater it'd kind of going from 98.
To at least 97, and even even below in certain cases, so 100 to 150 basis points out other spread widening exclusive of the the effect of the base rate or LIBOR slash sofa.
Got it and then yeah in terms of shifting credit Messiah leveraged statistics, and and added one investments and non accrual that has there been have you seen a greater demand for pick up an amendment activity and how would you.
They just kind of a healthy your portfolio and as companies deal with iron interest expense is ongoing inflation et cetera.
Yeah, absolutely so so not yet and I think the good the good point of the point of emphasis and hopefully.
This comes through and how we presented our approach for many years now is our borrowers within our corporate book.
95% plus have financial covenants and so the good news is we do have a seat at the table. There is a normal level of activity that happens anyway, whether opening up a document to.
Do an AD on acquisition or myriad other.
We then in terms of.
What what you're obviously getting that in terms of credit weakening.
The amendments we have not seen that pick up keep in mind that.
Metrics are tested on backwards looking basis and so for instance, the numbers that are filtering through those tests at this moment in time, Kyle R 630 numbers.
And so we would imagine it's only natural and this type of environment for them to pick up but as of now we've seen very limited excessive or above normal amendment activity.
Got it very helpful. Thanks for answering my questions.
It looks like the next question, Sir Melissa went only J P. Morgan. Please go ahead.
Good afternoon at most of my questions and <unk> I found it would be helpful. Just quickly review, how you're thinking about portfolio library, right, now and where you'd ideally like an offering given how things are evolving from a macro perspective. Thanks.
Yeah. Thanks Melissa.
As you saw and as I mentioned in our prepared remarks, we are.
At 1.42 times.
Our previous which is the lower end of our previous stated range.
And also drawing on my answer to <unk> question, we would expect to operate at or below that level.
In the near term.
In part due to some visibility.
Ability and some of the payments.
As we have said historically from a risk standpoint, we do believe our first lien strategy granular position size.
True first lien strategy brand, new a position size.
Does allow us to operate at that higher leverage level.
But yeah, that's where we said today and that's what that's what we see again based on some visibility in near term payments.
Gatland as a reminder to ask a question that is star and one.
<unk> can be that'd be it. Please go ahead.
[noise] yeah. Good evening, Thanks for [noise] excuse me thanks for taking my questions.
Real quick on just the the interest coverage ratios as you mentioned the just decline in this most recent quarter I guess with most sort of updated financial that you have dropping from 2.9 to 2.2 times.
Sounds like a big drop obviously also a fairly significant increase in rates over that time period as well.
But I was wondering if you could just kind of comment on that and I guess, if if he had any sort of commentary around EBITDA performance of your portfolio companies that panels is reflected in that.
To that number as well.
Yeah sure Yeah.
Yeah sure.
Thanks for the question just to clarify the LTM Mitrice coverage ratio went from 2.8 to 2.7, so only a modest.
Downward revision on in LTM basis as of June .
We did quota to two number which was a sensitivity.
Looking at the company data only for the June quarter.
Kind of makes sense as rates were starting to rise.
As we look forward.
We certainly do expect there to be more pressure.
As rates continue to rise I think one of the ways, we think about it as we're starting from a good point, we've got a significant amount of sponsor equity behind the majority of the loans that we make you know we're starting in the high twos as we mentioned two 700 LCM basis. So we have an equity cushion we've got through first lien positions.
And we've got covenants to get to get us to the table. If we do see EBITDA starts to deteriorate. So I think from an EBITDA standpoint to get to the next part of your question. We saw EBITDA growth EBITDA still being in a growth mode at 630.
In the the low to mid single digits.
Have tapered off from what we saw on prior quarters.
But still in positive territory and so.
Will continue to work closely obviously and as will everyone in the credit markets.
Got it thanks for that and I appreciate the the correction there it makes sense.
And then just on the the the dividend increase I I imagine.
<unk>, obviously with kind of your house you on forward rates and the new fee structure coming on I'm, just curious as if that's the case or if there's any I guess room for for potential.
An increase from that level.
Yes.
So.
We believe like our our view is that we we have significant ability to sort of out earn that state of dividend and so our you know our expectation as as we you know our feet don't kick into the you know the first quarter of next year calendar quarter of next year.
So as we you know as we get there and we started out earning the dividend either the choices, we have with regard to either raising our dividend or making special dividends. Instead it will be on the table, we would expect that at a minimum to be making special dividend. So and you know some of it depends on you know the extent of the of.
How much interest rates go from here, but even at today's raids. We we think we have you know.
Good cushion.
For the 37, so we wanted to we wanted to sort of put a mark on the ground of where we are very comfortable but we expect to be able to add her on that solid.
God I appreciate it that makes sense. Thanks, that's all for me.
Mmm no questions at this time I will now turn the call back over to the management team for closing remarks.
Thank you operator, and 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. If you have any questions and everyone have a good weekend and evening.
Thank you finish does conclude today's program. Thank you for your participation you may disconnect at anytime.
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