Q3 2022 Monroe Capital Corp Earnings Call
Ladies and gentlemen, this is the operator today's conference will begin momentarily. We thank you for your patience your lines will remain on music hold until we begin thank.
Thank you.
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Welcome to Monroe Capital Corporation third quarter 2022 earnings Conference call.
Before we begin I would like to take a moment and remind our listeners that remarks made during this call today may contain forward certain forward looking statements, including statements regarding our goals strategies beliefs future potential operating results or cash flows, particularly in light of COVID-19 pandemic. Although we believe these statements are reasonable.
And there's been estimates assumptions and projections as of today November eight 2020 field. These statements are not guarantees of future performance.
Further time sensitive information may no longer be accurate as at the time or any replay it really thing.
Actual results may differ material risks.
Risks uncertainty or other factors, including but not limited to risk factors described from time to time in the company's filings with the SEC.
Capital takes no obligation to update or revise these forward looking statements.
I'll now turn the conference call over to Todd kidney.
Executive Officer of Monroe Capital Corporation.
Good morning.
Thank you to everyone, who has joined us on our call today.
Welcome to our third quarter 2022 earnings conference call.
I am joined by mixed Salomi, our CFO and Chief investment Officer.
Last evening, we issued our third quarter 2022 earnings press release and filed our 10-Q with the SEC.
The M&A and financing markets maintained a cautious tone during the third quarter as concerns around slowing economic growth mounted in the face of inflationary and rising interest rate pressures at the end of the quarter. The fed raised interest rates 225 basis points in <unk>.
Of the 75 basis point rate increase announced last week in response to an annualized inflation rate that now stands at eight 2%.
According to refinish two middle.
Middle market financing volume totaled almost $212 billion through the first nine months of the year flat compare to nine months last year.
Middle market loan spreads and the LCD Middle market Index continued to widen down approximately 27 basis points during the third quarter, but at a slower pace than during the second quarter when spreads widened by more than 100 basis points.
Market volatility was much more pronounced in the public and leveraged financing markets, where transaction volumes dropped significantly and this created compelling opportunities for us in private credit.
To provide certainty of execution to our clients.
More lender friendly pricing in charge we.
Believe that the market dynamic will remain for the foreseeable future and we are prepared to be a trusted financial partner to our clients.
As a firm we've made over $3 7 billion.
New investments through the first three quarters of 2022.
Lower middle market remains active and current market conditions are showing us some with lower leverage levels and better priced investment opportunities across our platform that we have witnessed in the same period last year, which was a record breaking year for M&A and financing activity.
Turning now.
The third quarter results. We are pleased to report adjusted net investment income of $7 1 million or <unk> 33 per share.
Up from adjusted net investment income.
$5 $4 million or 25 per share for the second quarter.
We also reported any of the $226 million or $10 43 per share.
September 30th 2022, a decrease of 28 cents per share for many of $232 1 million or $10 71 per share as of June 32022.
The decline in any of you is substantially the result of unrealized losses as a result of fundamental performance on a couple of specific performing portfolio companies and the investments in RCC.
<unk> senior loan fund, one which suffered unrealized mark to market losses, which we referred to as the <unk> the <unk>.
Decrease in value and S. L. F was driven by the unrealized mark to market losses on the SLS investments, which are loans to traditional upper middle market borrowers and have continued to experience higher volatility and valuation as a result of recent macroeconomic events.
Okay.
During the quarter MRC <unk> debt to equity leverage decreased slightly from 1.38 times debt to equity to 133 times debt to equity.
New origination activity in Monroe remains strong and we expect to modestly increase leverage within our target leverage range of one three to one four times debt to equity.
We believe that our existing portfolio companies will continue to be able to navigate a somewhat higher interest rate environment is debt service coverage is generally solid across our portfolio and the companies are generally well positioned to manage the inflationary.
Supply chain and geopolitical headwinds that they're facing.
The strong dollar has not materially affected our borrowers as unlike most large companies most of the revenue generated by our lower middle market borrowers is from U S based sales.
We closely monitor and assess those risks as part of our portfolio management process, which involves close and regular communication with our portfolio companies.
New deals continue to undergo a comprehensive underwriting process that includes downside stress scenarios to assess performance volatility and cushion from rising interest rates margin pressures and an economic slowdown.
We believe that the portfolio continues to be well positioned to benefit from an increase in short term interest rates as all our borrowers were above their interest rate floors going into the fourth quarter. Therefore, any additional increases in interest rates should proportionately benefit our investment portfolio.
MRC see enjoys a strong strategic advantage in being affiliated with a best in class Middle market private credit asset management firm with approximately $14 $1 billion in assets under management and approximately 190 employees as of September 30.
2022.
Our dividend coverage is trending positively we.
We will continue to focus on generating adjusted net investment income that meets or exceeds our dividend and positive long term NAV performance. Despite some short term macro market headwinds.
I am now going to turn the call over to Mick who is going to walk you through our financial results.
Thank you Ted.
As of September 32022, our investment portfolio totaled $508 million down $28 million from $536 million as of June 32012.
Our investment portfolio consisted of debt and equity investments in 98 portfolio companies on September 30, as compared to debt and equity investments in 98 portfolio companies at June 30th.
During the quarter, we made investments in five new portfolio companies with fundings totaling $15 $2 million.
In addition, we have revolver add on or delayed draw fundings to 25 existing portfolio companies totaling $36 2 million.
During the quarter, we received five full payoffs totaling $45 million and had ordinary course loan repayments aggregating $28 5 million.
We are well positioned to redeploy this capital carefully and two attractive assets that will benefit from increases in interest rates through participating in a substantial pipeline of opportunities generated at Monroe.
At September 30, we had total borrowings of $301 $2 million, including $171 $2 million outstanding under our floating rate revolving credit facility and $130 million of our 475% fixed rate 2026 notes.
Total borrowings outstanding decreased by $18 $8 million during the quarter.
The revolving credit facility had $83 8 million of availability as of September 30.
Subject to borrowing base capacity.
Now turning to our results for the quarter ended September 32022.
Adjusted net investment income a non-GAAP measure was $7 1 million or <unk> 33 per share compared to $5 $4 million or 25 cents per share in the prior quarter.
This increase in adjusted net investment income is primarily primarily the result of the receipt of previously and accrued interest income associated with the repayment of the urban investment that had been on non accrual status in advance of its repayment and the increase in the average portfolio yield during the quarter.
When considering our target leverage.
Rising interest rate environment with favorable very favorable percentage of our fund leverage at a fixed rate and the current credit performance of MRC, We believe that on a run rate basis, our adjusted NII will more than cover the current 25 per share quarterly dividend all other things being equal.
As of September 30, our net asset value was $226 million, which decreased from the $232 1 million and net asset value as of June 30.
Our NAV per share decreased from $10 71 per share at September 30 to $10 43 per share as of September 30.
The 28 per share NAV decrease was substantially substantially the result of unrealized losses as a result of fundamental performance on a couple of specific portfolio of companies and the investment in EM RCC Senior loan fund one.
The decrease in value at the SLS was driven by unrealized losses on the Sof investments, which are loans to traditional upper middle market borrowers and have continued to experience higher volatility and valuations.
Looking to our statement of operations.
Total investment income was $15 $9 million during the quarter up from $13 million in the second quarter.
The $2 $9 million increase in investment income was primarily due primarily the result of a onetime benefit of $2 million representing previously on accrued interest income from the repayment of our loan investments and carry on holdings LLC during the quarter.
<unk> had previously been on non accrual status and during the quarter. We received proceeds in excess in excess of the cost basis of its investments as a result of the successful sale of the company.
We also saw an increase in prepayment gains this quarter of approximately $400000 and a decline in fee income this quarter of approximately $800000 as.
As we have previously discussed these components of our interest income can be lumpy and based on specific transactions.
In addition, during the quarter, we began to see the impact of increases in interest rates on our investment income is substantially all of the port portfolio borrowers exceeded their benchmark interest rates at the end of the second quarter.
At September 30, the effective yield on our debt and preferred equity portfolio was nine 9% up from eight 5% at June 30.
Sofa rates, which had been at historically low levels rose during the quarter with one month sulfur at approximately 314 basis points at September 30 versus approximately 179 basis points at June 30.
All other things being equal a rising interest rate environment will continue to improve we will continue to improve the yield on our investment portfolio and increase net investment income.
At September 30, we had four investments on non accrual status, representing 7% of the portfolio at fair market value.
Paired to six investments on nonaccrual status, representing 2% of the portfolio at fair market value at June 30.
Our performance has steadily improved in this area as we have been working out the underperforming companies in our portfolio as we said we would on previous calls.
This is the direct result of the turnaround and workout capabilities of our external manager Monroe capital and the resources they have provided to us.
During the quarter, we placed no additional borrowers on non accrual status and our investment portfolio risk rating distribution improved.
Moving over to the expense side total.
Total expenses increased from $8 million in the second quarter to $9 $7 million in the third quarter, primarily driven by higher incentive fees net of associated fee waivers, resulting from the increase in net investment income higher interest and other debt financing expenses on our floating rate revolving credit facility.
Due to the rising interest rate environment, and higher income tax expenses, primarily associates associated with blocker entities that hold certain of our equity investments.
Net loss for the third quarter totaled $7 million compared to a net loss of $12 $4 million in the second quarter.
Net realized and unrealized losses on investments were $7 9 million for the quarter.
Other net gains totaling approximately $900000 during the quarter related to foreign currency forward contracts used to hedge currency exposure on certain investments.
As of September 30.
The <unk> had investments in 62 different borrowers aggregating $192 1 million at fair value with a weighted average interest rate of eight 3%.
The <unk> underlying investments are loans to middle market borrowers that are generally larger and more sensitive to market spread movements and the rest of MRC six portfolio, which is focused on lower middle market companies.
The <unk> portfolio decreased in value by one 2% during the quarter from 94, 8% of amortized cost as of June 30 to 93, 6% of amortized costs as of September 30.
During the quarter MRC received income distributions from SL loss of $900000 consistent with the second quarter.
As of September 32022 E. L. F had borrowings under its nonrecourse credit facility of $129 3 million and 40 and had $45 7 million of available capacity under its credit facility subject to borrowing base availability.
I will now turn the call back to Ted for some closing remarks before we open the line for questions.
Thank you Mick we.
We feel that <unk> is well positioned to deliver stable and consistent dividends for our shareholders, especially where our earnings and dividend will benefit from an increase in market interest rates. We have made substantial progress on portfolio matters over the past couple of years, including the most recent quarter, where we achieved meaningful realization above our <unk>.
Im curious when.
When we saw our investment performance risk rating distribution improve.
This has been a consistent pattern with our workout names in terms of recovery. We believe our purposely defensive portfolio strategy is well positioned for potential economic volatility under the watch of a seasoned senior leadership team that has managed credit through multiple economic and business cycles.
Our external manager has a team of approximately 100 investment professionals for us to draw upon.
Our investment strategy remains focused on providing well protected and well structured senior secured first lien loans to companies with defendable market position resilient business models strong management teams and reliable sponsors and owners.
We will continue to selectively deploy capital in sectors with resiliency to economic cycles, and headwinds, including technology healthcare business services and opportunistic.
Our overall Monroe capital platform has a strong pipeline in excess of $2 billion of high quality and selective investment opportunities for all funds at Monroe, including MRC.
We are excited about our investment portfolio and our prospects and continue to believe that Monroe Capital Corporation, which is affiliated with an award winning best in class external manager provides of jewelry attractive opportunity to our shareholders and other investors.
Thank you all for your time today and this now concludes our prepared remarks, I am going to ask the operator to open the call up now for questions.
Certainly at this time, if you'd like to ask a question. Please press star one on your telephone keypad to withdraw your question again press the star one key.
Kevin folks with JMP Securities. Your line is open.
Hi, good afternoon, and thank you for taking my questions I wanted to dig in a bit on portfolio company metrics. Just curious if you could talk about where our weighted average EBITDA interest coverage and portfolio company leverage we're at quarter end and how thats trended over the last few quarters.
Okay.
So thanks for the question Kevin.
Don't disclose.
Interest coverage metrics, and we don't disclose weighted average leverage.
What I can say is that over the course of the quarter.
No from a performance perspective, we saw generally companies increased our top line. So <unk> revenues were up on both a unit basis.
And our enterprise basis.
Margins were generally flat.
Year to date and quarter over quarter or slightly down.
In the context of a rising interest rate and Barb environment. When you can imagine as we saw a slight decline in kind of interest coverage metrics among our borrowers.
But when we underwrite our loans and when we.
Perform surveillance on our loans.
We are Uber focused on making sure that.
Coverage cushions remain.
Adequate and comfortable.
And.
As we as we look at the portfolio, we feel that our interest coverage ratios our interest coverage cushions.
More than solid.
In this environment.
Okay. That's helpful color and then my follow up was on non accruals that came off during the quarter.
First congratulations on the positive resolution of Purion.
That too Jay came off nonaccrual and it looks like the stub physicians have written off prior to maturity maturity is that correct.
That is correct that is correct.
Okay, and then just one more quick one on amendment requests just curious have you seen any pickup in amendment requests and can you discuss your expectation for that to potentially pick up in the near term.
Sure so.
We've seen we've seen a modest increase or pickup in.
Kind of amendment activity.
Round arounds around financial covenants.
Contrast that with.
The Covid period of a couple of years ago, where it was.
Significantly greater than it is today, but we have seen kind of a modest pickup.
So from our from our borrowers with respect to.
Amendment activity and request with respect to financial covenants.
Okay I'll leave it there thanks for taking my questions and congratulations on a nice quarter.
Thanks, Kevin.
Robert Dodd with Raymond James Your line is open.
Okay.
Hi, guys congratulations on a revolving.
Non accruals and CASM good recovery yet.
All might be kind of follow ups.
The amendment request.
Can you give us any color.
Conceptually like what.
With.
Yeah.
Financial covenants.
Yes. It may be it may be there is going to be a little bit more pressure on those as we go forward.
What kind of brings.
P.
Two our solutions largely sponsor backed transactions to the table I mean did they come early do they wait until it.
Its close and obviously, it's not going to be a general problems in the portfolio is I think going to begin a handful of.
Paulo is maybe so.
Now how much incremental.
Yes.
Uh huh.
Information can you.
Squeeze out of the sponsor when they come.
With an amendment of question I'm trying to get a real handle on this.
Just about the interest rate so is there something else going on.
Okay, I think I'll try that one Robert thanks for the question.
So here's the way it works.
In practice.
Our market.
We have covenants in all of our transactions.
And the covenants we tend to have are relatively similar we have debt service.
We have leverage.
And we generally have some EBITDA covenants, so let's assume that those three covenants.
They're each designed to protect us against different elements of potential deterioration.
Profitability.
Increased leverage and.
The ability to service service our debt.
We monitor.
Our borrowers generally on a monthly basis.
So we're watching our portfolio management group is watching our.
Our clients on a monthly basis, so that we can anticipate quarterly covenant initiatives, we set covenants on a quarterly basis, but we monitor monthly.
Unlike public companies or large cap companies are large upper middle market companies that report quarterly.
But generally 60 days after the end of the quarter were receiving information 10 days. After the end of each month on a flash basis. So that we can anticipate where we are on a quarterly basis I will tell you that across the portfolio we've seen no material.
Covenant or amendment request activity yet and.
Again, we're speaking as of November 2022.
My.
Estimation is that the overall economy will deteriorate somewhat.
In Q4, and Q1 as interest rates continue to rise.
I think we've done.
Most everything we can do in <unk>.
Position to protect our portfolio by.
Rotating out of highly cyclical industries moving away from consumer facing brand products retail restaurants, the things that tend to be more.
Our consumer driven or more immediately affected by a slowdown in the economy. So we feel good about where the portfolio is I will tell you that we monitor we've been monitoring things closely.
Over the last several months with an.
Increasing interest rates and we have not seen any.
Pattern yet.
Covenant violations or amendment activities and.
I think we're.
Hopefully I think we're going to be able to say that again next call but.
Where our leverage point comes in is as we see it.
Any deterioration in any of these debt service coverage leverage or EBITDA covenants, we can be prepared in the quarter, yes, there's a violation of the covenant to bring that sponsor to the table and talk to the sponsor about what we're going to do to temporarily fixed center permanently fixed depending on the situation. So unlock.
Most of the market.
Those of us that play in this lower middle market.
Have.
An additional benefit and that we can generally bring the sponsors to the table or the owners or the second or third generation family members whoever it may be to effect change and sometimes that changes putting in more money, sometimes that change is changing the way they operate limiting capex.
Reducing dividends limiting compensation, there's lots of things that.
Lower middle market companies can do to steer the ship.
Unlike the very large companies that can take some actions.
We can we can put in some relatively quick remedies.
Solutions to solve covenant problems. So I know that's a long winded answer but you gave me an open ended question. So I figured I should say best of mobility.
I really appreciate it.
It was a very helpful and sorry EBITDA.
If it doesn't belong so I really appreciate that thank you flip it to the other side. If I can quickly follow up I mean, you said, you're probably going to take up leverage you're seeing a lot of opportunities I mean what areas.
<unk> attractive right now, but deploying new capital or would you expect that to mainly be follow ons to existing portfolio, you're talking about taking up leverage, but new companies or just expanding the existing relationships.
Both ways. So what we did purposefully this quarter and a quarter before as we've been.
Stockpiling, our capacity and in an increasing interest rate environment.
We've been doing this for 20 years at Monroe, well I can give you some perspective on history in an increasing interest rate environment or coming out of a downturn. We did this after the financial crisis. We did it after a couple of recessions we did it after COVID-19.
Try to stockpile, a little bit of liquidity.
The deals get better the new deals get better.
Existing deals were always funding add on opportunities, but those have already been priced those add ons, where you have the opportunity to move the needle in our business is to do new transactions at lower leverage attachment points at higher price spreads. So all of the deals that we're doing today.
Are virtually being done at.
50 to 100 basis points of current return higher than we were doing a couple of quarters ago.
So when I talk about optimism for the future.
<unk> core for MRC.
Im looking at what we're doing today and what the pipeline we have today in the pipeline that we're putting dollars to work at or 50 to 100 basis points higher in terms of interest rate margin than we were doing six months ago.
And what that means from a sector perspective to additives.
Focus on technology, and recurring revenue deals health care health care services deals and.
Opportunistic deals that have more kind of idiosyncratic characteristics.
And if you look at the deals we funded in the third quarter.
Deals in those sectors at spreads and create a greater spread levels at <unk>.
Described as well.
Got it. Thank you. Thank you.
Again, if you'd like to ask a question. Please press star one on your telephone keypad, Christopher Nolan with Ladenburg Thalmann. Your line is open.
Hey, guys.
Gratulation Cherry on.
Hey, guys good reputations for working through these.
Customer pools.
As noted Vinci brands, that's another large fully patch.
Can you give us any color what your expectations are for resolution of that please.
Sure Chris.
Good question Vincent brands, which was previously known as <unk>, we have our credit position.
Net.
That borrower that is a borrower that is in the throes of.
Consumer as well as some macroeconomic headwinds right now.
They make.
Telephone cases for.
Four.
Phones, and particularly iphones and if you've been watching the news.
Seeing what's happening with iPhone, the iPhone launch the new iPhone the demand supply imbalance.
Fox is having some issues in China right now supplying all the demand. The good news is that Apple is experiencing the highest level the demand for their new phones that they have overseen the bad news is that because of.
Covid restrictions.
Local.
Governments in China are closing down.
The vast areas of manufacturing and Thats affected Fox com tremendously in terms of being able to satisfy.
That demand so we've got some market headwinds there we have basically a.
Our company doing a.
$140 million or so of revenue. So we've got a good company or a real company, making a real product that is in the middle of a little bit of a headwind.
With getting iphones made and some supply chain issues. So we continue to work hard on that I will tell you that that's a <unk>.
High priority item for us.
And we're doing everything that we can do on that credit, but right now there are some factors beyond our control that.
We're hoping and.
We're waiting on Time's going to help US there we just have to get through some of these COVID-19 restrictions in China and Apple has got to be able to produce and sell and then we've got to be able to provide cases for the new phones that are being sold so.
Long answer to an easy question.
We're hopeful that as time goes on we'll be able to improve our overall recovery on that on that particular credit.
Great. Thanks, Thanks for the detail as a follow up.
Given that you have a fair amount of adjustable rate funding in terms of your bank facility.
Interest rates go up.
At a pricing disadvantage against other bdcs, which may have more fixed rates.
Funding.
Not really not really because if you look at the other bdcs that are fixed rate funding today.
It's generally much higher fixed rate funding, we still have on a relative basis because of the way we have.
Established our capital stack.
Between fixed and floating.
We are still floating off of.
Some of our bank lines of credit rates and there is still a positive arbitrage for us to do that and we're going to hold on to that positive arbitrage until we see rates move back in our favor before.
Think about doing any type of fixed rate.
Ted.
Great. That's it for me thanks, guys.
Thank you Christopher.
Bryce Rowe with B Riley your line is open.
Thanks, Good afternoon, Nick in Canada.
I was curious if maybe you could speak to the improvement in the portfolios internal risk weightings is that is that more a function of non accruals getting resolved or were there. Some other other factors at play.
Yes. Good good question actually price, there's two there's I'm going to let <unk> speak to it in detail, but there's two things that really move and affect that number one is <unk>.
Non accruals are getting resolved and if you look at.
Our history here over the last eight quarters I will tell you and Robert Dodd has really the kind of the police man here that's been watching this for everybody. We've done I think a really good job at moving.
Non accruals down.
And cleaning up some some historical.
Portfolio companies and some sponsors that have had some challenges. So that's number one but the second way things move in risk ratings as migration, both positive and negative and we've experienced some positive migration in companies, which means that we're doing a good job in our portfolio management and holding.
Company's feet to the fire and holding sponsors feet to the fire. So can.
And I think speak more specifically on the migration, but I think thats a really good question.
Thats absolutely right.
Those are the two components of non accruals and net credit migration.
We talked about the nonaccrual topic with carry on being resolved during the course of the quarter very very positive event.
On the net migration front, we think about this in a couple of ways first is exiting transactions from our portfolio.
And during the quarter, we were <unk>.
Successful in it.
Migrating out of the portfolio.
As a credit that was in that that risk rating category three.
<unk>. So we were happy with that event and then in terms of portfolio.
Kind of movements that result from kind of upgrades and downgrades.
We had a net positive experience in terms of that net upgrade net downgrade activity during that during the course of the quarter. So it was a good it.
It was a good quarter in terms of in terms of credit in terms of credit quality.
Okay. That's helpful commentary.
And then maybe.
Question on the on the SLS.
The dividend coming into Munro from the SLS has been stable here at $900000, just curious with rates moving higher.
There are an opportunity for income generated from the SLS to.
The increase here in future quarters.
So all things being equal we'd expect.
<unk> perform.
A higher bottom line net income levels.
So by extension, we would expect.
Performance of that portfolio to be accretive.
Got it. Thank you so much that said that's all for me appreciate the color.
Thank you Bryce.
There are no further questions at this time I will now turn the call back over to the presenters for closing comments.
Okay I just want to thank everybody for taking the time out today.
That's up <unk>.
Exciting time, I think in our business generally from a firm standpoint, we've continued our firm's growth at the at the manager level and it's very exciting I think for the BDC industry right now.
Managers that have the workout portfolio management and asset management capabilities I think can reap some rewards as rates continue to increase and that's certainly what our intention is to do here in the near term. So thank you. All we will speak to you again next quarter and then to the extent you have any questions on it.
Interim basis feel free to reach out to mix, all amini or to myself at any time. Thank you all bye.
Bye bye.
This concludes today's call. We thank you for your participation you may now disconnect.
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