Q3 2023 MidCap Financial Investment Corp Earnings Call
Our net asset value per share was $15 10.
A decline of two 3% quarter over quarter, mostly due to losses outside of our first lien corporate lending strategy regarding investment activity new commitments continue to focus on first lien corporate loans sourced by Midcap financial we have also made significant progress reducing our exposures outside of our core strategy sales and repayments during the quarter included <unk>.
Nearly all of our remaining oil and gas exposure, which is now less than $1 million at fair value. In addition post quarter end, we received a significant paydown from merck's, reducing our position by roughly 24% pro forma for this paydown merck's represents approximately eight 3% of the portfolio at fair value shifting to a review of our investment strategy as you.
May recall in August we made several key announcements, which underscored Apollo global management's commitment to being at the forefront of the democratization of finance. These announcements included the establishment of a new an industry leading fee structure for MFC and equity investment into the BDC by Midcap financial and a change in the company's name.
These announcements reinforce <unk> position as a pure play senior secured middle market BDC, providing public shareholder access to institutional quality private credit at a best in class fee structure among listed Bdcs.
As you have heard us discuss on our previous calls over the last several years, we have shifted the bdc's portfolio into first lien corporate loans, primarily sourced by midcap financial one of the world's leading middle market lenders with a proven track record mid cap financial has one of the largest direct lending teams in the United States with close to 200 investment professionals.
We believe the scale of Midcap financial combined with other Apollo managed capital makes MFC part of one of the largest market participants in middle market lending.
For reference in 2022 mid cap financial closed approximately $16 $4 billion in new commitments, including $4 billion in the December quarter. The BDC is fortunate to be in a unique position to have access to loans sourced by midcap financial given the strategic relationship between mid cap financial in Apollo Global and mid 16 concurrent.
With the receipt of our co investment order <unk> shifted our strategic focus to leverage Apollo Global's relationship with Midcap financial I wanted to take a moment to provide some historical performance data, which we think shows how well. The strategy has performed as of June 2016, which is approximately the date upon which we began utilizing our co investment order.
Our first lien corporate lending portfolio totaled approximately $300 million at the end of December 2022.
Our first lien corporate lending portfolio had grown to nearly 2 billion at fair value over that six and a half year period, we funded approximately $5 7 billion of new first lien corporate loans sourced by Midcap financial total losses on those first lien corporate loans during that period have been approximately $7 million or 12 basis points on a cumulative basis.
<unk>.
On a cumulative basis, our two basis points annually.
We have we are highlighting this track record because we do not believe the market is fully appreciate how these assets have performed over an extended period of time and because we believe it may help to inform how our first lien corporate lending portfolio should perform going forward. It is also worth noting that todays first lien corporate lending portfolio is not only well diversified by borrower and industry, but also.
Across five distinct product groups leveraged lending asset.
Asset based lending lender finance life science lending and franchise finance moving to merck's consistent with our strategic focus on being a pure play senior secured middle market BDC. We remained focused on accelerating the reduction of our investment in marks we are pleased to report that we have made significant progress in this regard at.
At the end of December <unk> investment in <unk> had a fair value of $261 million, representing 10, 9% of the total portfolio at fair value.
Quarter end merck's executed a significant transaction by selling its interest in a joint venture and repaid roughly $62 million to MFC, which was applied to the revolver, reducing the size of <unk> investment in <unk> to approximately $199 million or eight 3% of the portfolio at fair value we remain.
Just on continuing to reduce our investment in <unk> and while we don't.
<unk> pay downs to occur evenly we do expect to see additional pay downs in 2023 subject to market conditions, Greg will provide some additional color.
The reduction in March later during the call.
Moving to our quarterly dividend given the benefit we're seeing from higher base rates, the exit of lower yielding and non earning legacy assets and the expected benefit from our new fee structure, which became effective on January one.
2023.
Our board has increased <unk> regularly.
Our regular quarterly dividend by <unk> <unk> from 37 to 38, which equates to a 10% dividend yield.
On based on December Knapp this dividend increase marks the third consecutive increase in our quarterly base dividend at current base rates, we are well positioned to generate net investment income in excess of this new dividend level. The forward curve indicates that there will be additional rate increases in rates would remain elevated for some time as the operating environment continues to evolve.
Our board will continue to evaluate whether to retain additional earnings increase the base dividend declared a supplemental dividend with that I will turn the call over to Ted. Thank.
Thank you Tanner beginning with a few thoughts on the current evolving macroeconomic environment volatility in the leverage finance and equity capital markets continued during the period.
I will reserve continued to raise interest rates to curb inflation amid ongoing concerns around slowing economic growth in 2020 to the federal reserve increased rates of 425 basis points and it has increased rates by an additional 25 basis points. So far this year with more rate increases expected, albeit at a slower pace more recently.
We are seeing some signs of easing inflation, however, and fed hawkishness is expected to keep markets volatile in the near term as a result primary new issuance in the leveraged loan and high yield markets continues to be negatively impacted we believe it will take time for the federal reserve's actions to be fully absorbed by the economy, and therefore M&A transaction volumes.
We'll remain slower in the near term.
We believe that the increased volatility in the public markets has created more attractive investment opportunities for direct lenders as more companies turned to the private debt markets, we're seeing wider spreads lower leverage and tighter documentation across our origination platform I continue to be selective seeking to finance companies with defense defensible market share and resilient balance.
<unk> for example, credit spreads are at least 100 to 150 basis points higher than last year across our origination platform.
With this as the market backdrop, we thought it would be worthwhile to remind everyone. How we have constructed our corporate lending investment portfolio. We believe <unk> has one of the most senior secured portfolios among bdcs, our corporate lending portfolio is focused on floating rate investments at the top of the capital structure, which we believe positions us well going into <unk>.
Weaker economic environment in order to understand the stability and safety of our portfolio. We think it is important to focus on attachment point at the end of December the weighted average attachment point of our corporate lending portfolio was 0.2 times, which underscores that we are investing the most senior part of the capital structure or what we refer to as true first lien.
By focusing on the top of the capital structure. We believe we will be able to mitigate some of the credit risk that could arise in a more challenging operating environment.
Despite the more uncertain macroeconomic landscape, our borrowers have generally been able to navigate the current environment well as evidenced by their fundamental performance our portfolio of companies experienced positive year over year revenue growth in the most recent quarter and sound, but slightly lower EBITDA growth.
We believe our portfolio of companies are generally entering 2023 with solid fundamentals and we will be able to weather a potentially more challenging conditions to.
To date, we have not seen any meaningful increase in either amendment activity or revolver drawdowns beyond the normal levels.
That said, we acknowledge that some companies will have challenges in a slower economic environment and we could see a pickup in amendment activity in the coming quarters importantly, MFC benefit benefits from midcap financials dedicated portfolio management team of nearly 60 investment professionals, which helps identify and address issues early to maximize value.
Moving to investment activity, we believe the middle market is generating attractive investment opportunities as mentioned earlier midcap financials active during the December quarter closing approximately $4 billion in new commitments in the December quarter, <unk>, new corporate lending commitments totaled $73 million across nine companies for an <unk>.
Average new commitment of $8 1 million. These new commitments were all first lien floating rate loans with a weighted average spread of 680 basis points up 41 basis points compared to commitments made in the prior quarter the.
The higher spread on new commitments as another earnings tailwind, we continue to see the weighted average net leverage of new commitments made during the quarter was four eight times, which is 0.7 times below the five five times the average of our portfolio <unk>.
Excluding revolvers gross fundings for the quarter totaled $105 million in sales and repayments totaled $141 million net repayments for revolvers totaled $11 million in aggregate net repayments for the quarter totaled $48 million.
Especially notable sales and repayments included roughly $21 million from our remaining oil and gas exposure, which is now less than $1 million at fair value.
In 2022, we sold all of our ships and oil and gas assets as we continue to accelerate the execution of our true first lien strategy.
Turning to the overall portfolio our investment portfolio had a fair value of $2 4 billion at the end of December across 135 companies in 26 different industries corporate lending and other represented 89% of the total portfolio and merck's represented 11% of the portfolio at fair value.
As Tanner mentioned post quarter end merchant has been reduced to approximately 8% of the total portfolio at fair value at the end of December 94% of our corporate lending portfolio was first lien with a weighted average spread of 610 basis points, our portfolio company credit metrics remained relatively stable during the quarter at the end of December the weighted average.
<unk> net leverage of the corporate lending portfolio was 549 times down from 552 times last quarter.
The weighted average interest coverage ratio was two five times down from two seven times last quarter. These weighted average interest coverage ratios are based on company data for the last 12 months through September the weighted average interest coverage ratio was one nine times based on an annualized interest expense for the September quarter, and using the last 12 months of <unk>.
EBITDA given.
Given the significant and rapid increase in base rates, we're focused on current and future interest coverage and fixed charge coverage ratios across the portfolio as a component of an active risk monitoring process.
No investments were placed on non accrual status during the quarter at the end of December investments on nonaccrual status totaled $10 million or 0.4% of the total portfolio at fair value with that I'll now turn the call over to Greg to discuss our financial results in detail.
Thank you Chad and good afternoon, everyone before discussing our results.
I wanted to remind everyone that MFC has changed its fiscal year end from March 31 to December 31.
The change in fiscal year was done to better align MF Ics reporting calendar with other Apollo global entities. The transition report on Form 10-K, and Form 10-K, which was filed today includes a nine month period from April one 2022 through December.
<unk> 31 2022 <unk>.
<unk> next fiscal year will cover the period from January one 2023 to December 31 2020.
You can see the year over year results in the 10-K that we filed today shifting to our results net investment income per share for the December quarter was <unk> 43 compared to 35.
For the September quarter and 35.
In the year ago quarter net investment income for the December quarter continued to benefit from higher base rates on our floating rate assets solid fee and prepayment income as well as a lower incentive fee compared to the comparable periods prepayment income was $2 8 million down.
Lee from last quarter and fee income was approximately $700000 compared to $1 5 million last quarter dividend income was essentially flat quarter over quarter. The.
The yield at cost in our corporate lending portfolio was 10, 3% on average for the quarter, an increase of 140 basis points from last quarter, driven by the increase in base rates.
Yield figure is an average of the beginning and the ended the quarter at the end of December the yield of the corporate lending portfolio was approximately 11% compared to nine 6% at the end of September .
NAV per share at the end of December was $15 10.
A two 3% decrease quarter over quarter, primarily driven by losses outside of our first lien lending book.
In that regard and as previously indicated our corporate lending portfolio of $2 1 billion is made up of 94% first liens losses.
Less than 10% of our losses or $2 3 million were attributable to our first lien corporate lending book and was primarily due to mark to Mark Mark to market adjustments from spread widening as opposed to fundamental credit losses additional details on the net loss.
Net losses are shown on page 16 in the earnings supplement.
<unk> incentive fee on income includes a total return hurdle with a rolling 12 month 12 quarter look back given the net loss on the portfolio of incentive fees in the December quarter were significantly reduced as a reminder, beginning on January one 2023.
Base management fee was permanently reduced to one in three quarters on equity.
Among listed BDC <unk> management fee is now the lowest and is the only listed BDC to charge management fees on equity, which we believe provides a greater alignment and focus on net asset value.
The incentive fee rate on income was also permanently reduced from 20% to 17, 5%.
And we retained the total return feature.
Moving on from our balance sheet perspective.
Our net leverage stood at one four times at the end of December within our target range, we intend to amend and extend our revolving credit facility in the next few months.
Although no stock was purchased during the quarter. We believe <unk> is trading discount to NAV implies a loss rates significantly higher than our first lien corporate lending portfolio has experienced over the last six and a half years moving to Merck as Tanner mentioned in January Merck sold.
Its 50% interest in a joint venture.
Reducing <unk> fleet from 57 aircrafts to 43 today.
Proceeds from this sale were applied to the <unk>, reducing our investment in <unk> to approximately eight 3% of the portfolio at fair value. This sale in combination with other steps taken in connection with the reduction of our exposure to merck's resulted in a nominal write down on our investments during the quarter.
Turning to our outlook. We believe we are well positioned to grow earnings in the coming quarters due to the rising interest rate environment.
For perspective based on quarter end rates, we estimate that a 50 basis point 100 basis point increase in base rates.
Would result in incremental annual earnings of approximately 6% and 13 respective typically.
We have provided additional information on our sensitivity in our 10-K.
As we enter 2023, we feel very constructive about the outlook for the MSI for MFC, given the diversity of our corporate lending portfolio, which we believe is designed to weather a more challenging economic environment. This concludes our prepared remarks and operator, please open up the call to <unk>.
<unk>.
Thank you Sir.
At this time, if you would like to ask a question. Please press the star and one Keith on your Touchtone phone.
At any time you find your question has been answered you may remove yourself from the queue by pressing star Q.
Once again that is star one to ask a question.
And our first question will come from Mark Hughes with clear Ross Your line is open.
Yes, Thank you and good afternoon.
Okay.
For Merck.
I think you've talked about the opportunity for more pay down in 2023.
Our transactions required.
In order to.
<unk>.
Generate that or pay.
Pay down just from operating cash flow.
Yes, so yes, thanks Mark.
The answer there is it is not it is not it's not necessary for you.
Big wholesale transactions, we've got as Greg mentioned 43 planes in the portfolio today.
To state the obvious these are not CUSIP securities. So theyre not cannot be traded on the wire they take long, it's a long process.
In order to execute on these sales and there.
There are tax considerations as well we have we do have a yield on the on the portfolio today to see substantial moves in and the reduction of the of our exposure. There you would expect to need.
Sales of assets, either individually or in larger groups.
And then within the portfolio the high Tech industry.
17% I think.
Any impact there has been some volatility in the tech on the job front.
Are you seeing any of that within your portfolio.
No.
And high Tech.
<unk>.
This was a delineation that was made back in <unk> when the fund was.
<unk> was founded and it catches a lot of things, including software, which is something that the broader market has done quite a bit when we think about the exposure there. The good news from a software standpoint is oftentimes the software itself.
Is the different companies are targeting different underlying markets with different different fundamentals and.
And often times, we're creating.
Those.
Those deals typically are at even lower LTV than our average LTV across our leveraged lending portfolio, which is roughly 50%. So there is significant.
And in any event notwithstanding as you rightly pointed out there are some some some broader challenges in.
In the tech space.
I appreciate it thank you.
Thank you.
Our next question will come from Robert Dodd with Raymond James Your.
Your line is open.
Yes.
Hi, guys.
One other question is I think in your prepared remarks, you said spreads have widened significantly 100 to 150 basis points. When we could say the same thing but to that point when I look at your new commitments.
680, this quarter was <unk> 39 last quarter, but it was also six studies on that.
So that's about 40 basis points and Whiting and on the move.
The leverage is about let's say so could you give us.
We've taken the opportunity I assume that 100 to 150 is kind of like alike have over.
Over the course, we gave you taken the opportunity to go even more.
Cautious on the assets and maybe that's holding back the business.
The ability of.
That expansion and new commitments on any given moment.
Yes.
Thanks, Robert I think it's absolutely that and it's a little bit also that when we quote those.
Numbers were looking kind of across our businesses.
Across our kind of across our middle market lending platform and what we're doing at mid cap and I think this is a good point to emphasize this is one of the dynamics that.
And drove our decision to reduce our cost structure and give us the ability to participate in an even greater percentage of what mid cap is sourcing and so while we were always.
Trying to be in the six hundreds where we could in the most recent quarter you do see us deploying a roughly $75 million at the $6 80, which we think is reflective of the market.
And to your point reflects both one that we're trying to stay.
A little bit more conservative.
As well as also in anticipation of the.
The broader market.
Sorry, the fee change that we can participate in a greater percentage of the deals and effectively our cost of capital has come down.
Got it.
I appreciate that one.
I'm kind of.
The.
The energy exits.
Was that.
Hello, I don't want to work with.
I presume that that's something that's been worked on wildlife Linda just a decision to.
Just get out or once this quarter.
I mean, obviously there were.
Some realized losses, but we kind of knew that but.
Could you give us any color on.
Getting rid of or more than one quarter, which is quite active.
Yes.
Yes that was it.
Happy to come together.
Sure Robert having to address that.
So.
Several years ago, we began the process of migrating towards the broader strategy.
And starting in 2020.
In 2021, we took the opportunity to work with the management teams and restructure the business.
And get those businesses ready to go to market.
And then did so in 2022, and some cases hiring advisors running processes.
This is across oil and gas as well as the shipping.
Assets that we sold last year.
And so it turns out that.
For both of the assets they ended up closing in the quarter.
The two oil and gas assets. So they had been worked on for.
Operationally financially for a couple of years and then in terms of actual M&A process over the course of the year.
Got it thank you.
Thank you.
As a reminder, that star one to ask a question.
Our next question will come from Ryan Lynch with K B W. Your line is open.
Hey, good afternoon.
I had a.
Quick question was just on kind of the nature that you guys described the write downs in the NAV. This quarter I believe you said they were mostly due to spread widening but wasn't the largest markdown.
Coming from your corporate lending book and now its really just driven by the <unk>.
Debt to equity restructuring of <unk>, which to us would seem like kind of a <unk>.
Credit markdowns, so I guess I'm, just slow a bit confused a lot of misunderstanding of why the markdowns this quarter, where we're kind of described as mostly spread widening versus credit yes.
Yes, no I think I think the thing.
Thanks for the comment and happy to clarify that.
Youre right. There was one part of the write down component that was second lien that was the cayenne.
Investment that went through a restructuring.
Which was completed.
Post quarter end.
Then I think in the prepared comments.
The comment was within the first lien credit book the write down within the first lien credit was the mark to market.
So it was really kind of two different components. There, yes, the prepared remarks, Ryan we're emphasizing that it was outside.
The first lien strategy that we saw the big decline and Youre exactly right that pad has largely due.
Two the canon write down.
Okay.
And within the corporate strategy it was a mark to market.
Gotcha.
And then you guys gave some statistics on a weighted average interest coverage two five times on trailing 12 months one nine times in September annualized have you guys done any sort of analysis that looks at.
What that interest coverage, it's going to look like.
Calendar 2023, when kind of LIBOR so for.
Peak out and then <unk>.
Obviously that the weighted average interest coverage is kind of mostly quoted statistic.
But it but.
From a credit standpoint.
I think most investors are sort of worried about the average borrower default and I think it's more <unk>.
The risks are more in the tail ends of potential borrowers.
Having issues have you guys done any sort of analysis on that.
What interest coverage would look like on a forward basis and what percentage of your portfolio would fall below that that one times interest coverage level.
Yes sure.
So I. Appreciate there is these numbers are a little bit backward looking and so what.
What we've done or are all of the analysis.
Distill it down to the conclusion.
When you take the.
The current LIBOR kind of think in the 477 or the Libra as of 12.
The library so for at the end of the year.
We just have a handful kind of less than five names that fall below one times coverage and then we stress that another 100 basis points, which is slightly above what the market is pricing and in terms of <unk>.
Increases to LIBOR slash <unk> slash interest rates that number only increases.
By by three or four names and so still.
In that context, even with call it $5, 75% to 6%.
So far we're seeing fewer than 10 names.
Below one to one and that of course is before the benefit of the year.
To address and offset some of that increase in the underlying companies.
Okay.
That's really helpful. And then just one final one.
On the reduction in Merck's.
Pat.
Interest being sold is that what we should sort of expect going forward is more.
Sort of the Chunkier dispositions that kind of come over time or do you guys expect sort of.
Sort of a gradual repayment schedule of those to the extent that you guys can predict anything like that which may not be possible.
Yes, I mean, I think we would expect it to be a little bit of a step function, which would which would be lumpy, but probably not as lumpy as the one this quarter.
<unk>.
There are like sets of assets that sort of obviously go together same lessor for example.
Let's say for.
For example.
That that we would expect to exit so yes, so I mean, I think it will be more.
<unk> plane by plane as opposed to sort of like a complete entities, but it won't necessarily be just like one by one by one.
So I know that's like an imperfect cancer, so, but that's our that's our expectation.
No that makes sense.
And perfect sort of process, China trying to sell these things off so I definitely understand the predictability.
Appreciate the time this afternoon.
Thank you.
<unk>.
Once again that.
One to ask a question.
And our next question will come from Melissa Wedel with Jpmorgan. Your line is open.
Good afternoon, Thanks for taking my questions today.
I was hoping you could touch on portfolio leverage and how youre feeling about current levels.
I assume that with where youre at currently at about just about one four on a net basis that youre still at sort of that a bit of a capital recycling mode.
Repayments come in and exits occur is that.
Our assumption or are you thinking about things differently.
I think thats, a fair assumption that that is the one four.
101, we came out this quarter is that the.
Bottom of our range, we did provide guidance last quarter that we would expect to.
Operate in and around that range and to your point redeploying what comes back to US I would note.
Hopefully it's obvious from some of the other comments and questions as we do believe that.
Further economic volatility notwithstanding this will be a good vintage.
For credit lenders on account of a good spread improving documentation and lower all in all.
Leverage and so we do want.
To participate in this market.
And make sure we are properly indexed to what we believe is a good.
Market for private credit and make sure and if I see as a beneficiary of that.
Okay I appreciate that.
As a follow up on some of the outstanding commitment I'm looking at slide 18 in your deck specifically.
Do you think about sort of the.
And commitments available to be drawn down on I think I'm looking about 193 kind of rounding to.
$193 million as you think about.
The potential for a more challenging operating environment are you expecting to see that number start.
Being drawn upon.
Listing portfolio companies.
That's the case I assume that the terms have already been set so they're not sort of dictated by the current environment, but.
By the terms that were agreed upon.
When that commitment was made could you just.
You kind of elaborate on that process, a little on how youre thinking about it. Thanks, so much yes.
Yes, sure Melissa very good question.
And so the first point is we have not seen a tick up in revolver utilization across <unk>, our broader business and I think on this on this account good news Bad news is the bad news is we went through we went through Covid, but the good news is and having gone through Covid and <unk>.
<unk> those instances wherein there was.
The preemptive drawing down of the revolvers, we had the opportunity both in new loans as well as also an existing loans.
To put in the type of terms to protect on the margin against such as anti cash hoarding.
Eliminating netting in terms of covenant compliance and so well.
If stresses are more acute than we expect or are continuing at the level, obviously cash flows may.
May become challenging you would expect a higher utilization, but we havent seen and at a minimum on account of what we've been able to do from a documentation standpoint, I think that that risk of excessive drawdown within our revolvers to be to be much less risk than what we've seen historically.
And then on the term loans those are defined use of proceeds as well. So they are primarily in place to support sponsors going to make acquisitions to grow their portfolio of companies and so the delayed draw term loans, which is I think what you're pointing out and on the slide.
Those can be drawn down just for liquidity purposes.
Thank you.
Okay.
Thank you.
And at this time, we have no further questions in the queue. So I would like to turn it back over to management for any additional or 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 other questions have a good evening.
Thank you ladies and gentlemen, this does conclude today's conference call and we appreciate your participation you may disconnect at any time.
Okay.
Yes.
Okay.
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