Q4 2023 MidCap Financial Investment Corporation Earnings Call
Sara Lee.
[music].
Yeah.
Good morning, and welcome to the earnings Conference call for the period ended March 31st 2023 from Midcap Financial Investment Corporation.
At this time all participants have been placed on a listen only mode. The call will be open for a question and answer session. Following the Speakers' prepared remarks, if you'd like to ask a question at that time simply press star one on your telephone keypad, if you'd like to withdraw your question Press Star two I will now turn the call over to Elizabeth Besen Investor Relations manager for Midcap.
<unk> investment Corporation.
Thank you operator, and thank you everyone for joining us today speaking on today's call are Ken or Powell, Chief Executive Officer, Ted Mcnulty, President and Greg Hunt, Chief Financial Officer, how would readdress 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.
Like to advise everyone that today's call and webcast are being recorded. Please note that they are the property of Midcap financial investment Corporation and that any unauthorized broadcast in any form is strictly prohibited information about the audio replay of this call is available in our press release I'd also like to call your attention to the customary safe Harbor disclosure in our press release regarding forward looking information today's.
Call and webcast may include forward looking statements you should refer to the 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.
Dot com.
I'd 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.
On today's call, we will further midcap financial investment Corporation, either and if I see or the BDC and we will use midcap financial referred to the lender headquartered in Bethesda, Maryland at this time I'd like to turn the call over to our Chief Executive Officer Tanner Powell.
Thank you Elizabeth good morning, everyone and thank you for joining US today I will begin today's call by highlighting our results for the quarter and will then provide thoughts on the current environment.
Following my remarks, Ted will review, our investment activity and provide an update on credit quality Lastly, Greg will review our financial results in detail. We will then open the call to questions.
Beginning with our financial results after market close yesterday, we reported a strong march quarter with net investment income per share of <unk> 45 cents well above the current 38 dividend benefiting from the positive impact of higher base rates strong fee and prepayment income as well as our new fee structure, which became effective during the quarter as a reminder fee.
Prepayment income can fluctuate quarter to quarter.
At the end of March net asset value per share was $15.18 an increase of eight cents or 0.5% from the end of the December primarily due to net investment income in excess of the dividend as well as a slight net unrealized gain on the portfolio.
Regarding investment activity, new corporate lending commitments made during the quarter totaled 110 million all first lien floating rate and across 15 distinct borrowers as we continue to emphasize portfolio diversification as discussed on last quarter's call Merck's executed a significant transaction during the March quarter by selling its interest in a joint venture.
Sure, which allowed merck's to repay $65 million during the quarter at the end of March our investment in <unk> totaled 197 million, representing an eight 3% of the total portfolio at fair value.
We remain focused on reducing our investment in merck's and while we don't expect paydowns to occur evenly we do expect to see some additional paydowns in the remainder of 2023 subject to market conditions shifting to our perspective on the current environment the quarter began with a more constructive tone compared to a challenging market in 2022, However in March market sentiment shifted as re.
As you know banking challenges and renewed fears of a recession contributed to more uncertain financial markets. Even prior to recent issues, we were seeing a more favorable environment for direct lenders with new transactions pricing with wider spreads lower leverage and better terms, although M&A activity in the middle market has declined as the landscape evolves we believe.
Events may cause banks to pull back from lending, which in turn should accelerate the ongoing shift to nonbank lenders and tighter financial conditions.
Let me take a moment to compare today's investment opportunities versus a year ago, a typical investment today prices around so first 650 to 700 basis points within issue discount.
Three points.
A year ago, a typical deal would price at so for plus 575 to 600 with an issuance discount of two points. In addition to an increase in spreads in OID base rates have increased significantly three months. So for was four 9% at the end of March compared to 0.7% a year ago, an increase of over 400 basis points.
Taken together this translates into unlevered asset yields of around 12, 5% today compared to 75% a year ago.
Moving to the dividend our board of directors declared a dividend of 38 cents per share to shareholders of record as of June 13th 2023 payable on June 29 2023.
38 cent dividend represents an annualized dividend yield of 10%.
Our NAV as of March 31st at current base rates, we are well positioned to generate net investment income in excess of this dividend level. The forward rate curve has moved materially lower over the last month or so we expect net investment income will continue to exceed the current dividend based on the current forward curve for the foreseeable future with that I will turn the call over to <unk>.
Yes.
Thank you Tanner and good morning, everyone beginning with the portfolio. We believe the quality of our corporate lending portfolio continues to improve which should allow us to mitigate some of the risks that could arise in a slower economy. We saw improvements on several important metrics during the period, our average position size decreased enhancing the diversification of the portfolio.
The net leverage of our underlying borrowers decreased and the weighted average attachment point declined notably we realized all of these improvements while also slightly increasing the spread on the portfolio.
At the end of March our investment portfolio had a fair value of 2.39 billion invested in 141 companies across 25 different industries corporate lending and other represented 92% of the total portfolio and merck's represented 8% of the portfolio at fair value at.
At the end of March 94% of our corporate lending portfolio was first lien. The average funded corporate loan position was $16 2 million down from $16 5 million last quarter. The overall weighted average portfolio net leverage declined slightly to five four or five times down from 549 times last quarter. The overall.
The weighted average attachment point decline does euro 0.1 times down from 0.2 times last quarter, demonstrating the true first lien nature of our loan book.
The weighted average spread across the corporate lending portfolio was 613 basis points up from 610 basis points last quarter.
Despite a slowdown in new issue activity Midcap financial was active during the March quarter closing approximately $3 5 billion in new commitments and $15 6 billion over the last 12 months.
In the March quarter M F Ice's, new corporate lending commitments totaled 110 million all first lien across 15 different borrowers for an average new commitment of $7 4 million as we continue to focus on diversification by borrower as mentioned all new commitments were first lien floating rate loans with a weighted average spread of 660.
Five basis points or 675 basis points, excluding revolver commitments the weighted average net leverage of new commitments made during the quarter was four two times down from 4.8 times last quarter.
Most fundings, excluding revolvers for the corporate lending portfolio totaled $106 million sales and repayments totaled 54 million and net revolver pay downs totaled $7 million, resulting in net fundings of $44 million. In addition, as Tanner mentioned, we received a $65 million paydown from Merck's and aggregate M F I see.
Had net repayments for the quarter totally.
$20 million.
Despite the more challenging macroeconomic environment, our borrowers have proven to be relatively resilient and continue to demonstrate solid fundamental performance. We continue to see positive operating trends among the vast majority of our corporate lending portfolios.
Which have largely been able to pass along cost increases, thereby limiting the impact on margins.
Portfolio company revenue and EBITDA continued to trend positively, which supports the company's ability to service debt.
Amendment activity continues to be quite low although it picked up modestly since the prior quarter. The amendments were normal course in nature. As you know amendments generally provide additional fee income incremental spreads tighter terms and sponsor equity infusions importantly M. F I see benefits for midcap financials large dedicated portfolio management team.
Early 60 investment professionals, which helps identify and address issues early to maximize value.
Moving to interest coverage the weighted average interest coverage ratio was 2.3 times down from 2.5 times last quarter. These weighted average interest coverage ratios are based on company data for the last 12 months through December if we utilize December 31st base rates and LTM earnings you would see interest coverage declined to one seven times.
Given the significant 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 management process.
No investments were placed on nonaccrual status during the quarter at the end of March investments on nonaccrual status totaled $8 7 million or 0.4% of the total portfolio at fair value.
The March quarter was 45.
Net investment income benefited from higher base rates on our floating right assets strong fee and prepayment income and our new fee structure prepayment income was $2.6 million essentially flat quarter over quarter fee income was approximately $2.2 million compared to $700000 last quarter driven by us.
Pick up an amendment activity there was a nominal amount of dividend income earned during the quarter payment in-kind or pick income remains very low representing less than 1.2% of our total income for the quarter.
All else equal the new fee structure increased NII per share by approximately six and a half cents for the quarter.
The yielded cost of our corporate lending portfolio was 11.3% on average for the quarter compared to 10.3% last quarter driven by higher base rates. This yield figure is an average of the beginning and end of the quarter as of the end of March the yield on the corporate lending portfolio.
Cost was 11.5% up from 11% at the end of December night per share at the end of March was $15, an 18 cents an increase of eight.
Or a half a percent quarter over quarter. The increase was driven by seven cents of net investment income of 45 relative to the 38 cent.
Distribution recorded during the quarter. There was also a one cent per share increased do do net unrealized gains on the portfolio additional details on net gains and losses are shown on page 16, and the earning earning supplement.
Total expenses for the quarter with $38.3 million up from $35.3 million last quarter, primarily due to higher interest expense and higher incentive fees, partially offset by lower management fees gross management fees totaled $4.3 million compared to $8 $8 million last quarter a day.
Kris a four and a half million dollars or approximately 50%.
As a reminder, <unk> base management fee was reduced to 175, an equity beginning January 1st 2023 among.
Among listed Bdcs MFA sees management fee is now the lowest.
And we are the only one to charge the management fee on equity, which we believe provides greater alignment and focus on net asset value.
Gross incentive fees totaled $6.2 million an increase.
Approximately $6 million from last quarter.
Recall <unk> incentive fees on income includes a total return.
Hurdle with a rolling 12 quarter look back the total return fee net losses unrealized realized against pre incentive net investment income over a trailing 12 quarter period.
For March 2023, the look back period used to calculate the incentive fee was 12 quarter period between June 2020 in March 2023, the net loss recorded during the March 2020 quarter, which reflected the initial impact of the pandemic fell out of the look back.
Period as a result the incentive.
Cap resulted in a full 17.5% incentive fee for the March quarter. While this can create some volatility within our incentive fee. We believe this provide strong alignment of interest with our state stakeholders.
Recall the incentive fee rate on income was permanently reduced from 20% to 17 and a half beginning this quarter.
Moving on from a balance sheet perspective are net leverage ratio stood at 1.4 times at the end of March as previously disclosed in April we were pleased to extend.
The majority of our senior secured revolving credit facility by over two years to April 2028 week.
We greatly appreciate the support from our lending partners. The primary benchmark rate was changed from LIBOR to so far the spread under the facility was reduced from 2% to 1.9, 75% that remaining material terms of of the facility were unchanged our investment portfolio continues to transition from Leeboard.
So far and at the end of March 65% of our corporate lending portfolio utilize sopher shifting.
Shifting gears a bit.
In light of the recent banking crisis, we wanted to make a few comments from Mfc's about MF high seas exposure or lack thereof to the regional banks that have failed.
I see did not hold any cash deposits are securities at the failed banks and did not have any creditor or debtor exposure to the failed banks. We also reviewed the exposure at our portfolio companies only a few of our portfolio companies had cash balances. It failed banks and those are generally held insecurity account.
In the bank's broker dealer.
Said all depositors at the banks are being made hall, we continue to believe.
There is a disconnect between how aristarch currently trades, considering the repositioning of the portfolio into mostly first lien.
Corporate loans source by mid cap financial which is along an outstanding track record. We believe MFC presents an attractive investment opportunity. This concludes our remarks and we'd like to open it up to questions.
At this time they will open the flash or question. If you would like to ask a question. Please pass the stocky followed by the one key I a touchtone phone if at any time you'd like to remove yourself from the question can you. Please pass stalk him again to ask a question. Please pass star one we'll take our first question from my Kids from curious Securities.
Yeah. Thank you. Good morning, you mentioned, how the revenue and EBITDA growth within the portfolio was the sustained through Q1 I Wonder if you saw any kind of deceleration there and if that leads to any conclusions about how the economy.
Enemy is performing your recently, particularly around the bank crisis.
Any thoughts on the topic would be great.
Yeah sure.
We did see a slight deceleration.
Relative to the last few quarters revenue growth was in the double digits, although just barely and EBITDA growth was in the single digits high single digits. What we do continue to see is that there are.
Margins are not growing as fast as revenue.
And as we look out across the spectrum and we think about the impact of what the banking crisis would be.
It is kind of a double edged sword, you've got on one hand from an economic standpoint, you're going to have continued pressure on consumers and small businesses and their ability to obtain credit and.
And continue to spend and then on the other side of the coin yeah, private lenders like ourselves who will be able to.
You know take advantage of opportunities that pop up and continued to drive good pricing and importantly, good terms in terms of covenants and low advanced rates in terms of leverage and then just to add to that that data is is mostly as of December and then it's.
Not consistent.
Cross the portfolio, who actually reports monthly, but when we looked at those numbers and rolled forward since December that'd be a continuation of the trend of a slight moderation, but still healthy overall fundamentals.
Understood and then with the economy, perhaps absorbing the banking crisis or are you seeing any kind of early signs of a bit of a recovery. You said the first quarter started to show signs of life and then.
Slowed down as the news emerged are you seeing any.
Inflection here recently.
I wouldn't say, we are seeing any inflection and obviously.
Quarter started off with a kind of more benign more constructive environment and then.
We had the events with the regional.
Regional banking.
Issues emerge and I think the way we look at it Mark is is certainly as we look forward I think the volatility of outcomes has probably been enhanced from here we.
We are experiencing a market that was arguably you very compelling from a private debt standpoint, even prior to the regional banking stress and we think over the longer term.
Are encouraged by the opportunities that that could help the nice secular trends that are benefiting private credit, but are absolutely taken into account that increased potential for volatility of outcomes given.
The regional regional banking stress.
Just to add on how we approach that from an underwriting perspective, we have always done stressed underwriting we run stress cases.
About how.
Rates or course or.
Other parts of the economy could adversely impact the companies. So we do not underwrite two up into the right hockey six in terms of our approach to credit and so while we do hope that there will be some rebound.
From an underwriting standpoint, it's kind of hope for the best but we always plan for the worst and are very.
Diligent in those stressed underwriting approve.
Approaches.
Okay. Thank you.
Our next question comes from Tennessee from RBC capital markets.
Hi, good morning, and thanks for taking my question just.
Just one on <unk> I think it's the prepared remarks, you mentioned that you could expect some payments. This year just wanted to see if you could just further expand upon that some details about that thanks.
Thanks, Ken and.
As we mentioned the prepared remarks were very pleased to report as we did last quarter significant pay down to take us down to roughly 8% and I think the.
The emphasis from here is we have assets in all stages of the disposition process.
That will be market contingent and obviously also depending on the underlying financing arrangements.
And so from here, while payments and repayments in reducing the exposure of.
<unk> investment in marks.
We'll continue it won't be linear and it will be dictated by.
Those those dynamics from an industry perspective.
We do remain encouraged by the fundamentals within the aviation space and aircraft leasing in particular in terms of a good supply dynamics with.
All the cancelled orders during COVID-19 and demand that is approaching 90% pre COVID-19 levels and then more recently the opening up of.
China and better traffic volumes in in.
In Asia until awhile, and so we believe that those dynamics, we should should help to help us to reduce that exposure to marks and the emphasis though as I started with us it's not going to be it's not going to be linear, but as we mentioned in recent quarters very focused on on doing everything we can to.
Pull the exposure down.
Gotcha very helpful. There.
And then one follow up if I may one or two if there's any updates thoughts around leverage targets in the near term just given the current macro backdrop. Thanks.
Yeah, we are not amending are.
Our leverage.
Our leverage guidance, we ended kind of at the lower end of it.
The the <unk>.
Our approach in this market is obviously balancing.
Liquidity with what is.
With what is clearly and likely to continue to be a very good vintage for.
Private credit so I would expect we're not amending our our leverage target.
Again can I would emphasize that.
Our new fee structure has changed and we're only charging.
Fees on equity, so increases and leverage do not do not affect the manager and so we're very comfortable with our range.
And again, the where are we operate in terms of leverage will be a balance of the very attractive environment and an operating within that range.
Gotcha very helpful. There. Thanks again.
Your next question comes from Para Joseph I'm Jeffrey.
Yeah, Hey, you morning, guys. Thanks for taking my questions is kind of a follow up there in terms of.
The deal environment versus I think you guys.
Reference kind of your your undervalued stock you know, how you're thinking about like.
Capital ended new deal versus versus buyback.
Weighing leverage at the same time.
Yeah, Thanks, I mean.
I think we're we're balancing the opportunity and.
That we see in the marketplace.
Versus.
Keeping our leverage at the lower end of our.
Target range at this point, so I think we'll continue to evaluate it.
And as we move forward.
Okay, and then click modeling question for for Greg probably.
In terms of interest and other income or weak.
Run right, we should expect going forward.
Were there any sort of one time items in terms of dividend <unk>.
No there aren't any I mean, I think you can you can look at our recurring income interest income and.
Pro forma that out and.
Obviously the fee income.
Prepayment income does.
Bounce around quarter to quarter.
I would just.
And without going into the specifics Kyle broadly speaking dividends have historically correlated with non-core some of our non-core investments and that those have come down we would expect dividend income to come down as it relates to our current earnings and we did call. This out in our script.
There was.
Enhanced prepayment income and that's a that's a line item that.
As you know and we know can be can be volatile.
Quarter to quarter, depending on transaction activity, which is sometimes beyond beyond our control.
Yep got it all makes sense. Thanks, that's it for me.
Our next question comes from Santa Adams from Raymond James.
Hey, guys regarding your interest coverage that portfolio average kind of sets at one seven X right now.
Some portion of that had a significantly lower but your <unk> didn't rise. So have you guys had any discussions with sponsors regarding amendments by them or any incremental support from sponsors.
Yeah, but I mean this is Howard I mean, the the so no or pick hasn't risen nor do we sort of necessarily expected to rise.
Generally necessarily.
Part of our.
You know.
Like part of the normal course of things that we provide obviously if a if a loan is on non accrual. It may not be paying it may be pain, but we're generally like if something is picking and it's a first lien loan generally will be on non accrual right. So.
And so there hasn't been enough taken that obviously is interest coverage gets tighter you know there are more law. There are more companies that protect shall we get tighter, but as as Ted said, there hasn't really been a kick up and and murmured activities and they're still EBITDA growth and they're still sort of coverage that doesn't mean anecdotally there aren't loans.
You know, we're always talking too because they are underperforming as they were prior to this environment.
So the answer is we have very little pig, we don't expect it to take up we hope and expect nonaccruals not to pick up that much and certainly less than sort of are the market than our competitors because of the.
The quality of our portfolio.
But we're not we're not seeing nor expecting.
Our pick.
They pick up at least with regard to what is in our NII.
Okay. That's very helpful. Thank you.
And as a reminder, if you'd like to ask a question that is star and one we'll take our next question from Paul Johnson K W.
Yeah. Good morning, guys. Thanks for taking my questions.
Just hanging on to Kyle question is a little bit and just trying to get a sense of obviously see incomes a little bit higher it sounds like this quarter or a little bit of prepayment income in there as well.
Maybe just balancing that out a little bit with obviously the expected increase from higher base rates. How do you guys. I guess really look at this quarter's earnings run rate level based on this quarter. I mean are you looking at this is kind of a pretty secure level of earnings easy he can kind of generate into the future as far.
Or is this your is concerned or are we looking at sort of a peek Curtis level based.
Based on this Q1.
So you know we have guided before that we expect.
Prepayment in fee income to be around on average $3 million a quarter.
It can be more or less based on what tenant service timing, but it isn't a hugely volatile part of our earnings or or high percentage part as opposed to sort of you know like some ddc's take transaction fees unclosed deals you know as they originate things, we do not do that.
So we are not our fee and companies and driven by origination it's only driven by sort of either you know amendments are one time to answer exit fees or things like that and it has been pretty consistent if you look over the last three or four years around $12 million to $14 million a year.
So you know putting that putting putting that aside you know you. You then would expect or if you pull that number out.
With full fees being paid which they were this quarter you would expect our net income to go up marginally because interest rates are going up.
And and because we are incrementally redeploying capital that's under Ernie.
So so the answer is in this interest rate environment and even in a slightly more benign when we expect to sort of have to.
Continued coverage in those fees are.
Either that or they can fluctuate from you know I don't know one to five cents a share during a given quarter.
Got it thanks, that's that's very helpful.
Last question, just kind of bigger picture, but you you talked about it obviously a little bit on the call here, but.
But just the broader corporate lending world you know at this point.
I'm, just trying to get a sense of.
I guess, what the sponsor appetite really is I guess for deal activity today.
Talking about EBIT growth, that's still in place for a lot of these portfolio companies, but obviously the cost of financing has gone up as as the.
Just risk in general, but so what are what are your sponsors doing at this point I'm or is it mainly just kind of sitting.
Sitting tight waiting to see what happens with the economy or is there just to.
Just a very wide disparity between evaluations for between buyers and sellers kind of getting a sense of what the appetite as I guess for for corporate activity.
Yeah. Thanks, Paul.
I'll make I'll make two comments there first as it relates to the environment I think the <unk>.
The sponsor communities, certainly trying to digest higher higher rates and what the impacts are on valuation. We've seen I think the numbers for Q1 were M&A down kind of 10% and if you compare it to peek down as much as 30% and I think that bears out.
To that to that point about digesting different cost of capital within that environment private credit is certainly taking share and you've seen what is relatively muted.
Leveraged loan market and the size of deal or the quality of deal that's required to access that market, which has increased opportunity for private private credit lenders in terms of.
Our our business and more more specifically what what sponsors are looking at this goes back to a theme that we've talked about quite a bit in these calls is the power of incumbency and so while.
Undertaking a new LBO.
It's difficult you are seen a lot of activity or sponsor focus on add ons and whether we have delay draws to these existing companies and or they're looking for incremental commitments.
That's one aspect of the over 500 borrowers that we have within the mid cap M. F C system.
Enables a nice sourcing engine and what is your point or to the nature of your question more muted environment in terms of M&A in a higher cost of capital and sponsors digesting different valuation expectations.
God I appreciate that that's all the questions for me. Thanks.
Our next question comes from the <unk> from J P. Morgan.
Good morning, and thanks for taking my questions today.
Wanted to go back to your declared a dividend, but you maintained at 38, Okay sure, but also keep in mind your earlier comment about expecting to over earn that amount.
For the foreseeable future just based on the Ford right curve I believe the current portfolio physician.
Is that something that we should expect two per cent like I guess put different <unk> with you.
<unk>, just sort of support <unk>, three letting volatility that remain.
Going forward.
Well I you know I you know, we do not expect to be paid.
Pay a tax so we will distribute.
Special dividends.
At least consistent with that whether that's 90% or 98% remains to be seen so I think it's a little bit of both if we have this level about earning.
Consistently which we as we said we sort of expect we would expect that there will be special dividends.
But we don't actually expect there'll be quarterly so we will use something supported app at this level, we would expect to be paying for special dividends as well.
Okay. Thanks for that in terms of <unk> take.
Take your point that won't be a quarterly consideration, but he kidney expect something around is that part of the year and planning process that you guys been approach that.
Yeah that makes sense that that probably from a timing point of view makes sense.
Yes.
Thank you.
Our next question comes from <unk>.
Oh, Hi, guys I'm. So in recent quarters, you've had kind of more of a self towards life Sciences.
This quarter, we don't really see much in your original nation, so we'd be reading anything into that.
No no I think.
We're very lucky to have the various origination channels and what presents itself can can can modulate obviously in life Sciences midcap.
Midcap has a tremendous franchise there and.
Right a bit of opportunity, we would expect over than ever.
Several years, but I wouldn't I wouldn't take from that anything somatic or indicative.
Indicative of a trend.
Okay. Thank you.
Yeah, Let me Sir no further comments at this time I will now turn back to management, so closing remarks.
Thank you operator, thank you everyone for listening to today's call on behalf of the entire team. We thank you for your time today. Please feel free to reach out to us. If you have any other questions and have a good day [noise].
Thank you ladies and gentlemen. This concludes today's conference you may now disconnect.
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