Monroe Capital Q1 2023 Earnings Call Transcript

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May 11, 2023

There are 6 speakers on the call.

Operator

Welcome to Monroe Capital Corporation's First Quarter 2023 Earnings Conference Call. Before we begin, I would like to take a moment to remind our listeners that remarks made during this call today may contain certain forward looking statements, including statements regarding our goals, strategies, beliefs, future potential, are operating results and cash flows. Although we believe these statements are reasonable based on management's estimates, assumptions and projections as of today, May 11, 2023, these statements are not guarantees of future performance. Further time sensitive information may no longer be accurate as of the time of any replay or listening. Actual results may differ materially as a result of risks, uncertainty or other factors, including but not limited to the risk factors described from time to time in the company's filings with the SEC.

Operator

Monroe Capital takes no obligation to update or revise these forward looking statements. I will now turn the conference call over to Ted Koenig, Chief Executive Officer of Monroe Capital Corporation. Please go ahead.

Speaker 1

Good morning, and thank you to everyone who has joined us are on our earnings call today. Welcome to our Q1 2023 earnings conference call. I am joined by Mick Salamini, our CFO and Chief Investment Officer and Alex Parmacek, our Deputy Portfolio Manager. Last evening, we issued our Q1 2023 earnings press release and filed our 10 Q with the SEC. An uncertain macroeconomic backdrop and turmoil in the regional banking system led to increased market volatility and a decline in and M and A transaction activity in the Q1 of 2023.

Speaker 1

According to Refinitiv's, middle market deal volume in the quarter fell 39% are from the Q4 of last year to its lowest level since the height of the pandemic in the Q3 of 2020. Economic growth slipped amid still high inflation and rising interest rates and the general expectation That the Fed will remain diligent in combating inflation Towards the let's see, excuse me for this renegade, we remain diligent combating inflation towards Its long run trend of around 2%. These dynamics point to a more challenging economic environment for the remainder of 2023 And a general tightening of credit conditions, particularly among the regulated banking industry. Against this backdrop, Monro's ability to for a variety of underwritten solutions with a certainty of execution remains a distinct advantage for our clients. We remain mindful and cautious, however, that a slowing economy may create more stress within the portfolio and in the broader market.

Speaker 1

As we discussed on previous calls, this period of market dislocation presents a unique and compelling opportunity for MRCC And private credit to thrive. Historically, Monroe has outperformed in similar periods of economic volatility. While there was a slowdown in transaction activity in the Q1, direct lenders continue to dominate share of overall LBO volumes. Consistent with Refinitiv's Q1 2023 private deals analysis, we continue to see leverage and loan to value levels in the lower middle market declined with a corresponding increase in spreads. Further, deal terms, pricing, structures and documentation have shifted favorably to the lenders.

Speaker 1

These dynamics put Monro in a strong position to utilize our rigorous underwriting platform and broad capabilities to add attractive assets in recession resilient sectors as older vintage assets repay. As we navigate this period of volatility, our focus will be twofold. We will be concentrated on maintaining portfolio quality, Where we lean on our deep and experienced portfolio management team and our early intervention playbook to get ahead of potential challenges and develop strategies to maximize our outcomes. Concurrently, we will look to capitalize on the market share And pricing opportunities presented to private credit. Despite slowdown in the M and A markets, the number of deals we have assessed are in line with Historical levels, our focus will be on maintaining a disciplined, highly selective approach to our new deal originations as we look to redeploy capital and new assets that come with favorable structures and attractive yields.

Speaker 1

I will now transition to highlight our Q1 results. We are pleased to report adjusted net investment income of $6,900,000 were $0.32 per share, representing a 28% year over year increase to the Q1 of 2022 And a 23% increase from last quarter. This increase is primarily the result of increases in effective rates portfolio from the rising interest rate environment. We also reported NAV of $223,000,000 or $10.29 per share As of March 31, 2023 compared to $225,000,000 or $10.39 per share are as of December 31, 2022. The decline the slight decline in NAV was primarily the result of net unrealized losses on the portfolio that were primarily attributable to a couple specific portfolio companies that saw declining financial performance resulting from macroeconomic factors.

Speaker 1

On a net basis, the valuations on the remainder of the portfolio remained relatively flat during the quarter. During the quarter, MRCC's debt to equity leverage was unchanged at 1.49x debt to equity, are slightly above our long term target range of 1.3x to 1.4x. We continue to focus on managing our investment portfolio are selectively redeploying capital resulting from repayments. We believe that our purposely defensive portfolio will be able to navigate the higher interest rate environment and increasingly challenging economic macro environment. The weighted average interest coverage remains generally sound across our existing portfolio and has cushioned to sustain further rate hikes.

Speaker 1

Further, the portfolio continues to maintain a modest weighted average loan to value, and we believe that this coupled with the relationships we have developed with high quality sponsors with a track record of demonstrating strong support of their portfolio companies provides us with meaningful downside protection on

Speaker 2

our portfolio. Our

Speaker 1

loan underwriting focus continues to be on those companies with defensible market positions, resilient business models, exceptional management teams and strong sponsors or owners. By selectively redeploying capital from payoffs into new investments With attractive risk return dynamics, we will be able to recycle older vintage assets with new assets that benefit from lower risk profiles and higher yields enhancing the quality of the overall portfolio. MRCC enjoys strong strategic advantage Being affiliated with a best in class middle market private credit asset management firm with approximately 16,000,000,000 dollars and assets under management and approximately 200 employees as of March 31, 2023. We continue to focus on generating adjusted net investment income that meets or exceeds our dividend and positive long term NAV performance

Speaker 2

Thank you, Ted. As of March 31, 2023, Our investment portfolio totaled $532,100,000 a decrease of $8,900,000 are from $541,000,000 as of December 31. Our investment portfolio consisted of debt and equity investments in 102 Portfolio Companies as of March 31, 2023, as compared to debt and equity investments in 105 portfolio companies as of December 31, 2022. During the quarter, we made investments in 2 new portfolio companies with fundings totaling $9,600,000 At a weighted average interest rate of 11.7 percent, we also made nominal equity investments are both new portfolio companies. Further, we had revolver or delayed draw fundings and add ons to 29 existing portfolio companies totaling $12,700,000 During the quarter, we received 5 full payoffs totaling $20,300,000 We also incurred normal course pay downs and partial syndications totaling $10,100,000 Outside of a small syndication, we had no sales of portfolio investments this quarter.

Speaker 2

At March 31, 2023, we had total borrowings of $332,800,000 including $202,800,000 outstanding under our floating rate revolving credit facility And $130,000,000 of our 4.75 percent fixed rate 2026 notes. Total borrowings outstanding decreased nominally during the quarter. The revolving credit facility had $52,200,000 of availability as of March 31, 2023, subject to borrowing based capacity. Now turning to our financial results for the quarter ended March 31, 2023. Adjusted net investment income, A non GAAP measure was $6,900,000 or $0.32 per share this quarter, Compared to $5,600,000 or $0.26 per share in the prior quarter.

Speaker 2

This result was driven primarily by an increase in the average portfolio yield during the quarter ended March 31, 2023 on higher average asset levels. When considering our target leverage, the rising interest rate environment, the Favorable percentage of our fund leverage at a fixed rate and the current credit performance at MRCC, we believe that on a run rate basis, our adjusted net investment income will comfortably cover the current $0.25 per share quarterly dividend, All other things being equal. As of March 31, 2023, our net asset value was $223,000,000 which decreased slightly from the $225,000,000 at net asset value as of December 31, 2022. Our net asset value per share decreased slightly from $10.39 per share as of December 31 to $10.29 per share as of March 31. The 1% decrease was substantially the result of net mark to market unrealized losses of a couple specific portfolio companies during the period, partially offset by our net investment income outperformance of our dividend.

Speaker 2

I will now turn it over to Alex, will provide more details on our Q1 operating performance. Thank you, Mick. Looking to

Speaker 3

our statement of operations, total investment income was $16,800,000 during the Q1 of 2023, are up from $15,200,000 in the Q4 of 2022. During the quarter, we continue to see the impact of interest rate increases on our investment income. At March 31, The effective yield on our debt and preferred equity portfolio was 11.6%, up from 11% at December 31. SOFR rates continued to increase in the Q1 of the year with 1 month SOFR rising from 436 basis points at the end of 2022 are to 4.80 basis points by the end of March 2023. All other things being equal, A rising interest rate environment will continue to improve the yield on our investment portfolio and increase net investment income.

Speaker 3

At March 31, 2023, we had 3 investments on non accrual status, representing 0.4% of the portfolio of fair market value compared to 4 investments on non accrual status, which represented 0.5%

Speaker 4

of the

Speaker 3

portfolio at fair market value At December 31, the reduction in non accruals was due to restoring BLST operating company to accrual status during the quarter. This was due to sustained positive operating performance. During the Q1, we placed no additional borrowers on non accrual status. Moving over to the expense side. Total expenses slightly increased to $10,200,000 in the Q1 of 2023 are from $9,600,000 in the Q4 of 2022, driven by an increase in interest and other debt financing expenses resulting from the higher interest rate environment as well as an increase in incentive fees associated with the increase in net investment income.

Speaker 3

Our net loss for the Q1 was $3,300,000 compared to net losses of $1,000,000 for the quarter ended December 31, 2022. Net realized and unrealized losses on investments were $3,500,000 for the quarter. The net losses during the quarter were primarily attributable to fundamental performance of a couple specific portfolio companies. These losses were partially offset by $200,000 of net unrealized gains on foreign currency forward contracts used to hedge currency exposure on investments that are denominated in foreign currency. As of March 31, the SLF had investments in 59 different borrowers aggregating to 178 $200,000 at fair value with a weighted average interest rate of 10.3%.

Speaker 3

The SLS underlying investments are loans to middle market borrowers that are generally larger and more sensitive to market spread movements than the rest of MRCC's portfolio, which is focused on lower middle market companies. The SLF portfolio decreased nominally in value by just 4 basis points during the quarter from 93.49 percent of amortized costs as of December to 93.45 percent of amortized costs as of March 31. Additionally, SLF realized on its previously recorded unrealized loss on CBC Restaurant Corp. During the quarter. As of March 31, SLF had no investments on non accrual status.

Speaker 3

During the quarter, MRCC received income distributions from SLF of $900,000 consistent with the prior quarter. As of March 31, 2023, the SLF had borrowings under its non recourse credit facility of $115,700,000 $59,300,000 of available potassium subject to borrowing base availability. At this point, I will turn the call back to Ted for some closing remarks before we open up the line for some questions.

Speaker 1

Thanks, Mick and Alex. In conclusion, we remain dedicated to maintaining The portfolio quality in the face of potential Q3 and Q4 economic headwinds, but we believe that our purpose Defensive portfolio composition and experienced investment team will allow us to take advantage of an increasingly volatile market environment. The market dislocation that has recently accelerated due to the ongoing banking crisis has further enhanced our view that this year represents a unique and compelling opportunity For MRCC and private lending, prior similar periods of volatility have created the very best vintages for private credit. Our ability to provide certainty of execution and flexibility, capital solutions to lower middle market companies has become increasingly valuable In this time of tighter credit conditions and constrained liquidity at banks. This dynamic will allow us to redeploy Capital into sectors with solid cash flow characteristics and demonstrated resiliency to economic cycles, while benefiting from favorable deal terms, pricing and structures.

Speaker 1

Further, our effective yield and our predominantly 1st lien portfolio is 11.6%, Which portends well for the remainder of 2023 and Monroe Capital Corporation continues to be well positioned to deliver stable and consistent dividends for our shareholders. We are confident in our investment portfolio and its positioning to navigate the economic environment ahead. We believe that Monroe Capital Corporation, MRCC, which is affiliated with an award winning best in class external private credit fund manager with approximately $16,000,000,000 in assets under management provide a very attractive investment opportunity to our shareholders and other investors, particularly at the levels that our stock is currently trading. Thank you for all of your time today. And this concludes our prepared remarks.

Speaker 1

I'm going to ask the operator to open up the call now for questions.

Operator

And your first question comes from the line of Sean Paul Adams with Raymond James. Please go ahead.

Speaker 4

Good morning, guys, and congrats on a great quarter. My only question is regarding your adjusted net investment income for 2Q2024 and 1stq2024, with the way the sulfur curve is currently updated. It's actually trended a little bit lower since the end of 1Q 2023. If it goes down another 25 to 50 basis points, there is a risk that Your adjusted net investment income will not exceed the dividend by a GAAP of about $0.03 Do you guys have any current concerns on that? And What do you view the current curve to be going into 2024?

Speaker 1

Mick, why don't you take that one?

Speaker 2

Sure. So as kind of in terms of view of The interest rate curve, we're kind of in line with kind of where market sentiment is. We do expect Over time that the curve will moderate and on a lag basis contracts will reset. Those contracts are based on SOVR benchmarks. We believe that our adjusted net investment income was which is primarily driven by our Investment income will remain at comfortable levels in the context of even And levels that support our dividend, even in the context of a slight downshift in the curve.

Speaker 2

If you look at kind of our historical performance in terms of ANII dividend coverage or NII dividend coverage, We've maintained a $0.25 dividend for the past 13 consecutive quarters, including in the 3rd quarter where rates were around 3% on the benchmark and we were able to cover that dividend without any fee waivers. So we feel confident as we look at the curves into the intermediate term that we will comfortably be able to cover our dividend.

Speaker 1

Yes. Sean, I would just add, there's 2 parts to that, Sean. What you haven't factored into is the spread. If you look at there's 2 pieces to sulfur and our spread in terms of overall yield. Our spreads have continued to move north, And I anticipate that the rest of 2023 and into 2024, we're going to see some good trends in spread as well.

Speaker 4

Thank you for that color. I appreciate it.

Operator

Your next question comes from the line of Christopher Nolan with Ladenburg Thalmann. Please go ahead.

Speaker 1

Hey, guys. Do you expect this Quarterly EPS to be a decent run rate for the rest of 2023?

Speaker 2

Hey, Chris, could you repeat the question?

Speaker 1

Yes, I apologize. I'm just trying to see whether or not the Q1 earnings is a good run rate for the rest of the year.

Speaker 2

Yes. The way I would think about kind of Q1, We believe we're coming certainly to the peak of the rate cycle. Our leverage It was slightly above our range. I think about expenses kind of more on a run rate basis, But we had a really good Q1 at maybe as we come to the peak of this rate cycle And feel really comfortable about our earnings possibilities.

Speaker 4

Great. Thank you.

Operator

Your next question comes from the line of Bryce Rowe with B. Riley. Please go ahead.

Speaker 5

Thanks. Good morning. I wanted to kind of ask a question about the SLF to start. Indicated that you've got some capacity on that vehicle's credit facility and kind of given some of the commentary around wider spreads and attractive investment opportunities, any thought to trying to take balance sheet leverage at the SLF Up a little bit in this environment.

Speaker 2

That's a really good question. So as we look at SLF, Which is a different portfolio than MRCC. SLF is upper middle market And includes also kind of broadly syndicated loans in that portfolio. We're a little more cautious candidly in that end of the market. You'll find that leverage multiples are a little higher, loan to values are a little higher, spreads aren't quite as are attractive and there's probably a little more volatility in that.

Speaker 2

So as we look at kind of prosecuting transactions in the SLF, we're really mindful of that. We are considering kind of how to best effectively kind of utilize leverage within the SLF portfolio for sure. But we probably have a little more of a cautious tone around that end of the market than we do in kind of our core middle market where we're able to get Better credit metrics, loan to values, leverage, better spreads and pretty decent covenant protections. But we'll continue to assess this as we progress through the year And as we look at pipeline possibilities that come into the SLF, but it is definitely something that we are looking at closely.

Speaker 5

That's helpful, Mick. Let's see, wanted to maybe turn to credit quality And maybe a couple of questions around that. So you've seen continued movement lower in the number of non accruals, obviously working hard To address the troubled situations. Mick, maybe you can speak to that, any kind of further progress beyond The one that came off here in the last quarter. And then just you made some comment around weakness at a couple portfolio companies that drove some depreciation, just any color around that kind of what the outlook might be from this point forward?

Speaker 5

Thanks.

Speaker 2

For sure. Great question. So as you noted, we have made significant progress Reducing our non performing levels over time, we did during the Q1 place back on accrual Bluestem Brands to continuing positive operating performance. We have 3 kind of legacy Non performers that we are still in the process of working out. So stay tuned on that.

Speaker 2

As I look at we did mention we had a couple of specific credits That gave rise to most of our unrealized loss change during

Speaker 4

the course of the

Speaker 2

quarter. And both of those credits were impacted by kind of what's going on in the marketplace today. In one of those cases, The decline in kind of company performance is driven by the interest rate environment that directly impacted its revenues. Company is a leader in its field, working closely with the management team. They're doing all the right things in terms of rightsizing their P and L We're actually kind of taking market share interestingly in the context of this market.

Speaker 2

The other portfolio company that showed Some weakness and led to valuation decline was a business or is a business that has exposure to Kind of a lower income consumer. It's a business in the retail and discretionary consumer product space. Management team and the sponsor are acutely focused on kind of inventory management, liquidity management and Generally, we are doing kind of all the right things. So those are the two names that showed some weakness from a valuation perspective. The rest of the credit fundamentals in the portfolio are pretty strong.

Speaker 2

If you look at our average mark quarter over quarter, it was are slightly down by a little under 60 basis points. We did have some migration into the 3 category From the 2 category and handful of names,

Speaker 1

as I guess we

Speaker 2

kind of x-ray into that, Most of it was candidly idiosyncratic, not related to kind of what's going on in the inflationary world and the interest rate rule, But feel strong about kind of credit fundamentals in our portfolio, where we're seeing companies Continue to grow revenue, continue to grow EBITDA, although at a kind of slower pace than we saw in the 4th quarter.

Speaker 5

Okay. That's good color. One more for me. It's nice to see From repayment activity, I mean, I think across the space, we've certainly seen some repayments at some BDCs more so than others. Were you surprised to see the 5 full payoffs here in the quarter and any kind of visibility into repayment activity for Either the next quarter or the balance of the year.

Speaker 2

Yes. So another good question. So we had 5 full payoffs that totaled 20 Well over $20,000,000 for the quarter. In some ways they were surprised, in some ways they weren't. We have visibility into our pipeline.

Speaker 2

We know pretty accurately kind of if companies are up for sale and whether we're going to get repaid or whether we're going to get refinanced. And in the case of the 5 repayments, they were a result primarily of M and A activity. So those were pleasant surprises and payoffs, as you know, are good for us because we can Recycle capital generally accelerate things like fees and stuff like that. So We had anticipated some of this activity certainly in the Q1. As we look at kind of Yes.

Speaker 2

Potential repayment activity kind of from here on out, the repayment pipeline It is kind of average, I would say. We don't see any kind of M and A transactions accelerating for sure. I don't know that it will be as high as we saw in the Q1, but we are seeing Generally, a pickup in M and A activity that started really kind of post the end of the Q1. As Ted said in his opening remarks, Q1 was pretty light in terms of M and A activity. We're seeing some pickup and that will translate 2 fold to us.

Speaker 2

1 is Higher levels of repayments. And then secondly, obviously financing opportunities, We believe that at favorable terms, at favorable rates.

Speaker 5

That's good stuff, Nick. I appreciate it.

Speaker 1

You're welcome.

Operator

And there are no further questions at this time. I will turn the call back to Ted Koenig.

Speaker 1

Thank you all for attending our call today and asking the questions. We appreciate the opportunity to answer any questions you have. To the extent that there are any going forward, please feel free to contact Mick or Alex. And we look forward to speaking again on our next are quarterly call. So thanks and have a good day.

Operator

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

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Monroe Capital Q1 2023
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