Monroe Capital Q2 2023 Earnings Call Transcript

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August 10, 2023

There are 5 speakers on the call.

Operator

Welcome to the Monroe Capital Corporation's Second 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 may contain certain forward looking statements, including statements regarding our goals, strategies, beliefs, future potential, operating results and cash flows. Although we believe these statements are reasonable based on management's estimates, assumptions and projections as of today, August 10, 2023, these statements are not guaranteed 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, Munro Capital takes no obligation to update or revise these forward looking statements, I will now turn the conference over to Ted Koenig, Chief Executive Officer have Monro Capital Corporation.

Speaker 1

Good morning, and thank you to everyone who has joined us on our earnings call today. I'm here with Mick Salamini, our CFO and Chief Investment Officer and Alex Parmacek, our Deputy Portfolio Manager. Last evening, we issued our Q2 2023 earnings press release and filed our 10 Q with the SEC. An uncertain economic backdrop, elevated interest rates and volatility in the bank and syndicated capital markets continue to make direct lenders such as Monroe Capital consistent and reliable sources of capital. Direct lenders continue to amass a larger share of the middle market lending landscape.

Speaker 1

According to Refinitiv, direct lenders accounted for 85 percent of new LBO financing activity in the Q2 of 2023.

Speaker 2

Further M

Speaker 1

and A activity dipped to its lowest level since the Q3 of 2020 due to the expensive cost of capital and valuations and during a period of correction. During this period, direct lenders such as Monro have continued to step up to support existing portfolio companies as they execute on growth strategies to enhance enterprise value. Transaction activity began to show signs of picking up in the latter part of the second quarter and into the third quarter, particularly in the lower middle market, Monro's ability to offer a variety of underwritten solutions with a certainty of execution has proven to be a distinct advantage for our clients. In the first half of twenty twenty three, when middle market transaction activity marked a 3 year low, our platform funded nearly $1,400,000,000 a slight increase over the first half of last year. The market continues to offer direct lenders attractive pricing, terms and structures.

Speaker 1

Simultaneously, our transactions are being completed at lower leverage levels with higher equity contributions. We continue to selectively deploy new capital into recession resilient sectors that offer these compelling risk return dynamics. We will focus on capitalizing on opportunities where we can add attractive higher yielding assets as older legacy assets repay, we believe that we are positioned to generate strong risk adjusted returns supported by one of the most compelling vintages in recent history. While the economy has demonstrated more resiliency that many had anticipated, companies continue to face higher borrowing costs and the lingering impact of inflationary pressures. We've seen many instances where companies have been able to grow their top line, albeit at more compressed margins.

Speaker 1

Yes, certain sectors with consumer facing business models have faced bigger challenges. Through the economic backdrop remains highly uncertain, the Fed's latest interest rate increase has made an economic slowdown more probable. We continue to emphasize portfolio management, actively monitoring the cash flows in our portfolio companies and engaging with the management teams to keep a pulse on developing trends in these industries, we believe that the purposefully defensive positioning of our portfolio will allow MRCC to navigate the potentially challenging economic conditions ahead. The portfolio's interest coverage remains sound with sufficient cushion to weather the current interest rate environment. Additionally, the average loan to value and portfolio company leverage across the portfolio indicate meaningful equity value cushions below our debt.

Speaker 1

As the direction of the economy and interest rates become more apparent, our primary focus will be on maintaining the quality of the portfolio while being value add partners to our borrowers, we maintain a deep and highly experienced portfolio management team with a time tested playbook to navigate potential challenges and maximize our outcomes. Turning now to our 2nd quarter results. Adjusted net investment income was $6,100,000 year over year increase to the Q2 of 2022. Adjusted net investment income declined From $6,900,000 or $0.32 per share for last quarter, we also reported NAV of 2 dollars 113,200,000 or $9.84 per share as of June 30, 2023, compared to $223,000,000 or $10.29 per share as of March 31, 2023. The decline in NAV was primarily attributed to net losses and defensive realizations in 2 portfolio companies.

Speaker 1

These companies were impacted by difficult market conditions affecting consumer household end markets, and our portfolio has nominal remaining exposure to those specific sectors. During the quarter, MRCC's debt to equity leverage increased from 1.49x debt equity to 1.54x debt to equity. The increase in leverage was driven by the aforementioned decrease in NAV. The portfolio is well positioned to ride the current interest rate environment and face potential challenges resulting from an eventual slowdown in the economy. Our loan underwriting focus continues to be on those companies resilient business models, defendable market positions, proven and experienced management teams and exceptional sponsors or owners.

Speaker 1

MRCC enjoys a strong strategic advantage in being affiliated with a best in class middle market private credit asset management firm with approximately $17,200,000,000 in assets under management we had approximately 240 employees as of June 30, 2023. We continue to focus on generating adjusted net investment income that meets or exceeds our dividend and restoring positive long term NAV performance. I am now going to turn the call over to Mick, who is going to walk you through our financial results in greater detail.

Speaker 2

Thank you, Ted. As of June 30, 2023, our investment portfolio totaled $515,400,000 a decrease of $16,700,000 from $532,100,000 as of March 31, 2023, at the end of the quarter, our investment portfolio consisted of debt and equity investments in 99 portfolio companies compared to 102 portfolio companies at the end of the prior quarter. During the quarter, we made investments in 3 new portfolio companies with fundings totaling $6,300,000 at a weighted average effective interest rate of 11.9 percent, we also made a nominal equity investment in one of those portfolio companies. Further, we had revolver or delayed draw fundings and add ons to existing portfolio companies totaling $11,000,000 We received 2 full payoffs for $12,200,000 and incurred normal course paydowns totaling $14,400,000 At June 30, 2023, we had total borrowings of $327,400,000 including $197,400,000 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 $57,600,000 of availability, subject to borrowing based capacity.

Speaker 2

Now turning to our financial results. Adjusted net investment income, a non GAAP measure, was $6,100,000 or $0.28 per share this quarter compared to $6,900,000 or $0.32 per share in the prior quarter. Our average portfolio yield increased from 11.6% as of March 31 to 12.2% as of June 30, which was offset by a decrease in fee income and prepayment gains, a reversal of previously accrued interest related to the restructuring of Ormond Mills we will begin in slightly lower average portfolio balances. When considering current leverage levels, the interest rate environment in the favorable percentage of our fund leverage at a fixed rate, we believe that on a run rate basis, our adjusted net investment income will continue to cover our current $0.25 per share quarterly dividend, all other things mean equal. As of June 30, 2023, our net asset value was $213,200,000 which decreased from $223,000,000 in net asset value as of March 31, 2023.

Speaker 2

In the quarter, our NAV per share decreased from $10.29 per share to $9.84 per share. Our net asset value this quarter was affected by market conditions, which negatively impacted realizations our investments in Foreman Knolls and California Pizza Kitchen. These were 2 legacy investments in the brick and mortar retail space where we have only nominal remaining exposure. The balance of the decrease to net asset value was the result of net mark to market unrealized losses due to the fundamental performance of a couple specific portfolio companies still held in the portfolio and in SLF. These decreases were partially offset by our net investment income outperformance of our dividend for the quarter.

Speaker 2

I will now turn it over to Alex, who will provide more details on our Q2 operating performance.

Speaker 3

Thank you, Mick. Looking to our statement of operations, total investment income was $16,300,000 during the Q2 of 2023, down from $16,800,000 in the Q1 of 2020 the increase in effective yield on our debt and preferred equity portfolio was offset by several factors, including slightly lower average portfolio balances, a decrease in fee income and prepayment gains and the one time reversal of previously accrued interest income associated with restructuring and realization on the majority of our investment in Forman Mills. While rising interest rate environment we'll continue to improve the yield on our investment portfolio and increase investment income, fee income and prepayment gains and losses are tied to transactions, which can cause volatility in our investment income. As of June 30, 2023, we had 4 investments on non accrual status, representing 1.3% of the portfolio at fair market value, which compares to 3 investments on non accrual status 0.4% of the portfolio fair market value as of March 31, 2023. During the quarter, we placed 2 new investments on non accrual, ARC Storemay Co, which resulted in an impact of approximately $0.07 per share of NII and our remaining restructured position in Forman Mills.

Speaker 3

Additionally, during the quarter, we disposed of our previous non accrual asset, VINCI Brands. Moving over to the expense side. Total expenses slightly increased to $10,400,000 in the Q2 of 2023 from $10,200,000 in the Q1. The $200,000 increase in expenses during the quarter it's primarily driven by an increase in interest and other debt financing expenses resulting from the rising interest rate environment. Our net loss for the Q2 of 2023 was $10,300,000 compared to a net loss of $3,300,000 for the Q1 of 2023.

Speaker 3

Net realized and unrealized losses on investments were $10,200,000 for the quarter. Other net losses for the quarter, which were comprised primarily of net gains on foreign currency forward contracts

Speaker 2

used

Speaker 3

to hedge currency exposure on investments denominated in foreign currency totaled $100,000 as of June 30, the SLS had investments in 56 different borrowers aggregating to 168 we will be conducting $200,000 at fair market value with a weighted average interest rate of 10.7%. The SLS underlying investments our 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 in value by approximately 200 basis points during the quarter from 93.5 percent of amortized costs at March 31, 2023 to 91.5 percent of amortized costs as of June 30, 2023. During the Q2, MRCC received income distributions from SLF of $900,000 consistent with the prior quarter. As of June 30, 2023, the SLF had borrowings under its non recourse credit facility of $107,900,000 and $2,100,000 of available capacity, subject to borrowing base availability.

Speaker 3

At this point, I will turn the call back to Ted for some closing remarks before we open up the line for any questions.

Speaker 1

Thank you, Mick and Alex. In summary, we remain confident in the overall quality of the portfolio and its positioning to navigate a challenging economic and market environment, this quarter's challenge in the retail space was isolated, primarily with 1 company, Forman Mills, and our remaining sector exposure is nominal. Portfolio management is a primary focus, We remain actively engaged with our portfolio companies and our management teams, especially in this volatile environment. We have a time tested proven playbook and a highly experienced portfolio management team. And while the middle market is enduring a period of we are excited about the opportunity for MRCC to take advantage of this compelling lending environment where we are benefiting from increasingly favorable pricing, deal terms and structures, as legacy assets pay off, we will maintain our rigorous underwriting standards as we selectively redeploy capital into sectors, we have demonstrated recession resiliency and attractive cash flow characteristics.

Speaker 1

MRCC continues to be well positioned to deliver stable and consistent dividends for our shareholders. Monroe maintains a 2 decade track record of we believe that Monroe Capital Corporation, which is affiliated with an award winning best in class external private credit manager approximately $17,200,000,000 in assets under management provides a very attractive investment opportunity at this entry point, to our shareholders and to other investors, thank you all for your time today, and this concludes our prepared remarks. I'm going to ask the operator to open the call now for questions.

Operator

Followed by the number 1 on your telephone keypad. We'll pause for a moment to compile a Q and A roster. Your first question is from the line of Christopher Nolan with Lelandenburg Thalmann. Your line is open.

Speaker 4

Hey, guys. Sorry if you covered this in the prepared remarks to Have overlapping calls. What was the driver for the decline in the SLF fair value?

Speaker 2

So the decline in the value in SLF was largely due to mark to market adjustments on a handful of names. As you know, Chris, SLF is a differentiated portfolio relative to MRCC, it's mostly upper middle market loans and broadly syndicated loans. And so there were a handful of names that on a mark to market basis basically drifted downward during the course of the quarter.

Speaker 1

Yes, I would imagine, Chris, it's mostly is attributable to spread widening in current market versus legacy market. That's what usually happens when the market goes up. We see a slight decline and when the market retracts, we tend to pick it back up again.

Speaker 4

Great. And then I guess on a more strategic question, MRCC's external manager has acquired another BDC focus in technology space with an emphasis on Healthcare Technology, do we actually start seeing MRCC's investment book start Seeing more healthcare related investments?

Speaker 1

Good question. MRCC it gets the benefit of everything that the external management of Monroe Capital does. And Mick and Alex are the PMs for MRCC and to the extent they believe that there is some valuable risk adjusted returns that we can pursue through the origination and through the specific sector that Horizon Technology Finance has developed. We'll certainly incorporate that into some of MRCC's portfolio. But the venture debt business that Horizon does is a different business than the middle market financing from from a leverage and from a cash flow standpoint, EBITDA, so when there's overlap, which there will be in companies that are generating good EBITDA, I expect that MRCC will take advantage and have the ability to take advantage of those on a selective basis.

Speaker 1

Great. That's it for me. Thank you.

Speaker 2

Thanks,

Operator

there are no further questions at this time. I will now turn the call back to CEO, Ted Koenig. Please go ahead.

Speaker 1

Thank you all very much for your time today. We appreciate your time to the extent you have any other questions between now and our next call, please feel free to follow-up with Mick and Alex. And we look forward to seeing everyone again and enjoy the rest of the summer. Thank you very much.

Operator

Ladies and gentlemen, thank you for participating. This concludes today's conference call. You may now

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Monroe Capital Q2 2023
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