Monroe Capital Corporation (NASDAQ:MRCC) Q1 2023 Earnings Call Transcript

Monroe Capital Corporation (NASDAQ:MRCC) Q1 2023 Earnings Call Transcript May 11, 2023

Operator: Welcome to Monroe Capital Corporation’s First Quarter 2023 Earnings Conference Call. Before we begin, I’d 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, 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.

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, sir.

Ted Koenig: Good morning, and thank you to everyone who has joined us on our earnings call today. Welcome to our first quarter 2023 earnings conference call. I am joined by Mick Solimene, our CFO and Chief Investment Officer; and Alex Parmacek, our Deputy Portfolio Manager. Last evening, we issued our first quarter 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 M&A transaction activity in the first quarter of ’23. According to Refinitiv, middle market deal volume in the quarter fell 39% from the fourth quarter of last year to its lowest level since the height of the pandemic in the third quarter 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 diligent in 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, Monroe’s ability to offer 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.

And 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 first quarter, direct lenders continue to dominate share of overall LBO volumes. Consistent with Refinitiv’s first quarter 2023 private deals analysis, we continue to see leverage and loan-to-value levels in the lower middle market decline with a corresponding increase in spreads. Further, deal terms, pricing, structures and documentation have shifted favorably to the lenders. These dynamics put Monroe 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 we pay.

As we navigate this period of volatility, our focus will be twofold. We will be concentrated on maintaining portfolio quality, where we lead 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&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 in new assets that come with favorable structures and attractive yields.

I will now transition to highlight our first quarter results. We are pleased to report adjusted net investment income of $6.9 million or $0.32 per share, representing a 28% year-over-year increase to the first quarter of 2022, and a 23% increase from last quarter. This increase is primarily the result of increases in effective rates on the portfolio from the rising interest rate environment. We also reported NAV of $223 million or $10.29 per share as of March 20 — March 31 2023, compared to $225 million or $10.39 per share 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 of specific portfolio companies that saw declining financial performance resulting from macroeconomic factors.

On a net basis the valuations on the remainder of the portfolio remains relatively flat during the quarter. During the quarter MRCC’s debt-to-equity leverage was unchanged at 1.49 times debt to equity slightly above our long-term target range of 1.3 times to 1.4 times. We continue to focus on managing our investment portfolio and 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 is cushioned to sustain further rate hikes. 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 our portfolio.

Our 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 a strong strategic advantage being affiliated with a best-in-class middle market private credit asset management firm with approximately $16 billion in 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 despite anticipated macro market headwinds.

At this point, I will turn the call over to Mick who is going to walk you through the financial results in greater detail.

Mick Solimene: Thank you, Ted. As of March 31, 2023 our investment portfolio totaled $532.1 million, a decrease of $8.9 million from $541 million 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 two new portfolio companies with fundings totaling $9.6 million at a weighted average interest rate of 11.7%. We also made nominal equity investments in both new portfolio companies. Further, we had revolver or delayed draw fundings and add-ons to 29 existing portfolio companies totaling $12.7 million. During the quarter, we received five full payoffs totaling $20.3 million.

We also incurred normal course paydowns and partial syndications totaling $10.1 million. Outside of a small syndication we had no sales of portfolio investments this quarter. At March 31, 2023 we had total borrowings of $332.8 million including $202.8 million outstanding under our floating rate revolving credit facility and $130 million of our 4.75% fixed rate 2026 notes. Total borrowings outstanding decreased nominally during the quarter. The revolving credit facility had $52.2 million of availability as of March 31 2023 subject to borrowing base capacity. Now turning to our financial results for the quarter ended March 31, 2023. Adjusted net investment income a non-GAAP measure was $6.9 million or $0.32 per share this quarter compared to $5.6 million or $0.26 per share in the prior quarter.

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 million which decreased slightly from the $225 million in net asset value as of December 31, 2022. Our net asset value per share decreased slightly from $10.39 per share as of December 31st to $10.29 per share as of March 31st.

The 1% decrease was substantially the result of net mark-to-market unrealized losses of a couple of specific portfolio companies during the period, partially offset by our net investment income outperformance of our dividend. I will now turn it over to Alex who will provide more details on our first quarter operating performance.

Alex Parmacek: Thank you, Mick. Looking to our statement of operations, total investment income was $16.8 million during the first quarter of 2023, up from $15.2 million in the fourth quarter of 2022. During the quarter, we continued to see the impact of interest rate increases on our investment income. At March 31st, the effective yield on our debt and preferred equity portfolio was 11.6%, up from 11% at December 31st. SOFR rates continued to increase in the first quarter of the year with one month SOFR rising from 436 basis points at the end of 2022 to 480 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 increased net investment income.

At March 31, 2023, we had three investments on non-accrual status, representing 0.4% of the portfolio at fair market value compared to four investments on non-accrual status, which represented 0.5% of the portfolio at fair market value at December 31st. 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 first quarter we placed no additional borrowers on non-accrual status. Moving over to the expense side. Total expenses slightly increased to $10.2 million in the first quarter of 2023 from $9.6 million in the fourth quarter 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.

Our net loss for the first quarter was $3.3 million, compared to net losses of $1 million for the quarter ended December 31, 2022. Net realized and unrealized losses on investments were $3.5 million for the quarter. The net losses during the quarter were primarily attributable to fundamental performance of a couple of specific portfolio companies. These losses were partially offset by $0.2 million 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 31st, the SLF had investments in 59 different borrowers aggregating to $178.2 million at fair value with a weighted average interest rate of 10.3%. The SLF’s 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 four basis points during the quarter from 93.49% of amortized costs as of December to 93.45% of amortized costs as of March 31st. Additionally SLF realized on its previously recorded unrealized loss on CBC Restaurant Corp. during the quarter. As of March 31st, SLF had no investments on non-accrual status. 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 $115.7 million and $59.3 million of available capacity 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.

Ted Koenig : 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 purposely defensive portfolio composition and experienced investment team will allow us to take advantage in 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. Further, our effective yield and our predominantly first 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 billion in assets under management, provides 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. I’m going to ask the operator to open up the call now for questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] And your first question comes from the line of Sean-Paul Adams with Raymond James. Please go ahead.

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

Operator: [Operator Instructions] Your next question comes from the line of Bryce Rowe with B. Riley. Please go ahead.

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

Ted Koenig : 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 quarterly call. So thanks. And have a good day.

Operator: This concludes today’s conference call. You may now disconnect your lines.