Monroe Capital Corporation (MRCC) on Q1 2021 Results - Earnings Call Transcript
Operator: Welcome to Monroe Capital Corporation's First Quarter 2021 Earnings Conference Call. Before we begin, I would like to take a moment to remind our listeners the remarks made during this call today may contain certain forward-looking statements, including statements regarding our goals, strategies, beliefs, future potential operating results or cash flows, particularly in light of the COVID-19 pandemic. Although we believe these statements are reasonable based on management's estimates assumptions and projections as of today, May 5, 2021. 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 risk, 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.
Theodore Koenig: Good morning, and thank you to everyone who has joined us on our call today. Welcome to our first quarter 2021 earnings conference call. I am joined by Aaron Peck, our CFO and Chief Investment Officer. Last evening, we issued our first quarter 2021 earnings press release and filed our 10-Q with the SEC. We are pleased to report another strong quarter of solid net investment income and increased NAV performance for the first quarter of 2021. During the first quarter, the financial markets remained strong and loan markets continued to strengthen. This can be seen in the performance of a couple of key market indicators. For first quarter of 2021, the S&P index was up nearly 6% and after ending 2020, up over 15%. Price increases were also seen in traded credit investments as the S&P/LSTA Leveraged loan index was up 1.6% during the first quarter. The continued reduction in credit spreads has benefited all portfolio marks, which has contributed to an improvement in our per share NAV since the first quarter of 2020, including another increase in the first quarter of 2021. Turning now to the first quarter results. We are pleased to report adjusted net investment income of $0.25 per share, flat compared to the first quarter results. Aaron will go into more detail regarding the components of our net investment income later in the call. We also reported a net increase in assets resulting from operations of $7.1 million or $0.33 per share during the quarter, which was driven primarily by the increase in fair value of our investment portfolio, partially offset by realized losses on the extinguishment of debt associated with the refinance of our baby bonds and the prepayment of a portion of our SBA debentures, all of which are accretive to our shareholders. As a result, our NAV on a per share basis grew from $11 at December 31 to $11.08 per share at the end of the first quarter. This represents the fourth consecutive quarter of growth in NAV per share post COVID, which has increased by over 10% since the end of the first quarter of 2020. During the quarter, MRCC's regulatory debt-to-equity leverage decreased from 1.0x debt-to-equity to 0.9x. This decrease in leverage was primarily driven by heavy prepayment activity during the first quarter much of which occurred near the end of the quarter. New origination activity remains strong, and we expect to continue to increase leverage over the next few quarters, partially offset by continuing strong prepayment velocity. We continue to target regulatory leverage in the range of 1.1x to 1.2x debt-to-equity in the near term. Given the substantial pipeline of new deals in a row, we would expect to increase the leverage in MRCC carefully over the next few quarters in order to reach our near-term leverage target, which should benefit adjusted net investment income in future periods.
Aaron Peck: Thank you, Ted. During the quarter, we funded a total of approximately $43.7 million in investments, which consisted of $21.7 million in fundings to 5 new portfolio companies and $22 million of revolver and delayed draw fundings to existing portfolio companies. This solid portfolio growth was offset by sales and repayments on portfolio assets, which aggregated $75.8 million during the quarter. At March 31, we had total borrowings of $309.8 million, including $92.9 million outstanding under our revolving credit facility, $130 million of our new 2026 notes and $86.9 million of SBA debentures payable. Total borrowings outstanding decreased by $40.8 million during the quarter. Our outstanding balance under our revolver decreased by approximately $33.7 million, and we repaid $28.1 million in SBA debentures during the quarter. These decreases were partially offset by the $21 million increase in our unsecured bond balance.
Theodore Koenig: Thank you, Aaron. In closing, we continue to benefit from the resiliency of the financial markets and the strong proprietary origination network at Monroe to create differentiated risk-adjusted returns for our shareholders. Our overall Monroe Capital platform continues to maintain a very strong pipeline of high-quality investment opportunities for all funds that grow, including MRCC. And as a result, we are excited about our investment portfolio activity and our prospects. The key is our underwriting, a purposeful defensive portfolio and access to a large and experienced portfolio management team with experience managing through multiple economic cycles. As such, we continue to believe Monroe Capital Corporation provides a very attractive investment opportunity to our shareholders. Our dividend remains fully covered by net investment income, and we have sufficient liquidity to continue to grow our portfolio to reach our targeted leverage. We believe that MRCC is affiliated with an award-winning best-in-class external manager, which has decades of experience, over 130 highly skilled employees and approximately $10 billion in assets under management. Thank you all for your time today. And this concludes our prepared remarks. I'm going to ask the operator to open up the call now for questions.
Operator: . Your first question comes from the line of Mr. Christopher Nolan from Ladenburg Thalmann.
Christopher Nolan: In your discussions with your portfolio companies, are you hearing any discussion in terms of higher economic inflation?
Theodore Koenig: Good question, Chris. There's a lot of discussion right now. About that. I think we're going to see some wage inflation in the coming quarters, and we're also going to see some raw materials and supplies inflation. Everything that we're seeing where importing is involved. The process raw materials are up. Steel is up. I mean, steel is 2, 3x what it was. A couple of years ago. So I think it's going to happen, particularly on the wages and raw materials.
Christopher Nolan: Okay. And then on that, how would you guys position your capital structure any anticipation of higher inflation less - would there be less reliance on the facility? Or what were you thinking around that?
Theodore Koenig: We've got - and I'm going to let Aaron speak to it, too, but we've got a number of different levers that we can pull. We've got obviously our ING credit facility. We've got - we just refinanced some baby bonds down. We've got the SBA for leverage. So we're going to - depending upon what actually happens, several years ago, we went long in baby bonds, and we're trying to protect our balance sheet. And as it turned out, it was the right thing to do philosophically. But economically, we probably would have better off increasing the size of our ING credit facility. And taking advantage of the low rates that we've had for longer. So we're going to be very thoughtful, I think, at this time and looking at using all 3 of our levers to create capital structure stability?
Aaron Peck: I'll just add, Chris, we're pretty well set up to benefit from rising rates. Should we see that in the future because our book is almost entirely floating and while there are some LIBOR floors, so for some portion of the move, we won't benefit on the portfolio side. Over the long haul, we should benefit because we have some fixed rate debt as well as the floating rate debt with ING. So net-net, I think we're well set up for that.
Operator: Your next question comes from the line of Sarkis Sherbetchyan from B. Riley Securities.
Sarkis Sherbetchyan: This is Sarkis from B. Riley. You talked about gradual growth in the portfolio in your comments. Can you maybe speak to the cadence of the origination activity, especially in light of the level of significant prepayments and repayments we're seeing?
Theodore Koenig: Yes. Aaron, why don't you handle that one?
Aaron Peck: Sure. Good question, Sarkis. So the - as you know, Monroe manages close to $10 billion in assets. We have a very large origination group, over 20 people, full-time originators there's significant opportunities for the BDC to benefit from good origination. Our pipeline remains very, very strong. And so I think there's definitely some heavy prepayment activity as well. And I think it's a little bit hard to predict exactly what's going to prepay and when it's going to prepay, and we're trying to manage the growth without knowing what's going out the back door. It's a constant discussion point that we always talk about, which is it's very hard to know how much to put in when you don't know how much is going out. And so we're trying very hard to be thoughtful about how we add to assets in the portfolio. But we really don't have any concerns about our ability to get to our targeted leverage point. I think it's just a matter of how quickly we can get there. And we're still sort of evaluating that. But the biggest wildcard continues to be what goes out the back door and prepayments. And we don't have a good method to really predict that. It tends to be unpredictable. And so we're just trying to be as aggressive as we can in terms of making sure we stay invested in good assets that we originate and try to get the leverage up to a better point, which would help on the NII side.
Sarkis Sherbetchyan: And maybe to dive a bit deeper on the prepay side. I appreciate that it's unpredictable. I suppose, quarter-to-date here in 2Q anything different versus 1Q? Do you expect kind of a similar level or cadence? Or do you expect it to kind of start to normalize as we get into maybe the midpoint or the second half of this year? Any color there would be helpful.
Aaron Peck: Again, it's pretty difficult to guess. And the way that it typically works is we definitely see a larger amount of repayment near the end of the quarter. A lot of our competitors are trying to hit numbers on a quarterly basis so that they get aggressive. And they try to get things closed and rush things into the end of the quarter. So we sometimes get surprised at things that sort of show up right near the end. But - so it's difficult to predict the cadence of prepayment and what I can tell you is it was a very aggressive fourth quarter and first quarter in terms of activity and a lot of what was prepayable. And in other words, a lot of the deals that we had in the portfolio that we're looking to do something strategic or were refinanceable. A lot of that activity happened. And so my guess would be that we'll see it temper a little bit, but it's very difficult to predict.
Theodore Koenig: Yes. I mean, consistent with Aaron's comments, Sarkis. I think that fourth quarter and first quarter were active quarters in terms of repayments. I don't - from where I see it right now, I think that the cadence will slow down a little bit and we'll get to more of a normalized period here over the next couple of quarters.
Sarkis Sherbetchyan: Great. And then just one more for me. Maybe if you could talk to the size of the pipeline you're seeing on the platform overall. And maybe if you can also speak to any significant changes in terms of deal terms or structures that you're seeing evolve as we kind of head to the midpoint of this year?
Theodore Koenig: I'll talk about pipeline and a little bit on structure and let Aaron follow-up. We're seeing - today, I think we've got about $800 million across the firm pipeline. Last pipeline report I saw. Now not all of that is going to close, things come up in diligence, things come up in transactions, but we think we'll close a substantial amount of it over the next 90 days, give or take. So pipeline is about the same as it was in Q4 for us. It tends to build up early in the year and then towards once we get into kind of the end of the Q2, it tends to go down and build up again in Q3. So I think that's - we're in a normal cadence on that. From a structure standpoint, the market is competitive like it always has been. Our benefit is proprietary relationships, proprietary deal sourcing is driving a lot of what we're doing. We're seeing more aggressive leverage in COVID friendly deals, I would tell you, and probably less aggressive leverage in COVID unfriendly deals. Now that we've had a period of time to really look at COVID and look at industries, we've seen software, technology, cloud, services, distribution, e-commerce, those industries tended to do well during COVID. So what's happening is that private equity firms and lenders are being more aggressive in structure. In those areas and areas that given to as well in-person type of health care, retail, I think we're seeing a little bit of less aggressive terms in those areas.
Aaron Peck: Yes. The only thing I would add, Ted, is just to remind Sarkis and others, look, we've been doing this a really long time in Monroe. We have seen multiple cycles and so we've maintained our discipline in our deal structures because we know that structure is important to deal with trouble. And there are some other folks in the market who are maybe a little bit newer at this and haven't seen as a group protracted declines or major economic cycles, this has been a pretty big expansion cycle other than the blip for COVID. And so we're maintaining our discipline. We think that's key to long-term success. And we think it's the right way to underwrite, particularly in the lower part of the middle market.
Operator: Your next question comes from the line of Mr. Robert Dodd from Raymond James.
Robert Dodd: On credit quality, if I can focus on questions, nonaccruals - focus of the question is not accruals but nonaccruals first. Broadly, it looks like stress elsewhere in the portfolio, except at the Monaco, has gone down, clearly meaningfully. I mean my . And of course, it dropped precipitously this quarter versus that quarter. So can you give us any - is there anything that's not on nonaccruals, but you are too worried about? Or is it just the non explicitly stressed assets are just performing meaningfully better now?
Theodore Koenig: Yes. I'll start, Robert, and then let Aaron dive in here. I think your perception is a good one. We feel good about our portfolio. The non nonaccruals. The portfolio continues to improve as we've kind of rotated out of COVID. I think we've done a good job as a firm in managing the assets, but also in underwriting, portfolio management, and I think that overall, the portfolio has done well. That's on the non nonaccruals. And the nonaccruals, a lot of these companies are the same companies that we had non-accruals earlier, and we're diving in. So most of this has been COVID related. We have 520 companies across the firm in Monroe and a fraction of that in MRCC, but we had some industries that got hit, whether it was dental care, whether it was retail, whether it was - we had a restaurant deal we've done a pretty good job, I will tell you, in managing those assets, and we've got a number of strategies in place to create realizations in those strategies. And unfortunately, those don't always happen quickly. Some of these are longer term strategies, multi quarters. Some are - will go into 2022. But all in all, we feel pretty good about what we've done to take these nonaccrual assets and point them in the right direction. Hopefully, over the next couple of quarters, you'll start to see some of that as the work we did last year comes to fruition this year. So Aaron, I don't know if you want to make any other comment?
Aaron Peck: No. I mean, I think that was really well said, Ted. I mean, I think the answer, Robert, is, look, we worry all the time about everything because that's our job as lenders. And so we worry about the whole portfolio every day because if you don't worry about an asset, that becomes your next difficult asset. But I echo what Ted said. All of our names, almost all of our names are looking better, even the difficult deals, even the nonaccrual deals. Other than one or two that we're spending a lot of our energies on everything seems to be performing better than it did in the past. And so we're hopeful and confident that we're going to see continued benefits over the long-term from the work we're doing on the portfolio side.
Robert Dodd: Got it. Got it. And just a kind of follow-up on the non car. I mean, when I look at the fair value the cost of the nonaccrual assets, I mean, they're marked at about 37% of cost. If my math is right, that is obviously, lower than your historic recoveries on troubled assets. Obviously, there's a lot that goes to valuing an asset. It's not just about the recovery. But what's your confidence level that your realizations, when they happen, and to your point, sometimes that takes a lot, are going to be higher than 37% or 3 the current market or the right mark? Or are they conservatively marked by...
Theodore Koenig: I mean, that's another good question, Robert. The good news is you're jumping and you're hammering on the right things here. Historically, we've done better. It's no secret. Our recoveries have been very, very strong as a firm, and that's one of the ways we've created alpha. Unfortunately, in the business we're in, we don't get any extra points for valuing things higher at a point in our third-party valuation firms don't get any points for valuing things higher from time to time. So what we've tried to be, if you look at kind of the history here of Monroe, and you've been following us for a long time. We've tried to be as transparent as we possibly can with our marks. We try to take marks and not create any false sense of security. We try to be very, very serious when we create marks. And we consistently try to overachieve and generate higher recoveries. And if you look at our history over the last 8 years, 9 years, that's what you've seen. So we're hopeful that our third parties have done a good job in marking the portfolio. We work with them very closely. But at the end of the day, just because something is marked to $0.37, I will tell you that our portfolio team and our credit team doesn't view that as the high bar. Those - in their views, those are the low bars, and they're incented at Monroe to create recoveries far in excess of that. So all we can do is each one of those assets are separate assets, individual stories that we have individual strategies for and I can tell you that I've been involved in many of these in many of the meetings, and I like a lot of what we're doing in terms of the strategies. We've done some joint ventures with some parties. We've sometimes acquired some businesses. We've increased revenues. We've created more diverse portfolios. We've done joint ventures with strategic consultants. We've done lots of different things in these nonaccrual assets to not only build businesses, but diversify businesses, create new areas of revenue, bring in new management. It's a very hands-on business. We've got a number of people in the firm. Their only responsibility is portfolio management improvement. And we made an investment we've got 8 or 9 people in the firm that, that's their sole responsibility is basically taking those nonaccrual or those assets and creating value for us because we view that as a value creation opportunity, no different than a new deal.
Aaron Peck: I would just add to what Ted said.
Theodore Koenig: Go ahead.
Aaron Peck: I was just going to add one thing, which is and Ted hit on it right. We didn't hire a bunch of bank workout folks to work on our difficult deals, and there's nothing wrong with bank workout folks, but it's a different mindset. A lot of our team are equity investors. And when we - what Ted said is right, 37% of par is not our goal. And frankly, for some of these deals, par isn't the goal. The goal is maximum value. And when you have people on your team who know how to maximize value in equity transactions and some of these become equity transactions, there's a possibility to make a return, in many cases, in excess of par, just like we did at Rockdale. So we're not capping our potential return because the way you make money in this business is you take your shots when you have a chance to make more than par to make up for the ones that you may lose some money and not get a par recovery.
Operator: There are no further questions at this time. You may continue, sir.
Theodore Koenig: Thank you all for joining us today. We look forward to speaking to you again soon. And as always, if you have any individual questions or anything specific, please feel free to reach out to either Aaron or me, and we'd be happy to speak to you. But until our next meeting, enjoy the rest of the quarter. Thank you.
Operator: This concludes today's conference call. Thank you for participating. You may now disconnect.
