MidCap Financial Investment Corporation

Good morning and welcome to the earnings conference call for the period ended March 31st, 2024 for MidCap Financial Investment Corporation. At this time, all participants have been placed in listen-only mode. The call will be open for a question and answer session following the speaker's prepared remarks. If you would like to ask a question at that time, simply press star 1 on your telephone keypad. If you would like to withdraw your question, Press star 2. I will now turn the call over to Elizabeth Thessen, Investor Relations Manager for MidCamp Financial Investment Corporation. Please go ahead.

Elizabeth Thessen Thank you, Operator, and thank you, everyone, for joining us today. Speaking on today's call are Tanner Powell, Chief Executive Officer, Ted McNulty, President, and Greg Hunt, Chief Financial Officer. Howard Woodruff, 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. I'd 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 a customary safe harbor disclosure in our press release regarding forward-looking information. Today's conference call and webcast may include forward-looking statements. You should refer to our most recent SEC filings our 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 either the SEC's website at www.sec.gov or our website at www.midcapfinancialic.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. Throughout today's call, we will refer to MidCap Financial Investment Corporation as either MFIC or the BDC, and we will use MidCap Financial to refer to the lender headquartered in Bethesda, Maryland. At this time, I'd like to turn the call over to Jenner Powell, NFIC's Chief Executive Officer.

Thank you, Elizabeth, and thank you, everyone, for joining today's call. I will begin today's call with a summary of our results and will also provide our perspective on the current environment. I will then provide an update to our proposed merger with Apollo Senior Floating Rate Fund, Inc., and Apollo Tactical Income Fund, Inc. Ted will then cover our investment and activity and provide an update on the investment portfolio and credit quality. Lastly, Greg will review our financial results in greater detail. Yesterday, after market closed, we reported solid results for the March quarter, which included a slight increase in net asset value per share, relatively stable credit performance, and continued de-risking of the portfolio. Net investment income per share for the March quarter was 44 cents, which corresponds to an annualized return on equity, or ROE, of 11.4%. Results for the quarter reflect solid recurring interest income from our predominantly floating rate portfolio and strong fee and prepayment income. GAAP EPS for the March quarter was $0.39. Similar to last quarter, we continue to improve the risk profile of our portfolio by reducing our exposure in Merck's, our aircraft leasing portfolio company, as well as our second lien exposure. At the end of March, corporate lending and other represented 92% of the total portfolio, of which 97% was first lien on a fair value basis, up from 96% in the last quarter. With the repayment of one of our few remaining second lien positions, our second lien and other debt exposure is now only about 0.7% of the total corporate lending portfolio. We believe MFIC has one of the most senior corporate lending portfolios among BDCs as evidenced by our weighted average attachment point of essentially zero. We believe we have constructed a corporate lending portfolio that will perform well even during a potential economic downturn. Overall, we feel good about the health and quality of our corporate lending portfolio as our underlying borrowers have largely been able to handle higher borrowing costs. We have not seen any significant signs of credit weakness across the portfolio. We are, of course, closely monitoring our portfolio and mindful of the potential impacts of a higher for longer rate environment. I would now like to provide our perspective on the current environment. Despite high interest rates, elevated inflation, and geopolitical uncertainty, the U.S. economy has proven to be resilient and continues to display strong growth. At the beginning of 2024, investors expected the Federal Reserve to cut rates multiple times during the year. However, as the quarter progressed, sovereign inflation has pushed out the expectation for the start of rate cuts, and the market generally believes that we are in a higher-for-longer scenario. Economists believe that there's a reasonable chance that the Fed may not cut at all in 2024, while the market is currently pricing in only one cut this year. Specific to the lending market, during the first quarter, there has been an increase in activity in the syndicated loan market. MFIC is focused on the middle market, which is less susceptible to competition from the syndicated loan market. Although spreads in our market have decreased, the decline has been less than what we've observed in liquid loan markets. Spreads in our market are still healthy by historical standards, and we continue to believe risk return in the middle market remains compelling. In our market today, a typical deal would price with a spread of around 500 to 550 basis points. As you know, MFIC is squarely focused on the core middle market. MidCap Financial, which was founded in 2009, has a long track record, which includes closing on approximately $114 billion of lending commitments since 2013. Its origination track record provides us with a very large data set of middle market company financial information across all industries, and we believe makes MidCap Financial one of the most informed and experienced middle market lenders in the market. Apollo's affiliation with MidCap Financial is a significant competitive advantage for MFIC. In short, we believe the core middle market offers attractive investment opportunities across cycles and does not compete directly with either the broadly syndicated loan market or the high-yield market. Next, let's turn to the dividend. Our approach to dividends seeks to provide shareholders with an attractive current yield while also retaining some earnings for NAF stability and growth. To that end, our Board of Directors declared a dividend of $0.38 per share, consistent with our prior quarter dividend to shareholders of record as of June 11, 2024, payable on June 27, 2024. A 38-cent dividend represents an annualized yield of approximately 9.9 percent based on NAV per share as of March 31st. Our dividend continues to be well covered by net investment income. Before handling the call over to Ted, I would like to provide a brief update on MFIC's proposed mergers with AFT and AIF. We remain excited about these proposed mergers, and we believe that their consummation, which is subject to receipt of certain stockholder approvals and satisfaction of other customary closing conditions, will create a stronger combined company. We look forward to realizing the potential benefits of a larger combined company, including enhanced returns for all stockholders, greater scale, and enhanced portfolio diversification after closing. As a reminder, if one or both of these mergers close, MFIC will pay a one-time cash dividend of 20 cents per share to all stockholders following the closing. The exact record date for this dividend will be determined by MFIC's Board of Directors based on the timing of the closing. We filed a definitive joint proxy statement slash prospectus related to the mergers on April 4th, and the special meetings for the stockholders of all three funds to vote on the merger proposals have been scheduled for May 28th. We have officially commenced the proxy solicitation process related to these proposals, and we kindly request that any stockholders of MFIC, AFT, or AIF who have not yet cast their votes on these proposals do so in the coming days. Please note that we will not be able to answer any questions related to the current vote count on today's call. With that, I will turn the call over to Ted.

Thank you, Tanner. Good morning, everyone. Beginning with investment activity, as a reminder, MFIC is focused on investing in loans sourced by MidCap Financial, which provides MFIC with a large pipeline of investment opportunities. MidCap Financial is a leading middle market lender with one of the largest direct lending teams in the U.S. with close to 200 investment professionals. On last quarter's call, we mentioned we were seeing a noticeable pickup in pipeline activity. We're pleased to report that this has led to a strong level of closings during the March quarter. MidCap Financial was active during the March quarter, closing approximately $5.1 billion in new commitments, an increase of approximately 31% from the December quarter. During the March quarter, MFIC's new investment commitments totaled $149 million of new first lien commitments across 16 different borrowers for an average new commitment of $9.3 million as we continue to focus on diversification by borrower. 38% of new commitments were made to existing portfolio companies. Although we are seeing some pricing compression in the market, the weighted average spread of our new commitments in the quarter was relatively unchanged at 624 basis points, one basis point lower than commitments made during the December quarter. The weighted average OID for new commitments was approximately 211 basis points. The spread in OID translates into a very attractive unlevered asset yield of around 12%, assuming a 5% base rate. The weighted average net leverage of new commitments was 3.9 times. We believe the risk return on these new commitments is very compelling. Our pipeline of investment opportunities remains strong. In terms of funded investment activity, gross fundings for the corporate lending portfolio, excluding revolvers, totaled $129 million. Sales and repayments totaled $95 million. Net corporate lending revolver paydowns were $14 million, and we received a $4 million paydown from Merckx. In aggregate, net fundings for the quarter totaled $16 million. Our portfolio turnover continues to drive a positive shift in the composition of our portfolio. Sales and repayments included the exit of a $15 million second lien position, which reduced our already low second lien and other debt exposure by half to just $13.8 million, or 0.7% of the total corporate lending portfolio at fair value. We believe this negligible amount of non-first lien exposure highlights the very senior nature of our corporate lending portfolio. Turning to our investment portfolio, we have built a well-diversified senior corporate lending At the end of March, our portfolio had a fair value of $2.35 billion and was invested in 154 companies across 23 different industries. Corporate lending and other represented approximately 92% of the total portfolio, and Merck's accounted for 8% of the total portfolio on a fair value basis. The average funded corporate lending position was $14.6 million, or approximately 0.7% of the total corporate and other lending portfolio. 97% of our corporate lending portfolio was first lien, up from 96% last quarter. And over 99% of our corporate lending debt portfolio on a cost basis had one or more financial provenance. And 88% of our corporate lending portfolio is backed by financial sponsors who we know well and with whom MidCap Financial has longstanding relationships. Despite the higher for longer interest rate environment, our portfolio companies continue to exhibit strong fundamental performance and meet our expectations. On a median basis for the quarter, portfolio company revenue and EBITDA both increased by mid-single digits year over year. The growth in revenue is attributable to organic expansion, while improvements in margins are due to borrowers optimizing their cost structures. We believe the sustained positive improvement is an encouraging indicator of the portfolio's underlying strength. The weighted average yield at cost of our corporate lending portfolio was 12.1% on average for the March quarter, down slightly from 12.2% in the December quarter. At the end of March, the weighted average spread on the corporate lending portfolio was 621 basis points, down two basis points compared to the end of December. Turning to credit quality, our focus on true first lien, top of the capital structure, middle market loans has resulted in what we consider to be strong and resilient credit metrics. Given the second lien repayment I mentioned, the weighted average attachment point for our corporate lending portfolio is essentially zero, or to be more precise, 0.04 times. This metric means that there is no senior debt to our positions, illustrating that our corporate lending portfolio is indeed first lien. We believe it is key to look at this metric as not all debt labeled first lien is actually top of the capital structure, as its name would suggest. At the end of March, the weighted average net leverage of our corporate lending portfolio was 5.36 times, up from 5.27 times last quarter. Moving to interest coverage, the weighted average interest coverage ratio remained at 1.9 times unchanged, with four companies below one times. We're closely monitoring these situations and believe they are manageable, as the companies have strong current liquidity, good underlying business performance, or have strong financial sponsor support. The median EBITDA of the MFIC's corporate lending portfolio was approximately $47 million. We have not seen a meaningful increase in covenant breaches or a pickup in amendment activity. We believe our credit quality has benefited from MidCap Financial's strong sourcing and underwriting capabilities. Our underwriting on MidCap source loans has proved to be sound. Based on data since mid-2016, which is the approximate date upon which we began utilizing our co-investment order, our annualized net realized and unrealized loss rate is around two basis points on loans sourced by MidCap Financial. We think this performance data shows how well the strategy is performed. Although we added our $12 million investment in Naviga to non-accrual status during the quarter, investments on non-accrual remain very low, totaling $14.4 million, or 0.6% of the total portfolio, at fair value across three names. Naviga is currently in a sales process, and initial bids are reflected in our mark. We believe these stable credit metrics reflect the way in which we've constructed our portfolio, and it's the direct result of focus on sourcing assets from MidCap Financial, one of the leading middle market lenders. Importantly, MFIC benefits from MidCap Financial's large, dedicated portfolio management team of over 60 investment professionals, which helps identify and address issues early. It is also important to note that MidCap Financial leads and serves as administrative agent on the vast majority of our deals, which provides meaningful downside protection. As agent, we're in active dialogue with the borrower and have enhanced information flow, which allows us to be proactive in resolving problem credits. Moving on to MERCs. As discussed previously, we are focused on reducing our investment in our aircraft leasing and servicing businesses. While we don't expect paydowns to occur evenly, we believe aircraft sales and servicing income should allow for the paydown of third-party debt and MFIC's investment in MERCs over time. As of March 31, our investment in MERCs totaled approximately $190 million, representing approximately 8% of the total portfolio at fair value. During the March quarter, Merck's paid MFIC approximately $5.9 million, which included $1.9 million of interest and a $4 million return of capital. With that, I will now turn the call over to Greg to discuss our financial results in detail.

Thank you, Ted, and good morning, everyone. Beginning with our financial results, net investment income per share for the March quarter was $0.44, which reflects solid recurring interest income, as well as strong fee and prepayment income. For the quarter, prepayment income was $2.2 million and fee income was $1.7 million. Pick income remains very low, representing approximately 3% of the total investment income for the quarter. Gap net income per share for the quarter was $0.39, which reflects a $0.05 loss on our investment portfolio. Results for the quarter correspond to an annualized return on equity based on net investment income of 11.4%. and annualized ROE based on net income of 10.1%. MFIC's NAV per share at the end of March was $15.42, up one cent over the prior quarter, which reflects net investment income of 44 cents, which is six cents above the 38 cents distribution, and a five cent per share loss on the portfolio. As Ted mentioned, the vast majority of our corporate lending portfolio continues to have strong fundamental performance. Additional details on the change in unrealized gains and losses by strategy are shown on slide 17 in the earnings supplement deck. Net expenses for the quarter were $39.8 million, down $2.4 million compared to the prior quarter, primarily due to lower general administrative expenses as well as lower interest expense and lower incentive fees. We recruited a diminished amount of excise tax in March compared to approximately $1.1 million in the December quarter. The weighted average interest rate on our debt for the quarter was 7.09%, up from 6.94% last quarter, which reflects a full quarter impact of the CLO notes and the baby bonds, which both closed during the December quarter. On last quarter's call, we intend to continue to evaluate and monitor capital raising transactions going forward. Management fees totaled $4.4 million for the March quarter, essentially flat compared to the prior quarter. As a reminder, MFIC's base management fee was reduced to 1.75% on equity beginning January 1, 2023, and is one of the only listed BDZs to charge management fees on equity which we believe provides greater alignment and focus on net asset value. Incentive fees totaled $6 million for the March quarter. As a reminder, our incentive fee on income is 17.5% and includes a total return hurdle of a 12-quarter look-back. Our current estimate of undistributable taxable income or spillover income at the end of 2023 $1.03 per share. Moving to our balance sheet, MFIC's net leverage was 1.35 times at the end of March compared to 1.34 times at the end of December, reflecting $17 million of net funding during the quarter. This concludes our pair of remarks. Operator, please open the call to questions. The floor is now open for questions. If you would like to ask a question at this time, please press star 1 on your telephone keypad. Again, you may remove yourself at any time by pressing star two. Once again, to ask a question, please press star one. Our first question will come from Mark Hughes with Truist. Please go ahead.

Mark Hughes Yeah, thank you. Good morning. We've seen much in the way of competitive moves, say, given the broadly syndicated markets, a little more activity there. You've seen some lenders dip down more into the middle market and impacting spreads. And I'll maybe, along with that, I think you talked about 500 to 550 basis point spread today. Has that been relatively stable lately, or has that been moving through the quarter? How would you say it is, you know, kind of the trend there?

Tana, let me, I'll comment on that, this is Howard. the uh uh not not so immediately uh and that's really because you know obviously you you may see large sponsors that are covered by and doing larger deals occasionally get down in the middle market but in order to cover the middle market you know you need to have a comprehensive coverage effort uh which is a you know and and continuity in the market with a lot of those sponsors And so you just don't see, you know, the capability of the people who are focused on the larger market, you know, competing directly with the capabilities to sort of just step into that market, you know, holistically. It doesn't mean it doesn't happen on occasional deals. I mean, as a separate matter, there's capital being created in the middle market all the time. And then those teams may or may not have comprehensive coverage as well. So there is definitely competition that's causing compression, but it's not really the result of the broadly syndicated market. The middle market is one of the strengths of it. It's being sort of insulated from that variation.

And then any comment on the trajectory of spreads, you know, this year, if you think about where they were in January to where we are today?

Yeah, I'm happy to take that. So, yeah, Mark, I would call your attention to we alluded to the fact that deals are between 500 and 550. And in the quarter, we actually executed at 624. And that has to do with what we talk about a lot. There's a gestation period for deals getting done, and that reflects a lot of sale processes that have been commenced last year. And so, that pretty significant tightening that we see, what we are seeing is some modicum of stability. As at this juncture, post-December, where conditions improved and you saw some of the spread tightening and rally in markets more broadly, those sale processes are now at a point where we're able to create new credit assets. and our pipelines are very full. So I would say, you know, certainly the, my initial comment there reflects the tightening overall that we've seen in the middle market, but seeing some stability now that sale process have had an opportunity to run their course and the opportunity for new credit asset creation.

Yeah, thank you for that. One more in, You probably have addressed this, but I wonder if you could update us on the kind of the seniority profile. You certainly emphasize the focus on first lien. Once you do the merger with the other Apollo funds, how will that look, roughly speaking?

It will look similarly. Those funds, which is obviously publicly available, have some more broadly syndicated-type loans, but predominantly first lien. And then, Mark, as we've talked about, both in our prepared remarks in the filings as well as also our investor decks, the intention is obviously over time is as those loans mature or we can sell out of them to obviously reposition them into our core strategy of mid-cap loans, you know, first-lane floating rate loans that are sourced by the mid-cap platform. Thank you very much.

Thank you. Our next question will come from Kyle Joseph with Jefferies. Please go ahead.

Yeah, great. Thanks for taking my questions. And sorry if I missed this, but did you give a sensor proforma leverage or ballpark area post-merger?

It will be somewhere around between 1.15 and 1.2 times leverage.

OK, got it. Helpful. And I'll give a segue to my next. You know, over the last couple of years, you guys have been focused on reducing core and lowering all leverage. And now, especially with the merger, are we kind of at the point where you can think about more transitioning to kind of the offensive side, if that's fair to ask?

So, Kyle, I mean, certainly we're really excited by the prospect, should we be successful, of having an opportunity to – Did you play even more capital? Yeah, I wouldn't attach the offensive, defensive valence to it per se because, you know, our strategy, you know, since we got the ability to go up in leverage has been, you know, 100% focused on sourcing or, sorry, participating in or investing in loans that are originated at mid-cap. And so our approach doesn't change. I think this is just a very elegant opportunity to do even more of it and to kind of create the, you know, an even bigger percentage of the portfolio with those source loans.

Got it. Very helpful. And then one follow-up for me, probably Greg, just where we are on rates. I'm not going to ask you to predict where rates are going to go, but just how you're thinking about the right side of the balance sheet in the mix between floating rate and fixed rate liabilities. And that's it for me. Thanks, guys. Okay.

I mean, I think that, you know, from our point of view, we do have, you know, our $350 million 10-year note coming due in March of 25, which is fixed rate. I do think, you know, we did our baby bond on which was fixed rate, and we, you know, didn't swap it because we have a two-year call option on it. I do think that as we go out, we'll match our liabilities with our assets.

Great. Thanks for taking my question.

As a reminder, if you would like to ask a question, please press star 1 at this time. Our next question will come up. Our next question will come from Robert Dodd with Brandon James. Please go ahead.

Robert Dodd Morning. Credit quality obviously looks really good, right? I mean, picks not going up and always getting paid down, et cetera. Have you seen or heard any initial increased discussion from sponsors? I mean, it was five months ago, it looks like there were going to be six cuts and sponsors could afford to sit on their hands, so to speak, and wait and maybe interest coverage. that's still above one, but moving might resolve itself. But with the possibility of no cuts, but the high interest costs are going to live longer in the portfolio. Has there been any change in what sponsors are doing proactively and said no increasing amendment requests yet is are there any preliminary discussions there or any color you can give on on what the analog is given it looks like rates are going to stay extremely high for quite a long longer at this point yeah yeah uh happy to take that so there's a couple things going on one you know over the

I would say economic environment over the last few years, the sponsors and the companies have focused on really becoming more efficient so that they could prepare for a longer-term hold if necessary. And then as you alluded to, when there was a view that there were going to be five rate cuts, people got excited about doing M&A. With the prospect of rates cuts going away, I think we can at least kind of fall back from a fundamental performance standpoint that the companies are doing well. And then secondly, if you think about the technicals of the private equity market, you still have a lot of dry powder that needs to be put to work. You still have a number of sponsors that need to return capital in order to be able to raise their next fund. so that's going to drive uh that's going to drive transactions and you know there's going to be a period of time like any time that there is volatility and um you know rate expectations or market valuations uh for the bid asks to come together and so i think that's happening and then you know that that'll take a little bit of time to play out and then the third thing that we're seeing is more and more continuation vehicles where sponsors have companies within their funds and they need to hold on to those longer to really realize the multiples that they're looking for. And then I guess finally, The last thing I would say is that in terms of discussions with sponsors about other alternatives, there are some early conversations around extensions and repricings where they're coming back and saying, we thought we were going to monetize this year, but we're going to look to next year. They're not at the point in their fund where they need to do a continuation vehicle or they don't feel the pressure. to return capital. And so there are very constructive discussions around the lending groups, extending the maturity, and addressing the overall structure. So I would say those are kind of the four dynamics at play.

Really helpful. Thank you. I mean, quick follow-up to that one. Does a continuation vehicle constitute a change in control and the mandatory refinancing? Does that get you refinanced out or is it automatic that you get ported across to the vehicle with the existing load?

It is typical that that would be a change of control, but it's also typical in the direct lending space that you don't just show up one day at your desk and get a notice that it's going to happen. There's an ongoing dialogue about what the strategy is, what the financing is going to be, and there's some visibility around the sponsor will come and say, hey, do you want to support this going forward? And sometimes we say yes, and sometimes we say no, at which point they launch a financing process that aligns with their continuation vehicle.

Got it. Thank you. And then one more, if I can, hypothetically, the mergers close sometime in the not-too-distant future. Has the the something with changing the competitive environment at their BSL, et cetera, has that changed your plan about how fast you would churn the assets within those acquired vehicles if they were to close?

Thanks, Robert. I think I would say No, I think that you should rely on us or expect us to always be evaluating risk reward in the context of the market environment, what makes sense. And then furthermore, as you know, faced with, you know, as we think about investing, we're always cognizant of vintage and wanting to do things with a measured approach. And that would be the same if, hypothetically, these were to close. And so, if we are confronting an environment such as what we do today, we would be evaluating the market in a similar fashion and evaluating risk-reward. And our intention has always been to not take outsized exposure to any one particular vintage and would expect to conduct ourselves in a similar manner should the mergers be successful.

Got it. Thank you. Thank you. We show no further questions at this time. I would like to turn the call back to management for 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 with any other questions and have a good day.

This does conclude today's call. We thank you for your participation. You may disconnect your line at this time and have a wonderful day.