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Operator
Welcome to Monroe Capital Corporation's third quarter 2023 earnings conference call. Before we begin, I would like to take the 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, assumption, and projection, as of today, November 9, 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 risk, uncertainty, or other factors, including but not limited to the risk factor described from time to time in a 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, the call over to Ted Koenig, Chief Executive Officer of Monroe Capital Corporation. Please go ahead.
Ted Koenig
Good morning, and thank you to everyone who has joined our earnings call today. I am here with Mick Salamini, our CFO and Chief Investment Officer, and Alex Parmasek, our Deputy Portfolio Manager. Last evening, we issued our third quarter 2023 earnings press release and filed our 10-Q with the SEC. I am pleased to report that for the 14th consecutive quarter, our adjusted net investment income in the quarter covered our dividend. Our adjusted net investment income was $5.5 million, or $0.25 per share, compared to $6.1 million, or $0.28 per share, last quarter. We also reported NAV of $207.6 million, or $9.58 per share, as of September 30th, 2023, compared to $2.13 million, or $9.84 per share as of June 30th, 2023. The decline in NAV was primarily attributable to net unrealized losses on the portfolio, attributable to a few specific portfolio companies that were affected by idiosyncratic factors, as well as a decrease in value at SLF, which was driven by unrealized mark-to-market losses. the value of the remaining portfolio increased modestly. During the quarter, MRCC's debt-to-equity leverage increased from 1.54 times debt-to-equity to 1.60 times debt-to-equity. The increase in leverage was primarily driven by the aforementioned decrease in NAV. Before I turn the call over to Mick and Alex, I would like to share some insight to the economic environment and current market. In the face of an uncertain economic outlook, it continues to be an exciting time to deploy capital in direct lending where there are consistently attractive risk-adjusted returns. Direct lenders such as Monroe Capital remain the preferred solution to middle market companies seeking financing with an emphasis on providing a higher certainty of execution on new transactions and demonstrating ongoing support for portfolio companies. The volatile macroeconomic environment has resulted in lower New Deal activity than in prior years. Yet our new investment pipeline remains robust heading into the fourth quarter. This includes a steady flow of lower risk incumbency lending opportunities, which relate to add-on financings, which has allowed us to maintain highly selective approach when assessing and underwriting new investment opportunities. In order for the Fed to manage inflation, the interest rate environment will likely be higher for longer. Given GDP expansion, job growth statistics, and wage inflation, we see no signs of interest rate cuts on the horizon. At the same time, private equity and other middle market investors are facing heightened pressure to deploy dry powder and LP capital. This has led to an uptick in M&A and loan activity despite the higher cost of financing as direct lending volumes in the sponsored middle market increased 12% in the third quarter relative to the second quarter per refinitive. These dynamics provide compelling tailwinds to the private credit direct lenders as transactions being completed at lower leverage levels, more conservative attachment points, and with historically higher equity contributions. We believe this trend will continue in this fourth quarter and into 2024. We remain focused on capitalizing on these attractive market fundamentals and the growing opportunity set within private credit. Throughout 2023, the economy has shown more resiliency than many had anticipated. In turn, we have seen solid overall financial performance across our borrowers, and our portfolio maintains a healthy average mark of nearly 97% as of the end of the quarter. Our portfolio companies have demonstrated strong top-line growth with continued EBITDA growth, although at a slightly lower margin. Our companies continue to adapt their business models to combat the lingering impacts of inflation, and have begun to realize those benefits. The portfolio's overall interest coverage remains sound, with sufficient cushion to weather an extended period of elevated interest rates and potentially a more challenging economic environment. Looking ahead, we anticipate that some combination of an economic slowdown, a higher for long-term interest rate environment, heightened volatility in the capital markets, and geopolitical uncertainty around the globe seems inevitable. Companies are facing higher borrowing costs against a potential challenging economic environment. In addition to leaning on our defensive and diversified portfolio construct, we continue to emphasize our portfolio management and focus on capital preservation. We believe that our defensive portfolio is well positioned to navigate a potentially prolonged economic downturn, We have nominal exposure to highly cyclical industries, and our portfolio is predominantly comprised of first-lane senior secured loans and conservative loan-to-value attachment points. Our portfolio's modest average loan-to-value and portfolio company leverage provides comfort given the meaningful equity value cushions below our debt. Complementing the portfolio's risk-averse composition is our deep and highly experienced portfolio management team. Our portfolio team continues to actively monitor real-time performance and cash flows at our portfolio companies while regularly engaging with the management teams to stay informed on key operating and industry trends. Our portfolio management playbook, which has been time-tested over the course of nearly two decades, allow us to identify challenges early and to proactively develop strategies to maximize our outcomes. We believe that the portfolio stands to benefit from Tailwind's In the private credit and lower middle market segment, MRCC enjoys a strong strategic advantage in being affiliated with the best-in-class middle market private credit asset management firm with nearly $18 billion in assets under management and approximately 240 employees with over 100 dedicated investment professionals as of September 30, 2023. We continue to focus on generating adjusted net investment income that meets or exceeds our dividend and restoring the portfolio to positive long-term NAV performance. I am now going to turn the call over to Mick, who will walk through our financial results in greater detail.
Mick Salamini
Thank you, Ted. As of September 30th, 2023, our investment portfolio totaled $518.3 million. an increase of $2.9 million from $515.4 million as of June 30th, 2023. At the end of the quarter, our investment portfolio consisted of debt and equity investments in 99 portfolio companies, unchanged from the end of the prior quarter. During the quarter, we made an investment in one new portfolio company, funding $2 million at an effective interest rate of 12.6%. We also made a nominal equity investment in this new portfolio company. Further, we had revolver or delayed draw fundings and add-ons to existing portfolio companies totaling $10.7 million. We received one full payoff for a nominal amount and incurred normal course paydowns totaling $6.7 million. At the end of the third quarter, we had total borrowings of $331.1 million, including $201.1 million outstanding under our floating rate revolving credit facility, and $130 million of our 4.75 percent fixed rate 2026 notes. Total borrowings outstanding increased nominally during the quarter. The revolving credit facility had $53.9 million of availability, subject to borrowing-based capacity. Now, turning to our financial results, adjusted net investment income, a non-GAAP measure, was $5.5 million, or 25 cents per share this quarter, compared to $6.1 million, or 28 cents per share in the prior quarter. Our weighted average portfolio effective yield increased from 12.2 percent as of June 30th to 12.5 percent as of September 30th. The positive effect from this increase in portfolio yield on adjusted net investment income was offset by a $1 million reversal of previously accrued fee income associated with our former loan investment in IT Global Holdings, a loan that was fully paid off in 2022. This incremental fee income was to be paid in conjunction with a future liquidity event of the company. However, unforeseen circumstances resulted in the company filing for Chapter 11 prior to a sale where we would have monetized that fee income. We have $512,000 of remaining accrued fee income from IT Global, and we are actively monitoring the bankruptcy process to assess the likelihood of recovery for this exposure. Excluding this one-time reversal of previously accrued fee income, our investment income increased by $300,000 from last quarter. Further, adjusted net investment income would have been 29 cents per share up from 28 cents per share last quarter due to an increase in portfolio yield driven by rising interest rates. At this level, our dividend coverage would have been nearly 1.2 times. When considering current leverage levels, The interest rate environment and 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 the current 25 cent per share quarterly dividend, all things being equal, all other things being equal. As of September 30th, 2023, our net asset value was $207.6 million, which decreased from $213.2 million of NAV as of June 30th, 2023. And our corresponding net asset value per share decreased by 26 cents from $9.84 per share to $9.58 per share. The decline in net asset value this quarter was a result of net unrealized losses attributable to a few specific portfolio companies that were affected by market conditions and various idiosyncratic factors. The balance of the decrease to net asset value was the result of net mark-to-market unrealized losses that negatively impacted the value of SLF. I will now turn the call over to Alex, who will provide more details on our third quarter operating performance.
Ted
Thank you, Mick. Looking to our statement of operations, total investment income totaled $15.6 million during the third quarter of 2023, down from $16.3 million in the second quarter of 2023. As Mick mentioned, excluding the reversal of the $1 million of previously accrued fee income related to the former IT global investment, investment income increased by $300,000 compared to the last quarter due to a higher average portfolio yield driven by the rising interest rate environment. While the rising interest rate environment will 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. Fee income and prepayment gains were not significant contributors to investment income over the last two quarters. As of September 30, 2023, we had four investments on non-accrual status, representing 1.2% of the portfolio fair market value, a slight decrease from 1.3 percent of the portfolio at fair market value as of June 30th, 2023. In the third quarter, we did not place any new investments on non-accrual. Now, shifting over to the expense side, total expenses slightly decreased from $10.2 million in the third quarter of 2023, from $10.4 million in the second quarter. The $200,000 decrease in expenses during the quarter was primarily driven by a decrease in incentive fees from lower net investment income and a decrease in excise taxes. These decreases were partially offset by an increase in interest and other debt financing expenses driven by rising interest rates. Our net loss for the third quarter of 2023 was $5.7 million, compared to a net loss of $10.3 million for the second quarter of 2023. Net realized and unrealized losses on investments were $5.7 million for the quarter. This net loss on investments was primarily attributable to unrealized mark-to-market losses of a few specific portfolio companies and the slight decline in valuation of our SLS investment. As of September 30th, the SLS had investments in 53 different borrowers, aggregating to 148.2% million dollars of fair value with a weighted average interest rate of 10.9%. 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 the MRCC's portfolio, which is focused on lower middle market companies. In the quarter, the SLF portfolio decreased in value by approximately 2.1% from 91.5% of amortized costs as of June 30th to 89.4 percent of amortized costs as of September 30th. Consistent with the prior quarter, MRCC received income distributions from SLF of $900,000. As of September 30th, 2023, the SLF had borrowings under its non-recourse credit facility of $107.9 million and $2.1 million of available capacity subject to borrowing base availability. At this point, I will turn the call back to Mick for some closing remarks before we open up the line for any questions.
Mick Salamini
Thank you, Alex. To conclude, we remain confident in the overall quality of the portfolio and its ability to navigate prospective economic headwinds. Portfolio management remains top of mind, and we continue to actively engage with our portfolio companies and their management teams, especially in this volatile environment. While we are mindful of the potential challenges that may lie ahead, Fired similar periods of volatility have created some of the very best vintages in private credit. Further, our average effective yield of approximately 12.5% on our predominantly first-link portfolio pertains well for the remainder of 2023 and into 2024. MRCC continues to deliver stable and consistent dividends for our shareholders. We have a long-standing dividend track record, and as Ted highlighted earlier, This quarter marked the 14th consecutive quarter where our net investment income has met or exceeded our dividend. Our dividend yield is at an attractive 14.3 percent as of November 7, 2023. We believe that Monroe Capital Corporation, which is affiliated with an award-winning, best-in-class external private credit manager with nearly $18 billion in assets under management, provides a very attractive investment opportunity to our shareholders and to other investors. Thank you all for your time today, and that concludes our prepared remarks. I am now going to ask the operator to open up the call for questions.
Operator
Thank you. The floor is now open for your questions. To ask a question this time, please press star, then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Our first question comes from the line of Christopher Nolan with Leidenberg Talent. Your line is open.
Christopher Nolan
Hey, guys. On the SLF, given the decline in valuations, I know 2% is only small, but if it continues to decline, do the provisions of the SLF require you and your partner to, JV partner, to put in more capital?
Mick Salamini
The provisions of the JV agreement do not require us to put in new capital, and at this point we don't anticipate that any capital will be required for the vehicle.
Christopher Nolan
Gotcha. And then on the question of leverage, and by the way, congratulations on the asset quality. I mean, holding the line on that, and I think a lot of the efforts that you guys put in the past in terms of addressing those has really paid off. But going forward, given the uncertain environment that you guys outlined, should we view leverage as being one of those things that, as you get more cautious about the asset quality environment, that we could see leverage going down in the BDC?
Mick Salamini
That's a really good question, Chris. Our leverage at the end of the third quarter was, as we pointed out, 1.6 times increased slightly, you know, quarter over quarter. We have slightly higher debt levels associated with a slight increase in portfolio size and in conjunction with, you know, the decline in NAV. We're comfortable at today's leverage level and would guide you towards that in the near term. We feel comfortable around our leverage levels given, you know, the first lean weight of our portfolio. and our average mark of nearly 97 cents and our portfolio risk rating distribution, which didn't change over the course of the quarter.
Christopher Nolan
Okay. Final question. The fair value marks that you do in your portfolio, how has the rise in short-term interest rates affected those marks? I'm specifically thinking about discount rates on DCFs.
Mick Salamini
Yeah, it's a really good question, Chris. And as you know, we mark every one of our portfolio names with third-party marks on a quarterly basis. Discount rates have gone up. That has affected the yield calculations when we do our fair market value calculations. The impact this quarter was relatively flat as we looked at our portfolio companies, which have, you know, considerable enterprise value coverage cushion in that context.
Chris
Okay, thanks, Mick. That's it for me. Thanks, Chris.
Operator
Next question comes from the line of Robert Dodd with Raymond James. Your line is open. Hi, guys.
Robert Dodd
On IT Global, and thank you for the clarity on that, on the remaining income, I think you said 512 previously accrued fee income, what's the... What do you think the timeframe is where you'll be able to evaluate whether that should be reversed or kept? I mean, is that likely to be a one-quarter event, or could it be prolonged given there's a bankruptcy file?
Mick Salamini
Yeah, thank you for that question, Chris. I think we'll have more clarity around this IT global receivable in the fourth quarter. It could slip into the first quarter. But just as way of background, this was a loan that was about $14.4 million in MRCC. The loan was made in 2018, was repaid in full in 2022. The loan exclusive of that fee event had an IRR of around 12.4% and a MOAC of around 1.35 times. That incremental fee had to do with a future liquidity event related to the sale of the company. The company that the future fee event was related to filed for Chapter 11 in the third quarter when a significant tax liability kind of got in the way of a sale process, and hence the company filed for Chapter 11. So, we are monitoring that process to see what the results of the emergence from the proceeding might be, and that will influence pursuant to a waterfall analysis, the ultimate treatment of that, roughly $500,000 saleable. Got it. Thank you for that.
Robert Dodd
Then on the credit quality, obviously, a $4.00 stable versus Q3, so congratulations on that. I mean, you talked about the markdowns in the quarter being a couple or a handful of – of idiosyncratic issues with companies. I mean, can you give us any more, I mean, was that just operational issues? Was that something completely out of left field unrelated to operations? I mean, can you give us any color? Because obviously if it's operations that are beginning to underperform, that's a little bit more concerning than if it's just some wild card event of some sort. So can you give us any color on, yeah.
Mick Salamini
Yeah, good question. Good question, Robert. So as we look at the unrealized loss change quarter over quarter, and we look at kind of the idiosyncratic factors that have affected it, in one case, the idiosyncratic event was really factors outside the control of the management team, and the management team had to And the management team is in the process of kind of reacting to that and re-adopting their business model to it. And in the case of the other matter that was the subject of an idiosyncratic event, it was really kind of the same setup. It was an external event that really kind of impacted the company. A company took and is taking kind of quick charge of the situation to make sure that it can, you know, adapt its plan to kind of deal with that situation. So, you know, that kind of explains the idiosyncratic events that impacted a couple of names during the course of the quarter.
Ted
Yeah, and Robert, to your point, I mean, not so much focused on the actual operations of the business, as Mick noted, very much kind of factors either unforeseen or not, but outside of the nuts and bolts of the operation. Got it. Thank you.
Chris
That's it for me. Thank you, Robert.
Operator
There are no further questions at this time. Mr. Soleimani, I turn the call back over to you.
Mick Salamini
Thank you, operator, and thank you for everyone for joining us this morning. We look forward to speaking with you again next quarter.
Operator
This concludes today's conference call. You may now disconnect.
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