MONROE CAPITAL Corp Q2 FY2023 earnings call

• Economic backdrop: Uncertain economic backdrop, elevated interest rates, and volatility in bank and syndicated capital markets make direct lenders like Monroe Capital consistent. Direct lenders accounted for 85% of new LBO financing activity in Q2 2023. M&A activity was low due to cost of capital and valuations, but transaction activity picked up in the latter part of Q2 and into Q3, especially in the lower middle market.
• Company performance: In H1 2023, Monroe Capital funded nearly $1.4 billion, a slight increase over H1 2022. Adjusted net investment income was $6.1 million or $0.28 per share in Q2 2023, covering dividend by 1.12x. NAV decreased due to net losses on defensive realizations in 2 portfolio companies. Debt-to-equity leverage increased from 1.49x to 1.54x. Focus on lending to companies with resilient business models, defendable market positions, etc. Affiliated with a best-in-class middle market private credit asset management firm with $17.2 billion in assets under management as of June 30, 2023.
• Portfolio management: Actively monitoring portfolio company cash flows, engaging with management teams. Emphasizing defensive positioning of portfolio, with sound interest coverage and meaningful equity value cushions. Loan underwriting focus on specific types of companies.

Adjusted net investment income was $6.1 million or $0.28 per share in the second quarter of 2023, representing a 12% year-over-year increase. NAV was $213.2 million or $9.84 per share as of June 30, 2023, down from $223 million or $10.29 per share as of March 31, 2023. The investment portfolio totaled $515.4 million as of June 30, 2023, a decrease of $16.7 million from $532.1 million as of March 31, 2023. During the quarter, $6.3 million was funded into 3 new portfolio companies at a weighted average effective interest rate of 11.9%, $11 million was used for revolver or delayed draw fundings and add-ons to existing portfolio companies, $12.2 million was received from 2 full payoffs, and $14.4 million was incurred in normal course paydowns. Average portfolio yield increased from 11.6% as of March 31 to 12.2% as of June 30. The SLF had investments in 56 different borrowers aggregating to $168.2 million at fair market value with a weighted average interest rate of 10.7%, and its portfolio value decreased from 93.5% of amortized costs at March 31 to 91.5% as of June 30.

• Continue to focus on maintaining the quality of the portfolio while being value-add partners to borrowers. Aim to generate adjusted net investment income that meets or exceeds dividend and restore positive long-term NAV performance. Expect adjusted net investment income on a run rate basis to cover current $0.25 per share quarterly dividend all other things meaningful. Will capitalize on opportunities to add attractive, higher-yielding assets as older legacy assets repay.

• Economic uncertainty: Uncertainty in economy, Fed's interest rate increase makes economic slowdown more probable. Companies face higher borrowing costs and inflationary pressures. Certain consumer-facing business models face challenges.
• Market volatility: Impact on realizations of investments, such as net losses on defensive realizations in some portfolio companies. SLF portfolio value volatility due to mark-to-market adjustments on certain names.

Q: What was the driver for the decline in the SLF fair value?

A: So the decline in the value in SLF was largely due to mark-to-market adjustments on a handful of names. As you know, 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 dropped it downward during the course of the quarter.

Q: MRCC's external manager has acquired another BDC focused in technology space with an emphasis on health care technology. Do we actually start seeing MRCC's investment book start seeing more health care-related investments?

A: Good question. MRCC gets the benefit of everything that the external manager, Monroe Capital does. And Mick and Alex are the PMs for MRCC. And to the extent they believe that there's 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 a leverage and from a cash flow standpoint, EBITDA. So when there is 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.