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Monroe Capital Corp (MRCC 1.21%)
Q3 2020 Earnings Call
Nov 6, 2020, 2:00 p.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Ladies and gentlemen, thank you for standing by, and welcome to the Monroe Capital Corporation's Third Quarter 2020 Earnings Conference Call. Before we begin, I would 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 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 predictions as of today, November 5, 2020, 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, uncertainties 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 over to Ted Koenig, Chief Executive Officer of Monroe Capital Corporation. Please go ahead, sir.
Theodore L. Koenig -- President and Chief Executive Officer
Good afternoon, and thank you to everyone who has joined us on our call today. Welcome to our third quarter 2020 earnings conference call. I am joined by Aaron Peck, our CFO and Chief Investment Officer. Last evening, we issued our third quarter 2020 earnings press release and filed our 10-Q with the SEC. First and foremost, we hope you and your families remain healthy and safe. We are pleased that, despite the continued economic and public health challenges associated with the ongoing COVID-19 pandemic, we were able to generate a very good quarter of solid net investment income and increased NAV performance, again, during the third quarter of 2020. The continued uncertainty associated with COVID-19 pandemic has created concerns related to the economy as well as specific unanticipated challenges for many companies due to business interruptions and a slowdown in business activity. This market volatility caused by this uncertainty was most pronounced in March and through the early part of the summer, but has moderated and mostly reversed itself into the fall. This can be seen in the performance of a couple of key market metrics.
After being down as much as 30% for the year in late March, the S&P 500 index has seen a significant recovery and, as of the end of the third quarter, was up approximately 4% for the year. Price increases were also seen in traded credit investments as the S&P/LSTA Leveraged Loan Index, which finished the first quarter down approximately 14% in market value after being down as much as 22% in March, has rebounded considerably and, as of the end of the third quarter, was down less than 2% on the year. The reduction -- the recent reduction in credit spreads has benefited our portfolio marks, which has contributed to significant improvement in our per share NAV over this period, including a 4.4% increase in the third quarter. As we discussed on last quarter's call, we have been shifting our portfolios over the recent past and all of the Monroe funds away from higher risk cyclical industries. As a result, MRCC has limited to no direct material portfolio exposure in industries most affected by the pandemic, such as airlines, automobile, travel, leisure, oil and gas, minerals and mining and energy. However, the best thing about our portfolio is that we are typically a control lender. We are the agents on approximately 82% of our loan investments. We have good loan documentation with tight baskets regarding indebtedness and restricted payments, with no collateral leakage potential. We have at least 2, and often several more, financial covenants on most all of our deals, including maintenance and incurrence tests and leverage.
This allows us to be proactively engaged with our borrowers and their financial sponsors in terms of liquidity. It also allows us to opportunistically amend and reprice our loans to constantly rerisk our portfolio. In past calls, we have discussed the importance of tighter loan documentation in the lower middle market that we play in. In the larger broad middle market, almost 80% of all loans are covenant-light. In our market, we are dialoguing with our companies weekly and sometimes on a daily basis. This allows us to manage risk and do many things to enhance our risk and return positions. Our risk was also mitigated by the fact that we maintain conservative starting leverage and loan to values when we underwrite our loans off in the neighborhood of 50% loan-to-value. Turning now to third quarter results. We are pleased to report that in this challenging environment, we generated adjusted net investment income of $0.27 per share. While this was a decrease from adjusted net investment income of $0.62 per share in the second quarter, prior quarter performance was primarily the result of a onetime receipt of proceeds related to the Rockdale Blackhawk proceedings. Without Rockdale, our adjusted net investment income would have been approximately $0.26 per share in the second quarter, lower than the $0.27 per share we generated in the third quarter. 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 $15.2 million or $0.71 per share during the quarter, which was driven primarily by the increase in the fair value of our investment portfolio during the quarter. As a result, our NAV on a per share basis grew from $10.37 per share at June 30 to $10.83 per share at the end of the third quarter, continuing our trend of increasing NAV per share in the last two consecutive quarter end periods. Net increases in the fair value of investments contributed approximately $0.49 per share to our book value growth during the quarter or 4.7% on a per share basis. We estimate that of the $0.49 per share increase in book value attributable to changes in portfolio valuations, approximately $0.30 per share was primarily as a result of the tightening of credit spreads during the period, unrelated to individual credit performance. During the quarter, LCD first-lien three-year discounted loan spreads tightened by approximately 130 basis points after tightening approximately 365 basis points in the prior quarter. Of that $0.30 per share of NAV increase primarily attributable to spread tightening, approximately $0.21 per share or 70% was attributable to assets held directly by us, while $0.09 per share or 30% was as a result of net markups on assets held in the MRCC Senior Loan Fund joint venture. The loans in the joint venture tend to be larger middle market companies, and those loans experienced higher price volatility in times of market correction. During the quarter, we also experienced an increase in book value of approximately $0.19 per share attributable to recovery in the valuation of specific portfolio companies, which had previously been marked down due to specific credit performance, a significant portion of which was as a result of the impact of the COVID-19 pandemic on these borrowers. During the quarter, we reduced MRCC's regulatory debt-to-equity leverage from 1.16 times debt-to-equity to 0.09 -- 0.9 times, much below the level of regulatory leverage we reported at the end of the first quarter of 1.47 times.
This significant decline in leverage was primarily driven by strong repayment activity as well as the increase in the fair value of our portfolio during the quarter. We continue to focus on managing our investment portfolio at the appropriate risk-adjusted leverage level going forward and are targeting regulatory leverage in the range of 1.1 to 1.2 times debt to equity. Given the substantial pipeline of new deals at Monroe, we would expect to increase leverage at MRCC carefully over the next few quarters in order to reach our leverage target, which should benefit adjusted net income in future periods. The Monroe Capital organization has over 125 employees, with many devoted to underwriting, risk management and workout strategies. During periods like this, we have brought the very best resources to bear on the portfolio. As many of you know, we have a long track record of success in managing through difficult economic environments, notably the great financial crisis in 2008 and 2009, including select workout transactions with borrowers. If need be, we are not afraid to take over and own a business. While that is not our preferred option, we know how to do it and have done it successfully in the past. If necessary, we will roll up our sleeves and do what we need to do in order to achieve the best possible recovery. The important thing is we have the ability, experience and internal resources to do that, if needed. The results of this process are ongoing and are evidenced in the improvement in book value we experienced during the third quarter. As we look ahead, there continues to be a high bar for investing capital during these uncertain times. We are seeing many attractive opportunities to invest capital today, and we have adequate liquidity to take advantage of these opportunities, including $156 million of availability on our ING-led revolving credit facility, subject to borrowing base capacity. Aaron will discuss more about that later.
Our focus for the balance of the year and into early next year will be to slightly increase leverage levels and to make new investments in portfolio companies with compelling risk return dynamics, just as we have done at Monroe in the years following the last economic downturn in 2010 and 2011. We are now very well positioned to do this. Investment spreads are wider today than they were prior to the start of the pandemic, and terms and leverage have improved as well. And we have the liquidity to take advantage of these improved market conditions. MRCC enjoys a strong strategic advantage in being affiliated with a best-in-class middle market private credit asset management firm, with over $9 billion in assets under management and over 125 employees as of October 2020. We will continue to focus on generating adjusted net investment income and positive NAV performance, just as we have shown in the last two consecutive quarters.
I am now going to turn the call over to Aaron, who is going to walk you through our financial results.
Aaron Peck -- Managing Director, Portfolio Manager-BDCs and Co-Head, Opportunistic Credit
Thank you, Ted. During the quarter, we funded a total of $15 million in investments, which consisted of new fundings to existing borrowers. This modest portfolio growth was offset by sales and repayments on portfolio assets, which aggregated $68.4 million during the quarter. At September 30, we had total borrowings of $323 million, including $99 million outstanding under our revolving credit facility, $109 million of our 2023 notes and SBA debentures payable of $115 million. Our outstandings under our revolver decreased by approximately $47 million during the quarter, as we continue to reduce our leverage during the period. It is important to note that our significant reduction in leverage over the last two quarters was primarily as a result of paydowns and payoffs of performing credits, in addition to the significant positive settlement related to the Rockdale Blackhawk matter in the second quarter. We achieved a significant deleveraging of our portfolio without a significant sale of assets or having to recognize losses on dispositions, thereby avoiding any realized losses, which was our plan that we articulated earlier this year. We are well situated to carefully grow our portfolio through participating in the substantial pipeline of opportunities generated at Monroe.
Any future portfolio growth, revolver draws or advances to existing borrowers will predominantly be funded by the $156 million of availability under our ING-led revolving credit facility, subject to borrowing base capacity, and the uninvested cash held in our SBIC subsidiary. Turning to our results. For the quarter ended September 30, adjusted net investment income, a non-GAAP measure, was $5.8 million or $0.27 per share, a decrease from the prior quarter's adjusted net investment income of $12.8 million or $0.62 per share. Last quarter's results were positively impacted by a onetime recognition of previously accrued interest and fees received on Rockdale Blackhawk of $0.36 per share, which was previously recorded as part of our mark-to-market gain on our investment in Rockdale. Without last quarter's income associated with Rockdale, adjusted net investment income would have been approximately $0.26 per share, which is $0.01 per share lower than the adjusted per share NII realized this quarter. Incentive fees were again fully limited during the quarter as a result of the total return limitation in our shareholder-friendly advisory agreement. LIBOR rates fell slightly during the period and three-month LIBOR, as an example, fell from approximately 30 basis points as of June 30 to 23 basis points as of September 30. We maintain LIBOR floors in nearly all of our deals, with the majority of our floors at a level of at least 1%. As of September 30, our net asset value was $230.7 million, which was up approximately 4.6% from the $220.6 million in net asset value as of June 30. Our NAV per share increased from $10.37 per share at June 30 to $10.83 per share as of September 30.
As Ted already discussed in his earlier remarks, the increase in our per share NAV was primarily as a result of unrealized mark-to-market valuation adjustments in the portfolio related to general tightening of credit spreads during the quarter and some specific positive mark-to-market adjustments on certain names in the portfolio that have been impacted directly by COVID-19 and marked down in previous quarters. Looking to our statement of operations. Total investment income decreased during the quarter primarily as a result of a decrease in interest income due to the previous quarter recognition of onetime interest in fees on the Rockdale matter. This decrease was partially offset by an increase in dividend income from the SLF during the period. Without the prior quarter beneficial impact of Rockdale, normal course investment income increased slightly during the period. During the quarter, we placed two additional positions on nonaccrual status. Total nonaccruals now approximately -- approximate 5.2% of the portfolio at fair value, which compares to 4.7% as of June 30. The increase in nonaccruals at fair market value is primarily as a result of the decline in the size of the investment portfolio during the period due to repayments. Moving over to the expense side. Total expenses for the quarter decreased primarily driven by the reduction in interest and other debt financing expenses in the quarter due to lower average debt outstanding.
At the end of the quarter, our regulatory leverage was approximately 0.9 debt-to-equity, a further decrease from the regulatory leverage of nearly 1.16 at the end of the prior quarter and down from 1.47 times at the end of the first quarter. The decrease in regulatory leverage is as a result of positive fair market value adjustments in our portfolio as well as the $47 million in net pay downs on our revolving credit facility during the period. The current level of regulatory leverage is below the targeted leverage range we have guided you to on prior calls. We are currently comfortably in compliance with the SEC asset coverage limit -- ratio limitation and significantly below our previously discussed target regulatory leverage level of 1.2 to 1.3 times debt to equity. As Ted discussed in his prior remarks, we would expect to grow our portfolio at a measured pace and slightly increase our regulatory leverage over the next several quarters. As of September 30, the SLF had investments in 59 different borrowers, aggregating $207 million at fair value, with a weighted average interest rate of approximately 5.8%. The SLF had borrowings under its noncourse -- nonrecourse credit facility of $142.1 million and $27.9 million of available capacity under this credit facility, subject to borrowing base availability. We do not expect to significantly grow the assets held in the SLF at this time, and the SLF continues to be in compliance with all covenants in its credit facility. As discussed earlier, the loans held in the SLF saw significant unrealized mark-to-market increases during the period as a result of market spread tightening.
I will now turn the call back to Ted for some closing remarks before we open the line for questions.
Theodore L. Koenig -- President and Chief Executive Officer
Thank you, Aaron. In closing, we find ourselves in an unprecedented economic environment. At the same time, we see unique opportunities in the market to utilize our proprietary sourcing channels to create differentiated risk-adjusted returns for our shareholders. Our overall Monroe Capital platform is experienced -- experiencing its largest pipeline of high-quality investment opportunities in almost a year. As a result, we are excited about our investment portfolio and our prospects, similar to what we saw in the substantial growth of our firm after the Great Recession of '08 and '09. The key is our conservative underwriting, a purposeful defensive portfolio and our access to a large and experienced portfolio management team, with experience managing through multiple economic cycles. We have a defensively positioned portfolio with solid loan documentation and a lot of control over our own destiny in terms of risk management. As such, we continue to believe that Monroe Capital Corporation provides a very attractive investment opportunity to our shareholders. Our dividend is fully covered by net investment income, and we have sufficient liquidity to now play offense in this market. We are committed to navigating successfully through this economic period, and we are confident that we have the skills and experience necessary to maximize returns for all of our lending partners, bondholders, JV partners and shareholders.
We believe that MRCC is affiliated with the best-in-class external manager, which has decades of experience, over 125 highly skilled employees and more than $9 billion in assets under management, which provides us the infrastructure and stability in times like these, which is important. It also provides us an opportunity for MRCC to outperform. We would like to thank our shareholders for their loyalty and confidence. We would also like to thank the entire team at the Monroe Capital organization for their hard work and dedication.
Thank you for all of your time today, and this concludes our prepared remarks. I am going to ask the operator to open the call now for questions.
Questions and Answers:
Operator
[Operator Instructions] And there are no questions in queue at this time.
Theodore L. Koenig -- President and Chief Executive Officer
Okay. Thank you, everyone, for joining the call today. We appreciate your continued support, and we look forward to speaking to you again in our next call. Like we say each quarter, to the extent anybody has any questions or any thoughts they would like to ask, please do not hesitate to call Aaron directly or me. Thank you.
Operator
[Operator Closing Remarks]
Duration: 23 minutes
Call participants:
Theodore L. Koenig -- President and Chief Executive Officer
Aaron Peck -- Managing Director, Portfolio Manager-BDCs and Co-Head, Opportunistic Credit
