MidCap Financial Investment Corporation (MFIC) Q1 2022 Earnings Report, Transcript and Summary

Good afternoon, and welcome to Apollo Investment Corporation’s Earnings Conference Call for the Period Ended June 30, 2021. At this time, all participants have been placed in a listen-only mode. The call will be opened for a question-and-answer session following the speakers’ prepared remarks. [Operator Instructions] I’ll now turn the call over to Elizabeth Besen, Investor Relations Manager for Apollo Investment Corporation.

Thank you, operator, and thank you everyone for joining us today. Speaking on today’s call are Howard Widra, Chief Executive Officer; Tanner Powell, President and Chief Investment Officer; and Greg Hunt, Chief Financial Officer. I’d like to advise everyone that today’s call and webcast are being recorded. Please note that they are the property of Apollo 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 earnings press release. I’d also like to call your attention to the 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 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 our website at www.apolloic.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. At this time, I’d like to turn the call over to our Chief Executive Officer, Howard Widra.

Thanks Elizabeth. Good afternoon, and thank you everyone for joining us today. I'll begin today's call by providing an update on our ongoing progress, repositioning the portfolio, followed by a review of our results for the quarter. Following my remarks, Tanner will discuss the market environment, review our investment activity for the quarter and provide an update on credit quality. Greg will then review our financial results in greater detail. We will then open the call to questions. During today’s call, we will be referring to some of the slides in our investor presentation, which is posted on our website. Beginning with an update on our portfolio repositioning, we continue to make good progress increasing our exposure to first lien floating rate corporate loans, while reducing our exposure to junior capital and non-core positions. From a volume standpoint, the Apollo Direct Origination platform was very active closing 4.6 billion in new commitments during the June quarter. AINV’s new investment commitments were strong, totaling $332 million all-in first lien floating rate loans. We believe we have constructed a granular and diversified portfolio of high quality senior corporate loans. We believe Merx has successfully navigated this challenging period, and we expect AINV will be able to generate higher revenue from Merx in the coming quarters. We also continue to make progress reducing our exposure to non-core and junior capital investments. Repayments during the quarter included the exit to second lien investments, as well as a small partial pay down from one of our shipping investments. We remain focused on reducing our exposure to the remaining non-core assets, while ensuring an optimal outcome for our shareholders. Moving to financial results, we delivered solid results for the quarter. Net investment income for the June quarter was $0.39. We ended the quarter with net asset value per share of $16.02, up 14% or 0.9%. The increase was driven by our corporate lending portfolio, which continues to perform well. The investment portfolio grew modestly, as solid fundings were mostly offset by prepayment activity. Gross fundings for the quarter were $230 million, excluding revolvers fundings, while net fundings totaled $29 million. Net leverage increased to 1.39 times at the end of June, up from of 1.36 times last quarter and slightly below our target leverage range of 1.4 times to 1.6 times. As we look ahead, we are confident in our ability to grow our portfolio and operate within our target leverage range, given the tremendous need for creative and flexible private capital and the unique and robust nature of the Apollo mid cap platform. With that said, as Tanner will discuss later, the current market environment is very competitive, and we will continue to focus on first lien assets and will remain disciplined in our credit selection process. Turning to our distribution. For the quarter, the board has declared a base distribution of $0.31 per share, and a supplemental distribution of $0.05 per share. Both distributions are payable on October 8, 2021 to shareholders of record as of September 21, 2021. With that, I'll turn the call over to Tanner to discuss the market environment and our investments decision.

Thanks, Howard. Beginning with the market environment, the US economy continues to recover on the back of more back vaccinations, supportive fiscal and monetary policy, high stock prices and tight credit spreads and significant excess savings in the household sector in the corporate sector. Daily data for travel credit card usage and restaurant bookings continue to approach or exceed pre pandemic level. While there may be a slower reopening in some parts of the country, the ongoing improvements in GDP, employment and earnings are likely to continue. The reopening of the economy has been associated with a significant spike in inflation as prices of cars, fly and dining other services have recovered, we generally believe that the growth backdrop will serve as an offset to the inflationary pressures that our portfolio companies. Based on the data from LCD, new issue loan volume in the June quarter was $145.8 billion, the second highest quarterly total in the last four years. Amid strong supply, the market continues to see strong demand from both CLOs and retail investors. Secondary loan prices also continued to move higher. Specific to our business, the middle market lending environment has generally returned to pre-pandemic conditions due to several factors including, a growing number of private credit providers, a strong syndicated loan market, and a strong economic backdrop, all of which have contributed to the return of borrower friendly pricing in terms. Private Equity M&A activity is robust as sponsors continue to deploy capital. As a result of the favorable conditions, more companies, including the upper end of the middle market are seeking syndicated solutions. Moving to AINV’s investment activity. New corporate lending commitments for the quarter total $332 million across 24 companies for an average new commitment of $13.8 million. By strategy, 82% of new commitments were leveraged lending, 12% were life sciences and 6% were asset-based. Consistent with our strategy, all these new commitments were first lien floating rate loans, with a weighted average spread of 620 basis points and a weighted average net leverage of 5.2 times. All of these new commitments include LIBOR floors at 92% were made pursuant to our co investment order. Gross fundings for the quarter totaled $230 million, excluding revolvers and Merx. Due to the strength in the overall market, repayments were also strong, totaling 189 million, excluding revolvers and Merx. The strength in the loan market has enabled us to continue to reduce our exposure to second liens. During the quarter repayments included $57 million from the exit of two second lien positions, and over the past four quarters second lien repayments have totaled $133 million. We also receive $4 million repayment during the quarter from MC, one of our shipping investments from the sale of one of its vessels. Net repayments for the -- for revolvers totaled $12 million. In total, net fundings were $29 million. Moving to Merx and beginning with the overall market. We are optimistic that the demand for air travel will continue to improve with the ongoing rollout of the vaccine and the lifting of travel restrictions. Additionally, we expect to see -- we expect the aircraft leasing market will continue to be an important and growing percentage of the world fleet, as airlines will need to increasingly look to third party balance sheet to finance their operating assets. As the aircraft sector continues to recover, we have seen a notable pickup in sale leaseback transactions and in the ABS market, an important source to financing for aircraft lessors. Specific to our investment, we believe Merx has successfully navigated this challenging period. The level of lease revenue generated from our fleet has stabilized. We have worked through our exposure to airlines that have undergone restructurings. We've been able to remarket aircraft during this period with long term leases or sales. Our current lease maturity schedule is well staggered. Additionally, Merx continues to benefit from a growing servicing business, which has increased in value over time. We believe Merx's portfolio compares favorably to other lessors in terms of asset, geography, age, maturity, and lessee diversification. Merx's portfolio skewed towards the most widely used air -- types of aircraft, which means demand for Merx's fleet is anticipated to be resilient. Merx's fleet primarily consists of narrowbody aircraft serving, both U.S. and foreign markets. At the end of June, Merx's own portfolio consisted of 78 aircraft, 10 aircraft types, 39 lessees in 25 countries with an average aircraft age of 11.5 years, and an average lease maturity of 4.3 years. Merx's fleet includes 75 narrowbody aircraft, two widebody aircraft and one stryder. The Apollo aviation platform will continue to seek to opportunistically deploy capital. To be clear, Merx is focused on its existing portfolio and is not seeking to materially grow its own balance sheet portfolio. However, growth in the overall Apollo aviation platform will nurture the benefit of Merx as the exclusive servicer for aircraft owned by other polyflon. Turning to the overall AINV portfolio. Our investment portfolio had a fair value of $2.49 billion at the end of June across 140 companies in 25 different industries. We ended the quarter with core assets representing 92% of the portfolio and noncore assets representing 8%. First lien assets represented 90% of the corporate lending portfolio, up from 87% last quarter. At the end of June, the weighted average spread on the corporate lending portfolio was 616 basis points. As a reminder, the weighted average LIBOR floor on our floating rate assets is approximately 1% well above today's current LIBOR. The weighted average net leverage of our corporate lending portfolio declined to 5.22 times from -- down from 5.34 times last quarter. The weighted average attachment point declined to 0.4 times, down from 0.6 times last quarter. The decline in these metrics, both for the quarter and over the past few years reflects the continued improvement in the credit quality of the portfolio. Investments made to our co-investment order represented 81% of the corporate lending portfolio at the end of the quarter. Amendment activity remained modest this quarter with no material amendments. No investments were played on -- were placed on or removed from nonaccrual status during the quarter. At the end of June, investments on nonaccrual status represented $27 million or 1.1% of the portfolio at fair value. With that, I will now turn the call over to Greg, who will discuss the financial performance for the quarter.

Thank you, Tanner. Beginning with AINV's statement of operations. Total investment income was $50.5 million for the quarter, reflecting lower interest income, partially offset by higher prepayment and fee income. The quarter-over-quarter decline in interest income was attributable to the pace of the investment activity and a relatively higher yield on repayments versus fundings. Fee income was $1.1 million, up from $700,000 last quarter. Prepayment income was $4 million, up from $3.3 million last quarter. Dividend income was essentially flat for the quarter. The weighted average yield at cost on our corporate lending portfolio was 7.7% at the end of June, down from 7.8% last quarter. Expenses for the quarter were $25.2 million, essentially flat quarter over quarter and there was no incentive fee paid during the quarter. Net investment income per share for the quarter was $0.39. That leverage at the end of June was 1.39 times up from 1.36 times at the end of March. On page 16 in the earnings supplement, we disclose the net gain or loss by strategy over the past six quarters. As Howard mentioned, our corporate lending portfolio continues to perform well. During the quarter our corporate lending portfolio had a gain of $6 million or $0.09 per share. Merx had a slight loss of $1.2 million or $0.02 per share, and our non core and legacy assets had a net gain of $2 million or $0.03 per share. The net gain on non-core and legacy included a $9.8 million gain on carbon free, a legacy investment partially offset by losses on oil and gas and shipping. As a reminder, our investment in carbon free consists of investment in the company's proprietary carbon capture technologies and an investment in the company's chemical plant. Carbon free is benefiting from the strong interest in carbon capture utilization and storage. The increase in valuation is a result of a recent third party capital raise at carbon free. NAV per share at the end of June was $16.02 or $0.14 or 9.9% increase quarter over quarter, the $0.14 increase was attributable to $0.10 cents of net share gain on the portfolio and net investment income per share of $0.03. Regarding liquidity, given the continued improvement in the quality of our investment portfolio, our liquidity position continues to strengthen both quarter end in July, we issued $125 million up 4.5% unsecured notes due on July 26. Despite the dilutive impact of these notes, we believe it was prudent to diversify and extend the maturity of our funding sources. In addition, we're pleased to call affirmed our investment grade rating and revise the outlook to stable from negative in July. Regarding stock buybacks during the quarter AINV purchased 145,500 shares at an average price of $13.92 for a total cost of $2 million. From July 1 -- this is first quarter to August 4, 2021, we purchased an additional 44,000 shares at an average price of $13.46 for a total cost of $600,000, leaving approximately 24 million authorization for future purchases under the Board's current authorization. And before opening the call to questions, we wanted to briefly remind everyone. Given the total return hurdle feature in our fee structure and the recovery in our portfolio over the last several quarters, we expect to begin to pay a partial incentive fee in the quarter ending September, 2021. The exact timing and amount will vary based upon -- based on future gains and losses if any, as well as the level of net investment income for the quarter. As we said on last quarters call, we believe AINV net investment income, may fluctuate over the next few quarters as we begin to pay incentive fees. That said we expect to generate higher revenue from certain investments, including Merx, which will help offset the impact from incentive fees. We remain confident in the trajectory of our earnings, and our long-term plan. As mentioned last quarter, we intend to declare a quarterly based dividend distribution of $0.31 per share, and a quarterly supplemental distribution of $0.05 per share for at least the next two quarters. To be clear, this would be an addition to the distribution declared today. This concludes our prepared remarks, operator, and please open the call to questions.

[Operator Instructions] And we will take our first question from Finian O’Shea with Wells Fargo. Please go ahead. Your line is open. Finian O’Shea: Hi, everyone. Good afternoon. Just a question, I guess for Howard on the rebound and origination outlook and so forth. Can you give us I guess, your high level thoughts on how much? A lot of this is, you know, pent-up demand versus, of course, sustainable shift in the demand for private credit?

Sure. I mean, I don't know if -- so I think, the activity has been very robust versus historical standard. So, it's hard to say that it's like a permanent shift at a higher level. That said there are some secular things that are happening that seem to suggest that it will -- it can stay elevated for some period of time. So, one is just a lot of dry powder out there for equity firms to do deals. So, that's likely to keep things elevated for one. And so -- if you combine that with the fact that there continues to be like this secular shift to the private credit market, both from the higher end deals from the syndicated market, and also continuing from what banks provide for different companies, both of those things, secular suggests that there will be more activity. That said, this is also there's also some pent up demand. So, I mean, our expectation is that activity across the industry, and I think you've seen it from a lot -- some of the other BDCs will be robust, certainly through this quarter, and we would expect it to continue in the in the near and medium term. Finian O’Shea: Very well, Thank you. Can you give -- just second question also sort of high level platform level, can you give an update on generally, the direct lending, the middle market side, that is at Apollo with MidCap and so forth at the BDC invest with us sort of, the applicable capital or sort of, fun complex that we're co-investing with at this stage.

Sure. It has been -- and we mentioned a lot of volume, a lot of transaction volume, large pipelines across the sort of the whole Apollo direct origination business and actually across a whole -- the sort of a full array of products. So, that's lender finance, that's our real estate business which we don't -- the way I -- as asset based lending. There's a lot of activity. And at the same time, there has been a good amount of capital creation at Apollo to be able to serve those clients. So, one thing we've talked about before is one of the keys to be able to execute is basically be able to speak at size for transactions of all different kinds. And so we've continued to sort of, create capital through SMAs, through some significant capital raises of MidCap on the debt and equity side and through continued allocations from some of our insurance balance sheets of these assets. So, like the sum total is a lot of growth of capital at Apollo to sort of fund these different strategies. At the same time that the market generally is demanding, more credit, which again, we talked about, could be secular, could be, sort of, cyclical probably a little bit of both. And so, we are in a benign credit environment. So, when you have a lot of growth with a good amount of capital without a lot of, sort of, without a headwind of credit problems across very many sectors, because it's just sort of the growth in a economy and liquidity. Obviously, that's a pretty favorable environment. And that's, where we are. Finian O’Shea: Very well. Appreciate the color. That's all for me. Thank you.

We'll take our next question from Kyle Joseph with Jefferies. Please go ahead. Your line is open.

Hi. Good afternoon, guys. Thanks for taking my questions. I guess, first one for Tanner really sounds like Merx, is kind of kind of out of the woods. You've talked about growing revenues AI and Big going forward. Can you give us any sort of recognizing there's a lot of uncertainty remaining, but give us a sense for the potential magnitude and also the form, whether it be dividend or interest income?

So let me just sort of take a crack at it. I mean, I think, last quarter, we talked about, sort of like, the earnings capability or the or sort of really not the earnings have those sort of the early that -- the earnings momentum of Merx. And that is in, sort of, you know, the ballpark of the, you know, the low -- the low 30 millions across the whole investment, let's put aside for a second interest or, or dividends. And right now, or over the last few quarters, that that cash flow or that income has, first of all, built up as we work through leases, but it's also been used to pay down debt to get the sort of the debt facilities back in line. And so the expectation is that, most of that will be available for distribution, because, again, right? So not going be available for building up cash. You know, right now we have $190 million, of our investment is in debt. And that pays and has been paying in the in the low fours per quarter. You know, and it is expected the rest would come through dividend income there. And so that's like, that's, that's where we are right now. Could you know, something be restructured to make it, to make more of a debt and less of an equity? Possibly, if that made sense for some other reason. But as we've sort of always said, you shouldn't view it as vastly different. You know, the income coming off Merx. In terms of you know -- it was pretty predictable. Historically, this closet glitch into it, it was steady in for that debt component part, which was contractual. But we would expect it to go from 4.5 million levels per quarter, moving towards most of the net income is producing over near-term and medium-term. I can't predict exactly. It just depends on, where we want to use the capital.

No. That's really helpful. I appreciate it. And then, in terms of credit performance, I know, non-accruals were stable. It look like, leverage came down a bit in the portfolio or recognize 2021 is the unique year in terms of comps, in terms of revenue and EBITDA growth. And I'm sure it's all over the board, depending on the company. But can you just give us a sense for, how you're evaluating portfolio company performance that you factoring in 2019 levels of performance and how you see portfolio growth evolving, as we kind of laps some of the COVID comps?

Yeah. Sure. And I assume, Kyle, you're really getting at the underlying economic fundamentals. Keep in mind that these valuations are by and large the March quarter in 2021. And so you're clearly competing against only a portion that was COVID affected. And so in that respect, you in this quarter actually had you probably the first time where sort of the rubber meets the road, in terms of really getting a feel for just the level of stabilization, because you're copying against a non-COVID quarter, right. And I think what we've seen is economic strength. We -- there is obviously a very large debate in the market, concerning, just how -- whether inflationary pressures will be transitory or not? We've certainly seen it in certain of our businesses. The way we think about that part of the equation is if we've done our job right. And we are indeed, creating risk, first lien risk at roughly 60% LTV. The hope is that, what ultimately drives the ability to repay is not going to be infringed by some inflationary pressures. And so, we're not as concerned on that side. But to your larger question, definitely seeing some fundamental strength, a lot of fundamental strength, consistent with what you hear about the broader economy. And that, our overall leverage to go down, just over $0.1 across to roughly $2 billion corporate book speaks to sort of that underlying strength and deleveraging within the portfolio due to strong economic performance.

Got it. That's really helpful answer. Thanks a lot.

[Operator Instructions] And we'll take our next question from Matt Tjaden with Raymond James. Please go ahead.

Hey, all, afternoon. I appreciate you taking my questions. First one for me, following up on Merx. Has the rise in COVID cases in the US and the Delta variant, has it slowed the recovery of Merx versus kind of where we sat maybe three months ago?

Yeah. I would say, the recovery was never going to be linear. Obviously, the Delta variant is something that everyone is looking at and scrutinizing very, very heavily. It is it is still too early to judge whether that's a meaningful change. Certainly, on the margin, people are very cognizant of it, but I wouldn't say it's changed the outlook. Yeah. We did mention that and this is not exactly to your question there, Matt. But one of the things we made mention of in the -- in our prepared remarks, one of the things that has helped the market has been the reemergence of financing markets and that's something that has contributed to the strength alongside an increase in sale leaseback activity, that's helped to provide some back into the market. So to your specific question, I think, Delta variant, it's still too early to say, we were cognizant that this was never going to be linear in any case. And that's not certainly how we’d manage the business or what we anticipated. We are encouraged by the level of sale leaseback activity and the repairing or reemergence of the financial markets and notably the ABS market as a very good sign for the industry.

Got it. That's helpful. Last one, for me, kind of a more high-level one. From the perspective of shareholder returns, how does AINV balance higher target leverage versus peers to your cost of unsecured debt currently?

How do we balance -- I'm just saying, one of the transfer questions. You're asking, how do we take on this debt at this cost, given the returns we want to generate?

Yes, sir.

Well, I will say this, we felt like this offering was very well priced for the investors, overpriced and certainly versus the relative risk of our peers. But we also felt like that there was a lot of interest announced from all our constituencies, our equity constituencies. Our equity holders asked, a lot of investors have rating agencies or senior debt holders, when are we going to issue again, and sort of like – it's sort of like a – you get, you want to get back on the train to be able to bring your cost of debt down. So what we did was a small issuance to reestablish our name. We focused very much on the quality of the investors, long-term holders, who have big appetite in the space, so they can get familiar with how the portfolio is performing in order to sort of bring down the cost to a level that is consistent with driving the ROEs we want to drive, you know, that sort of those 9% ROE. So it's a great question, probably the most apt question this quarter. You know, we felt like it was the right strategic thing to do. And it was of a bite size enough that you know, the strategic benefit and flexibility it gives us an. And by the way, also, like, you know, it's $125 million or 4.5%. It's obviously, we pay down revolver which is in the twos. So that's a financial loss. But it did – it does extend out I think Greg, 18, 20 months beyond the existing bonds, which when those get redeemed are more expensive. Obviously, that's a little ways down the road. But when you sort of look at our overall capital structure, we're focused on long-term bringing down our cost of debt, and we just thought like this step was a necessary step.

That's it for me, I appreciate the time.

That appears to be no further questions. I will now turn the call back to management for any closing remarks.

Thank you, and thanks, everybody for calling in today on behalf of all of us. We thanks for your time today and feel free to reach out to any of us, if you have any questions. Have a good day.

Thank you. And this concludes today's program. Thank you for your participation. You may disconnect at any time.