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Monroe Capital (NASDAQ:MRCC)

Q2 2014 Earnings Conference Call

August 11, 2014 02:00 PM ET

Executives

Ted Koenig - CEO

Aaron Peck - CFO and CIO

Analysts

Nikesh Rane - Lautenberg Thalmann

Bob Napoli - William Blair

Christopher Nolan - MLV & Company

Bryce Rowe - Robert W. Baird & Company

Jeff Rudner - UBS

Operator

Good morning and welcome to Monroe Capital Corporation’s Second Quarter 2014 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 goal, strategies, beliefs, future potential, operating results or cash flow. Although we believe these statements are reasonable based on management's estimates, assumptions and projections as of today August 11, 2014 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, uncertainty or other factors including but not limited to the factors described to 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. As a reminder this conference is being recorded.

I will now turn the conference over to Ted Koenig, Chief Executive Officer of Monroe Capital Corporation.

Ted Koenig

Good morning and thank you to everyone who has joined us on our earnings call today. I am joined by Aaron Peck, our Chief Financial Officer and Chief Investment Officer. Earlier today, we issued our second quarter earnings press release and filed our 10-Q with the SEC. I will first provide a brief overview of the quarter before turning the call over to Aaron to go through the results in more detail. He will then turn the call back over to me and I will update you on the current market conditions for our business. As in the past, we have provided an update of the Company’s asset growth to demonstrate the progress we have made since our IPO on October 24, 2012. As you can see in the bar graphs attached to our press release, on a par value basis, we have more than tripled the size of our investment portfolio, growing from $67.6 million at the time of our IPO to approximately $240 million as of June 30, 2014.

We have grown the number of unique portfolio companies as well from 15 at launch to 42 as of the end of June. We have continued to be focused on safety and security with approximately 89% of our assets representing senior secured loans as of June 30, 2014. As we have previously announced on April 24th, we received a commitment letter from the SBA for SBA-guaranteed debentures which allow us to begin to access the leverage in our SBIC subsidiary. We have been approved to receive SBA leverage on a 2 to 1 debt to equity basis, subject to funding the full amount of regulatory capital of $20 million. As we have discussed we believe that the SBIC subsidiary license will provide an opportunity to grow the portfolio and generate additional returns for our investors which should be a huge positive and create real value for shareholders. At the end of June, we have drawn $8 million in SBIC debentures, all other things being equal, over time accessing the leverage in the SBI subsidiary should have a materially positive impact on our net investment income per share.

Turning to our results, for the quarter ended June 30, 2014 adjusted net investment income, a non-GAAP measure, was $3.3 million or $0.35 a share, an increase of $0.02 per share when compared to the first quarter of 2014. Net investment income was $3.5 million or $0.37 per share, an increase of $0.05 when compared to the prior quarter. Additionally we generated net income of $2.7 million or approximately $0.28 per share, down from the net income in the first quarter due to a reduction in the fair value of certain assets in the portfolio. As we discussed previously, we have reached a milestone and that our adjusted net NII per share has exceeded our quarterly dividend for the first time since our IPO in late 2012 as we have been able to achieve both growth in the size of the portfolio as well as continued growth in the weighted average yield.

This was achieved primarily through true core earnings, not large one-time non-recurring fees. Our booked value per share at June 30th was $13.93 per share, down slightly when compared to the book value per share at March 31, primarily as a result of a small net decrease in fair value of our portfolio.

I am now going to turn the call over to Aaron, who is going to discuss the financial results in more detail.

Aaron Peck

Thank you, Ted. Our investment portfolio continues to grow an aggregated $237.7 million at fair value as of June 30, 2014, an increase of approximately $13 million from the prior quarter end. We had total borrowings of $95.5 million at quarter end under our revolving credit facility and SBA debentures payable of $8 million. As of June 30, 2014 our net asset value was $133.2 million which declined from the $135.1 million in book value as of March 31, 2014. This decrease in book value was primarily due to share repurchases under our previously announced share repurchase plan as well as the net decrease in the fair value of the portfolio. As a result, net asset value per share decreased slightly from $13.99 per share at March 31, 2014 to $13.96 per share as of June 30th.

Looking to our statement of operation, total investment income for the quarter was $7 million compared to $6.5 million in the prior quarter. Total expenses of $3.5 million included $1.1 million of interest and other debt financing expenses, $1 million in base management fees, $667,000 in incentive fees and $720,000 in general, administrative and other expenses.

Of the $1.1 million in interest and other debt financing expense, approximately $878,000 was cash interest expense with the remainder representing non-cash amortization of the upfront cost associated with establishing our credit facility and our SBA debentures as well as the interest expense associated with secured borrowings recorded under ASC (860) [ph].

We also have net depreciation on investments and secured borrowings of approximately $1.1 million in the quarter due to some markdowns in the fair value of certain portfolio assets.

Turning to the portfolio, we have continued to focus on senior secured first lien lending with approximately 51% of our investments representing senior secured first lien loans and 38% representing first lien unitranche or one stop loans. Approximately 11% of the portfolio investments were junior secured loans and equity co-investments represented approximately one half of 1%. As we predicted in last quarter’s earnings call, the second quarter saw a pickup in deal closings when compared to the first quarter which allowed us to grow the portfolio and continue our focus on the optimization of our assets.

Going forward, we expect most of our near term growth to come from growth in our SBIC subsidiary. We would expect to have access to up to $40 million of SBIC debentures based on our expectation of reaching $20 million in regulatory capital during the third quarter which would allow us to grow the SBIC subsidiary portfolio from approximately $20 million in assets as of June 30, 2014 to up to $60 million of assets in the future.

I will now turn the call back to Ted for some closing remarks before we open the line for questions.

Ted Koenig

Thanks Aaron. As Aaron just mentioned, we remained focused on growing and optimizing our portfolio for the measurable future with the goal of increasing our per share net investment income.

The addition of our recently licensed SBIC subsidiary has provided us with liquidity to grow the portfolio and should help grow our net investment income over time. The third quarter is shaping up to be another active quarter for us in terms of new deal originations which should result in portfolio growth and continued portfolio optimization.

On our last quarterly call, we told you that we are singularly focused on growing our NII per share, our results this quarter demonstrate the success we have had in fulfilling that commitment. In a competitive market for lending we have been able to make solid asset growth and the continued optimization of the portfolio in order to grow our average effective yield. We have grown our adjusted per share NII by $0.02 per share in each of the last two quarters at a time when many of our peers are experiencing declining NII trends.

We attribute this to our differentiated origination platform which has supported and increased effective yield on our portfolio at a time when many have experienced declining yields. As we access additional SBIC debentures and grow the SBIC subsidiary we expect to continue the success we have had in growing our NII per share.

We remain very excited about our company’s prospects and we believe that our managers, extensive investments and high quality origination underwriting staff will continue to provide the company with unique high quality high yielding investment opportunities. With a predominantly first lien senior secured investment portfolio, a greater than 10% dividend yield, fully supported by net investment income and a stack price trading below our book value per share we believe that Monroe Capital Corporation provides a very attractive investment opportunity for investors that continues to be significantly undervalued.

Thank you all for your time today. And with that I am going to ask the operator to open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Nikesh Rane of Lautenberg. Your line is open. Please go ahead.

Nikesh Rane - Lautenberg Thalmann

Good afternoon Ted and Aaron. I just wanted to touch on the unrealized portfolio depreciation. I was curious whether that was driven more by comparable valuation or whether there were credit issues that particular borrowers that you wanted to highlight?

Aaron Peck

Thanks Nicky it's Aaron. It’s a combination of things. I think that we had some general changes in assumptions under the valuations which took a couple of our portfolio or several of our portfolio assets down a half point here and there just on general market trends and then we do have a couple of write-downs in a couple of our names on a fair value basis which is really interesting because for several of these names I feel like they’re actually doing it pretty well and maybe better than they have in the past but it’s sort of it just starts being trailing 12 months earnings tick down even though there is turnaround in some of these companies and we still seek a mark to market hit for a short term period.

So it’s a combination. We continue to have I think a very good portfolio everything is performing relatively well in general. And in general we are still receiving interest on all of our portfolio assets. And so all the loans are still accruing and we feel pretty good about the portfolio but you will see it when you go through the statements of investments. You'll see a we couple of names that did take a little bit of a mark to market hit for the quarter.

Operator

Thank you. (Operator Instructions). Our next question comes from the line of Bob Napoli of William Blair. Your line is open. Please go ahead.

Bob Napoli - William Blair

A question just on your capital availability that’s with the capital that you have available today with the SBIC, how much more can you grow your investment portfolio? Because essentially somewhere in the $40 million to $50 million without leading to an increase in your equity base?

Aaron Peck

Bob, it's Aaron. Good question and I would say that’s right. We have $20 million of assets in our SBIC subsidiary today that’s moved up to another 40 million effectively of assets. We do have some room under our credit facility which would allow us to also increase in the parent company a little bit but I think a good guidance area, focus area is the number you threw up probably another 40 million to 50 million on the current equity basis probably as much as we'd expect to see the portfolio grow on the current equity base.

Bob Napoli - William Blair

And then the NII, I mean few years ago the NII, I mean still something like that as you are still on that additional portfolio assuming the credit quality.

Aaron Peck

Yes, all things being equal, all other things being equal growing that SBIC subsidiary should really drop down the NII per share number nicely because that’s all sort of incremental.

Bob Napoli - William Blair

Okay and then just on what are the yields of your rates, are you seeing on the new originations, any deterioration in that yield and what percentage of your loans that you are putting on today are directly originated?

Aaron Peck

That’s a great question, so I will just talk about the second quarter as the best example. In the second quarter, we put on new assets of about just under $34 million, all of which were direct originations, where we're the agent. If you go through the numbers, and you could pull it, so you could figure this out by going through the queue on your own but I will just tell you that the effective yield on a weighted average faces for those assets was about 11.6%. And then we sold out of or got repayments on assets as we optimize the portfolio of about $15.8 million and the weighted average effective yield on the assets that went off the books was about 7.5%. So, you can see that we are still maintaining, yield increases were originating and so while the market continued to be competitive, we still pick our spots. We are still finding good yield to add to our business and all the assets I just mentioned are really first lien senior secured assets so the quality is still there in terms of the safety of the portfolio and the spreads we are seeing.

Bob Napoli - William Blair

Thank you. And then just finally, the fee income in the quarter, I haven’t had enough chance to look at the Q yet but at what levels of fee income did you have and is there [indiscernible] normal level?

Aaron Peck

Sure and you can find all this in the Q but I will help you with it. We had total interest income in the quarter of $0.74 per share, or $7 million. We would call about 6.5 million of that or $0.68 of normal interest income but in the rest you recall it’s about $0.05 a share sort of fee related income but if you look back it’s not any one big fee, it's sort of stuff we have earned every quarter, so we are increasing the fees that we are seeing. We are increasing the interest income, the core interest income is quite a bit higher from last quarter and some of the stuff, some of that is -- if you look at the components, the standard interest income is about $0.66, and another $0.02 of pick, so it’s about $0.683 of interest income which is what we are calling that normal interest income and if you look at the other things $0.016 is the amortization of premium discount that’s something you would expect every quarter because we are just amortizing in the upfront fees and we have got some amendment fees, a $0.02 of amendment fees and then some pay down, noise gain and loss of about $0.01, $0.015 which was about $0.02 last quarter. You can see it’s stuff that we would expect on sort of a quarter in and quarter out basis that we have seen every quarter.

Operator

Thank you. Our next question comes from the line of Christopher Nolan of MLV & Company. Your line is open. Please go ahead.

Christopher Nolan - MLV & Company

Quick questions, do you interest paid SBA borrowings to drive balance sheet growth in the second half of 2014?

Aaron Peck

And the answer to that is yes Chris.

Christopher Nolan - MLV & Company

And do you expect asset growth should accelerate in the second half of the year?

Aaron Peck

I would say the answer to that is also yes, so I mean we have -- obviously all things are sort of subject to what we see on the repayment side but we do have a very nice pipeline. It continues to be extremely strong and we do have access to the SBIC leverage and so we would expect to see continued growth throughout the balance of the year.

Ted Koenig

[Indiscernible] Chris, second half of the year tends to be seasonally more active particularly Q4 in our business.

Christopher Nolan - MLV & Company

That’s good color. Final question guys share repurchases I know you guys been very active on it and right now the share price is roughly 5% discount to in that. Given that you’re investing in assets that typically yield roughly 11% and your cost of funds on the SBA is roughly 4%. Is there a sort of a wash at the share price at this point to actually to keep on buying back stock particularly since you might start becoming more stretched on the equity capital side as you go towards the end of the year?

Aaron Peck

Good question Chris. Obviously we can’t provide you any guidance on what we will and won’t do with regards to the share repurchase plan. I’ll remind you that we were authorized for 7.5 million and you could see through the numbers that we’ve used a fair amount of it. And so we do have a limited amount under that authorization last. We look at all the same things you do when we think about when and if we should be buying back stock and we’re mindful of all the things that you would expect us to be mindful of including how we could put the money to work and where we could put it to work and what the yields would be and what’s best for NII and what’s best for looking at the book value dilution and accretion.

And so we’re thinking about all the things you want us to and so only the only way I can answer that question without giving any guidance.

Operator

Thank you. Our next question comes from the line of Bryce Rowe of Robert W. Baird. Your line is open. Please go ahead.

Bryce Rowe - Robert W. Baird & Company

Thank you and congratulations on the milestone of earning the dividend. Wanted to ask you guys you’ve talked about the continued optimization of the portfolio. Maybe Aaron and Ted could you talk about what’s left within the portfolio that could be optimized out of into some of the higher yielding investments you made similar to what you made this quarter?

Aaron Peck

Sure. If you look at the scheduled investments it’s kind of anything that's sort of under that 11% as a candidate. So it’s hard to pinpoint one thing here or there but I mean there is some obvious things that roll out when you look at this. So if you look at all of our second lien portfolio for example the junior secured portfolio those are all liquid, relatively liquid other than the one [indiscernible] position.

So those opportunities are there. Those are little bit high yielding than some of the first lien positions. There are opportunities in the first lien portfolio as well. But basically you just look at the junior secured loan portfolio and the sort of sub 9% loans that are in the senior secured loan category and those are all candidates.

Bryce Rowe - Robert W. Baird & Company

Okay, that’s helpful. And then a question on the SBA and the SBIC, you talked about having capacity to go up to $40 million of SBA debentures once you get fully capitalized. Should we assume that the $40 million is kind of -- will be the max of SBA debenture capacity within the BDC and the remaining portion of the second license we go to other parts of Monroe Capital?

Aaron Peck

Ted, you want to address that?

Ted Koenig

Yes, I think, I can’t say anything for sure. But I think that’s probably a pretty good operating assumption as of now.

Operator

Thank you. Our next question comes from the line of Jeff Rudner of UBS. Your line is open. Please go ahead.

Jeff Rudner - UBS

Thank you for taking my question and most importantly congratulations both Ted and Aaron on an excellent quarter and as was pointed out previously covering the dividend for the first time since you’ve been a public company. You pointed out that the NII has increased by approximately $0.02 a quarter for the last number of quarters and I guess it kind of begs a question at what point in time would you consider raising the dividend?

Ted Koenig

That’s a great question Jeff. I told you last year that we are singularly focused on increasing our NII and moving our book value. We continue to be focused very much on growing NII and moving our book value. The neat thing about a business from our standpoint is when you look at kind of the peer group which is seems to get larger each year our earnings that we’ve covered the dividend with have been core earnings mostly blocking and tackling as opposed to prepayment fees or warrant gains or anything else. We’ve got a lot of that stuff in the portfolio, it just still hasn’t realized.

So we’re very focused on doing what we need to do to grow the business for the benefit of our shareholders. So your question is a good one when the time comes I am sure we’ll consider that but as of right now it’s all systems go on doing what we need to do.

Operator

Thank you. And with no further questions in queue, I’d like to turn the conference back over to Mr. Koenig for any final remarks.

Ted Koenig

Well I want to thank everyone for joining us today and continuing to follow us. I mentioned last year that our intention here is to cover our dividend and to generate net income and if you look at our last four quarters you will see a nice trend line. And our plan is going to be continue to work hard and grow this business. So keep watching. I think you’ll like which you see to come.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program and you may all disconnect. Have a great rest of your day.

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