Good afternoon, and welcome to the earnings conference call for the period ended September thirtieth, two thousand twenty-two for MidCap Financial Investment Corporation. At this time, all participants have been placed in a listen-only mode. The call will be open for a question-and-answer session following the speaker's prepared remarks. If you would like to ask a question at that time, simply press star one on your telephone keypad. If you would like to withdraw your question, please press star two. I will now turn the call over to Elizabeth Besen, Investor Relations Manager for MidCap Financial Investment Corporation.
Thank you, operator, and thank you everyone for joining us today. Speaking on today's call are Tanner Powell, Chief Executive Officer, Ted McNulty, President, and Greg Hunt, Chief Financial Officer. Howard Widra, Executive Chairman, as well as additional members of the management team are on the call and available for the Q&A portion of today's call. I'd like to advise everyone that today's call and webcast are being recorded. Please note that they are the property of a MidCap Financial 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 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 recent 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.midcapfinancialic.com. I'd also like to remind everyone that we 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, Tanner Powell.
Thank you, Elizabeth. Good afternoon, everyone, and thank you for joining us today. I will begin today's call with some comments about the market environment and why we believe our corporate lending portfolio is well-positioned and well-constructed for a challenging market environment. Next, I will highlight our results for the quarter, provide an update on Merx's, and then I will discuss the increase to our quarterly dividend. Following my remarks, Ted will discuss our investment activity, including the meaningful cash paydowns we received from several investments we are seeking to reduce. Ted will also cover the portfolio's credit quality, including how our portfolio companies are performing in the current environment. Lastly, Greg will review our financial results in detail. We'll then open the call to questions.
Throughout today's call, we will refer to the company as MFIC or the BDC, and we refer to the Bethesda-based lender which sources senior secured middle-market investment opportunities for Apollo-managed capital, including the BDC as MidCap Financial. Beginning with the current environment, the public credit markets remain volatile as the Fed reiterated its commitment to tighter financial conditions in order to combat inflation. The secondary price rally in the leveraged loan and high yield markets in the first half of the quarter were all but erased in the second half as investor sentiment was dampened by the elevated interest rate environment and recessionary concerns. During the quarter, credit spreads continued to widen and U.S. leveraged loan issuance plummeted to the lowest level since the fourth quarter of 2009, driven by a pullback from CLO investors.
Banks continue to struggle to offload financing commitments made prior to the current, more volatile environment. Although deal activity has slowed, borrowers continue to turn to the private credit market, which offers certainty of execution. In general, periods of economic stress and broader market volatility create better opportunities for direct lending. Amid this broader market volatility, we have seen improved lender terms and spreads for the private direct lending market, which continues to experience strong demand from financial sponsors and companies. We would expect terms to continue to tighten and spreads to continue to widen should economic stress continue or worsen. For scaled capital providers like MidCap Financial, we believe that there are opportunities to lend to high quality companies with attractive pricing and terms. MidCap Financial was relatively active during the September quarter with $3.3 billion of new originations.
In the first 9 months of 2022, MidCap Financial's new originations totaled $12.5 billion. Additionally, the tougher economic environment should lead to an increase in ABL opportunities in an area where MidCap Financial has a large and successful franchise. In the face of significant market volatility, our corporate lending portfolio continues to perform well, which we believe demonstrates the value of our senior secured investment strategy and the quality of our portfolio companies. Our underwriting process contemplates the potential for macroeconomic headwinds. As the macro environment continues to become more challenging, we believe the strength of our underwriting and the quality of our portfolio will become more apparent. We have constructed what we believe to be a well-diversified portfolio of true first lien floating rate corporate loans invested in less cyclical industries with granular position sizes.
At the end of September, our corporate lending loans were 94% first lien, with a weighted average attachment point of 0.2x, a metric which demonstrates that we are invested in the most senior part of the capital structure. Moving to our financial results, net investment income was $0.35 per share for the quarter, which reflects an increase in interest income due to higher base rates as well as strong fee and prepayment income, partially offset by a slight decline in income from Merx's as we continue to reduce the size of this investment. Amid the challenging market conditions we were able to generate considerable cash paydowns from several investments which we are seeking to exit, which Ted will discuss later during the call.
Overall, given the volatile market environment, we recorded a net loss of $6.6 million on our portfolio. Given the total return feature in our incentive fee structure, incentive fees accrued during the quarter were below the full rate. We ended the period with net asset value per share of $15.45. Moving on, as discussed previously, we are focusing on reducing our investment in Merx, our aircraft leasing portfolio company, by selling aircraft and de-emphasizing its servicing business. During the September quarter, Merx continued to make progress by selling 2 aircraft, reducing the number of planes in its own fleet from 62 to 60, which allowed Merx to prepay $14 million to MFIC. In conjunction with the pay down to MFIC and the aircraft sales, we converted $111 million of Merx's revolver into equity.
Accordingly, at the end of September, our investment in Merx totaled $266 million, representing 11% of the total portfolio, consisting of a $150 million revolver with a 10% interest rate and a $116 million of equity. The pay down and conversion of debt to equity will reduce the amount of interest that Merx pays to MFIC from approximately $6 million in the September quarter to approximately $3.8 million per quarter going forward. Despite the broader uncertain macroeconomic environment, there are no signs of slowdown in daily global flight activity, and we continue to focus on reducing our exposure. Now let me switch to our dividend policy.
Given the impact of higher rates on our net interest income, the strong performance of our corporate lending portfolio, and considering the upcoming reduction in our fee structure, we are pleased to announce that we are raising our regular quarterly base dividend by 15.6% from $0.32 per share to $0.37 per share, payable to shareholders of record as of December 19, 2022. As a reminder, on our last conference call, we made several important announcements, including the establishment of what we consider to be the industry-leading fee structure among listed BDCs. Recall that BDC's base management fee was permanently reduced to 1.75% on equity. Among listed BDCs, MFIC's management fee is the lowest and is the only one to charge management fees on equity.
The incentive fee on income was permanently reduced from 20% to 17.5%. The changes to the fee structure will be effective for the period beginning January 1, 2023. We are raising the dividend to a level which we believe reflects the current earnings power of our portfolio, including some of the permanent benefit of our reduced fee structure, which is not yet reflected in our financial results. When the new fee structure becomes effective, we expect to significantly outearn this $0.37 base dividend, and we will reevaluate our dividend at that time. With that, I will turn the call over to Ted to discuss our investment activity.
Thank you, Tanner. Beginning with investment activity. Given our focus on reducing the fund's net leverage, MFIC's new investment activity was limited during the quarter. MFIC's new corporate lending commitments totaled $21 million across 3 companies for an average new commitment of $7 million. The new commitments were first lien floating rate loans with a weighted average spread of 639 basis points and a weighted average net leverage of 4.5x. Excluding revolvers, gross fundings for the quarter totaled $67 million, and sales and repayments totaled $154 million. Net revolver fundings were approximately $5 million. In aggregate, net repayments for the quarter totaled $83 million. Repayments for the quarter included $101 million from corporate lending positions, $14 million from Merx, and $39 million from other investments, including some shipping and oil and gas positions.
Post quarter end, we exchanged 50% of our non-income generating investment in CarbonFree at our September 30 mark for $7.5 million cash and $12.5 million interest-bearing notes. Net leverage at the end of September was 1.4 times. Given our visibility into additional repayments in the coming months, we are well positioned to make new commitments during what we will believe will be an attractive vintage, characterized by relatively wider spreads, lower leverage levels, and tighter documentation. Turning to the overall portfolio, our investment portfolio had a fair value of $2.46 billion at the end of September across 136 companies in 26 different industries. Corporate loans and other represented 89% of the total portfolio, and Merx represented 11% of the portfolio at fair value.
94% of our corporate loans were first lien. The weighted average spread on our corporate loans was 613 basis points at the end of September. In general, despite an environment of heightened uncertainty, we've seen minimal negative impact in the fundamental performance of our corporate lending portfolio companies. While we're cognizant that borrowers will likely face increased challenges over the coming months due to inflationary pressures, higher interest rates, and potential headwinds from an economic slowdown, we believe we have designed our corporate lending portfolio to be defensive and perform well during periods of increased stress. We believe MFIC has one of the most senior secured portfolios among BDCs, as evidenced by our low attachment point of 0.2x. Our corporate lending portfolio consists of granular position sizes with our average position of $16.9 million.
Our credit metrics remained relatively stable during the quarter. At the end of September, the weighted average net leverage of the corporate lending portfolio was 5.52 times compared to 5.45 times last quarter. The weighted average interest coverage ratio was 2.7 times compared to 2.8 last quarter. These weighted average interest coverage ratios are based on company data from the last twelve months. Looking at the most recent quarter, we have observed some pressure on this metric as expected. The weighted average interest coverage ratio was 2.2 times based on company data from the June quarter. Our second lien term loan at K&N, which had a fair value of $14.2 million at the end of September and which was originated in 2016, was placed on non-accrual status during the quarter.
At the end of September, investments on the non-accrual status totaled $23.6 million or 1% of the total portfolio at fair value. With that, I will now turn the call over to Greg to discuss our financial results in detail.
Thank you, Ted, and good afternoon, everyone. Beginning with our statement of operations, total investment income was $58.9 million for the quarter, up 10.3% quarter over quarter. Recurring interest income rose due to the impact of higher base rates. Fee and prepayment income was strong. Prepayment income was $2.9 million, up from $1.9 million last quarter, and fee income was approximately $1.5 million, up from $500,000 last quarter. Dividend income was essentially flat quarter- over- quarter. The weighted average yield at cost on our lending portfolio was 8.9% at the end of September, up from 8% at the end of June. The increase in yield was primarily due to higher base rates.
Net expenses for the quarter totaled $36.2 million, up $6.3 million quarter-over-quarter due to higher interest expense related to our credit facility, which bears a floating rate interest rate and higher incentive fees. As a reminder, MFIC's incentive fee on income includes a total return hurdle with a rolling 12-quarter look-back. Given the net loss of $6.6 million for the quarter, incentive fees during the quarter totaled approximately $4 million, up from $1.4 million last quarter. Net investment income per share for the quarter was $0.35. During the quarter, we recorded a net loss on the portfolio of $6.6 million or $0.10 per share.
When you look at our corporate loan book and you exclude the impact of ChyronHego and K&N, considering our spreads began to widen during the quarter, our corporate loan book was slightly down. On page 16 in the earnings supplement, we disclose the net gain or loss by strategy over the past five quarters. NAV per share at the end of September was $15.45, a 7-cent or half a cent decrease quarter-over-quarter. The decrease is primarily attributable to the 10-cent loss on the portfolio, partially offset by 3 cents from net investment income relative to our dividend. Moving on, our liquidity position remains strong, with undrawn revolver capacity well in excess of unfunded commitments to borrowers. We are well positioned to benefit from higher rates.
To put some color around the potential for near-term earnings impact, based on quarter end rates, we estimate that a 100 basis point and a 200 basis point increase in reference rates would result in annual incremental earnings of approximately $0.13 and $0.26, respectively. No stock was repurchased during the quarter. Lastly, I wanted to mention that MFIC will be changing its fiscal year-end from March 31 to December 31, effective December 31, 2022. Accordingly, MFIC will file its annual report on Form 10-K for the fiscal year ended December 31, 2022 in late February of 2023. This concludes our prepared remarks. Operator, please open the call to questions.
Certainly. At this time, if you would like to ask a question, please press star one on your touch-tone phone. We will take our first question from Kenneth Lee with RBC Capital Markets. Please go ahead.
Hi. Good afternoon, and thanks for taking my question. Wondering if you could talk a little bit about key drivers for the unrealized losses that you saw in the Merx business in the quarter? Thanks.
Yeah, sure. Thanks, Kenneth. When we look at Merx, we are evaluating each plane and you know, its prospects with impending lease maturities. More specifically, the slight write-down that we saw in this particular quarter pertained to our view on the resolution of a number of planes as we are working through lease maturities. Nothing other than you know, no broader point there other than you know, marking to reflect our current view on those particular situations.
Gotcha. One follow-up, if I may. In terms of the cash paydowns you received from some of the investments, is there any visibility in near term of any additional cash paydowns from other investments? You know, realizing it might be a little idiosyncratic, but you know, what could be some key drivers there to see some additional cash paydowns in the future? Thanks.
Yeah, sure. You know, when we look across our, you know, granular portfolio of 130 obligors, you know, and with the obvious caveat, Kenneth, that you know, things are somewhat volatile out there, as our near-term visibility suggests, you know, more paydowns in the future against a backdrop of, you know, broadly, you know, declining M&A volumes. If anything, you know, our current forecast as we sit here today would suggest, you know, some modest further paydowns from here.
Gotcha. Very helpful. Thanks again.
We'll take our next question from Finian O'Shea with Wells Fargo Securities. Please go ahead.
Hi everyone. Good afternoon. Back to Merx. Tanner, can you go back to the essence or driver of why so much was converted to equity? Sort of to follow on Ken's question on the write-down, can you reconcile that to the proportionally steeper decline in the quarterly interest payment that we'll see from Merx, the $6 million in unrealized Merx today versus the, I think, a couple million a quarter, correct me if I'm wrong there, on interest income.
Great. Yeah. Finian, this is Howard Widra. You know, I think, you know, which we said we should look at Merx. You know, we're liquidating Merx, and we have a combined mark of, you know, in the $250 million range. We got a pay down. When we got that pay down, we felt like as we're liquidating and we expect to see, you know, additional cash coming in over the next quarters, it was better to just have less income coming off of the combined position. We recast it. It really wasn't. There was nothing behind sort of the underlying value that changed. We just felt like the, you know, the less capital that comes out of it, the more capital goes to return to basis.
Because, you know, of our earnings power as sort of we show it, you know, in our dividend raise and our expected earnings, we, you know, we felt like we were well positioned to be in that, you know, to be in that position. The first thing is we do expect to get, you know, additional pay downs, although, you know, it can be lumpy. But we're focused on it and are in the throes of making that happen. The recast is just really towards the intent of having, you know, as much capital go to basis as possible.
Okay. Thank you. Just a small follow on there. How much of an issue is sort of net investment income? Leases are maybe flat or stagnant and LIBOR base rates are going up, or is that an item or are you hedged there?
Well, you know, we have leases set, so they're not based off, you know, rates. You know, they're sort of basically fixed, you know?
Mm-hmm.
The debt is fixed. Yeah.
Fixed rate debt.
Yeah, we have fixed rate debt in our securitization, so we're not really impacted by that.
Okay. That's helpful. Thanks so much.
We'll take our next question from Kyle Joseph with Jefferies. Please go ahead.
Hey, good afternoon. Thanks for taking my questions, and apologies. A couple calls today hopped on a little late, so if you cover this. Obviously, originations were light. I think you guys talked about that was in on purpose to de-lever the balance sheet. Can you give us a sense for, you know, your pipeline and then also kind of the spreads you're seeing on new deals and how that compares to the portfolio?
Yeah, sure. I'm happy to take that, Kyle. Like you said, there was some de-leveraging in the particular quarter. When we look at the current market environment, clearly, M&A has slowed. We are very fortunate and benefit from the wide funnel that MidCap Financial, the Bethesda-based lender afford us. Interestingly, as we look forward and as we alluded to in our prepared remarks, you know, across the various product areas, in particular, ABL is one area where we see increasing opportunity. Our outlook is, you know, broadly, lower M&A, but still a nice level of opportunity.
What I would say to add to that is, while certainly as things are moving so quickly and valuation expectations have been recalibrated, that's certainly one of the drivers for limited M&A opportunity on the sponsor side. We are still seeing a good pipeline of, you know, add-on acquisitions, and that's both in the form of funding our existing delayed draws as well as also new commitments to existing borrowers, as those relatively smaller add-ons are more palatable in the environment.
Yeah.
Sorry, Kyle. I didn't hit spreads. Sorry.
Okay.
If we look at spreads and, you know, even ignore obviously the effect of the base rate. Right now versus, you know, call it the beginning of the year, we're seeing spreads at 100-200 basis points wider. That's not just in spread. We're seeing, you know, if you think the average deal that we were doing about a year ago was 575, we're seeing 650-675. Importantly also seeing more convexity come from a greater OID, you know, kind of going from 98 to at least 97 and even below in certain cases.
You know, 100 to 150 basis points of the spread widening exclusive of the effect of the base rate or LIBOR/SOFR going up.
Got it. Then, yeah, in terms of shifting to credit, we saw your leverage statistics and added one investment to non-accrual. You know, have you seen a greater demand or pickup in amendment activity? You know, how would you gauge kind of the health of your portfolio as companies deal with higher interest expenses, ongoing inflation, et cetera?
Yeah, absolutely. Not yet. I think, you know, the good point of emphasis and hopefully this comes through in how we presented our approach for many years now is, you know, our borrowers within our corporate book, you know, kinda 95% plus have financial covenants. The good news is we do have a seat at the table. There is a normal level of activity that happens anyway, whether opening up a document to, you know, do an add-on acquisition or myriad other reasons. In terms of what you're obviously getting at, in terms of credit weakening type amendments, we have not seen that tick up. Keep in mind that these metrics are tested on a backwards-looking basis.
For instance, the numbers that are filtering through those tests at this moment in time, Kyle, are 6/30 numbers. We would imagine it's only natural, in this type of environment for that to pick up. As of now, we've seen very limited, you know, excessive or above normal amendment activity.
Got it. Very helpful. Thanks for answering my questions.
We'll take our next question from Melissa Wedel with J.P. Morgan. Please go ahead.
Good afternoon. Most of my questions have been asked already, but I thought it would be helpful just to quickly review how you're thinking about portfolio leverage right now and where you'd ideally like to operate, given how things are evolving from a macro perspective. Thanks.
Yeah. Thanks, Melissa. As you saw and as we mentioned in our prepared remarks, we are at 1.42 times, you know, our previous, you know, which is the lower end of our previous stated range. You know, and also drawing on my answer to Kenneth's question, we would expect to operate at or below that level in the near term, in part due to, you know, some visibility in some of the repayments. As we have said historically from a risk standpoint, we do believe our first lien strategy, granular position size, our true first lien strategy, granular position size does allow us to operate at that higher leverage level.
You know, that's where we sit today, and that's where we see, you know, again, based on some visibility in near-term payments.
Good. Once, as a reminder, to ask a question, press star one, and we'll go next to Paul Johnson with KBW. Please go ahead.
Yeah, good evening, guys. Thanks for taking my questions. Real quick on just the interest coverage ratio that you mentioned, just decline in this most recent quarter, I guess, with most sort of updated financials that you have, dropping from 2.9 to 2.2 times. Sounds like a big drop, obviously, also a fairly significant increase in rates over that time period as well. I was wondering if you could just kind of comment on that and I guess if you had any sort of commentary around EBITDA performance of your portfolio companies, if that at all is reflected in that number as well.
Yeah, sure.
Yeah.
Go ahead.
Yeah, sure. Yeah, no, thanks for the question. Just to clarify, the LTM interest coverage ratio went from 2.8 to 2.7, so only a modest, you know, downward revision on an LTM basis as of June. We did quote a 2.2 number, which was a sensitivity, looking at the company data only for the June quarter. That kinda makes sense as rates were starting to rise. You know, as we look forward, we certainly do expect there to be more pressure, as rates continue to rise. I think one of the ways we think about it is we're starting from a good point. You know, we've got a significant amount of, you know, sponsor equity behind the majority of the loans that we make.
You know, we're starting in the high 2s, as we mentioned, 2.7 on an LTM basis. So we have an equity cushion. We've got, you know, true first lien positions, and we've got covenants to get us to the table if we do see EBITDA start to deteriorate. You know, I think from an EBITDA standpoint, to get to the next part of your question, we saw EBITDA growth, EBITDA still being in a growth mode, you know, at 6/30, you know, in the low- to mid-single digits%, which has tapered off from what we saw in prior quarters, but still in positive territory. We'll, you know, we'll continue to watch this closely, obviously, and as will everyone in the credit markets.
Got it. Thanks for that and appreciate the correction there. It makes sense. Just on the dividend increase, I imagine, you know, this was obviously with kind of your house view on forward rates and the new fee structure coming on. I'm just curious if that's the case or if there's any, I guess, room for potential increase from that level.
Yeah. We believe, like our view is that we have significant ability to sort of outearn that stated dividend. Our expectation is as we, you know, our fees don't kick in till the, you know, the first quarter of next year, calendar quarter of next year. As we, you know, as we get there and we start out earning the dividend, you know, the choices we have with regard to either raising our dividend or making special dividends will sort of be on the table. We would expect at a minimum to be making special dividends. Some of it depends on, you know, the extent of how much interest rates go from here.
Even at today's rate, we think we have, you know, good cushion for the 37. We wanted to sort of put a mark on the ground of where we're very comfortable, but we expect to be able to outearn that solidly.
Yeah, I appreciate it. That makes sense. Thanks. That's all for me.
There are no questions at this time. I will now turn the call back over to the management team for our closing remarks.
Thank you, operator, and thank you everyone, for listening to today's call. On behalf of the entire team, we thank you for your time today. Please feel free to reach out to us if you have any questions, and everyone, have a good week, weekend and evening.
Thank you. This does conclude today's program. Thank you for your participation. You may disconnect at any time.