MidCap Financial Investment - Earnings Call - Q2 2021

Transcript

Speaker 0

Good afternoon, and welcome to the Apollo Investment Corporation's Earnings Conference Call for the period ended 09/30/2020. At this time, all participants have been placed in a listen only mode. The call will be open for question and answer session following the speakers' prepared remarks. I would now like to turn the call over to Elizabeth Besson, Investor Relations Manager of Apollo Investment Corporation. Please go ahead.

Speaker 1

Thank you, operator, and thank you everyone for joining us today. Speaking on today's call are Howard Guidra, 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 release.

I'd also like to call your attention to today's conference call and webcast may include forward looking statements. Forward looking statements involve our business prospects and the prospects of our portfolio companies. 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.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 Widstra.

Speaker 2

Thanks, Elizabeth. Good afternoon, and you, everyone, for joining us today. Before we begin, I'd like to say that we hope everyone is doing well and you and your families are safe and healthy. I'll begin today's call with an overview of our portfolio and a review of our financial results for the September quarter. Following my remarks, Hannah will review our investment activity for the quarter and we'll discuss the impact of the COVID-nineteen pandemic on our portfolio.

Greg will then review our financial results and provide an update on our liquidity position. 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. As we all know, the COVID-nineteen pandemic has been an unprecedented shock to the global corporate lending portfolio continues to perform well, and we continue to recoup some of the unrealized losses taken in the March. Over the past two quarters, our corporate lending portfolio has recovered approximately $22,000,000 or $0.34 per share of unrealized losses.

We believe that the performance of our corporate lending portfolio during this challenging period demonstrates its resiliency and quality. The corporate lending portfolio, which represents 79% of total investment portfolio, is eighty six percent first lien, 100% floating rate and 86% sponsor backed. No investments were placed on nonaccrual status during the quarter. We continue to work closely with our sponsor clients and portfolio companies, and we have generally been pleased with how sponsors and borrowers have been managing through this current environment. Conversations with sponsors and management teams continue to be cooperative and constructive.

We are generally seeing strong equity support by sponsors. Away from corporate lending, results for the quarter were negatively impacted by our investment in Merx and from noncore and legacy investments, which Jen will discuss. During the September, we made significant progress deleveraging to within our target range of 1.4x to 1.6x. The Fund's net leverage ratio declined to 1.56x at the September compared to 1.66x at the June and 1.71x

Speaker 1

at the end of

Speaker 2

new investments as marketing activity resumes, while we also continue to manage our existing portfolio. Moving to our financial results, net investment income for the quarter was $0.43 per share, reflecting a smaller portfolio given net sales and repayments, a lower portfolio yield, partially offset by an increase in prepayment income compared to the prior quarter. In addition, given the total return feature in our incentive fee structure, no incentive fees were accrued during the quarter. The portfolio had a net gain of $5,400,000 or $08 per share, driven by a net gain of $17,800,000 or $0.27 per share on the corporate lending portfolio, partially offset by a net loss on Merx and on non core legacy assets. Slide 16 in our investor presentation shows the net loss for the quarter broken out by strategy.

Net asset value per share at the September was $15.44 a $0.15 or 1% increase quarter over quarter. The $0.15 increase is attributable to the dollars net gain on the portfolio and $07 of retained earnings. Turning to our distribution. As discussed last quarter, in addition to our quarterly basis distribution, the company's board is expected to declare supplemental distribution and amount to be determined each quarter. Accordingly, the board has declared a base distribution of 31¢ per share and a supplement distribution of 5¢ per share, payable on 01/07/2021, to shareholders of record as of 12/21/2020.

With that, I'll turn the call over to Tanner to discuss our investment activity in portfolio.

Speaker 3

Thanks, Howard. Beginning with the market environment, credit markets continue to recover during the quarter. Although spreads are still somewhat higher than prior to the COVID-nineteen outbreak, they've declined significantly since peaking in late March or early April. Additionally, covenant waivers and credit amendments have slowed down. The new issue market has also been gaining momentum as borrowers sought to complete deals ahead of the election.

The use of proceeds has been expanding from mostly add on acquisitions to buyouts, sponsor sponsor sales and dividends. And while credit documents and structures have tightened, borrowers are seeking private credit solutions that were broadly syndicated portfolio, which is primarily firstly, we believe the credit quality of our corporate lending for some of our borrowers during the quarter. During the quarter, we saw a 40% drop in the number of investments in our portfolio. Sales were 13. Opportunistically deploy capital in the face of widespread uncertainty and market disruption.

To be clear, Merck's just focused on the existing portfolio and not seeking new investments. However, growth in the overall Apollo aviation platform nurture the benefit of Marks as the exclusive servicer for aircraft owned by other Apollo stocks. Moving to overall credit quality, as Howard mentioned, no investments were placed on nonaccrual status during the quarter. At the September, investments on nonaccrual status represented $143,000,000 or 4.9% of the portfolio at cost and $30,000,000 or 1.2% at fair value. With that, I'll turn the call over to Greg, who will discuss the financial performance for the quarter.

Speaker 4

Thank you, Tanner, and good afternoon, everyone. Beginning with the statement of operations. Total investment income was $54,900,000 for the quarter, comparatively lower due to the smaller portfolio, a slightly lower overall yield, and partially offset by an increase in income. Prepayment income was 2,000,000 for the quarter compared to $300,000 last quarter, reflecting the greater portfolio activity. Dividend and fee income remained below historical levels.

The weighted average yield at cost on the corporate lending portfolio declined slightly from 8.1% to 7.9%. Expenses for the quarter were $27,000,000 down $1,400,000 quarter over quarter, primarily due to lower interest expense and lower management fees. Interest expense declined due to net sales and repayments and as a result of a decline in the average interest cost by approximately 16 basis points due to a slight decline in LIBOR. Our weighted average interest cost for the quarter was 2.96%. Management fees declined due to the decline in the average portfolio size.

There was no incentive paid during the quarter. Net investment income per share for the quarter was 43¢ with 1.56 times six six times at the end payments and an increase in net assets. The increase in net assets were driven by the 5,400,000.0 or 8¢ a share net gain on the portfolio. And approximately $4400000.0.07 a share of retained earnings during the quarter. On page 16 of the earnings supplement, we have broken out the net gain or loss by strategy.

We continue to see some reversal previously recorded unrealized losses reflecting the further tightening of credit spreads relative to the 2020 and for 20¢ September, Merck's core and legacy assets had an unrealized loss of 6,500,000.0 or 10¢ per share, primarily due to our oil and gas investments given the continued weakness in the forward oil curve. NAV per share at the September was $15.15.44, a 1% increase quarter over quarter. Moving to liquidity. Since the pandemic began, many of our portfolio companies drew on their revolvers during the March to short liquidity. Many of these drawdowns were repaid in the June and repayments continued in the September.

MidCap is the agent for nearly all of our revolvers and delayed draws in them. For context, revolver utilization peaked at approximately 70% in mid April and has since declined to 33% today. At the September, we had 1,600,000,000.0 of debt outstanding, a decrease of 155,000,000 quarter over quarter. At the September, we had 268,000,000 of immediately available liquidity, up from 227,000,000 at the June and 224,000,000 at the March. Also, the September, we had 287,000,000 of additional capacity under our credit facility, up from a 167,000,000 at the June and 131,000,000 at the March.

Moving to unfunded commitments. On page 18 in our earnings supplement, we break out for you our outstanding commitments as of the September. During the quarter, we continue to experience considerable net revolver payments. Of the $282,000,000 of unfunded revolver commitments outstanding at the September, 183,000,000 are available to borrowers, and 99,000,000 are not available to borrowers. Availability is based on limitations and other covenants.

Turning to the portfolio composition. Our investment portfolio had a fair value of 2,600,000,000.0 at the September across 147 companies in '29 industries. We ended the quarter, with core assets representing 92% of the portfolio, up slightly from the June. Non core assets decreased to 8%, down slightly. First lien assets represented 86% of the corporate lending portfolio.

The weighted average attachment point remained point eight times. Investments made pursuant to our co investment order were 78% of the corporate lending portfolio at the September. We continue to remain focused on preserving liquidity as our leverage and liquidity continue to improve. We will continue to evaluate repurchasing our securities. Please open the call to questions.

Speaker 0

Your first question comes from the line of Kenneth Lee with RBC Capital Markets.

Speaker 5

Hi, thanks for taking my question. Just wondering whether you could just provide any further details behind the visibility into additional repayments for the December and whether you see any additional gross pay downs beyond the ones that were mentioned in the release? Thanks.

Speaker 2

Yes. Well, so gross pay downs, we have, you know, we have visibility, you know, deals that we know are in the process of being sold or paying down of, about another $100,000,000, whether the you know, of those creep over to the, you know, over the over the new year, we don't know. But, about another $100,000,000, that's that's gross pay downs. You know, we we do expect to do, you know, as we as I mentioned, you know, some some new business. And so, you know, our leverage, Greg said, 1.47 today, and probably below 1.45 in the next week or so based on, you know, stuff that's paying off in the near term, and then then probably starting to tread water around there in the lower side of our range.

Speaker 5

Great. Very helpful. And just one follow-up, if I may. Wondering if you could just provide any update on thinking around potential funding mix changes in the near term. Thanks.

Speaker 4

Not in the near term. We continue on we have a very supportive bank group with over 24 banks, and we're constantly monitoring the market. And so we will at some point, but not at this time.

Speaker 2

I appreciate the call.

Speaker 0

The line of Kyle Joseph with Jefferies. Mister Joseph, go ahead with your question.

Speaker 6

Apologies. Thanks guys for having me on. Apologies I was on mute. Anyway, I'll get right into the questions. So deployments have been light, not surprisingly, over the last few quarters as you guys have focused on delevering, but I think it sounds like you've gotten to a point where you're comfortable at evaluating new transactions.

Tanner, I think, can you give us a sense for how the pipeline looks in terms of size and in terms of terms, how it looks versus kind of pre COVID deals?

Speaker 3

Yes, sure. Thanks, Kyle. Thanks for the question. So I think you're spot on. That has certainly been the focus getting back within our targeted leverage level and you saw some deployment in the September.

I would expect that to increase in the December. As it relates to pipeline, it's something we've stressed in the past, and I'll stress it once again. The good news is when you look at the middle market platform in its totality, including mid cap, that origination continues to be strong and our participation in that origination does not dictate whether or not we're able to provide those solutions to clients. So even while we have not been able to make as many deployments or do as much deploying, deals are still getting done. As it relates to the nature of COVID, you've definitely seen an increase in activity, not surprisingly.

Also you've seen a bifurcation and a better understanding of those sectors that will be affected and those that won't. And not surprisingly, the M and A has increasingly gravitated or has gravitated to those that haven't. In terms of terms, I think as we said in the prepared remarks, we're still seeing we still see an increase relative to pre COVID. So that owing to continued robust competition in the private capital markets private debt markets has seen that spread compress. And so I would say if I were to try to generalize, it's probably 50 wider and in general maybe a half turn, quarter to a half turn better than what you would have seen COVID, but obviously that is a more generic term.

And generally speaking, a little bit better documentation. I would also note as it relates to documentation, certainly we've seen less stability, especially in light of what we're grappling with as well as the rest of the market in terms of those unfunded commitments getting funded proactively by borrowers at the onset of COVID. So that's how I'd capture it. A little better, definitely tightening relative and importantly, AI and V having done some sufficient deleveraging would expect us to participate more in the origination coming off the mid cap platform and the broader Apollo platform.

Speaker 6

Got it. That's very helpful. In terms of the portfolio yields in the quarter, obviously, there's a little, Q on Q pressure. Obviously, that I would guess it's not rate driven. Is that more of a mix shift in terms of assets that are being

Speaker 3

Yes. I'll mention that you've got a little bit of that dynamic where your highest yielding investments are not surprisingly the ones that are most targeted for repayment from from the borrower side are set prior to the finally kind of rolling through the the system. Right? The The LIBOR kind of came down steeply earlier in the year, and it takes time for those some of those contracts to roll off. And that was contributing, to a lesser extent, to what you saw in terms of yield movement.

Speaker 6

Got it. And then last question for me, just from a modeling perspective, probably for Greg. But just based on the losses in the earlier part of the year, when would know, if we can assume that status quo, no more losses, no, no more gains from here, when would you expect the incentive fee to begin being paid out again? Just to check my math.

Speaker 4

Yeah. I think, it based on your assumptions, it should be December '21.

Speaker 6

Okay. That's it for me. Thanks a

Speaker 4

lot for answering my questions. Yes. Thanks, Kyle.

Speaker 0

Your next question comes from the line of Matt Jaden with Raymond James.

Speaker 4

Hey, everyone. Good afternoon and thanks for taking my questions. Tander, maybe first one for you. I know you said last quarter on the call that through July cash flows at Merx were tracking at or above expected levels. Did that hold throughout the entirety of calendar third quarter?

And any commentary you

Speaker 2

can give on what you're seeing thus far through November?

Speaker 3

Yes, sure. Happy to. So that was what we were seeing through July. I would say that, that held true through September. That forecast is based on the deferrals granted and what we had expected to kind of come back online.

You had a dynamic where obviously, while unfortunately this has affected all parts of the world, hasn't necessarily been equal. And so in Asia, you've obviously seen a return or greater return or pickup in air travel. And then also in The U. S. While air traffic still remains very, very challenged, obviously the capital markets and the government support have been very, very robust.

And so in general, we are still seeing a modest outperformance relative to our expectations in terms of lease cash flows. I would caution and I think we remain appropriately cautious as if you think about a lot of those deferrals that were granted, Matt, they were in that April to June period and were typically six to nine months. And so it is during this period, we're kind of real time on those coming back online. And so while we are encouraged by kind of relative to expectations what we've seen to date, we remain cautious in as much as not all of those borrowers not all of those lessees have been scheduled to come back online as of now.

Speaker 4

40% drop in amendments during the previous of those amendments compared to the prior quarter?

Speaker 3

I think so you were right to recognize, and I think this is you it makes sense in the midst of the pandemic and the worst of the downdraft, you saw a lot of borrowers reaching out proactively. And then as that activity has passed, you've been in the phase where we were especially in light of or coincident with sponsor support for transactions, we obviously gave the runway for those transactions. In terms of the activity we saw, was down 40%. We had about nine amendments in the quarter, about half of which were what we would consider more substantive, again, many of which entailed equity contributions from the sponsor. And then the other half would be more kind of strategic and less less substantive.

So in terms of in terms of your specific question, I I would say, you know, those that were subs substantive, you know, sort of very much, you know, dealt with, you know, underperformance or COVID effects. But in terms of volume, as we, you know, mentioned in our prepared remarks, definitely less activity. And importantly, where there were those, you know, more COVID affected names, saw good sponsor support, in in those particular amendments.

Speaker 4

That's it from me. Appreciate the time.

Speaker 0

Again, if you would like to ask a question, please press

Speaker 1

Your next question is from the line of

Speaker 7

Hi. Good afternoon, everybody. Start this quarter, sort of a two part. First of all, question on the valuation going down 1.8%. You said there was an offset from the the collateral value versus the servicing contract.

The first part is, what, like, was the the the magnitude of of those swings? Were they were they larger? Were they both pretty modest given the the net impact was was pretty modest? And then second part, to the extent the servicing business increased for for your servicing business, what was sort of the, you know, level of of collateral or assets that that the business want to service to Apollo presumably generated, you know, maybe in quantity of airplanes or or capital invested if you understand how we prefer to answer if you can. That's the first question.

Thanks.

Speaker 3

Yes, sure. And Greg might have the specific number. So I'll jump in first and answer the net down $5,000,000,000 And in terms of clear question related to the servicing platform, we mentioned in August our August call, we've done a big transaction for Delta. The pipeline remains very, very robust in terms of other opportunities as well as also the servicing platform also benefits to the extent that transactions are harvested. And part of the write up was related to some of that harvesting.

And so not as much a specific quantum that I can point to in terms of what drove that increase except to say though we do have we have successfully raised a dedicated fund, which is still has available capital to it to undertake these transactions and also have the benefit of the broader Apollo platform and their potential demand for aircraft leasing transactions as well. And I don't know, Greg, if you have the specific numbers, but relatively up

Speaker 2

and down. I think the ballpark of the numbers were there's a total write down of five and I think the servicing platform was written was increased in value between like the sort of medium single digits. So between something like five and ten. And so that took the you know, that means the, you know, the the the collateral part was down, you know, 10 to 12. It's it's like that ballpark.

So And and and the servicing platform went off went off for a couple of reasons, both because they're more trying to get back to the platform and also because there were some, you know, explicit fees generated that are, you know, now receivables of of, you know, disposition of some claims. And that's even, you know, you know, that that's even more direct value because there'll be cash coming in full.

Speaker 4

Right. And and

Speaker 2

same helpful. The

Speaker 4

and the other directional thing that you can get is the metal, you know, the way that we we look at it, you know, has been written down, and and you said based on cash flows and residuals and all that, over 18%. Okay? So, you know, that's kind of the the magnitude that we have written down. The

Speaker 7

matter, you know, assuming things as we talked about, you know, a lot of these aircraft are are tied to government sponsored or or major airlines around the world. Maybe they were somewhat being renegotiated and such. But assume now you have assume assume now that you've been through most of that, what kind of, like, top line impact overall for the business Merck's experience? And how far along do you think you are in in in that process?

Speaker 2

Well, you you want me to help? Let let me let me take a a shot first. So, yes, but we've worked there. We won't have initial agreements or or or agreements with all of the airlines. Of course, you know, they have to live by those terms going forward.

Right? And so if there's other challenges, you know, that that could change going forward, but we feel like we have a reasonably good view on sort of what the cash flows are going forward. You know, previously, prior to all this, the cash flows from Merx, you know, generally was in the 40 to $45,000,000 range between, you know, debt payment and and dividends come coming out of March to to, you know, to to a I n d each quarter. Now it's $20,000,000 of interest. So so it's less.

So so the so answer is that once those cash flows what if people perform under these leases, you know, we will generate significantly more. I you know, it's between that 45 and 20 per quarter, but but significantly more than the 20. The issue in the short term is that there's some catch up to do, you know, in some of the securitization structures. So the cash is initially produced that month it's pay you know, that quarter is paying down debt. But under these new lease contracts, it's sufficient to generate cash flow well above the income we're recognizing off Merx every quarter, which gives us further cushion into sort of the value we have as well as building our servicing platform.

And and it's does that make sense? And

Speaker 7

Yes. Very helpful.

Speaker 2

And that's sort of how we're looking at it. And so the key is keeping these lease you know, these these we now know what to expect. It's not as good as it was before, but it's but, you know, effectively, when you look at AI and D, you're you're paying for that through the lower return we have off Merx, but we've modeled our dividend off those lower returns off Merx. And we believe, in addition, we we have some ability to outperform because we can we can create we can generate liquidity off some of our planes that are either cargo planes or have some strategic value to somebody to bring our basis down some as well over the next few quarters, and that's our goal, to even further make you know, that that picture, that gap less impactful to our cash flows and and give people a sense of, you know, a a more range bound on sort of where the value is or cushion we have in the valuation.

Speaker 1

We have now to turn the call over

Speaker 0

to management for closing remarks.

Speaker 2

Thanks everybody for listening today. And on behalf of our team, we thank you again for taking the time and support us through this challenging environment. Feel free to reach out to any of us with any questions and we hope everybody has a nice day.

Speaker 0

Thank you. This concludes today's conference call. You may now disconnect. Speakers, please

Speaker 4

hold

Speaker 0

the line.