Earnings Call Transcript - MFIC Q2 2025

Operator, Operator

Good morning, and welcome to the earnings conference call for the period ending June 30, 2025 for MidCap Financial Investment Corporation. I will now turn the call over to Elizabeth Besen, Investor Relations Manager for MidCap Financial Investment Corp.

Elizabeth Besen, Investor Relations Manager

Thank you, operator, and thank you, everyone, for joining us today. We appreciate your interest in MidCap Financial Investment Corporation. Speaking on today's call are Tanner Powell, Chief Executive Officer; Ted McNulty, President; and Kenny Seifert, our newly appointed Chief Financial Officer. Howard Widra, Executive Chairman; and Greg Hunt, our former CFO, who now serves as an adviser, is 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 MidCap Financial Investment Corporation, and 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. To obtain copies of our SEC filings, please visit either the SEC's website or our website at www.midcapfinancialic.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. Throughout today's call, we will refer to MidCap Financial Investment Corporation as either MFIC or the BDC, and we will use MidCap Financial to refer to the lender headquartered in Bethesda, Maryland. At this time, I'd like to turn the call over to Tanner Powell, MFIC's Chief Executive Officer.

Tanner Powell, CEO

Thank you, Elizabeth. Good morning, everyone, and thank you for joining us for MidCap Financial Investment Corporation's Second Quarter Earnings Conference Call. In case you missed our mid-June filing, we're pleased to share that Kenny Seifert has been appointed as MFIC's new Chief Financial Officer, effective as of the close of business on June 30. Kenny has been a key leader within Apollo's finance and accounting team since 2015. Kenny previously served as the CFO of both AFT and AIF, the two funds that MFIC merged with last year. Greg Hunt, MFIC's former CFO, will continue to support the company as an adviser through the end of December to ensure a smooth and effective transition. Additionally, Howard Widra, MFIC's Executive Chairman, informed our Board of his intention to retire from Apollo at the end of 2026. We are thankful to both Greg and Howard for their many contributions to MFIC. For today's call, I will begin by providing an overview of MFIC's second quarter results, along with an update on the meaningful progress we've made reducing our investment in Merx. I will then turn the call over to Ted, who will share our views on the current market environment, walk through our investment activity for the period, and provide an update on the portfolio. Kenny will then review our financial results and capital position. Yesterday after market closed, we reported results for the second quarter. Net investment income, or NII, per share was $0.39 for the June quarter, which corresponds to an annualized return on equity, or ROE, of 10.5%. GAAP net income per share was $0.19 for the quarter, which corresponds to an annualized ROE of 5.2%. NAV per share was $14.75 at the end of June, down 1.2% compared to the prior quarter. The decline in NAV per share was primarily due to a handful of positions that are experiencing company-specific challenges, partially offset by a gain on Merx, which we will touch on shortly, and NII slightly exceeding the dividend. During the June quarter, MFIC made $262 million of new commitments across 29 transactions. MidCap's strong incumbent position continues to be a competitive advantage, evidenced by the fact that slightly more than half of the 29 commitments were made to existing portfolio companies. This underscores the power of incumbency, particularly in a muted M&A environment. We also observed a slight increase in the spread per unit of leverage on new commitments compared to the prior quarter, which Ted will discuss later. Moving on to Merx, our aircraft leasing portfolio company, we have been actively working to reduce. During the June quarter, Merx sold one aircraft, resulting in an $8.5 million paydown to MFIC. We are pleased to share several recent positive developments related to our investment in Merx that occurred subsequent to quarter-end. As mentioned on last quarter's call, we were working on multiple sales campaigns and anticipated MFIC's exposure to Merx to decline in the coming quarters. We are happy to report that we've made significant progress toward this objective. Post quarter-end, Merx successfully completed a sales transaction covering the majority of its aircraft. Given the strong market environment, we were able to sell these aircraft at above the value embedded in Merx's valuation, resulting in a modest write-up on our investment during the June quarter. In addition, in July, Merx received payments from insurers related to the three aircraft detained in Russia in the amount of $30.9 million, which brings Merx's total recoveries to date to approximately $47.4 million on those three aircraft. Similar to the sales transaction, the insurance proceeds were slightly above the amount assumed in Merx's valuation. Following the sales transaction and the insurance recoveries, Merx will be repaying approximately $90 million to MFIC on a net basis in the September quarter, reducing MFIC's investment by nearly half. As part of the sale transaction, Merx is also expected to receive additional consideration of approximately $30 million anticipated by year-end 2025 or early 2026. Both the insurance recoveries and the sales transaction combined are expected to result in a positive impact to NAV in the high-single-digit per share range relative to its June 30, 2025 carrying value. To facilitate the Merx sales transaction, MFIC temporarily provided additional capital to Merx. As a result, MFIC incurred incremental interest expense associated with this temporary capital infusion in the September quarter of approximately $1 million or $0.01 per share. On a pro forma basis, adjusting Merx's $185 million fair value as of the end of June for this $90 million net paydown, MFIC's investment in Merx will total approximately $95 million, representing approximately 2.8% of the total portfolio, down from 5.6% at the end of June. Of the $90 million net repayment, approximately $25 million will be used to reduce Merx' revolver and the remaining $65 million applied to our equity investment in Merx. As mentioned, MFIC will be receiving additional consideration totaling approximately $30 million by the end of 2025 or in early 2026, which will further reduce MFIC's exposure to Merx. Let me now walk you through what remains at Merx. MFIC's remaining investment in Merx consists of four aircraft plus the value associated with Merx's servicing platform. As a reminder, Merx earns income through its servicing activities for Navigator, Apollo's dedicated aircraft leasing fund. Navigator is actively pursuing the sale of its fleet. Merx receives a servicing fee on each aircraft sale. This reduction in our exposure to Merx lowers MFIC's exposure to an under-yielding asset and provides us with capital to deploy into first lien middle market loans sourced by MidCap Financial, which we believe will deliver a higher and more attractive risk-adjusted return. At the current base rates, we estimate that reinvesting $90 million, comprising $25 million from Merx's revolver and $65 million from equity, is expected to generate approximately $0.06 per share in additional annual net investment income, enhancing long-term value for our shareholders. The remaining value of Merx, once realized and reinvested, will generate another approximate $0.06 per share in additional net investment income at current base rates. Turning to our dividend. On August 5, 2025, our Board of Directors declared a quarterly dividend of $0.38 per share for shareholders of record as of September 9, 2025, payable on September 25, 2025. As mentioned, we intend to redeploy the capital repaid from Merx, which should be accretive to MFIC's earnings power and strengthen our dividend coverage going forward. With that, I will now turn the call over to Ted.

Ted McNulty, President

Thank you, Tanner. Good morning, everyone. Beginning with the market environment, the quarter began with heightened volatility, driven by the U.S. presidential administration's announcement of aggressive tariffs. This announcement temporarily disrupted activity, leading to a pause in new issuance. However, as the quarter progressed, we observed a significant improvement in market sentiment, and issuance activity picked up, particularly after a pause on tariffs was announced and several trade deals were struck. Despite the turbulent start to the quarter, most major asset classes delivered positive returns. Importantly, we are beginning to see signs of a pickup in sponsor M&A activity. The U.S. economy has continued to show stability, characterized by high but gradually moderating inflation despite the pressure from tariffs. The labor market has shown resilience, with unemployment holding steady. In response, the Federal Reserve has kept its policy rate unchanged, opting to wait for greater clarity on the economic impact of evolving trade and fiscal policies. We believe the core middle market where we are focused does not compete directly with either the broadly syndicated loan market or the high-yield bond market. Regardless of muted M&A activity, we see that many of our borrowers continue to have add-on financing needs, which is an important source of deal flow. Next, I'm going to spend a few minutes reviewing our second quarter investment activity and then provide some detail on our investment portfolio. As a reminder, MFIC is focused on lending to the core middle market on a first lien senior secured basis. We believe this segment of the direct lending market offers attractive risk-adjusted yields and is less competitive compared to other segments of the direct lending market. MidCap Financial's long-standing presence in the middle market and its deep network of sponsor relationships enable us to continue to see a wide range of attractive investment opportunities. As a result, we believe the risk-adjusted returns available to firms like MidCap Financial and MFIC are among the most attractive in the direct lending market across cycles. In the June quarter, we continued to deploy capital into assets with what we believe to be strong credit attributes. As mentioned, MFIC's new commitments in the June quarter totaled $262 million with a weighted average spread of 538 basis points across 29 different companies. Excluding two outliers, the weighted average spread on new commitments was 526 basis points. We also observed a slight decline in the net leverage on new commitments. The weighted average net leverage on new commitments was 4.0x in the June quarter, down from 4.2x in the prior quarter. Our fee structure, which is one of the lowest among listed BDCs, allows us to produce attractive ROEs at current spreads. Gross fundings, excluding revolvers, totaled $254 million. Sales and repayments, excluding revolvers and Merx, totaled $108 million. Net revolver fundings were approximately $7 million. Moving to our investment portfolio. At the end of June, our portfolio had a fair value of $3.33 billion and was invested in 249 companies across 51 industries. As a reminder, in the March quarter, we transitioned our industry classification from the Moody's industry system to the Global Industry Classification System, or GICS. Direct origination and others represented 92% of the total portfolio. We expect this percentage to increase next quarter, given the Merx paydown. At the end of June, the non-directly originated loans acquired from the closed-end funds represented just 2% of the portfolio. Merx accounted for 5.6% of the total portfolio at the end of June, but today, it's closer to 2.8%, given the post quarter-end paydown. All of the figures above are on a fair value basis. Specific to the direct origination portfolio, at the end of June, 99% was first lien and 90% was backed by financial sponsors, both on a fair value basis. The average funded position was $13.1 million. The median EBITDA was approximately $50 million. Approximately 96% had one or more financial covenants on a cost basis. Covenant quality is a key point of differentiation for the core middle market, as substantially all of our deals have at least one covenant compared to larger deals, which are generally without covenants. The weighted average yield at cost of our direct origination portfolio was 10.5% on average for the June quarter, down from 10.7% for the March quarter. At the end of June, the weighted average spread on the directly originated corporate lending portfolio was 568 basis points, down one basis point compared to the end of March. Since the initial tariff announcements earlier this year, MidCap has been analyzing the potential impacts across the entire portfolio on a company-by-company basis. This review has been refined and is ongoing. As a reminder, we primarily lend to U.S. service-oriented businesses, and we are underweight businesses that are heavily dependent on imports and exports. Our underwriting process always includes a downside scenario, and we have supplemented our underwriting process in response to the tariffs. MidCap Financial leads and serves as administrative agent on the vast majority of MFIC's direct lending deals. At the end of June, MidCap Financial or Apollo was the agent on 72% of MFIC's direct lending portfolio at fair value. This leadership position allows us to be in active dialogue with our borrowers and have enhanced information flow, which is particularly valuable during volatile periods. Being agent allows us to detect and address any issues early. Our underwriting on MidCap Financial source loans has proven to be sound. Based on data since mid-2016, our annualized net realized and unrealized loss rate is approximately 6 basis points on loans sourced by MidCap Financial. We think this performance data shows how well the strategy has performed. We observed a slight increase in net leverage or debt-to-EBITDA of our borrowers. The weighted average net leverage was 5.32x at the end of June, up from 5.25x at the end of March. The increase was small due to a small number of existing positions, partially offset by new investments. As mentioned, new commitments made during the quarter had a net leverage of 4.0x. At the end of June, the weighted average interest coverage ratio was 2.1x, flat compared to last quarter. We believe the stable level of revolver utilization is an additional sign of the health of our portfolio companies. At the end of June, the percentage of our leveraged lending revolver commitments that were drawn was roughly unchanged from the prior quarter. We believe a steady revolver utilization rate is an indicator of financial stability. During the quarter, we restored three positions to accrual status, following the successful restructuring in two of these cases, highlighting our ability to navigate credit issues. We also placed three first lien positions on nonaccrual status due to company-specific challenges, New Era, Amplity, and Compass Health. Investments on nonaccrual status represented 2% of the portfolio at fair value, up from 0.9% last quarter, and the number of companies on nonaccrual decreased by one. PIK income represented 6.4% of total investment income for the June quarter. With that, I will now turn the call over to Kenny to discuss our financial results in detail.

Kenneth Seifert, CFO

Thank you, Ted, and good morning, everyone. I'm honored to join MFIC as Chief Financial Officer and excited to be part of the team and look forward to connecting with each of you soon. Since stepping into the role a little over a month ago, I've been working closely with Greg to ensure a seamless transition. I will now review our second quarter results in greater detail. Total investment income for the June quarter was approximately $81.3 million, up $2.6 million or 3.2% compared to the prior quarter. The increase was primarily attributable to higher interest income due to growth in the portfolio, as well as higher prepayment income, partially offset by a decline in fee income and the impact from an increase in investments on nonaccrual status. Prepayment income was approximately $1.2 million, up from $0.6 million last quarter. Fee income was approximately $220,000, down from approximately $330,000 last quarter. Dividend income was approximately $200,000, essentially flat quarter-over-quarter. The weighted average yield at cost of our directly originated lending portfolio was 10.5% on average for the June quarter, down from 10.7% last quarter. Net expenses for the quarter were $44.9 million, up from $44.4 million last quarter. This increase was driven by higher interest expenses and G&A expenses, partially offset by a lower incentive fee. Interest expense rose due to a higher amount of debt outstanding due to growth in the portfolio. Other G&A expenses totaled $1.6 million for the quarter, up from $1.2 million in the March quarter. As discussed on the last quarter's call, during the March quarter, we received a reimbursement from Merx for certain expenses previously incurred by MFIC on Merx's behalf. This was recorded as a contra expense. As mentioned on last quarter's call, we expect other G&A to average around $1.6 million per quarter. MFIC's stated incentive fee rate is 17.5% and is subject to a total return hurdle with a rolling 12-quarter look back. Given the total return hurdle feature and the net loss incurred during the look-back period, MFIC's incentive fee for the June quarter was $3.9 million or 9.6% of pre-incentive fee NII. For the June quarter, net investment income per share was $0.39 and GAAP earnings per share or net income per share was $0.19. These results correspond to an annualized ROE based on net investment income of 10.5% and an annualized ROE based on net income of 5.2%. Results for the quarter include a net loss of approximately $18.3 million or $0.20 per share, primarily due to losses on a handful of investments as previously mentioned. Turning to the balance sheet. At the end of June, the portfolio had a fair value of $3.33 billion, total principal debt outstanding of $2.05 billion, and total net assets stood at $1.3 billion or $0.1475 per share. Net leverage at the end of the quarter was 1.44x. Average net leverage for the June quarter was 1.35x, reflecting the timing of investment activity. This compares to average net leverage of 1.21x for the March quarter. Given our visibility to the anticipated Merx paydown, we adjusted our pace of deployment in the June quarter accordingly. On a pro forma basis, including the approximate $90 million net repayment from Merx, net leverage at the end of June would have been around 1.37x. Gross fundings for the quarter, excluding revolvers, totaled $254 million. Net fundings for the quarter were $144 million. Turning to our capital base. We currently intend to reprice and upsize our first CLO, MFIC Bethesda CLO 1, in the fall. CLO spreads have tightened considerably since our first CLO priced in September 2023. Of course, the timing and pricing of any future CLO transaction is subject to prevailing market conditions. Lastly, we were pleased that in June, Kroll affirmed MFIC's investment-grade rating of BBB- with a positive outlook. This concludes our prepared remarks. Operator, please open the call to questions.

Operator, Operator

We'll take our first question from Finian O'Shea with Wells Fargo Securities.

Finian O'Shea, Analyst

Congratulations on Merx and all the new appointments. I wanted to revisit Merx. There was a lot to discuss. Will the pro forma comprise 40% of the servicing business, with the rest being equity? Does that mean the remaining structure will resemble the current leveraged aircraft business and include part of the servicing business, maintaining its role as a strategic portfolio position?

Tanner Powell, CEO

So thanks, Fin. The 40% is correct regarding the remaining roughly $95 million of exposure; 40% is in the servicing business. The slight modification I'd make to how you described it is that it is not a strategic investment. We are not taking on any more servicing contracts there. And the 40% represents previously signed contracts, particularly servicing our drawdown commingled fund Navigator. Those are revenues that will come in over time. So, it's not a strategic business but is related to the servicing of planes, meaning there’s no balance sheet risk for Merx. Merx will be paid a portion of the rent that is paid to Navigator. When we sell transactions, Merx will benefit from a payment concerning the amount of the planes that are sold. So not strategic, but it is related to the servicing.

Finian O'Shea, Analyst

And again, does that run off with the current Navigator fund family? Or is that complex growing? Is that service business expected to grow?

Tanner Powell, CEO

That will run off over time as we sell the remaining planes that are in Navigator. That is not expected to grow.

Finian O'Shea, Analyst

Okay. Just a follow-up on co-investment. It looks like you placed a series of consecutive orders. I know there are some regulatory changes, but I would like to understand what that means for MidCap and if more Apollo funds are able to originate through MidCap.

Tanner Powell, CEO

Generally speaking, the movement in the order has been positive. There were COVID-related modifications that were enhanced, some of which became permanent. The direction has allowed for greater flexibility. In terms of the MidCap origination, the availability of the origination is the same as it always was; the modification in the rules has generally meant greater flexibility for balance sheets across Apollo to participate in transactions. Some of the new rulemaking has enabled funds to come in even if they didn't participate in the original transaction, thus providing more flexibility.

Operator, Operator

And next, we'll go to Arren Cyganovich with Truist.

Arren Cyganovich, Analyst

I was just hoping you could talk a little bit about investing expectations for the second half of the year, what you're seeing, how busy the pipeline is, etc.

Ted McNulty, President

Thanks for the question, Arren. Just taking it from the beginning of the year, there were high expectations for a robust M&A market. In the first half, uncertainty around tariffs and what type of legislation was going to get passed played out. By the end of April, we started to see a little more clarity around those issues, and market sentiment began to get a bit more bullish. If you look at most major markets, they're up for the year. The M&A pipeline has continued to build. Sponsors are very active. There's been reports that sponsors have maintained a longer duration of their portfolios and have been holding on to companies longer. There's still a lot of dry powder that needs to go to work. The liquidity in the private credit markets indicates we should have a pretty active second half. If that doesn't play out, we have the power of incumbency, and we think there'll be plenty of activities to deploy. MidCap has a very large origination business, and MFIC only needs a small percentage of that to meet its quarterly and annual origination needs. We see plenty of activity and opportunities.

Arren Cyganovich, Analyst

Great. I appreciate that. The other question was around leverage. It ticked up this quarter to 1.44 net. And I just want to know where you're expecting that to trend and if that is a bit higher than what you like? Or is that in the same ballpark that you're okay with?

Ted McNulty, President

In terms of new deployments, we're deploying at 4x to 4.5x. We like to be in that range. We are comfortable at that leverage level on new deployments. A lot of the deals we do involve middle market strategies, and the borrowers are acquisitive. You'll see sponsors purchase something at 4x, and their intent is to make acquisitions and then begin to delever again over time. In terms of the weighted average numbers we cite on the overall portfolio, we are comfortable there. The net leverage ratio at 1.43x is still within the parameters we're managing first lien lending while adjusting for the anticipated Merx transaction.

Tanner Powell, CEO

If I could add to that quickly, Arren, we assigned a non-zero probability of getting the Merx transaction done, so we came in a little hot. It's our intention to operate toward the bottom end of our range, and you should expect us to do that going forward. As we weigh the back half of the year, we're hopeful, as Ted alluded to, that we will see a pickup in M&A that will create opportunities and provide stability to spreads. We will remain deliberate and account for the risks in the market as we redeploy the Merx proceeds we received.

Operator, Operator

Our next question will come from Kenneth Lee with RBC Capital Markets.

Kenneth Lee, Analyst

Just one on Merx. And to clarify, it sounds like after all the announced sales transactions, there's going to be four aircraft remaining in addition to the services platform. Is the four aircraft remaining related to one of the two securitizations you had left? Or I just want to clarify how many of the securitizations will be left to wind down?

Tanner Powell, CEO

Thanks, Ken. At this juncture, the securitizations have been completely paid off. These are four planes that we own on the balance sheet at Merx without any leverage.

Kenneth Lee, Analyst

In terms of the insurer payments at this point, is there anything remaining there?

Tanner Powell, CEO

Without going into detail, the dynamics of the court process in the U.K. are such that the court fines regarding the insurance claims require a subsequent trial to adjudicate the interest and costs of recovery. We have conservatively estimated what those remaining proceeds will be. However, the majority of our claims related to our Russia exposures have already been received.

Kenneth Lee, Analyst

Great. And just one follow-up, if I may, just on the new nonaccruals in the quarter there. Any commonalities that you're seeing there? And how many were either indirectly or directly related to tariffs perhaps?

Ted McNulty, President

In terms of themes, there are different types of businesses. They've all seen some level of cost pressure across the board, whether that's interest rates, labor, etc. There's no single factor causing issues; it’s a culmination of various levers that come together resulting in restructuring. One aspect we see are balance sheets constructed in a lower interest rate environment, where you have good companies but bad balance sheets, driving our biggest issues.

Operator, Operator

Our next question comes from Robert Dodd with Raymond James.

Robert Dodd, Analyst

Just on the spread environment and the opportunities going into the rest of the year, there's about a 40 basis point gap between what's coming on versus what's in the portfolio. Should we continue to expect spread compression in the portfolio? If deployment spreads remain stable, should we expect spread compression, or is that more about a mix?

Tanner Powell, CEO

If we're at 5.68% and the primary market is low-5s or dipping into the 4s, we would expect it to come down. The primary market has underperformed consistently in producing new M&A and new credit creation opportunities, but there's hope that this will stabilize in the second half of the year. Market underperformance relative to expectations has contributed to lower spreads. We believe we can create good risk-adjusted returns despite challenges.

Robert Dodd, Analyst

Got it. When do you think the leverage ask is going to increase going into the second half of the year or next year? Is it possible that sponsors will want higher leverage?

Tanner Powell, CEO

We anticipate that leverage levels could tick up as the market becomes more favorable for borrowers. If we don't see M&A volumes materialize, it's likely that leverage levels will increase due to the supply of capital available and sponsor needs to enhance IRRs.

Robert Dodd, Analyst

To clarify, you've already redeployed capital from the Merx transaction, right?

Tanner Powell, CEO

Yes, the bulk of the $90 million has already been redeployed into earning assets.

Operator, Operator

We'll go next to Melissa Wedel with JPMorgan.

Melissa Wedel, Analyst

Many of the questions have already been addressed, but I wanted to briefly discuss repayment expectations. Aside from Merx, if there is an increase in M&A activity, do you anticipate a similar increase in repayments?

Ted McNulty, President

I wouldn't say that there are major specific deals that we have earmarked for repayment. We know that a handful of companies are in processes via our dialogue with the sponsor. Most of our portfolio falls below the threshold of term loan B, making takeouts rare. If M&A picks up, we'll have opportunities to deploy.

Melissa Wedel, Analyst

In terms of what that means for dividend coverage, are you feeling good about that $0.38 and fully covering that through NII, given these portfolio developments?

Tanner Powell, CEO

While we don't think about it specifically, the trajectory is important. Given the $0.06 annual net investment income from the redeployment of Merx, we feel good about the dividend coverage at the current trajectory.

Operator, Operator

Just to clarify on the impact of the Merx transactions. The 10-Q says they should result in a positive impact to NAV in the high-single-digit per share range. By high-single digit, do you mean $0.06 to $0.09?

Tanner Powell, CEO

Yes, $0.06 to $0.09.

Operator, Operator

That does conclude our question-and-answer session. I'd like to now turn the call back to management for any final or closing remarks.

Tanner Powell, CEO

Thank you, operator. 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 other questions. Have a good day.

Operator, Operator

Thank you. And ladies and gentlemen, that does conclude today's conference. We appreciate your participation. Have a wonderful day.