Earnings Call Transcript - SPMC Q3 2025

Operator, Operator

Good morning, ladies and gentlemen, and welcome to the Sound Point Meridian Capital, Inc. Third Fiscal Quarter Ended December 31, 2024 Earnings Conference Call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. This call is being recorded on Wednesday, February 12, 2025. I would now like to turn the conference over to Peter with Investor Relations. Please go ahead.

Peter Sceusa, Investor Relations

Good day, ladies and gentlemen. Thank you for standing by. Sound Point Meridian Capital refers participants on this call to the Investor web page, www.soundpointmeridiancap.com, for the press release, investor information, and filings with the Securities and Exchange Commission for a discussion of the risks that can affect the business. Sound Point Meridian Capital specifically refers participants to the presentation furnished today on the Form 8-K with the SEC, and to remind listeners that some of the comments today may contain forward-looking statements and as such, will be subject to risks and uncertainties, which, if they materialize, could materially affect results. Reference is made to the section titled Forward-Looking Statements in the company's earnings press release for the period ended December 31, 2024, which is incorporated herein by reference. We note forward-looking statements, whether written or oral, include or are not limited to Sound Point Meridian Capital's expectation or prediction of financial and business performance and conditions, as well as its competitive and industry outlook. Forward-looking statements are subject to risks, uncertainties and assumptions, which, if they materialize, could materially affect results and such forward-looking statements do not guarantee performance and Sound Point Meridian Capital gives no such assurances. Sound Point Meridian Capital is under no obligation and expressly disclaims any obligation to update, alter or otherwise revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. In addition, historical data pertaining to the operating results and other performance indicators applicable to Sound Point Meridian Capital are not necessarily indicative of results to be achieved in succeeding periods. I will now turn the call over to Ujjaval Desai, Chief Executive Officer of Sound Point Meridian Capital.

Ujjaval Desai, CEO

Thank you to everyone joining us today for your interest in Sound Point Meridian Capital, and welcome to our earnings call for the third fiscal quarter ended December 31, 2024. We would like to invite you to download our investor presentation from our website, which provides additional information about the company and our portfolio. With me today is our Chief Financial Officer, Kevin Gerlitz. And after our prepared remarks, we will open it up to your questions. We're happy to report that for our third fiscal quarter, SPMC delivered strong results. For the quarter, we generated net investment income, or NII of $12.5 million, or $0.62 per common share and net realized gain on exited investments of $0.10 per common share, while we paid dividends during the quarter of $0.66 per share. Net asset value per share ended the quarter at $20.52, up from where it stood on September 30 at $19.59, driven mainly by value created from resets of CLOs in the portfolio and a mark-to-market increase due to CLO equity trading at tighter yields in the market. During the quarter, we deployed approximately $43.4 million in eight CLO warehouse investments. We closed six new warehouses that generated six new equity positions with an amortized cost of $66.7 million as of December 31, 2024, and a weighted average GAAP yield of 15.4%. We priced two new warehouses resulting in the commitment to purchase two CLO equity positions with a cost of $28.4 million. We refinanced the liabilities of eight CLO equity investments in the portfolio, significantly reducing liability costs in those transactions. As of December 31, the weighted average GAAP yield on our equity portfolio was 15.2% versus 15.7% as of September 30. The decrease in GAAP yield was mainly the result of loan repricings in the underlying CLO portfolios, which reduced estimated future cash flows available to CLO equity holders. This was slightly offset by CLO refinancing and reset activity, which lowered the CLO liability costs on certain CLO investments in the portfolio. Our portfolio as of December 31 was diversified across 74 CLO investments, managed by 23 CLO managers. The underlying loan portfolio consisted of roughly 1,500 loan issuers across 30-plus industries on a look-through basis. We believe this strategy of broad diversification enables us to manage risk effectively, providing us with dividend sustainability and downside protection through changing market conditions. Subsequent to quarter end, as of January 31, 2025, our estimated net asset value per common share was $20.56, a slight increase from December 31 at $20.52. On February 5, we announced monthly distributions for calendar Q2 2025 of $0.25 per share, an increase of 4.2% over the calendar Q1 2025 monthly distribution rate of $0.24 per share. This announcement is consistent with our IPO strategy of raising our distribution steadily over time as we deploy the proceeds from our IPO offering, our senior financing facility and our Series A preferred stock. With that, I'll now turn the call over to Kevin for a more detailed review of our financial highlights for the quarter.

Kevin Gerlitz, CFO

Thanks, Ujjaval, and hello, everyone. As Ujjaval mentioned, for the quarter ended December 31, 2024, we delivered net investment income of $12.5 million or $0.62 per share. For the quarter ended December 31, 2024, we recorded net realized gains of $2 million and unrealized gains on investments of $17.7 million. Total expenses for the period ended December 31, 2024, were $7.5 million. GAAP net income for the quarter was $32.2 million or $1.59 per share. Moving to our balance sheet. As of December 31, 2024, total assets were $523.4 million. Net assets were $415.9 million, and our net asset value stood at $20.52 per share. The fair value of our investment portfolio stood at $503.7 million, while available liquidity consisting of cash was approximately $19.7 million at the end of the quarter. As of December 31, 2024, the company had outstanding debt that totaled 18.6% of total assets. During the quarter, we declared monthly income distributions of $0.24 per share payable at the end of January, February, and March. Based on our share price as of December 31, 2024, this represents an annualized dividend yield of 13.8%. Overall, we are pleased with our strong results this quarter and believe we are well positioned to sustain our momentum going forward. I will now turn it back to our CEO, Ujjaval Desai.

Ujjaval Desai, CEO

Thanks, Kevin. Before opening up for questions, I want to give a quick update on the overall market environment for corporate loans and CLO equity. Primary loan activity climbed to $400 billion in calendar Q4, the second largest quarter on record. This capped off a record-breaking year of $1.4 trillion of primary activity, 41% higher than the prior record year of 2017. That said, of the $400 billion of activity in the quarter, only 12% came from new issuance unrelated to refinancing or repricing, adding about $50 billion of net loan supply to the market. The majority of activity in the quarter came from loan repricings with approximately $250 billion of activity. In December alone, borrowers launched $153 billion worth of amendments to lower the spread on existing term loans, the busiest month ever recorded. Turning to CLOs, demand for new issue CLOs heated up in calendar Q4. New CLO issuance volume was $60 billion during the quarter, a significant increase compared to $41 billion in calendar Q3. For the full calendar year 2024, new CLO issuance of $202 billion set a new annual record, exceeding the prior annual record of $187 billion set in 2021. Along with strong new issue CLO activity in the quarter, refinancing and reset activity saw another quarter of significant momentum. For the fourth calendar quarter, refinancing activity totaled $23 billion and reset activity totaled $80 billion. This was a strong end to a 2024 that saw full-year refinancing activity of $84 billion, the second highest year on record and reset activity of $223 billion, shattering the prior annual reset record of $138 billion in 2021. The heavy refinance and reset activity throughout 2024 was driven by compression of CLO liability costs, creating a significant window for CLO managers to improve liability costs and lengthen reinvestment periods of existing CLO deals. As we noted on our last call, this reset and refinancing activity presents a significant opportunity as the reduction in liability costs helps to offset the reduction in yields from loan repricing, thereby increasing the excess cash flow available to CLO equity holders, which is what we commonly refer to as a CLO's arbitrage. Furthermore, an extension of the CLO reinvestment period provides a longer runway for CLO managers to optimize the underlying loan portfolios during times of volatility, which can provide further upside to CLO equity returns. With the Fed cutting rates twice more before the end of the year, CLO equity yields were modestly impacted in the near-term. That said, as we previously mentioned, while it's true that lower base rates mean slightly less cash flow available to CLO equity, it is the spread between loan yields and a CLO's liability costs, coupled with the CLO structural leverage, which determines the bulk of the CLO equity returns. In the medium term, we continue to view rate cuts as a net positive for CLO equity as interest costs decrease for floating rate loan issuers, which may be a catalyst for lower corporate default rates. As of calendar year-end, the trailing 12-month default rate stood at 1.5%, still remaining below the historical 27-year average of 2.8%. We continue to monitor the Fed closely to observe its appetite for any further cuts in 2025 as it looks to stave off a return toward more elevated inflation. In summary, it was an excellent third quarter for Sound Point Meridian Capital and we remain excited about the abundant opportunities in the CLO market. We remain bullish on CLO equity as an effective and attractive way to invest in senior secured corporate loans. We will continue to leverage our disciplined investment approach, Sound Point's unique sourcing capabilities, and the expertise of our team to drive attractive risk-adjusted returns for our shareholders. With that, we thank you for your time and would like to open up the call for Q&A.

Operator, Operator

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. Your first question comes from Randy Binner with B. Riley. Your line is now open.

Randy Binner, Analyst

Thank you and good morning. It was a solid quarter, and I appreciate the comments on the market overall at the end of the call. With the primary CLO market being quite active in terms of new issues, how does that impact your process and your view of the credit quality of these new issues? I apologize if I missed it, but do you have any statistics on default activity that you're observing compared to the broader market? It's an open market, but I’m always thinking about credit and what is happening beneath the surface. I would love to hear your thoughts on the credit environment.

Kevin Gerlitz, CFO

Thanks for the call, Randy. You're correct that the market is quite busy with a lot of new issuances. However, much of this new issuance isn’t necessarily fresh activity; it mainly involves older deals being called, reset, or refinanced. Therefore, the net new issuance of CLOs may not be as high as it seems. Regardless, our primary focus remains on the credit quality of loans, which we believe is currently strong. Default rates are stable, hovering around 1.5% for the overall market, and we’re not overly concerned about credit quality at this time. Our main priority is to select the right underlying managers who can maintain low default rates. We are concentrating on the underlying portfolios to minimize tail risk, as that’s where defaults are likely to arise. High-quality loans trading close to par are not the concern; instead, we focus on the 5% to 6% of the market that trades below $0.90 on the dollar, as those loans could drive up default rates. We are acutely focused on ensuring that part of our portfolio remains as minimal as possible. Overall, we are fairly comfortable with the current credit quality in the loan market and believe we can exceed some of the base case assumptions used for modeling CLO equity going forward.

Randy Binner, Analyst

Yes, that's helpful. I have another question. Given that you can utilize the scale and resources of SoundPoint, do you have any quantitative methods or non-fundamental approaches to identify potential sponsors? There are so many sponsors that you would expect to see them appearing in different groups. Can you explain how you use the broader platform to assist with this?

Kevin Gerlitz, CFO

Yes, we utilize our proprietary system called Compass to systematically analyze all available information. There are many CLO sponsors and numerous old CLOs and portfolios, resulting in a vast amount of data. This allows us to screen, analyze, and identify which managers, deals, and vintages are performing well, enabling us to focus on those opportunities. Our data analysis is crucial in identifying suitable investments, and our platform facilitates this process. In addition to the numerical analysis, we also leverage Sound Point's credit platform to gain insights into industry performance and systemic risks. We maintain communication with our manager partners to stay informed about emerging risks. With our systems' assistance, we manage risks within our portfolio by not only making purchase decisions but also engaging in active trading and repositioning throughout the year. All these elements are vital for maintaining the credit quality of our portfolio.

Randy Binner, Analyst

All right. Great. Thank you.

Operator, Operator

Your next question comes from Erik Zwick with Lucid Capital Markets. Your line is now open.

Erik Zwick, Analyst

Thank you. Good morning. In your previous kind of discussion this morning, you talked a lot about the volume and activity in the primary market. Just in your last comments indicated that you do make some trades within the portfolio throughout the year. So I'm wondering, if you could just kind of maybe compare the risk reward from your seat today in terms of the primary and secondary markets.

Ujjaval Desai, CEO

Yes, great question, Erik. We currently prefer the risk-reward in primary equity compared to the secondary market. The primary portfolios are inherently cleaner because the CLO manager selects them today, resulting in lower risk parameters. For instance, loans trading below $0.90 would have much lower presence in a clean portfolio right now. Additionally, our sourcing strategy for new issue deals is crucial. Due to our size and relationships with market counterparts, including managers and banks, we can access transactions early, identify the best deals, and negotiate favorable terms. This allows us to reduce costs, ensure accurate documentation, and manage loan ramp-up times effectively, ultimately leading to significantly higher returns in the new issue market. Our current results reflect yields of over 17% on recent new issue investments, while returns in the secondary market fall 300 to 400 basis points lower. This disparity makes new issues particularly appealing, and we primarily focus on this market, although we do keep an eye on secondary opportunities as well. If certain secondary transactions appear attractive, we may engage selectively. It’s about being thorough and diligent in assessing both markets and capitalizing on relative value differences. We actively shift risk by selling in the secondary market when yields are favorable and then redeploying those funds into primary markets. This rotation of our portfolio is critical for us and has been part of our strategy since inception, and you should expect to see this continue moving forward.

Erik Zwick, Analyst

Thank you for your insights. I appreciate it. Transitioning to a different topic, during last quarter's call, you indicated that an appropriate pace of deployment is around $160 million, which is still below your leverage target. It seems you have more room to maneuver than you mentioned a couple of quarters ago before you deploy all that capital. Given the current attractiveness of your comments regarding the primary market, once you've utilized that capital, it seems there could be an opportunity to raise additional funds and further expand the portfolio. If I'm correct in this assumption, I would like to know how you plan to approach your funding sources moving forward, particularly the balance between fixed and floating rates, considering the prevailing high short-term interest rates and the delays in anticipated Federal Reserve cuts.

Ujjaval Desai, CEO

We have been deploying capital steadily. The funds we raised through preferred issuance last year have already been utilized. As of the end of January, we've accessed $60 million of our $100 million senior financing facility, leaving us with $40 million that we plan to deploy soon. After this, we aim to explore additional capital raising, which could include various formats such as preferred stocks, adjustments to the senior facility, and raising equity capital over time to expand our platform, particularly given the appealing opportunity set available today. We anticipate that interest rates will remain elevated for an extended period, which benefits CLO equity since the investments tied to it are generally floating rate. This situation should enhance our income from investments and support the issuance of liabilities, whether fixed or floating, depending on market conditions. We still have some remaining capital to allocate from our existing facilities, and after that, we will assess whether to pursue fixed or floating rate options based on the market landscape.

Erik Zwick, Analyst

Great. Thanks for the thought there. And one last one for me. Just in terms of the unrealized gain in this quarter. Can you talk about what drove that?

Ujjaval Desai, CEO

The unrealized gain comes from two main sources. Firstly, much of Meridian's portfolio, particularly the seed portfolio, was invested in 2022 and 2023 vintage CLOs, which are now available for reset. At that time, the liability costs were quite high. Some of these deals have already been reset while others are currently going through the process. As these resets occur, value is unlocked in the CLOs, leading to an increase in the valuation of the CLO equity position and generating unrealized gains. Secondly, CLO equity is trading at tighter yields in the market, which has raised the secondary market valuations, contributing to the unrealized gains as well. We experienced a strong quarter with significant unrealized gains, resulting in the NAV rising to 2052. As of the end of January, it has increased to $20.56. There are substantial unrealized gains in the portfolio, which is something we are pleased about. Since the beginning, preserving our NAV while providing attractive dividends has been a key part of our investment philosophy, and we are successfully continuing that trend. Looking ahead, there remains considerable reset optionality in the portfolio. If the market conditions hold steady, we expect to unlock additional reset opportunities, and we will manage the portfolio accordingly.

Erik Zwick, Analyst

Understood. Thanks so much for taking my question today.

Ujjaval Desai, CEO

Of course. Thank you.

Operator, Operator

There are no further questions at this time. I will now turn the call over to Ujjaval Desai, CEO.

Ujjaval Desai, CEO

Great. Well, thank you, everyone, for your time today. I appreciate your support for Sound Point Meridian Capital, and we'll see you guys on the next call in a quarter. Thank you.

Operator, Operator

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.