(EDGAR Online via COMTEX) -- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Except as otherwise specified, references to "we," "us" and "our" refer to Monroe Capital Corporation and its consolidated subsidiaries; MC Advisors refers to Monroe Capital BDC Advisors, LLC, our investment adviser and a Delaware limited liability company; MC Management refers to Monroe Capital Management Advisors, LLC, our administrator and a Delaware limited liability company; Monroe Capital refers to Monroe Capital LLC, a Delaware limited liability company, and its subsidiaries and affiliates; and SLF refers to MRCC Senior Loan Fund I, LLC, an unconsolidated Delaware limited liability company, in which we co-invest with NLV Financial Corporation ("NLV") primarily in senior secured loans. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes appearing in our annual report on Form 10-K (the "Annual Report") for the year ended December 31, 2019, filed with the U.S. Securities and Exchange Commission ("SEC") on March 3, 2020. The information contained in this section should also be read in conjunction with our unaudited consolidated financial statements and related notes and other financial information appearing elsewhere in this quarterly report on Form 10-Q (the "Quarterly Report").
This Quarterly Report, including Management's Discussion and Analysis of Financial Condition and Results of Operations, contains statements that constitute forward-looking statements, which relate to future events or our future performance or future financial condition. These forward-looking statements are not historical facts, but rather are based on current expectations, estimates and projections about our company, our industry, our beliefs and our assumptions. The forward-looking statements contained in this Quarterly Report involve risks and uncertainties, including statements as to:
our future operating results;
our business prospects and the prospects of our portfolio companies;
the dependence of our future success on the general economy and its impact on the industries in which we invest;
the impact of global health epidemics, such as the current novel coronavirus ("COVID-19") pandemic, on our or our portfolio companies' business and the global economy;
the impact of a protracted decline in the liquidity of credit markets on our business;
the impact of changes in London Interbank Offered Rate ("LIBOR") on our operating results;
the impact of increased competition;
the impact of fluctuations in interest rates on our business and our portfolio companies;
our contractual arrangements and relationships with third parties;
the valuation of our investments in portfolio companies, particularly those having no liquid trading market;
actual and potential conflicts of interest with MC Advisors, MC Management and other affiliates of Monroe Capital;
the ability of our portfolio companies to achieve their objectives;
the use of borrowed money to finance a portion of our investments;
the adequacy of our financing sources and working capital;
the timing of cash flows, if any, from the operations of our portfolio companies;
the ability of MC Advisors to locate suitable investments for us and to monitor and administer our investments;
the ability of MC Advisors or its affiliates to attract and retain highly talented professionals;
our ability to qualify and maintain our qualification as a regulated investment company and as a business development company; and
the impact of future legislation and regulation on our business and our portfolio companies.
We use words such as "anticipates," "believes," "expects," "intends," "seeks," "plans," "estimates," "targets" and similar expressions to identify forward-looking statements. The forward-looking statements contained in this Quarterly Report involve risks and uncertainties. Our actual results could differ materially from those implied or expressed in the forward-looking statements for any reason, including the factors set forth in "Part I-Item 1A. Risk Factors"in our Annual Report and "Part II-Item 1A. Risk Factors" in this Quarterly Report.
Although we believe that the assumptions on which these forward-looking statements are based are reasonable, any of those assumptions could prove to be inaccurate, and as a result, the forward-looking statements based on those assumptions also could be inaccurate. Important assumptions include our ability to originate new loans and investments, certain margins and levels of profitability and the availability of additional capital. In light of these and other uncertainties, the inclusion of a projection or forward-looking statements in this Quarterly Report should not be regarded as a representation by us that our plans and objectives will be achieved.
We have based the forward-looking statements included in this Quarterly Report on information available to us on the date of this Quarterly Report, and we assume no obligation to update any such forward-looking statements. Although we undertake no obligation to revise or update any forward-looking statements in this Quarterly Report, whether as a result of new information, future events or otherwise, you are advised to consult any additional disclosures that we may make directly to you or through reports that we may file in the future with the SEC, including Annual Reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K.
Monroe Capital Corporation is an externally managed, closed-end, non-diversified management investment company that has elected to be regulated as a business development company ("BDC") under the Investment Company Act of 1940, as amended (the "1940 Act"). In addition, for U.S. federal income tax purposes, we have elected to be treated as a regulated investment company ("RIC") under the subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"). We are a specialty finance company focused on providing financing solutions primarily to lower middle-market companies in the United States and Canada. We provide customized financing solutions focused primarily on senior secured, junior secured and unitranche secured (a combination of senior secured and junior secured debt in the same facility in which we syndicate a "first out" portion of the loan to an investor and retain a "last out" portion of the loan) debt and, to a lesser extent, unsecured subordinated debt and equity, including equity co-investments in preferred and common stock, and warrants.
Our shares are currently listed on the NASDAQ Global Select Market under the symbol "MRCC".
Our investment objective is to maximize the total return to our stockholders in the form of current income and capital appreciation through investment in senior secured, unitranche secured and junior secured debt and, to a lesser extent, subordinated debt and equity investments. We seek to use our extensive leveraged finance origination infrastructure and broad expertise in sourcing loans to invest in primarily senior secured, unitranche secured and junior secured debt of middle-market companies. Our investments will generally range between $2.0 million and $18.0 million each, although this investment size may vary proportionately with the size of our capital base. As of March 31, 2020, our portfolio included approximately 81.5% senior secured debt, 9.4% unitranche secured debt, 2.0% junior secured debt and 7.1% equity securities, compared to December 31, 2019, when our portfolio included approximately 77.1% senior secured debt, 12.4% unitranche secured debt, 2.2% junior secured debt and 8.3% equity securities. We expect that the companies in which we invest may be leveraged, often as a result of leveraged buy-outs or other recapitalization transactions, and, in certain cases, will not be rated by national ratings agencies. If such companies were rated, we believe that they would typically receive a rating below investment grade (between BB and CCC under the Standard & Poor's system) from the national rating agencies.
While our primary focus is to maximize current income and capital appreciation through debt investments in thinly traded or private U.S. companies, we may invest a portion of the portfolio in opportunistic investments in order to seek to enhance returns to stockholders. Such investments may include investments in high-yield bonds, distressed debt, private equity or securities of public companies that are not thinly traded and securities of middle-market companies located outside of the United States. We expect that these public companies generally will have debt securities that are non-investment grade.
On February 28, 2014, our wholly-owned subsidiary, Monroe Capital Corporation SBIC, LP ("MRCC SBIC"), a Delaware limited partnership, received a license from the Small Business Administration ("SBA") to operate as a Small Business Investment Company ("SBIC") under Section 301(c) of the Small Business Investment Act of 1958. MRCC SBIC commenced operations on September 16, 2013. See "SBA Debentures" below for more information.
We generate interest income on the debt investments in portfolio company investments that we originate or acquire. Our debt investments, whether in the form of senior secured, unitranche secured or junior secured debt, typically have an initial term of three to seven years and bear interest at a fixed or floating rate. In some instances, we receive payments on our debt investment based on scheduled amortization of the outstanding balances. In addition, we receive repayments of some of our debt investments prior to their scheduled maturity date. In some cases, our investments provide for deferred interest of payment-in-kind ("PIK") interest. In addition, we may generate revenue in the form of commitment, origination, amendment, structuring or due diligence fees, fees for providing managerial assistance and consulting fees. Loan origination fees, original issue discount and market discount or premium are capitalized, and we accrete or amortize such amounts as interest income. We record prepayment premiums and prepayment gains (losses) on loans as interest income. As the frequency or volume of the repayments which trigger these prepayment premiums and prepayment gains (losses) may fluctuate significantly from period to period, the associated interest income recorded may also fluctuate significantly from period to period. Interest and fee income is recorded on the accrual basis to the extent we expect to collect such amounts. Interest income is accrued based upon the outstanding principal amount and contractual terms of debt and preferred equity investments. Interest is accrued on a daily basis. We record fees on loans based on the determination of whether the fee is considered a yield enhancement or payment for a service. If the fee is considered a yield enhancement associated with a funding of cash on a loan, the fee is generally deferred and recognized into interest income using the effective interest method if captured in the cost basis or using the straight-line method if the loan is unfunded and therefore there is no cost basis. If the fee is not considered a yield enhancement because a service was provided, and the fee is payment for that service, the fee is deemed earned and recognized as fee income in the period the service has been completed.
Dividend income on preferred equity securities is recorded as dividend income on an accrual basis to the extent that such amounts are payable by the portfolio company and are expected to be collected. Dividend income on common equity securities is recorded on the record date for private portfolio companies. Each distribution received from limited liability company ("LLC") and limited partnership ("LP") investments is evaluated to determine if the distribution should be recorded as dividend income or a return of capital. Generally, we will not record distributions from equity investments in LLCs and LPs as dividend income unless there are sufficient accumulated tax-basis earnings and profits in the LLC or LP prior to the distribution. Distributions that are classified as a return of capital are recorded as a reduction in the cost basis of the investment. The frequency and volume of the distributions on common equity securities and LLC and LP investments may fluctuate significantly from period to period.
Our primary operating expenses include the payment of base management and incentive fees to MC Advisors, under the investment advisory and management agreement (the "Investment Advisory Agreement"), the payment of fees to MC Management for our allocable portion of overhead and other expenses under the administration agreement (the "Administration Agreement") and other operating costs. See Note 6 to our consolidated financial statements and "Related Party Transactions" below for additional information on our Investment Advisory Agreement and Administration Agreement. Our expenses also include interest expense on our various forms of indebtedness. We bear all other out-of-pocket costs and expenses of our operations and transactions.
Net gain (loss)
We recognize realized gains or losses on investments based on the difference between the net proceeds from the disposition and the cost basis of the investment without regard to unrealized gains or losses previously recognized. We record current period changes in fair value of investments, foreign currency forward contracts, foreign currency and other transactions within net change in unrealized gain (loss) on the consolidated statements of operations.
Portfolio and Investment Activity
During the three months ended March 31, 2020, we invested $41.3 million in six new portfolio companies and $29.8 million in 34 existing portfolio companies and had $52.8 million in aggregate amount of sales and principal repayments, resulting in net investments of $18.3 million for the period.
During the three months ended March 31, 2019, we invested $36.2 million in eight new portfolio companies and $33.9 million in 21 existing portfolio companies and had $29.1 million in aggregate amount of sales and principal repayments, resulting in net investments of $41.0 million for the period.
The following table shows portfolio yield by security type:
March 31, 2020 December 31, 2019 Weighted Average Weighted Weighted Average Weighted Annualized Average Annualized Average Contractual Annualized Contractual Annualized Coupon Effective Coupon Effective Yield (1) Yield (2) Yield (1) Yield (2) Senior secured loans 8.4 % 8.4 % 8.9 % 8.9 % Unitranche secured loans 6.3 6.6 9.3 9.8 Junior secured loans 8.9 8.9 9.1 9.1 Preferred equity securities 1.8 1.8 0.5 0.5 Total 8.0 % 8.1 % 8.8 % 8.9 %
(1) The weighted average annualized contractual coupon yield at period end is computed by dividing (a) the interest income on debt investments and preferred equity investments (with a stated coupon rate) at the period end contractual coupon rate for each investment by (b) the par value of our debt investments (excluding debt investments acquired for no cost in a restructuring on non-accrual status) and the cost basis of our preferred equity investments. We exclude loans acquired for no cost in a restructuring on non-accrual status within this metric as management believes this disclosure provides a better indication of return on invested capital. This exclusion impacts only the junior secured loans and total disclosed above. The weighted average contractual coupon yield including debt investments acquired for no cost in a restructuring on non-accrual status was 4.6% for junior secured loans and 7.8% in total as of March 31, 2020. The weighted average contractual coupon yield including debt investments acquired for no cost in a restructuring on non-accrual status was 4.8% for junior secured loans and 8.6% in total as of December 31, 2019.
The following table shows the composition of our investment portfolio (in thousands):
March 31, 2020 December 31, 2019 Fair Value: Senior secured loans $ 481,565 81.5 % $ 475,157 77.1 % Unitranche secured loans 55,826 9.4 76,247 12.4 Junior secured loans 11,704 2.0 13,676 2.2 LLC equity interest in SLF 31,325 5.3 42,412 6.9 Equity securities 10,417 1.8 8,739 1.4 Total $ 590,837 100.0 % $ 616,231 100.0 %
Our portfolio composition remained relatively consistent with December 31, 2019, with the largest shifts in portfolio composition resulting from the funding of senior secured loans and unrealized losses on SLF during the three months ended March 31, 2020. The decrease in total contractual and effective yields on the portfolio was primarily attributed to general decreases in LIBOR and moving additional investments to non-accrual status during the three months ended March 31, 2020.
The following table shows our portfolio composition by industry (in thousands):
March 31, 2020 December 31, 2019 Fair Value: Automotive $ 7,616 1.3 % $ 7,787 1.3 % Banking, Finance, Insurance & Real Estate 73,872 12.5 76,351 12.4 Beverage, Food & Tobacco 21,547 3.6 15,634 2.5 Capital Equipment 15,534 2.6 - - Chemicals, Plastics & Rubber 26,398 4.5 29,509 4.8 Construction & Building 18,183 3.1 30,887 5.0 Consumer Goods: Durable 23,645 4.0 21,237 3.4 Consumer Goods: Non-Durable 15,288 2.6 20,365 3.3 Containers, Packaging & Glass 7,017 1.2 8,377 1.4 Energy: Oil & Gas 4,203 0.7 4,306 0.7 Environmental Industries 11,810 2.0 12,001 1.9 Healthcare & Pharmaceuticals 68,845 11.7 62,727 10.2 High Tech Industries 90,172 15.3 90,385 14.7 Investment Funds & Vehicles 31,325 5.3 42,412 6.9 Media: Advertising, Printing & Publishing 27,372 4.6 26,333 4.3 Media: Broadcasting & Subscription 1,892 0.3 1,491 0.2 Media: Diversified & Production 6,450 1.1 10,652 1.7 Retail 16,228 2.7 16,998 2.8 Services: Business 100,236 17.0 108,704 17.6 Services: Consumer 13,797 2.3 22,051 3.6 Wholesale 9,407 1.6 8,024 1.3 Total $ 590,837 100.0 % $ 616,231 100.0 %
Portfolio Asset Quality
MC Advisors' portfolio management staff closely monitors all credits, with senior portfolio managers covering agented and more complex investments. MC Advisors segregates our capital markets investments by industry. The MC Advisors' monitoring process and projections developed by Monroe Capital both have daily, weekly, monthly and quarterly components and related reports, each to evaluate performance against historical, budget and underwriting expectations. MC Advisors' analysts will monitor performance using standard industry software tools to provide consistent disclosure of performance. When necessary, MC Advisors will update our internal risk ratings, borrowing base criteria and covenant compliance reports.
As part of the monitoring process, MC Advisors regularly assesses the risk profile of each of our investments and rates each of them based on an internal proprietary system that uses the categories listed below, which we refer to as MC Advisors' investment performance rating. For any investment rated in grades 3, 4 or 5, MC Advisors, through its internal Portfolio Management Group ("PMG"), will increase its monitoring intensity and prepare regular updates for the investment committee, summarizing current operating results and material impending events and suggesting recommended actions. The PMG is responsible for oversight and management of any investments rated in grades 3, 4, or 5. MC Advisors monitors and, when appropriate, changes the investment ratings assigned to each investment in our portfolio. In connection with our valuation process, MC Advisors reviews these investment ratings on a quarterly basis. The investment performance rating system is described as follows:
Investment Performance Risk Rating Summary Description Grade 1 Includes investments exhibiting the least amount of risk in our portfolio. The issuer is performing above expectations or the issuer's operating trends and risk factors are generally positive. Grade 2 Includes investments exhibiting an acceptable level of risk that is similar to the risk at the time of origination. The issuer is generally performing as expected or the risk factors are neutral to positive. Grade 3 Includes investments performing below expectations and indicates that the investment's risk has increased somewhat since origination. The issuer may be out of compliance with debt covenants; however, scheduled loan payments are generally not past due. Grade 4 Includes an issuer performing materially below expectations and indicates that the issuer's risk has increased materially since origination. In addition to the issuer being generally out of compliance with debt covenants, scheduled loan payments may be past due (but generally not more than six months past due). Grade 5 Indicates that the issuer is performing substantially below expectations and the investment risk has substantially increased since origination. Most or all of the debt covenants are out of compliance or payments are substantially delinquent. Investments graded 5 are not anticipated to be repaid in full.
Our investment performance risk ratings do not constitute any rating of investments by a nationally recognized statistical rating organization or reflect or represent any third-party assessment of any of our investments.
In the event of a delinquency or a decision to rate an investment grade 4 or grade 5, the PMG, in consultation with the investment committee, will develop an action plan. Such a plan may require a meeting with the borrower's management or the lender group to discuss reasons for the default and the steps management is undertaking to address the under-performance, as well as amendments and waivers that may be required. In the event of a dramatic deterioration of a credit, MC Advisors and the PMG will form a team or engage outside advisors to analyze, evaluate and take further steps to preserve our value in the credit. In this regard, we would expect to explore all options, including in a private equity sponsored investment, assuming certain responsibilities for the private equity sponsor or a formal sale of the business with oversight of the sale process by us. The PMG and the investment committee have extensive experience in running debt work-out transactions and bankruptcies.
The following table shows the distribution of our investments on the 1 to 5 investment performance risk rating scale as of March 31, 2020 (in thousands):
Investments at Percentage of Investment Performance Risk Rating Fair Value Total Investments 1 $ - - % 2 490,546 83.0 3 84,888 14.4 4 14,445 2.4 5 958 0.2 Total $ 590,837 100.0 %
The following table shows the distribution of our investments on the 1 to 5 investment performance risk rating scale as of December 31, 2019 (in thousands):
Investments at Percentage of Investment Performance Risk Rating Fair Value Total Investments 1 $ - - % 2 517,597 84.0 3 83,701 13.6 4 13,899 2.2 5 1,034 0.2 Total $ 616,231 100.0 %
As of March 31, 2020, we had eight borrowers with loans or preferred equity . . .
May 08, 2020
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