Theodore Koenig - Chairman, President & CEO Aaron Peck - CIO, CFO & Director.

Timothy Hayes - B. Riley FBR, Inc. Leslie Vandegrift - Raymond James Christopher Nolan - Ladenburg Thalmann Allison Rudary - Oppenheimer Leslie Vandegrift - Raymond James & Associates Robert Napoli - William Blair & Company.

Welcome to Monroe Capital Corporation's Second Quarter 2018 Earnings Conference Call.

Before we begin, I would like to take a moment to remind our listeners that remarks made during this call today may concern -- excuse me, may contain certain forward-looking statements, including statements regarding our goals, strategies, beliefs, future potential, operating results or cash flows.

Although we believe these statements are reasonable based on management's estimates, assumptions and projections as of today, August 8, 2018, these statements are not guarantees of future performance. Further, time-sensitive information may no longer be accurate as of the time of any replay or listening.

Actual results may differ materially as a result of risks, uncertainty or other factors, including, but not limited to, the factors described, from time to time, in the company's filings with the SEC. Monroe Capital takes no obligation to update or revise these forward-looking statements.

I will now turn the conference over to Ted Koenig, Chief Executive Officer of Monroe Capital Corporation..

Good day, and thank you, to everyone who has joined us on our call today. I'm with Aaron Peck, our CFO and Chief Investment Officer. Last evening, we issued our second quarter 2018 earnings press release and filed our 10-Q with the SEC. Before we discuss our results in detail, I want to take a moment to speak about Monroe Capital platform.

As a reminder, Monroe Capital was founded in 2004 and is a leading provider of senior debt to lower-middle market companies, specializing in lending to both private equity sponsored and nonsponsored borrowers with EBITDA of $30 million and below.

I challenge you to find a more successful platform that is primarily focused in this segment of the market. Our platform is a track record of generating consistent and predictable risk-adjusted returns for its investors. Across our platform, we have approximately $5.6 billion in assets under management.

We have one of the largest groups of dedicated and experienced deal origination professionals in the market across our 7 offices in the U.S. These origination professionals generate over 2,000 potential transactions each year for Monroe to consider. And on average, our platform closes around 60 to 70 deals per year from that pipeline.

MRCC, or BDC, comprises less than 10% of our total firm assets under management and therefore, benefit significantly from the scale and depth of the overall Monroe Capital platform, both in terms of deal flow and portfolio management. Across our funds, our goal is to deliver stable distributions to our investors and to protect net asset value.

We accomplish this by originating a diversified portfolio of primarily senior secured debt investments in companies we believe have a reason to exist with capable management and that can perform well over the long-term irrespective of business cycle.

Our group of 35 talented underwriters and portfolio managers structure loans with significant cushions to both cash flow coverage and enterprise value to ensure that we can deliver on these goals for our investors.

And to that end, we have loan covenants in our deals, not fake covenants or meaningless covenants, but real loan covenants that provide us with early warning detection of potential problems or issues. With that in mind, we're very pleased to have announced another solid quarter of financial results.

For the quarter, we generated adjusted net investment income of $0.39 per share, exceeding our second quarter dividend of $0.35 per share. This represents the 17th consecutive quarter we have covered our dividend with adjusted net investment income.

We're very proud to have been able to maintain a $0.35 per share dividend fully covered by adjusted NII without any reduction in our dividend since our IPO in late 2012. This is a testament to our unique origination capabilities and our credit underwriting and portfolio management process.

Our book value per share during the quarter decreased slightly to $13.35 per share as of June 30, primarily due to a negative net unrealized mark-to-market valuation adjustment during the quarter on TPP Operating, Inc. During the quarter, we wrote our debt investments in TPP down to 0, as the company ceased its operations and sold most of its assets.

While I am not pleased about the overall result on this individual credit, the good news is that the challenges associated with this borrower are now behind us. Please refer to the company's Form 10-Q for additional information concerning the company's investment in TPP.

At quarter-end, our investment portfolio had a fair value of $498.2 million, a slight increase from the prior quarter-end, and was invested in 71 companies across 23 different industry classifications. Our largest position represented 4.4% of the portfolio, and our 10 largest positions were 34.9% of the portfolio.

Our portfolio was heavily concentrated in senior secured loans, in particular, first lien secured loans. 94% of our portfolio consists of secured loans and approximately 88% is first lien secured. We are very pleased with the construction, diversity and the senior secured nature of our investment portfolio at this point in the credit cycle.

As of the end of the second quarter, our senior-secured loan joint venture with National Life Group had experienced portfolio growth to $94.8 million in fair value, a substantial increases from the $58.2 million at fair value at the end of the prior quarter.

The weighted average yield in the portfolio increased from -- increased to 7.5% from 7.4% at the end of the prior quarter. Much of the growth in this portfolio during the quarter was through borrowing on the joint venture's leverage facility.

As of quarter-end, the joint venture had debt outstanding on its leverage facility of $56.4 million at a rate of 4.6% or LIBOR plus 2.25. As we have discussed in the past, MRCC is well positioned for future interest rate increases, most all of our loan portfolio is invested in floating rate debt of LIBOR floors.

Given the current LIBOR level, we have surpassed the level of the LIBOR floors on virtually all our loans, and therefore, we believe MRCC is situated to meaningfully benefit from any increase in short-term interest rates going forward.

In addition, we have $150 million outstanding in fixed-rate debt from our SBA debentures, which will allow us significant interest rate arbitrage and any increase in LIBOR in the future.

Currently, we continue to maintain approximately $0.44 per share of undistributed net investment income, which in our view, provides a significant cushion to our ability to maintain a consistent quarterly dividend payment to our shareholders without returning capital.

But for the mark-to-market valuation adjustments on TPP Operating, Inc., which is now carried at 0 value, we are very pleased with the results of the second quarter. I am now going to turn the call over to Aaron, who is going to discuss the financial results in more detail..

Thank you, Ted. During the quarter, we funded a total of $38.2 million in loan investments, which was due to 5 new deals and several add-on and revolver fundings on existing deals. Additionally, we funded $2.1 million in equity to the senior secured loan joint venture.

This growth was offset by complete prepayments on 6 deals and partial repayments on other portfolio assets, which aggregated $34.8 million during the quarter. At June 30, we had total borrowings of $125.5 million under our revolving credit facility and SBA debentures payable of $115 million.

As of June 30, our net asset value was $270.7 million, which was down slightly from the $273 million in net asset value as of March 31. Our NAV per share decreased from $13.49 per share at March 31 to $13.35 per share as of June 30.

This decrease was primarily as a result of the unrealized mark-to-market valuation adjustment on 1 borrower, TPP Operating, Inc. Turning to our results.

For the quarter ended June 30, adjusted net investment income, a non-GAAP measure, was $7.9 million or $0.39 per share, a decrease of $0.6 million or $0.03 per share when compared to the prior quarter. At this level, per share adjusted NII comfortably exceeded our quarterly dividend of $0.35 per share.

Looking to our statement of operations, total investment income for the quarter was $14.8 million compared to $15 million in the prior quarter.

The slight decrease in total investment income for the quarter was primarily as a result of a reduction in discount accretion during the period, partially offset by an increase in dividend income from our senior secured loan joint venture and an increase in prepayment gains. Moving over to the expense side.

Total expenses for the quarter of $6.9 million included $2.8 million of interest and other debt financing expenses, $2.2 million in base management fees, $1 million in incentive fees and $0.9 million in general, administrative and other expenses.

Total expenses increased by $0.4 million during the quarter, primarily driven by an increase in interest expense, driven by a higher average LIBOR rate during the quarter and a slight increase in incentive fees during the quarter.

Like in the first quarter, our second quarter incentive fees were limited due to the total return requirement in our management agreement. Without the total return requirement, we would have seen approximately $0.8 million in additional incentive fees paid during the quarter.

As for our liquidity, as of June 30, we had approximately $74.5 million of capacity under our revolving credit facility. As of the end of the quarter, we had fully drawn all of our available $115 million in SBA debentures.

As of June 30, the senior secured loan joint venture had made investments in 28 different borrowers, aggregating $94.8 million at fair value with a weighted average interest rate of approximately 7.5%. We had borrowings under our nonrecourse joint venture credit facility of $56.4 million.

We would expect the senior secured loan joint venture to continue to grow over the next few quarters. I will now turn the call back to Ted for some closing remarks before we open the line for questions..

Thanks, Aaron. Since going public with our IPO in 2012, we have generated 45% cash-on-cash return for our shareholders based on changes in NAV and dividends paid since our IPO, assuming no reinvestment of dividends.

Based on the closing market price of our shares on August 7, investors that purchased stock in our IPO in 2012 have received a 44% cash-on-cash return, assuming no reinvestment of dividends. On an annualized basis, this represents approximately 8.2% annual return for our stockholders since 2012.

We believe that these returns compare very favorably to those achieved by our peers and puts MRCC in a very small and elite group of BDCs that have delivered this level of performance for shareholders.

Based on our pipeline of both committed and anticipated deals, we expect to increase our new investment momentum for the remainder of the year, with growth in both our core portfolio and in our senior secured loan joint venture.

We believe that Monroe Capital Corporation provides a very attractive investment opportunity to our shareholders and other investors for the following reasons. One, our stock pays a current dividend rate of around 10.3%. Two, our dividend is fully supported by consistent adjusted net investment income coverage for the last 17 straight quarters.

Three, we have a very shareholder-friendly external adviser management agreement in place that limits incentive management fees payable in periods where there was any material decline in our net asset value.

And four, we're affiliated with a best-in-class external manager with 7 offices located throughout the U.S., almost 100 employees and approximately $5.6 billion in assets under management.

MRCC is one of the few BDCs that has access to distinct proprietary deal flow, which should result in differentiated returns and an increase in shareholder value over the long term. Thank you, all, for your time today. And with that, I'm going to ask the operator to open the call for questions..

[Operator Instructions]. Our first question comes from Tim Hayes of B. Riley..

My first question, the yield on the portfolio declined modestly quarter-over-quarter on the -- not the JV, on the balance sheet portfolio.

And just wondering if that was primarily just a result of the weaker accelerated OID you talked about? Or if there were some investments that were put on the books that were lower yielding than those that rolled off this quarter?.

Yes, Tim, good question. This is Aaron.

So the weighted average effective yield in the portfolio declined ever so slightly, I think, in the period, but most of the difference that you are seeing is really related to the cessation of the discount accretion on one of our holdings in the Gibson Brands Holdings, which had a pretty big pull to par in the first quarter, but we know longer were accreting to it par in the second quarter as they filed for bankruptcy in the period.

I'll just point out that, that investment has continued to trade extremely well and is in a very strong market as of today as well. So the potential for bankruptcy was not unexpected and it's doing fine..

Right. And that's actually good segue to my next question. I was just -- I saw, obviously, that Gibson got moved over to nonaccrual as well as Incipio Technologies.

Just if you wouldn't mind just shedding a little color on those 2 credits and kind of your outlook for both of those companies?.

Yes, sure. Let me start with your second one, which is Incipio. The only thing that was put on nonaccrual is the Incipio third lien, and so just a little color on that. Incipio is a portfolio company.

They have been going through some challenges and as part of a restructuring agreement that we're working on, we were basically handed a third lien note that a equity sponsor had previously owned. So we put that on our books now as in the other funds that are in the deal at 0 cost, we didn't pay for it.

And because that was a deal that we didn't pay for and we don't necessarily know that we'll ever get interest on that, we're not accruing that piece into interest income. So that's the only part that's nonaccrual.

The actual investments that we made in Incipio -- the dollars investments that we made in the debt pieces continue to be on accrual status and that company is going through a pretty extensive turnaround, we think, which will have very good outcomes in the end, and we feel very good about our position there and how we will do on that.

As for Gibson, I covered that in my original remarks, Gibson's bank -- it's gone through a bankruptcy. The folks that own a lot of the notes are working together to basically put through bankruptcy and own the equity on the back end and the market has treated that well and the papers actually trade up.

We also participated in the DIP facility at Gibson in a small way and that's also traded up and it's worth more than what we paid for it today. And so we continue to believe that Gibson is a good investment for us, that will have a good outcome, and it's -- but it's not accruing interest today in our portfolio..

Got it. I appreciate the color there.

And I just wanted to confirm, other than the $0.8 million of waived incentive fees this quarter, would you say this $0.39 quarterly adjusted NII number reflects the true earnings power of the portfolio? Or is there any other unusual or outsized items that you would point to?.

There's nothing that's unusual. But what I will point out, which is important for you all to recognize is that without the incentive fee waiver, the NII -- the adjusted NII in the quarter would have been $0.35 per share.

So assuming that you don't make any further assumptions about incentive fee waivers, which I think is a safe place to be right now, we'll see as the quarter unfolds, then you -- then the $0.39 is not a sustainable number in our expectation, and it's all -- it all has to do with incentive fee limitation that's in our management agreement.

And without that limitation, we would have been at $0.35 per share..

Our next question comes from Leslie Vandegrift of Raymond James..

First question is just on the nonaccruals and some of the other ones that are marked down a bit. It seems like there's a large portion of those that are consumer goods portfolio companies.

Is there a particular reason why those have been the troubled assets to do with the industry and expertise in that, et cetera, that leads to those issues?.

I'm not sure that there's really a trend in terms of us having markdowns in consumer good companies. I think, clearly, TPP was a consumer-oriented business. We've talked a lot over multiple calls about the issues at TPP. Incipio seems to be -- is definitely a credit that has a consumer aspect, they mostly are involved in making cellphone cases.

So that's a consumer-related business. I don't think that the issues are -- that Incipio is having is necessarily related to what's going on in the consumer space. I'm not sure what other ones that you're really referring too. Maybe do you have specific ones you want to ask about, we can respond to that..

Well, I mean, Rocket, in the past, was also -- it's still nonaccrual, and then you also have Bluestem Brands and Gibson, all of those sit in the consumer.

It just -- when you look at them, though, the material amount of them are consumer goods companies?.

Yes, I think, Leslie, in general, I think if you look at kind of market trends right now that we're seeing across our entire portfolio of 250 companies at the external manager, I think, that we've got a heightened view right now and a watch for all consumer, especially consumer retail that sold through kind of the big-box traditional locations.

Mall traffic is down, store closings are up. The alternate distribution channels have taken a toll. So you're right.

In the few names that you've mentioned, but across our portfolio in general, we're watching that very carefully, and we're doing things that we can to shore up those risks, whether it's focusing on additional sponsor equity, whether it's making sure that we've got strong and stronger covenants as well as making sure that we're watching cash expenses, capital expenditures, things like that.

We're taking a proactive role in that and when you see us mark these things that you've mentioned, that's part of that proactive role that we're taking across the firm by marking these at a different level that creates some internal watch levels and some additional work on our part for our portfolio account officers.

So we're trying to get out ahead of this wave a little bit, if we can..

I'll just add. I mean, you mentioned nonaccruals. Bluestem Brands is not on nonaccrual. We expect to continue to earn a coupon on that name. Gibson is on nonaccrual, but that was purchased at a discount, that's sort of a special situation. We -- the investment premise didn't necessarily expect to continue to receive current interest on that name.

It was more of a total appreciation play, and there'll be more to say on that sort of in the successive quarters, but Gibson has actually performed to our expectations with the rest of the investment thesis, and so just to be clear on those in terms of nonaccrual..

Yes, the mention of Bluestem was simply because of where the markets versus cost, not because they are on nonaccural..

Yes, it has underperformed. It's a small holding for us. It's -- public markets, it's a traded name -- a small traded name, and that's why we continue to monitor, but we still feel pretty good about the recovery on it..

Okay. And then just a quick one on answers. Obviously, the senior secured loan was gone this past quarter.

What was the exit? Was that close to your previous mark?.

Oh, it was paid off at par. It was paid off by the company. We didn't sell it. It was paid off..

Okay. And then just lastly, on Rockdale. I know -- noticed you wrote the equity again down to 0, which was the cost to begin with. But all of the debt investments in Rockdale were marked up quarter-over-quarter. And they'd already been slightly above costs and now they are again further so.

Is that to do -- or you're seeing a high likelihood of repayment coming up here soon?.

I wouldn't say that reflect necessarily an expectation of a near-term repayment. And I think the -- what's going on with Rockdale, just to remind everyone, we made an investment in Rockdale couple of years ago, and the connection received the equity, as you said Leslie, without any cash outlay, company went through a pretty good big growth phase.

And then over time, they had some reductions in reimbursement rates and some other issues, and we saw a reduction in revenue and EBITDA. The company is going through a pretty extensive restructuring, it's hired a bunch of advisers and professionals to help it through its restructuring.

We believe the company has significant assets available to us to cover the loan, and we did mark the equity to 0. The reason for -- particular reason for the debt markup is that there was a fairly significant royalty agreement that is attached to the loan, which we believe that's considerable long-term value.

And so that we marked into the loan this period, which was a result of an increase in the debt valuation. So the net-net on Rockdale was basically flat to slightly up, flat period-to-period when you combine both pieces, but that's really the explanation for that, about as much detail, unfortunately, as I can provide today..

Our next question comes from Bob Napoli of William Blair..

And I guess, the -- obviously, the leverage is very low and you didn't get the growth and then, obviously, lumpy by quarter, but I think, Ted, you suggested that you have a very healthy pipeline and you expect to see leverage or loan growth in both the core portfolio and the senior secured -- the loan fund.

What are your thoughts around leverage as we get to the end of 2018? And what is -- is it getting incrementally more competitive from your view?.

Okay. Thanks for the questions, Bob. I hope you're well. Yes, several questions. I'll try and break them down and answer each one. Number one, I guess, loan growth. I think that we've got a great pipeline right now. We've had a good second quarter, which is usually a slower quarter. We're going into a decent third quarter from what I see in the firm.

But I think that you have to look at this as kind of long-term loan growth. Quarter-to-quarter as you said, it's bumpy, and we're trying to take our time here as a firm and do good deals. And sometimes good deals appear in bunches, sometimes they appear sporadically. Somehow by the end of the year, we always end up hitting our targets.

It's just that I can't tell you, which quarter always that the loan growth is going to come in. So I think, on a long-term basis, you can expect our results to be consistent with kind of prior performance. The second question you asked about was leverage. As I told you on the last call, as a business, as a company, I believe we're under leveraged.

We've been operating our business conservatively, and we are underleveraged. I think our regulatory leverage today is about 0.5:1. As you know, the omnibus bill that was passed, allows us to go to 2:1. 2:1 is a long, long cry from 0.5:1. I'm hopeful that we can manage our business effectively to get to 1:1 leverage here by the end of the year.

It's my hope. I don't think we'll get there. I think that we'll probably end up somewhere closer to 0.7:1 or 0.75:1 in that range. But my goal was going to try and get us to 1:1 here on leverage because I think that's probably the right place for us to be in the near term..

Bob, one thing we can't control is what comes out the back door. We can control what comes in the front door. It's harder to control what comes out the back door. So that's the biggest risk for us reaching the goal that Ted talked about. It's just the uncertainty around what's going to come around in terms of repayments..

Right, repayments. And I guess, the third item or third question that you asked was relating to -- the kind of the competitive market. And I will tell you that, I said it on the last call, the market continues to be competitive.

There's been a bunch of new entrants that have come into the market over the last 2, 3 years that are -- that have money, burning holes in their pockets. And there's been a bunch of new entrants that have announced their entry into the market in the last couple of quarters. We don't really view that as a material concern.

We've got our own origination teams and we have our own origination channels, and we've been doing this now 17 years as a firm. We've seen a lot of competitors come into the market, leave the market, come back to the market, leave the market. I don't get too concerned about it. What I do get more focused though on is structural concerns in the market.

And when I see firms make loans without covenants or make loans that have meaningless covenants or do things from a leverage standpoint, that are not prudent. That's what concerns me.

And we're seeing an increasing rate of other platforms do things that we lose deals on because for example, we lost a deal in the last quarter because we requested and insisted on a meeting with management. And another firm agreed to do the transaction and do the financing without the requirements of meeting management.

And when things like that happen, you just have to -- in our business, you just have to stay disciplined, retain your focus, and don't -- kind of don't go with the rest of the fish, and sometimes you have to swim by yourself.

And we've been doing this long enough where I know that if -- we may lose a deal or 2, but at the end of the day, it's about building a long-term lasting platform and that's where I'm very focused on..

Our next question comes from Christopher Nolan of Ladenburg Thalmann..

Ted, following your comments about you conservatively operate the business, which I completely agree with, should we read into it where given the approval for higher leverage that you're willing to operate the business in terms of balance sheet leverage slightly less conservatively than in the past?.

No, I don't think you should read that at all. I think that given the ability to put a -- again, we're operating at 0.5:1 leverage, that is a -- clearly, in my view anyway, an underlevered situation. And getting to 1:1, which I said, is my goal, I don't think we'll get there, is still an underlevered situation.

We run our private credit funds anywhere from 1.5:1 to 2:1, if we can. Our joint venture with National Life, our senior secured joint venture runs at 2:1. So I don't think you can connect the dots on that at all. We're not going to change, Chris, on how we run our business here.

We're going to continue to originate the same deals that we've been originating in the past with the same leverage levels. And if you look at our portfolio, in general, in MRCC, we're less than 4x leverage across the board on an average basis -- on a weighted average basis. And you look at the market today, middle market, the U.S.

middle market leverage is probably somewhere around 5.5 turns. If you look at S&P and LCD and all the other stats. So I don't see that premise at all. We're not changing what we do..

Yes, what we have said though in the past, Chris, as you recall is that the benefit of having access to additional regulatory leverage over the long term is that there are times where even lower risk deals come into the portfolio that don't make the hurdle rate work at the 1:1 limitation, and so they have a lower coupon.

And so what we've said is that over time it's possible that you could see us do those slightly lower returning deals on a spread basis, now with LIBOR moving up, they tend to be about the same on an actual absolute return basis, and put more leverage on them over time in order to achieve what we believe is a very good risk-adjusted return with slightly more leverage.

The other thing I'll just point out is, what we're planning for when we can go out and get approval to be above of 1:1 long-term is the fact that over time, our equity base could grow.

And if our equity base grows and we don't find a way to get access to more SBIC leverage because right now, we're at our limit for family funds, the impact of that becomes muted over a larger equity basis.

And so while, yes, we're at 0.5 leverage today on a regulatory basis, we're like closer to 1:1 on an actual average basis, but if we had doubled the equity raise, lever the same way because of the limitation of the SBIC debentures for us, we will be considerably less than 1:1 leverage.

So we want the ability as that could have a muted impact on our performance over the long term to sort of mitigate that by putting a little bit more regular leverage level on the books on a regulatory basis..

Our next question comes from Allison Rudary of Oppenheimer..

You've addressed most of my increase regarding the opportunity for an expanded balance sheet. But correct me if I'm wrong, you guys do have an approval now to expand as of your last June meeting.

And I'm curious just maybe if you guys could talk to some of your thoughts about what sources of leverage you might add, whether it be an expanded facility, maybe tapping the unsecured market, so and so forth kind of outside of where you currently source your leverage now?.

Thanks, Allison. Yes, no your observation is a good one. We do have the ability to achieve expanded leverage. We had an overwhelming vote from shareholders in favor of that. As we speak, we're considering all those options. As you know, there is a lot of different options available to us.

I mean, we're trying to determine internally here is to from a cost benefit analysis from a shareholder value standpoint, what's our best long-term option that's going to create value for shareholders. And we hope to be back with you on that sometime relatively soon..

Okay, that's great.

So then that it's fair to say that you haven't necessarily made final decisions about how you might structure management, incentive fees, different hurdle kind of in light of the fact that you guys are certainly allowed to, but haven't necessarily made full plans for [indiscernible] pathway to leverage and how you might kind of restructure your management agreements, et cetera?.

That's correct. As I said, we're focusing on how to create long-term value, and there is a lot of leverage that go into that. And we're doing an internal examination of those things now..

I'm showing no further questions. One moment, please. Our next question comes from Leslie Vandegrift of Raymond James..

Sorry, just one quick follow-up. The new investment in -- at the unitranche loan Rugs USA in the quarter LIBOR plus 650 on the interest.

Can you just kind of give me a little color on the thoughts around that investment?.

Well, as you know, Leslie, we don't normally get into lot of specifics around individual names, unless there is a province issue that we need to discuss with investors. It's a regular deal for us. It's consistent with all the other deals we've done over the history.

It's a company that is involved with the selling predominantly rugs online, very successful company. And so we had an opportunity to invest in that deal, and we did..

Thank you. I'm showing no further questions at this time. I'd like to turn the conference back over to Ted Koenig for any closing remarks..

I just want to thank you, everyone, for their time today. And we appreciate your efforts, and we will continue to do our part here. And we look forward to speaking to you next quarter..

Thank you. Ladies and gentlemen, this does conclude today's conference. Thank you for your participation, and have a wonderful day. You may all disconnect..