MFIC Q3 2023 Updates By Scott Kennedy
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Related to the stocks in this article:
CWMF is long: RITM-D, GPMT-A, DX-C, EFC-A, MFA-C, RITM-C, EFC-B, PMT-C, PMT-B, CIM-B, AGNCP, CIM-D, RITM, SLRC, MFA, GPMT, RC.
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The rest of this post is from Scott Kennedy.
Summary
This 27th (and final) earnings assessment article reviews MFIC’s NAV and NII performance during Q3 2023.
This article also discusses how MFIC’s quarterly change in NAV and NII “matched up” to expectations. Earnings remain a key driver to stock performance.
MFIC’s NAV matched my/our expectations while its NII was a minor underperformance.
No change in MFIC’s percentage recommendation ranges or risk rating. MFIC is currently deemed appropriately valued (HOLD).
MFIC's announced merger with AFT and AIF should provide a slight benefit to the company. However, not enough for warrant an upgrade at this time (MFIC was upgraded in 2022).
Introduction:
Hi subscribers. For new members, my name is Scott Kennedy and currently I fully cover 20 mortgage real estate investment trust (mREIT) and 15 business development company (“BDC”) common stocks within this Investing Group regarding research/data, subscriber questions, weekly projected book values/net asset values (BV/NAV), and common stock recommendation ranges. Colorado (“CO”) Wealth Management handles the mREIT preferred stocks and he and his team handles all other applicable REIT sectors outside the mREIT sector. CO also provides some mREIT common stock and BDC articles from time-to-time which are more of an “overview/introduction” discussion; typically based either on my or our combined research/data. This also includes some macroeconomic trends and data. My name is always attached to all Investing Group articles I personally wrote so there is no confusion for subscribers.
This REIT Forum article is part of a series of articles over a span of 6-7 weeks which will analyze my previously projected BV/NAV and core earnings (or core earnings equivalent)/net investment income (“NII”) figures and compare these metrics to each mREIT’s and BDC’s actual reported results, respectively. For readers who are familiar with my public mREIT and/or BDC articles, these types of articles are beneficial to readers who desire to pursue a more active investing strategy and/or want more “real time” thoughts/analysis.
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1) MFIC’s NAV and NII Q3 2023 Performance (Projected Versus Actual Results):
On 11/7/2023, MidCap Financial Investment Corp. (MFIC) reported the company’s earnings results for the third quarter of 2023. Table 1 below provides MFIC’s NAV and earnings summary.
Table 1 – MFIC Q3 2023 NAV and Earnings Summary
Source: Taken Directly from the REIT Forum’s © Analytical Spreadsheets/Data
Hi subscribers. I was able to review MFIC’s Q3 2023 earnings results in more depth. MFIC’s Q3 2023 net investment income (“NII”) of $0.428 per share was a minor underperformance versus my projection of $0.445 per share (range $0.420 - $0.470 per share). MFIC’s NII was $0.442 per share for the second quarter of 2023. As such, I projected a NII increase of $0.003 per share. In actuality, MFIC reported a NII decrease of ($0.014) per share during the third quarter of 2023. The institutional analysts’ consensus average was NII of $0.435 per share. Let us reconcile MFIC’s minor quarterly NII underperformance.
First, let us review MFIC’s quarterly investment activity. MFIC recorded loan originations funded at close and add-on investments of only $16 million during the third quarter of 2023. This was another decrease versus an already rather subdued quarterly loan originations funded at close and add-on investments figure of $102 million during the prior quarter. In comparison, I projected quarterly loan originations funded at close and add-on investments of $75 - $125 million (mean of $100 million). MFIC recorded loan prepayments/repayments/restructurings of ($60) million during the third quarter of 2023. In comparison, I projected quarterly prepayments/repayments/restructurings of ($50) – ($100) million (mean of ($75) million). When calculated, excluding fair market value (“FMV”) fluctuations, MFIC decreased the company’s investment portfolio size by ($43) million during the third quarter of 2023. In comparison, I projected MFIC would increase the company’s investment portfolio size by a mean of $25 million. This directly led to a lower amount of quarterly accrued interest income. When calculated, including the incentive fee offset from lower total pre-incentive fee income, this ultimately resulted in a NII underperformance of ($0.024) per share when compared to my expectations.
Second, MFIC continued to experience a rise in its weighted average annualized yield during the third quarter of 2023 when compared to the prior quarter. Simply put, this was due to the continued increase in LIBOR/SOFR/PRIME. MFIC reported a weighted average annualized yield of 11.40%, 11.80%, and 12.00% for the first, second, and third quarter of 2023, respectively. When calculated, this was a quarterly increase of 0.4% and 0.2%, respectively. This past quarter, this matched my expectations. This metric should begin to plateau towards the end of 2023. In addition, it should be noted the higher LIBOR/SOFR/PRIME rises, the more underlying credit risk (non-accruals) needs to be respected (and monitored). This will have heightened importance as we head through 2023 and into 2024. When quantified, including the incentive fee offset from similar total pre-incentive fee income (not applicable in this specific case), this directly led to no/a de minimis NII variance when compared to my expectations.
When the 2 variances noted above are combined, along with a NII net outperformance of $0.007 per share within all non-incentive fee expense and fee waiver accounts (mainly lower-than anticipated base management fees and interest expense from a slightly smaller investment portfolio size), this fully reconciles to MFIC’s NII underperformance of ($0.017) per share during the third quarter of 2023 when compared to my expectations.
On a side note, MFIC’s leverage of 1.44x as of 9/30/2023 remains well above the 15 BDC peer average I/we cover which is a bit troubling. MFIC’s leverage ratio as of 9/30/2023 was the 2nd highest out of all covered BDC peers. MFIC’s leverage needs continued monitoring. As a reminder, a BDC’s regulatory leverage cap. is currently 2.00x. For comparative purposes, the 15 BDC peers I/we currently cover had an average leverage ratio of only ~1.10x as of 9/30/2023.
Moving on, MFIC reported a net asset value (“NAV”) as of 9/30/2023 of $15.28 per share (0.5% increase) versus my projection of $15.20 per share (unchanged). I consider this basically an exact match (at or within a 0.5% variance) and was well within my $14.80 - $15.60 per share range.
This very minor NAV outperformance was simply scattered amongst MFIC’s 149 portfolio companies as of 9/30/2023. There were no notable surprises in any 1 portfolio company when compared to my expectations. Regarding MFIC’s entire investment portfolio, the company recorded a combined net realized loss and unrealized appreciation of $2 million during the third quarter of 2023. In comparison, I projected a combined net realized loss and unrealized depreciation of ($5) million. When calculated, this $7 million variance directly led to a NAV outperformance of $0.10 per share when compared to my expectations.
When the variance noted above is combined with MFIC’s NII underperformance of ($0.017) per share discussed earlier, this fully reconciles to the company’s NAV outperformance of $0.08 per share during the third quarter of 2023 when compared to my expectations.
Regarding credit risk, MFIC put 1 new portfolio company on non-accrual status during the third quarter of 2023. MFIC’s first lien debt investment in ViewRay Inc. (ViewRay), with a principal balance of $9.6 million as of 9/30/2023, was placed on non-accrual status during the quarter. As such, a fairly small-sized loan. In addition, 0 portfolio companies were taken off non-accrual status during the quarter. I continue to believe there will be a general rise in credit risk during late 2023 – 2024 so this is just something to take note of.
So, all-in-all, a minor underperformance on MFIC’s NII (variance of $0.017 per share) and basically an exact match on the company’s NAV (variance of only 0.5%). I would say an average quarter for MFIC (not “horrific”, not great). That said, I was pleased MFIC’s capitalized payment-in-kind (“PIK”)/deferred income percentage remained very low - low. In addition, Merx Aviation Finance LLC ("Merx") has basically stabilized operational performance which is “cautiously optimistic” at this point in time. Merx is in the process of slowly de-consolidating/shrinking the company’s operations.
As noted 5 quarters ago, MFIC announced a change in general strategy to basically solely focus on lending to “safer” portfolio companies. This included a new partnership/equity sponsor with MidCap Financial, an affiliate of MFIC’s external manager, Apollo Global Management, Inc. MFIC had “hinted” at this type of strategy over the past couple of years. However, with the recent fears of rising credit/recessionary risk surrounding global markets, this “shift” finally occurred. In addition, this recently included a notable base management fee reduction (based on equity versus assets) which started on 1/1/2023. This directly resulted in my/our modest percentage recommendation range (relative to CURRENT NAV) upgrade back in 2022.
In conjunction with reporting earnings, MFIC also announced the company has entered into merger agreements with 2 affiliates, Apollo Senior Floating Ratio Fund Inc. (AFT) and Apollo Tactical Fund Inc. (AIF). I recently performed a fairly detailed internal AFT and AIF review. AFT and AIF also mainly invest in private, middle market (“MM”) loans. Both entities also have some broadly syndicated loans, structured credit, and equity investments. As such, the merging of these affiliate companies should not be overly complicated/move MFIC away from the company’s niche investments. These mergers will probably result in a very slight benefit to MFIC through operational synergies and a slight reduction in operational costs of the combined investment portfolios. However, not beneficial enough to warrant another upgrade in my professional opinion. AFT and AIF are currently generating yields below MFIC by a pretty good margin. Also, as noted above, I/we already modestly upgraded MFIC on the company’s base management fee reduction back in 2022 and shift to less risky loans. AFT and AIF both have non-accrual percentages higher than MFIC.
When taking MFIC’s recent and projected performance into consideration, along with macroeconomic trends/events (mainly Fed monetary policy, the general projected movement of rates/yields, and projected economic performance over the foreseeable future), no change to my/our MFIC percentage recommendation ranges (relative to CURRENT NAV) or risk rating (remains at a 4). Countering low capitalized PIK/deferred income and stable performance from Merx, I remain a bit concerned on MFIC’s very high leverage and the risk of additional non-accrual portfolio companies heading into 2024. Due to MFIC’s high leverage, this BDC continues to have modestly – notably less “leeway” regarding increasing leverage in the future (especially if the company continues to trade at a discount to CURRENT NAV). This will likely “crimp” quarterly NII whereas other BDC peers can take up leverage as rates/yields plateau (and eventually decrease looking further out on the time horizon). We will see how much the AFT and AIF merger helps regarding reducing leverage next quarter.
At a closing price as of 11/21/2023 of $13.28 per share, MFIC is deemed to be APPROPRIATELY VALUED/a HOLD recommendation (price target of $13.45 per share). However, MFIC is close to our OVERVALUED/SELL recommendation range. Currently, MFIC is not the most overvalued BDC stock that I/we cover but, in my opinion, is far from being the most undervalued either.