SLR Investment Corp (SLRC) 2011 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Second Quarter 2011 Solar Capital Limited Earnings Conference Call.

My name is Erica and I'll be your coordinator for today.

At this time all participants are in a listen-only mode.

We will be facilitating a question-and-answer session towards the end of this conference.

(Operator Instructions)

I would now like to turn the presentation over to your host for today's call, Mr.

Michael Gross, Chairman and Chief Executive Officer.

Please proceed.

Thank you, and good morning.

Welcome to Solar Capital Limited Earnings Conference Call for the Second Quarter of 2011.

I am joined here today by Bruce Spohler our Chief Operating Officer, and Nick Radesca our Chief Financial Officer.

Nick, before we begin, would you please start off by covering the webcast and forward-looking statements?

Sure.

Thank you, Michael.

I would like to remind everyone that today's call and webcast are being recorded.

Please note that they are the property of Solar Capital Limited and that any unauthorized broadcasts in any form are strictly prohibited.

This conference call is being webcast on our website www.solarcapltd.com.

A replay of this call will be made available on our website later today.

I would also like to call your attention to the customary disclosures in our Press Release regarding forward-looking information.

Statements made in today's conference call and webcast may constitute forward-looking statements which relate to future events or future performance or financial condition.

These statements are not guarantees of our future performance, condition or results and involve a number of risks and uncertainties.

Actual results may differ materially from those in the forward-looking statements as a result of a number of factors, including those described from time to time in our Filings with the SEC.

Solar Capital Limited undertakes no duty to update any forward-looking statements made herein unless required to do so by law.

To obtain copies of our latest SEC Filings please visit our website, or call us at 212-993-1670.

At this time I would like to turn the call back to our Chairman and Chief Executive Officer, Michael Gross.

Thank you, Nick.

As a result of our direct origination model and commitment to our strategic objectives we are pleased to report the following results for the second quarter of 2011.

Net investment income for the second quarter of $0.59 per share was fueled by interest income and prepayment premiums.

Our NAV per share as of June 30th, is $23.22.

During the second quarter we made progress on each of our strategic objectives which are to, one, utilize our sponsor-focus origination platform to underwrite investment with attractive risk-reward profiles; second to grow our net investment income so we can increase our dividend over time; and third, to expand our access to credit while prudently managing leverage.

Our underwriting platform continues to deliver.

During the second quarter, we originated approximately $142 million of new investments with approximately $100 million invested in five new portfolio companies, and approximately $42 million in two existing portfolio companies.

During the same time period the company received principal repayments totaling approximately $131 million, all of which were redeemed at or above par.

We expect the net originations for the third quarter to increase due to lower expected redemptions and the deployment of our new -- of our over $340 million of available credit.

A portion of our net investment income was comprised of incremental income on redemptions that involve refinancings and change of control events.

This form of income can vary meaningfully from quarter to quarter.

However, as we have demonstrated in prior quarters, the structuring of such premiums is a consistent practice for our Direct Origination business model.

All of the assets in our portfolio are performing.

In each of the six financial reporting periods since our IPO, 99% or more of our portfolio on a fair-value basis has been performing.

The fair value weighted average mark on the credit portfolio is approximately 95.5%.

We continue to believe that our portfolio will experience redemptions at or above par.

That, in conjunction with the expected realizable value of our equity positions, provides additional potential NAV appreciation.

In May, we received an investment grade rating from Fitch.

This rating is further affirmation of our strong risk management policies, careful credit selection and prudent use of leverage.

It positions us to expand our debt capacity and diversify our funding sources and maturities by accessing the capital markets.

And, finally, our Board of Directors declared a quarterly dividend of $0.60 per share.

The third quarter 2011 dividend will be paid as taxable earnings on October 4, 2011 to holders of record as of September 20, 2011.

At this time I'll turn the call over to Nick, to take you through the financial highlights.

Thanks, Michael.

Earnings of $1.69 per share for the first half of 2011 exceeded our dividends paid of $1.20 per share.

Our total investment portfolio had a fair market value of approximately $1 billion on June 30th, versus $989 million on March 31, 2011.

The portfolio value increase for the quarter resulted primarily from positive net originations.

The NAV at June 30th was $846.3 million or $23.22 per share, compared to $854.2 million or $23.48 per share at March 31, 2011.

As of August 1, 2011, investable capital was in excess of $1.3 billion, with over $340 million available for new investments.

For the second quarter of 2011, gross investment income was $35.3 million, compared to $32.3 million from the prior quarter.

Improvements in investment income were driven by income resulting from refinancing and change of control transactions, which contributed prepayment of premiums and accelerated amortization of fees related to the prepayment of loans.

As Michael mentioned, the amount of these premiums varies from quarter to quarter.

Net investment income totaled $21.4 million for the second quarter, and $40.5 million year-to-date.

We had net realized gains and unrealized losses totaling $9 million for the second quarter.

Year-to-date, net realized and unrealized gains totaled $20.9 million.

The net unrealized gain for the first half of 2011 reflect steadily improving portfolio values.

As of June 30th, the portfolio is 100% performing.

The weighted average investment risk rating of our total portfolio has remained steady at approximately two, measured at fair market value at the end of the second quarter based on our one to four risk rating scale, with one representing the least amount of risk.

We continue to actively manage our balance sheet and interest rate risks.

During the second quarter of 2011 we capped the LIBOR rate on an additional $50 million of notional amount through the purchase of a multi-year interest rate cap bringing our total notional amount cap to $150 million.

At this time I would like to turn the call over to our Chief Operating Officer, Bruce Spohler.

Thank you, Nick.

I would like to start by giving you an overview of our portfolio.

At quarter end, the fair market value of our investment portfolio was approximately $1 billion.

Our portfolio continues to be comprised of 100% performing assets.

As of June 30th, we had investment in 37 portfolio companies across 24 industries, with approximately 30% being comprised of senior secured investments, 61% subordinated debt and 9% equity.

The fair value weighted average yield on income producing investments in the portfolio was approximately 14% consistent with last quarter's yield.

Overall, credit quality of our underlying companies demonstrate a further improvement during the quarter.

We do have however, one portfolio company that did experience credit deterioration during the quarter, Direct Buy.

It has a market value of approximately $10 million at June 30th.

The company completed a refinancing this past January.

To help facilitate the refinancing we reinvested a portion of the repayment of our $38 million mezzanine investment into the company's new second lien notes.

This reduced our total exposure to the company by approximately one-third, and allowed us to move to a more senior position in the capital structure.

We continue to closely monitor this investment.

Our portfolio activity during the quarter was significant, both in terms of new investments as well as redemptions.

The terms and leverage levels of our approximately $140 million par value of new investments reflects our disciplined underwriting standards.

And, our approximately $130 million of redemptions supports our original expectations for these investments.

Let me highlight some of our Q2 investment activity.

We originated a $38 million second lien investment in Totes Isotoner, a leading designer, distributor and retailer of branded accessories such as gloves, umbrellas, galoshes, for cold and wet weather sector.

Due to the company's substantial free cash flow and future visibility, we view this investment as very attractive on a risk-reward basis.

We also invested $15 million in mezzanine notes to support Wellspring Capital's acquisition of Crosman Corporation, which is the world's leading designer, manufacturer and marketer of paintball guns, air guns, and related consumables.

Our notes carry a 13% coupon, upfront fees, as well as attractive call protection.

During the quarter we made a $15 million investment in an aircraft leasing company which consisted of a $10 million senior secured note investment, as well as a $5 million equity investment bearing an 8% dividend, as well as the potential for additional capital appreciation.

Finally, Asurion, an existing portfolio company which provides cell phone insurance programs, completed a refinancing this past May.

Our second lien investment of $49 million was redeemed at par.

We reinvested approximately $40 million of those proceeds into the new second lien term loan.

Our new investment carries a higher yield than the predecessor investment, albeit with similar leverage characteristics.

For the new credit investment that we funded year-to-date, the initial weighted average yield based on cost is approximately 12% and the current leverage ratio through our security, averages in the high 3 times EBITDA.

We view this yield on such modest leverage as extremely attractive on a risk-return basis.

During the quarter, we also received several redemptions, all at or above par.

Ares Capital repaid the 6% notes it had assumed in the Allied Capital acquisition.

We were called out of these notes representing in excess of $15 million of par value, and also received a prepayment premium.

We had originally purchased these bonds in mid-2009 for a little over $8 million.

Our realized IRR in this investment is approximately 70%.

In addition, Classic Cruises refinanced its second lien notes with a high-yield offering.

We received $26 million of principal repayment, in addition to a prepayment premium above par.

As mentioned on our Q1 earnings call, Bird's Eye Iglo, the premier owned European frozen food group, accessed the credit markets to refinance our mezzanine debt this past May.

As a result we received full repayment of our approximately 19 million of both euro and pound sterling denominated investments.

At present we don't expect high redemption activity in Q3, however, future redemptions will continue to drive our NAV growth.

Now, I would like to turn the call back over to Michael.

Thank you, Bruce.

Overall, we are pleased with the results of the second quarter, we re focused on increasing net investment income to grow the dividend over time; we have substantial low-cost capital available to invest, which enables us to maximize our risk reward.

We have recently seen an uptick in M&A activity and continue to see a strong pipeline of new investment opportunities.

Shortly, we will be hosting an earnings call for the first full quarter of operations for Solar Senior Capital, or SUNS, as we call it.

Our ability to provide senior secured financing to this vehicle, enhances our origination team's ability to meet our client's capital needs.

We have seen benefits of this value proposition in Solar Capital's deal flow.

Thank you for your time.

Operator, at this time will you please open up the line for questions?

(Operator Instructions)

And our first question comes from the line of Vernon Plack, with BB&T Capital Markets.

Please proceed.

Thanks.

Michael, or Bruce, I was curious the percent of bank debt and senior secured loans went up a little bit during the quarter from about 26% to 30%.

And I don't know if there is a deliberate shift on the way to move into more senior investments, or if it's really just a coincidence based on the opportunities that you're seeing.

Yes, I think it's more the opportunity set, we continue to see a nice mix of mezzanine and second lien investments.

But as we have discussed in prior conversations there is an increase in a demand for the Unitron product out there, which allows us to effectively attach [$1.01] in an issuer's capital structure.

And so you will see a little bit more of that creep in and that drives up that senior secured percentage.

Okay.

And I just wanted to get your sense of the market compared to three months ago.

Just some color on what you're seeing and how you're feeling about things.

Yes, I think, Vernon, it's pretty consistent.

We haven't seen any real change.

We are seeing a pick up in activity.

The competitive dynamic hasn't really changed a bit.

There are no new entrants into our business, no real capital inflows that have changed that.

And we are able to kind of stick to our guns, of doing highly-structured transactions with covenants, with coupons that we are attracted to and leverage ratios that make sense for us.

Okay.

Thank you, very much.

And your next question comes from the line of John Stilmar with SunTrust.

Please proceed.

Thank you.

Good morning, gentlemen.

As I just kind of looked through the highlighted investments, Isotoner and paint -- and it seems paintball gun and aircraft leasing, both on the surface seem like they are consumer discretionary.

Your prudence and sort of building a very defensive portfolio has certainly proven out to-date.

How do -- is it really capital structure and leverage in these transactions that gets us comfortable, because on the outset it seems like those are a little bit more discretionary?

Or, is there something else that you're seeing out there that we should be, kind of, reading into?

I'm wondering if you have some comments on that, please.

Yes, I think that we do continue to remain defensive in how we construct the portfolio and our perspective on the economy.

I think you look at something like Totes, for example, and while it is a consumer discretionary -- speaking for myself, umbrellas and gloves and slippers tend to be consumables almost, given the frequency with which I lose them.

So this business has done extremely well during the downturn.

And so, we feel very comfortable given the high free cash flow dynamic and the good visibility that we have on the business's performance over the next year or two.

So we continue to be very defensive.

I think if you look at the Aircraft Leasing business -- same thing.

We are not doing these on a levered basis, this is an unlevered investment where we are predominantly a senior secured note; it's short-term leases where we are taking very little counter-party risk.

They are effectively two year, monthly, cash-pay leases.

So good free cash flow over the near term where we have good visibility.

Perfect.

And then, with regards to SUNS -- you touched on it very briefly at the end, Michael.

Is there any specific example other than, sort of, the broad strategic implications that you gave both during the SUNS' calls as well as this past call?

But is there anything specific during this quarter that might be kind of a concrete example of the value that having a discussion across the capital structure might lead?

I'm not sure if you have a specific example for us.

Well I think, Totes is an example where we actually had come into the situation because we are thinking about it from a first lien perspective, and eventually morphed over to a second lien because we like the risk-return there, relatively speaking.

And so, there is a number of transactions that go both ways, where we might start looking at senior and migrate junior or visa versa.

And then, additionally, what happens is the sponsors perspective on the desired capital structure might morph during the course of their underwriting and their due diligence.

And so, I think the real answer is having the ability, John, to bring both to the table, gets us at more tables.

Great.

That's -- good quarter, guys.

Thank you.

Our next question comes from the line of Arren Cyganovich with Evercore.

Please proceed.

Hi, thanks.

The first half of the year had a relatively high amount of recap and refi activity.

What's your outlook on that for the second half of the year?

I think we expect that to continue.

But I think as you saw in Q2, and we continue to see in Q3, in addition to the recap and refi activity, we are seeing an increase in the M&A activity.

And so, what that's really doing is just expanding the total opportunity set for us in which to deploy capital.

So we think that will continue, but we think -- and we have already seen M&A activity enhance that incrementally.

Seeing the economic slowdown in the US recently, are you concerned that the M&A activity that's kind of been creeping up is going to get knocked back a little bit -- just seeing CEOs get a little bit less comfortable with the economic outlook?

No, I mean, we haven't seen that yet.

I think the number of new transactions we are seeing on a weekly basis hasn't abated.

You know, most of the things we are doing are not strategic acquisitions.

These are -- tend to be LBOs or recapitalization, and so it's not necessarily a CEO wanting to buy [into] the business.

There continues to be a tremendous amount of untapped and unspent private equity dollars that are going to chase transactions, and frankly we don't see that changing.

Okay.

And then, lastly, can you tell us exactly what the prepay penalty income was this quarter, or are you not disclosing that?

We are not disclosing it.

Frankly, it's been -- in every quarter that we've been public we've had some portion in our earnings of that.

And, frankly, we expect that going forward -- it's part of our business.

And when you have a high-performance portfolio as we do, you do expect churn, and the benefit of that churn is you get acceleration of your upfront fees, and you get prepayment penalties that will -- inure to net investment income on a quarterly basis.

Fair enough, thanks.

Our next question comes from the line of Joel Houck, with Wells Fargo.

Please proceed.

Okay, good morning.

I'm wondering -- if you kind of just look at the -- and some have already touched on this.

But the macro backdrop -- first half we had really slow growth, probably lower than people realize now - it's like the economy is slowing down a lot at the margin.

How do you guys thin about -- you have $400 million of dry powder, do you slow originations waiting for, perhaps, spreads to widen?

Or do you just -- the returns are so attractive right now that it doesn't matter?

Because if you kind of look at the, the yield on the last two quarters, I mean we do see some yield compression in terms of the new loans put on, but the stuff that's refying is also coming at a low rate.

So the current spread looks okay, but I'm just kind of wondering prospectively how you guys look at it.

A couple things, on the spreads our portfolio yield has held in there nicely.

I think we have put some capital out at lower yields, although we've taken what we think is meaningfully less risk, when you are talking about leverage levels in the mid to high, 3 times for 12% type yield.

So, we like the risk-return profile of what we are seeing.

As you know we have -- in the last couple of years, been rather defensive in how we construct the portfolio.

We continue to feel that way.

We don't have much that's tied to housing other than the Direct Buy investment that I mentioned.

And so, if you look across our portfolio it tends to actually be doing reasonably well with some improvement.

I would say it's not as dramatic as we saw last year, where cost cutting helped elevate earnings.

But for us, nominal revenue growth is what we are seeing, offset a little bit by increased input prices has resulted in good free cash flow.

So, we are still seeing deleveraging across the platform.

So our feeling is that this continues to be a good time to deploy capital; the key issue is to continue to be highly selective in where you deploy it.

And we will not, as you know, underwrite growth in our investments.

Okay, great.

Thanks.

Our next question comes from the line of Don Fandetti with Citigroup.

Please proceed.

Hi, Michael, a quick question on credit.

I know you had one asset that was experiencing some issues.

You know, do you think that's a precursor to sort of, as time goes by the economy remain sluggish, that you could have some more creep up?

Or, as you look out, you know, is that more sort of sector specific and that you feel very good that you're not going to have these kinds of issues?

Yes, again, I think, Don, that's rather sector-specific, given that they are tied to purchases of home furnishings and other products into the home.

And I think the housing doldrums have really (inaudible) that business out right now.

We think that's a bit of an isolated incident.

Again, we are not underwriting growth, and we are being very selective in terms of the sectors that we are willing to deploy capital into.

But I think things are improving, albeit slowly, and I think asset selection is going to be critical.

Okay.

And this may have been asked, but in terms of the sort of capital markets, uncertainty we are seeing right now in macro, do you think that that could potentially lead to a moderation of deal flow?

Or, is the market just going to be consistently fairly healthy here?

I think, the deal flow continues to be very strong.

I think it may, which to us is a positive, slow some of our repayments, where sponsors may decided not to get exits or refinance it at this point in time.

And frankly -- and virtually all of our company -- that's just fine.

We love the credits we own.

But again, absent kind of the August slowdown that you typically see in our business, we haven't seen things slow down.

Thanks.

Our next question comes from the line of Rick Shane with JPMorgan.

Please proceed.

Mr.

Shane, your line is open, you may proceed.

Guys, can you hear me?

I apologize.

Yes, we can hear you now.

Excellent.

Sorry about that.

No problem.

You talked about seeing a pick up in M&A activity.

One thing we've seen over the last, you know, five or six weeks is -- and I think dislocation is probably an overstatement, but a pull back in leverage loan trading in the secondary market.

Do you see any opportunity right now to deploy capital there?

Again, I realize that your primary focus is to focus on your proprietary underwriting and on that platform, but what about trading in the secondary markets?

The answer is -- we always look.

And, frankly, although there's been quote dislocation, it's not very big dislocation.

And the risk-reward we continue to see in our direct origination relative to [buying] secondary positions is not comparable.

You know, typical company in the high-yield market that's healthy is levered 5 to 6 times, and trades at 8% to 9% yields, even with this quote dislocation.

Whereas we are putting out investments levered 3.5 to 5 times, and getting substantial double-digit returns.

So it's not comparable to the point where it makes sense (inaudible) on the market.

Great, that's helpful.

And, again, I agree with you, that the comment dislocation is an overstatement given what we've seen.

I'm just curious if you've seen that valuation gap narrow to the point that's it's attractive, and it sounds like it hasn't.

Perfect.

Thank you, guys.

Thank you.

Our next question comes from the line of Eric Cohen with Guggenheim.

Please proceed.

Hi, good morning.

Just real quick, on Direct Buy.

Given some of the issues here I was wondering if you felt like it could be a potential opportunity to take advantage of the situation?

Additionally, if you guys had any exposure to a US downgrade.

With respect to Direct Buy, part of the issue -- while they are current and it's good free cash flow business given that it's a franchisor, there is a little bit of uncertainty out there with respect to some potential settlements that they're working through with attorney generals.

They've had a history of doing that successfully.

But I think until that gets resolved, it creates a little bit of uncertainty that is difficult to underwrite.

So, I think we are watching it closely.

And I'm sorry, your second question?

Just if you guys had any exposure at all to a US downgrade, any more or less than any other financial institution.

No.

No.

And as I say less -- we are not dependent upon funding from the US government at all or anything like that.

So, we are not worried about that.

Okay, great.

Thank you.

Our next question comes from the line of Casey Alexander with Gilford Securities.

Please proceed.

Hi, good morning.

Can you update me on the proportion of the fixed to floating rate in the portfolio, since you had origination and some pay backs?

I'd love to see how that's changed.

Sure.

It hasn't changed materially, is the short answer.

Hold on one second.

Floating rate continues to be in the high 20% range, just under 30%.

Okay.

So that has moved up some then.

And I know that for technical reasons you draw down the entire credit facility.

But for practical reasons, how much -- and let's count in the term loan -- how much do you have out in terms of leverage right now?

As of the end of the quarter.

As of the end of the quarter, we had the whole 435 drawn.

Yes, I understand that.

But you take it down the last day and you pay some substantial portion of it back the next day.

That's for technical reasons that you do that, but for practical reasons what do you actually have out?

Because you're going to pay some portion of that back tomorrow or the day after.

Right.

The net debt at the end of the quarter was about $50 million.

$50 million?

Okay, that's the number that I'm really looking for.

Okay, so --

And that's the right number to focus on.

Okay.

And that's why talk about having $340 million of dry powder.

All right.

But presumably the $150 million interest rate cap is to hedge against an upward movement against your credit facility but you only have $50 million out.

I mean, so to a certain extent --

That's -- let me interrupt you, that's going to quickly change.

As we deploy our capital you're going to see us get to a higher level, and that will become more of a permanent type layer of capital in our capital structure.

Okay.

Now the $4.8 million derivative loss during the quarter, was that a mark to the market of the existing interest rate cap?

Yes.

Both interest rate caps were mark-to-market.

All right.

Okay, great.

Thank you.

(Operator Instructions)

Our next question comes from the line of Jonathan Finger with Finger Interests.

Please proceed.

Hi, good morning.

My first question related to the derivatives, so that's been answered.

On the change in unrealized loss in the investments, is that a portfolio-wide issue where spreads are changing, or is that just related to a specific credit?

No, Jonathan, it's really -- the bulk of it is in the one credit, Direct Buy, that went from a mark in the high 70s to low 40s for the quarter.

Okay.

All right, that's it.

Thank you.

Thank you.

Our next question comes from the line of [Greg Borland].

Please proceed.

Hi.

My question regards the compressed yields that we are currently seeing.

And I'm wondering if you have any expectation, that is if yields continue to be compressed whether you will have to decrease the dividend that you're paying, or whether you expect that dividend to be able to grow as just the business grows?

We have no intent, or no need, or expectation to decrease our dividend.

In fact, the opposite.

Because we are so unlevered as we just mentioned, we have virtually no debt yet, and the ability to borrow at L plus 3.75 and deploy capital.

With the investments we are putting out these kinds of rates, we actually expect to increase our dividend some time the next several quarters.

So, that's not a concern.

All right.

That's kind of the answer I was hoping for.

But do you have any projection of what that increase might be percentage-wise over the next year or two, as long as business continues to go as you're projecting?

No, that's something we -- we've talked about publicly.

All right.

Thank you, very much.

Thank you.

Thank you.

There are no further questions.

I will now turn the call back over to Michael Gross, Chairman and Chief Executive Officer, for any closing remarks.

Thank you for all your time and we will, I'm sure, speak to another group of you in about half-an-hour when we do the SUNS Earnings Call.

Thank you

Thank you for your participation in today's conference.

This concludes the presentation.

Everyone may now disconnect.

So, have a great day.