SLR Investment Corp (SLRC) 2012 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the first quarter 2012 Solar Capital Ltd. Earnings Conference Call. My name is Stephanie, and I'll be your coordinator for today.

At this time, all participants are in a listen-only mode. Following the prepared remarks, there will be a question and answer session.

(Operator Instructions)

As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to Mr. Michael Gross, Chairman and CEO of Solar Capital. Please proceed.

Thank you, and good morning. Welcome to Solar Capital Ltd.'s earnings call for the first quarter ended March 31, 2012. 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?

Of course. Thanks, Michael. I'd like to remind everyone that today's call and webcast are being recorded. Please note that they are the property of Solar Capital Ltd. and that they -- any unauthorized broadcast 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'd 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 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 Ltd. undertakes no duty to update any forward-looking statements made herein, unless required to do so by law.

To obtain the copies of our latest SEC filings, please visit our website or call us at 212-993-1670. At this time, I'd like to turn the call back to our Chairman and CEO, Michael Gross.

Thank you, Nick. The liquid high yield and bank loan market technicals improved throughout much of the first quarter, continuing the momentum that we witnessed at the end of 2011. Healthy corporate earnings and encouraging US economic data bolstered investor confidence, which increased the demand for higher yielding investments.

Record influence helped drive the first quarter high yield returns up 5%. Similarly, the liquid senior loan market returned more than 3% for the quarter. Our net asset value per share of $22.68 at the end of the quarter represents a 3% increase from yearend. The portfolio generated net investment income per share of $0.58, continuing our positive earnings momentum.

The fair value weighted average mark on the credit portfolio was approximately 95% at March 31, compared to approximately 94% at the end of 2011. At March 31, 99.5% of our debt portfolio is performing, and we are very encouraged by the financial performance of our underlying portfolio companies. We continue to believe strongly that realizable value of our portfolio is north of $24.50 per share.

In the less liquid middle market loan segment, new platform creation during the quarter was seasonally low. Typically, M&A activity builds during the first quarter, as sponsors evaluate new acquisition targets and reach financing alternatives post the holiday break. This year, that trend was particularly evident. SMP's first quarter volume of middle market LBO transactions was down approximately 30% from the fourth quarter levels, while sponsored loan issuance was essentially flat [from] the prior quarter.

During the first quarter, we originated over $60 million par value of new investments in five existing portfolio companies. Financing add-on acquisitions accounted for the majority of our origination activity. Our pipeline increased in the second half of the first quarter, and it's continued to strengthen in the second quarter to date.

As you know, the typical investment process takes two to three months, so the uptick in activity during the first quarter will be reflected in our second quarter results. As a result of reduced repayments and increased origination activity one month into the first -- into the second quarter, we are already positioned for an excess of 10% net portfolio growth.

The lack of new supply from sponsor led M&A activity provided a number of middle market issuers with an attractive refinancing environment. Our redemption for the quarter totaled approximately $106 million, and sales of equity investments totaled approximately $29 million. To date, we have not received notice for any redemptions during the second quarter.

We continue to opportunistically rotate out of our co-investment common equity positions, such as NSA and [NSP], at favorable valuations. Over 75% of the fair value of our portfolios now comprise of investments made post the 2008 credit crisis. We therefore expect reduced repayments in the near term. At the end of the first quarter, our uninvested capital totaled approximately $350 million, which gives us substantial dry powder to further drive growth in net investment income.

Finally, our Board of Directors declared a quarterly dividend of $0.50 per share, which is fully covered by our taxable earnings. The second 2012 dividend will be paid on July 3, 2012, to holders of record as of June 19, 2012. At this time, we'll turn the call back over to Nick to take you through the financial highlights.

Thanks, Michael. Solar Capital's net asset value, or NAV, at the end of the first quarter, was $830.1 million, or $22.68 per share, an increase of 3% from $22.02 per share at December 31, '11. Our investment portfolio had a fair market value of approximately $1 billion on March 31, 2012. Change in portfolio value for the quarter resulted from redemptions in sales that exceeded origination, in addition to an increase in the fair value of our investments.

For the first quarter, gross investment income totaled $36.3 million, a 12.4% increase over $32.3 million for the first quarter of 2011, due to higher interest income on a larger average investment portfolio in 2012 and higher income related to loan repayments. Net investment income for the first quarter was $21.1 million, or $0.58 per share versus $19.2 million in the first quarter of 2011, or $0.53 per share.

This represents a 9.9% increase compared to the first quarter of 2011, driven primarily by increased investment income, partially offset by higher expenses. Sequentially, the first quarter was up from the fourth quarter 2011 net investment income of $20.7 million, or $0.57 per share.

Net realized and unrealized gains totaled $25.1 million for the first quarter, driven by an increase in the fair value of our portfolio during the period, due to improved market conditions and realizations of a prior period mark. This improvement was a continuation of the fair value improvements experienced in the fourth quarter of 2011, for which net realized and unrealized gains totaled $31.2 million.

As of March 31, investable capital was in excess of $1.35 billion, with approximately $350 million available for new investments. As of March 31, 99.5% of our debt portfolio was performing with one asset on nonaccrual, which has a fair value of $4.4 million.

The weighted average investment risk rating of our total portfolio has remained steady at approximately two, measured at a fair market value at the end of the first quarter, based on our one to four risk rating scale, with a one representing the least amount of risk. At this time, I'd like to turn the call over to our Chief Operating Officer, Bruce Spohler.

Thank you, Nick. Let me start by giving you an overview of our portfolio. At quarter's end, the fair market value of our investment portfolio was approximately $1 billion. The fair value weighted average yield on our income producing investments was approximately 14.3%, consistent with a 14.2% yield at the end of Q4.

As of 3-31, our portfolio consisted of 41% senior secured debt, 52% subordinated debt, and 7% co-invest equities. We had investments in 34 portfolio companies operating across 20 industries.

I'll now take a moment and provide a little color on our Q1 investment activity. During the first quarter, we received approximately $106 million of repayments, all at or above par and all at or above our prior quarter's marks. We experienced full redemption from two of our remaining 2007 vintage credit assets.

Our $19 million par value investment in Magnolia was redeemed in conjunction with the Company's refinancing, and our $27 million [pick] investment in AMC Theaters was also redeemed. In addition, our investments in Roundy's, [Van Pool], and Shoes for Crews were also repaid in full. These assets continued to demonstrate the [pull support] scenario which we expect in our current portfolio as investments are repaid.

In addition to our repayments, we actively sold shares of [NXT], generating $8.5 million in proceeds. NXT's share price nearly doubled during the first quarter, and we were able to sell into this strength. Despite having sold nearly half of our remaining position, the 3-31 value of our remaining NXT position is approximately similar to the 12-31 fair value that we held. We will continue to sell these shares opportunistically and recycle the proceeds into income producing investments.

We also received approximately $21 million from the sale of our equity investment in National Specialty Alloys to Reliance Steel. We had originally invested $10 million in 2007, representing an $11 million realized gain. Together with the dividends that we received over the life of our investment, our IRR is approximately 30%. These realizations, which were all at or above our cost, speak to both our conservative valuation methodology as well as the benefit of a long-term, patient investment approach.

Post quarter-end, we finalized the recapitalization of our investment in DS Waters. We and other note holders exchanged our pick notes into participating preferred equity. The resulting security has a dividend rate and liquidation preference consistent with our prior note. Our resulting attachment point in the capital structure continues to be at 3.2 times leverage.

Importantly, our group received a majority of the company's common equity, control of the board, and we'll have control over all significant corporate actions, including refinancing and monetization events.

Since our last update, the company has continued to outperform its budget. Customer growth in Q1 was the best that the company has seen in nearly ten years. In addition, DS Waters closed on a sizeable acquisition of a coffee business, and they are currently in the process of integrating this company into their operations.

In connection with the recapitalization of DS Waters, we invested approximately $30 million in the new second lien secured loan facility. We view this as a strategic investment, having a highly attractive risk reward profile, with a leveraged attachment point at 0.5 times, ending at 3.2 times. The market currently values DS Waters' loans at approximately par.

During the first quarter, we invested over $60 million par value in five existing portfolio companies. We view these follow-ons or add-on investments as extremely attractive opportunities to put additional capital to work and extend our duration in businesses [with healthy] fundamentals that we have observed from prior investments.

As Michael mentioned, refinancing activity during the first quarter was high. We took advantage of attractive follow-ons and refinancing opportunities in our existing portfolio companies, where we were very comfortable with the fundamentals and business prospects. In the first quarter, new investments had an averaged leverage to our security of below 4 times. We originated a $7 million investment in [ViaWest] incremental second lien notes, bringing our total investment in the company to approximately $40 million.

As a reminder, ViaWest is owned by Oak Hill and is one of the nation's largest privately held data center operators, with over 20 centers, located predominantly in the Pacific and Mountain West. The incremental capital will help fund new data center build outs in 2012 and '13. The all-in yield on our investment is in the high 13% area. In connection with our financing, we were able to extend the duration on the asset for our portfolio.

In addition, we invested $12 million in Asurion's new subordinated term loan and continue to hold an investment in the company's second lien term loan. Asurion is the leading global provider of warranty services to cell phones. We first invested in this company in 2007, and given its strong credit profile, which was maintained throughout the financial crisis, we have participated in multiple refinancing and follow-on opportunities. The yield on this new loan exceeds 11%, with leverage in the mid 4 times.

We also increased our position by $10 million in the subordinated notes of MidCap Finance, which is a secured lender to healthcare related companies. MidCap has low leverage, with total debt to equity of under 3 times, and its portfolio of loans is diversified across over 90 different issuers, with an average loan size of approximately $9 million. This transaction resulted in the repricing of our existing notes to 13% and extended our expected duration. We first invested in this company with a $12 million -- a $25 million investment in 2010 and have been extremely pleased with its performance.

To date, we have no visibility of additional repayments during Q2. We do, however, have strong conviction around Q2 being an active quarter for origination, which will grow and further diversify our portfolio. Now I'll turn the call back to Michael.

Thank you, Bruce. As we move into the second quarter of 2012, a level of activity in the middle market sponsor community has increased, and we expect this trend to continue. We continue to see an uptick in requests for finance -- refinancing and add-on acquisitions for sponsors' existing portfolio companies, as well as new LBO activity. The longer term structure in efficiencies in middle market direct lending to private companies continued to persist, creating new attractive opportunities. We are actively pursuing those transactions which we find the most compelling.

As long-term veterans in the leveraged finance industry, we understand the importance of being patient investors and maintaining our investment discipline. We continue to invest in recession resilient stable companies that can generate cash flow and reduce leverage throughout an economic cycle. Our [storishing] efforts have been successful in the first month of the second quarter. Currently, net investment portfolio growth in Q2 exceeds 10%, based on existing commitments and a lack of visibility on any redemptions.

In conclusion, we believe that the realizable value of our portfolio exceeds $24 per share, as our debt investments, with an average mark of 95%, pull to par. We are focused on continuing to recycle equity investments at or above recent marks and rotating our lower yielding credit assets into higher yielding investments. We are encouraged by the forward calendar and improved level of activity as well as the continued healthy fundamentals of our portfolio companies.

At 11.00 this morning, we'll be hosting an earnings call for Q1 2012 operations for Solar Senior Capital, or SUNS. Our ability to provide senior secured financing through this vehicle enhances our origination team's ability to meet our clients' capital needs. We are seeing benefits of this value propositioned in Solar's capital deal [club].

Thank you for your time. Operator, please open up the line for questions.

Ladies and gentlemen, we are ready to open the lines up for your questions. (Operator Instructions) Please stand by for your first question. Arren Cyganovich, Evercore.

Thanks. If you guys could talk a little bit about your investment pipeline and, [visually], what the mix of it is, in terms of capital structure and the yields associated with those new investments, and then, I guess, finally, just the -- your confidence seems pretty high that these will close in the second quarter.

Yes, our confidence is high. The nature of the investments -- as Michael mentioned, in Q1, the activity, I think, broadly, in the marketplace, as well as for Solar, really focused on refinancing and add-on acquisitions to existing portfolio companies held by sponsors. I think, as you look into Q2, you'll see an increasing portion, broadly speaking, across the market, as well as for Solar, in terms of new LBO platform creations in addition to add-on acquisitions and refinancing.

So I think the mix is broadening out as we head into Q2, and we're seeing that in our pipeline, not only expanding the opportunities, but allowing us to be that much more selective and drive marginally better terms.

I think pricing had drifted a little bit in Q1. As you know, historically, mezzanine pricing doesn't really move much beyond a 12% to 14% band, and so, I think, as deal activity picks up, given the lack of real meaningful capital creation, you're finding that terms are moving back slightly towards lenders. And so, I would say pricing is probably all in yields in the middle of that range on mezzanine. And that's what I would say.

Okay, that's helpful. And then, I guess, lastly, the -- your yield expanded a bit, and I think you touched on this in your comments a little bit from some lower yielding. What's the opportunity there to sustain the yields at the current levels?

I think that we will see some continued rotation out of some lower yielding investments, be they equities or just low yielding credit investments that will help mitigate any yield compression that we see at the asset level. But, by and large, we like where our assets are pricing.

All right. Thank you.

Thank you.

[John Fillmore], [Vaughn Trust].

Good morning, gentlemen. Just really quickly -- you guys have chosen in the first quarter to really concentrate your investments in some of your existing portfolio companies. Can you talk to whether that's a conscious reflection of activity at the portfolio level? Or is it just really your evolution and comfort with the credit?

Or is it really a third issue, which might be the opportunity, where, in those credits, you've developed a certain franchise value, and so, you know the credits, and it gives you the opportunity -- just wondering if you could kind of lay out how deal activities starting to form and how that process informed you guys to lead to making those types of investments.

Yes. I think -- not to dodge the question, but the answer is kind of all of the above. But, to step back, I think we like nothing better than to invest in companies that we've invested in over the years.

So, the ones you're alluding to, whether it's MidCap, we started an investment at $25 million, and as we got more comfortable, and they grew, we've grown it to where it is today. Same thing is true of Asurion and the same true is ViaWest. These companies are growing companies in need of capital, and if we can continue to invest on attractive terms, that's what we like to do. Another example of that is -- in our portfolio is Earthbound Farms that we upsized that investment after being at a year, as well, some time ago.

Okay. And then, in terms of -- with the existing sponsors or, at least, sponsor penetration, is there any statistic or is it more just qualitative, at least, in terms of sponsor penetration, with regards to improving deal flow and deal activity and looks, in terms of what you guys are seeing in the marketplace today? Thank you.

Yes, I would say the sponsor penetration, as you may recall, coming out of the crisis, John, only increased as -- both, because I think there were people exiting the sector in their ability to hold illiquid credit assets, but importantly, the long-term relationship, the permanent nature of our capital, and the partnership approach that we bring to bear was a real differentiator as sponsors looked for long-term partners rather than [fast capital against] their transactions.

I think, additionally, our penetration has increased by virtue of the fact that we've created Solar Senior. As Michael referenced, the ability to offer the midmarket senior bank capital solution is very compelling to the sponsor. There's a real dearth of providers there beyond a couple of key lenders, and that's an important capital need. So, I think the ability to go to market benefits Solar Capital by virtue of increasing our deal flow with the sponsor community, as they look to us for both senior and junior capital.

Joe Hogg, Wells Fargo.

Thank you, and good morning. Couple questions. One, regarding new investment activity, as you alluded to kind of a ramp coming in portfolio growth in Q2. What's your comfort level around not only just current returns, but long-term IRRs, as we see the portfolio grow? And then, I guess a second question is you guys obviously are running at relatively low leverage levels. What should we look for as the year plays out, in terms of getting into more of your credit facilities and actually optimizing, if you will, with the [EC] structure in terms of the bottom line ROE?

Sure. Yes, I think, on the new assets -- again, as you know, it's a mixed question in terms of where we're doing stretch first or secondly or mezzanine. The yields move within a band there; depends on where you are in the cycle, at any given point in the year, based upon what deal flow looks like and who has the leverage to push pricing 25, 50 basis points one way or the other.

But generally speaking, I would tell you that things -- yields have been stable, and importantly, while two weeks does make a trend, the last couple weeks, given increased deal flow, broadly speaking, it feels as if pricing and tightening of documents are moving in the lender's favor rather than the issuer. So, we obviously hope that will continue, but I think, importantly, as somebody else mentioned earlier, the recycling of some of the lower yielding investments contributes additional NII upside as we look at the yield across the whole portfolio.

And as far as optimizing our capital structure, our target secured debt to equity rate, which has always been about 0.65 times, we failed to get in there so far. But at quarter end, we have about $350 million of available capacity. If you read into what (inaudible) portfolio growth, that will eat away at a significant portion of that, and I think we expect to get to the optimized balance sheet sometime this calendar year. Hard to predict when; obviously, it has a function of what we get in repayments, which, at this point, we don't think will be very much. But we are targeting that growth each time we find the attractive investments.

Okay. And then, maybe, I guess, lastly -- obviously, the state of credit quality is pretty good. What are you -- maybe give us a sense in a real-time basis what you're seeing at the portfolio company level, because from where we sit, there's a lot of conflicting economic data. Obviously, the US is in a much stronger position than Europe. But what's kind of your outlook for the balance of the year in terms of performance of portfolio companies?

Yes, I would say that what we're hearing from the various management teams across the portfolios, both at Solar and SUNS, give us a pretty good window, in terms of the mindset, and I think the management teams are cautiously optimistic. One of the headwinds that teams faced last year was that they had increasing input costs, and I think, at the moment, while most would argue that they are at high absolute levels, people feel that they can budget around them so long as there's not continued movement.

So, I think, whether it's food input, soil input, people feel that there's some sense of stability, and so, if anything, we're seeing nice free cash flow; not a lot of growth, but people are cautiously optimistic. We continue to be somewhat defensive and continue to not underwrite growth, but rather, stability and nice free cash flow generation.

All right. Thanks, gentlemen.

Thanks, Joe.

Mick Schleien, Ladenburg.

Yes. Good morning, and thank you. I just wanted to make sure I understand the recapitalization of DS Waters. On a pro forma basis, are we going to see this $30 million second lien note on your schedule of investments and the $125 million pick note replaced by an equal amount of preferred? Is that right?

That's exactly right, and that is what is on our schedule of investments as of yearend.

Okay. And the new preferred -- the preferred is also a pick, right?

Correct.

Okay. And did you receive any common equity in all of this?

Yes. As part of this -- just to step back, we took our investment, which was hold co subordinated debt, which had a risk of exposure from 3.2 times debt to EBITDA to 6 times, which had a pick dividend, and we moved that to a holding company as well, changed it to preferred, so that we could get the most favorable treatment at the operating company for the refinancing. And long with that, our group of investors got 55% of common equity, and most importantly, we got control of the board and the company.

So --

So, just as a point of clarification, the $30 million second lien remained $30 million of second lien.

Right. And so, we'll see that. We'll the preferred, and we're going to see some portion of common equity in the company as well?

Yes.

Okay. And can you give us a sense of the scope of amount of common equity you have in DS Waters?

The group received 55% of the common equity.

Okay.

And we're the largest piece of that.

All right. The -- you mentioned that, so far, in the quarter, net portfolio growth is running at 10%. Is that a quarter to quarter number or year over year?

Quarter to quarter.

So, that's versus --

And in Q1, 3-31 of this year?

Yes.

Versus to date.

To date. Okay. That's very good. And can you give us a breakdown on the portfolio, roughly, of how much is fixed versus floating rate?

I would say it is roughly 70% fixed.

All right. And my last question is any update on the status of DirectBuy that you can offer us?

There's nothing really new. It's going through the restructuring process. That position has a $5 million market value for us, and we expect, upon restructuring, that value to go up somewhat. We do not expect to get par back on the investment, but that will take some time throughout the calendar year to get done.

And at the operating level, the business feels to have shown some stability, albeit, at lower levels than we had originally underwritten. So, I think, as the housing sector and employment goes, so will DirectBuy, and they're starting to see some sense of stability there. So, to Michael's point, we don't expect this to yield par, but we think there's upside beyond where this is marked.

Okay. Fair enough. And just a quick follow-on -- any sense of the timeline on DS Waters, in terms of the ultimate exit or whatever else you're considering in that deal?

Yes, I think there was obviously a lot on management's plate the first part of this year, between the recapitalization, as well as continuing to drive good performance on a fundamental basis, and last, but clearly, not least, the acquisition of the coffee business. So, I think the plan is to let them do what they do best, which is run the business and integrate coffee over the next couple of quarters, but now that we control our monetization, it's something that we'll be actively investigating as the year unfolds.

Thank you for your time.

Thank you for your questions.

(Operator Instructions). Greg Mason, Stifel Nicolaus.

Great. Thank you. I wanted to talk a little bit about capital raising activities. First, on the debt side, can you talk about your opportunity, now that you have an investment grade rating, to potentially change the interest rate you're paying on your large [Citi] revolving facility? And then, also, how do you look at some of the new debt opportunities that's been out there for BDC's convertible debt retail baby bonds versus your credit facility?

Good question. We do expect to take advantage of our investment grade rating, and frankly, some of the activity that's taken place in the lending market to BDC. Typically, a few of our competitors have already redone their facilities and haven't seen them price down fairly substantially. We would expect they'll do that sometime in the near term, as well, and reduce our cost in the L-plus rated quarter level we have today.

The -- you're right. Having gotten our investment grade rating, it opens up a lot of opportunities for us, whether it is converted baby bonds, private placements with insurance companies, and we continue to look at that very actively, and we'll opportunistically access that (inaudible).

I'd like to just get your theoretical view, given where some of those bonds have priced at longer maturities, but call it 6% to 7% cost of capital versus a floating rate L plus 300 or something less on your revolving facility. How do you balance the long-term maturity versus the higher interest rate, in your guys' view, for funding your balance sheet?

Sure. I think, as we look at it, there's a couple of factors. Obviously, it's the cost of capital, to your point. Duration is important; matching our assets and our liabilities, given that we do have longer duration assets. We also, as you know, have a meaningful portion of fixed rate assets.

But I also think there's an important thing here, which is diversification of your funding sources. Capital begets capital, and it -- together, with the investment grade rating, I think terming out some of our liabilities gives the bank that much more comfort to provide us additional capital. So, I think, long-term, you should expect us, as others have, to diversify the funding and have an appropriate mix of low-cost bank financing, together with term financing.

Great. And then, just one more on the equity raise capital side of the equation. Several of your peers have raised capital. I know you, in answer to Joe's question, want to get your leverage up, but how do you view raising equity here, and do you do it as soon as you hit your target leverage ratio? Do you run a little while your target leverage ratio? What's your thoughts on raising equity capital?

For us, we are extremely price sensitive to where we raise equity capital. We are just about the largest shareholder of the company. We own 6%, and so, we're very conscious of where we take dilutions. We obviously don't want to wait until the last second, when you're fully leveraged, but we obviously aren't going to do it at a price that we're not comfortable with. So, we kind of have to watch our stock price and watch our capital needs and be opportunistic. The beauty of having a [shelf] outstanding is that we can access the capital markets on a very timely basis when we see opportunity to do so.

Great. Thank you, guys.

At this time, there are no more questions in queue. I will turn the call back over to Mr. Michael Gross for any closing remarks. Please proceed.

Thank you for your attention this morning. We look forward to speaking to those who will participate on our Solar Senior Capital call in the next half hour.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect; great day.