SLR Investment Corp (SLRC) 2017 Q2 法說會逐字稿

Good day, ladies and gentlemen.

Welcome to the Solar Capital Second Quarter 2017 Earnings Conference Call.

(Operator Instructions) As a reminder, this conference call may be recorded.

I would now like to introduce your host for today's conference, Mr. Michael Gross, Chairman and Chief Executive Officer.

Sir, you may begin.

Thank you very much, and good morning.

Welcome to Solar Capital Limited's earnings call for the quarter ended June 30, 2017.

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

Before we begin, Rich, 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 Limited and that any unauthorized broadcasts in any form are strictly prohibited.

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

Audio replays of this call will be made available later today, as disclosed in our earnings press release.

I'd like to also 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 our future performance or financial condition.

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

Additionally, past performance is not indicative of future results.

Actual results may differ materially 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 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'd like to turn the call back to our Chairman and Chief Executive Officer, Michael Gross.

Thank you, Rich.

The second quarter saw a continuation of recent trends, with the leveraged loan market supported by capital inflows, low interest rates, and stable issuer fundamentals.

The lack of new money opportunities, combined with below average default rates and slow but steady economic growth, have extended the issuer-friendly underwriting environment.

According to Thomson Reuters, middle market loan volume was up a modest 2% from Q1, with 50% of the transactions representing refinancings and repricings.

Since early 2016, middle market transactions have experienced a steady deterioration in pricing, as lenders have been forced to incur higher risk with lower yields.

Year-to-date 2017 returns have remained approximately at the same level, but leverage has crept up and terms are looser.

In this extended period of elevated repayments and frothy markets, Solar Capital has remained disciplined and focused on its strategic objectives.

Our priorities have not changed.

First and foremost is to preserve capital and protect our net asset value.

Second is to use our available capital to source investments that meet our strict criteria and grow our net investment income.

Third is to expand our specialty finance capabilities in niches that are less competitive, offer attractive risk-adjusted returns, and have a low correlation to the liquid leveraged loan market.

Fourth is to enhance Solar Capital's role as a solutions provider to middle market issuers through the creation of strategic partnerships and joint ventures that increase the scale of our platform and are expected to result in more attractive senior secured investment opportunities.

And finally, to invest with principles, align with our fellow shareholders, and focus on building long term value.

Further to our strategic objectives, Solar Capital announced last night that on July 31 it acquired NEF Holdings LLC, or NEF, an independent equipment finance company that provides senior secured equipment financings to companies in the U.S. Solar Capital invested approximately $210 million to effect the transaction.

The acquisition expands our proprietary origination opportunities and provides differentiated sources of growth for Solar.

Pro forma for the NEF acquisition, approximately 2/3 of Solar's comprehensive portfolio is expected to be comprised of specialty finance investments, with the remainder from directly originated investments in senior secured cash flow loans to sponsor owned companies.

NEF was founded in 2010 by former GE Capital Equipment Finance professionals to fill a void in the marketplace created by the dislocation of traditional lenders.

The acquisition offers a compelling opportunity for Solar to invest in an established business whose experienced management team has underwritten approximately $1 billion of equipment finance transactions and built a strong historical track record.

The addition of NEF's sourcing channel enhances Solar's flexibility to originate across multiple business lines in order to find the best risk reward opportunities while also increasing the earnings power of Solar.

We expect our investment in NEF will generate approximately a 10% to 11% net cash yield, consistent with other specialty finance assets in our portfolio.

NEF will distribute substantially all of its earnings to Solar on a quarterly basis.

Based on NEF's current existing portfolio, the investment would currently generate quarterly net investment income for Solar of approximately $0.04 to $0.05 per share.

Bruce will provide additional details on the NEF transaction.

We funded our investment with available liquidity, including borrowings under Solar Capital's existing credit facility.

At June 30, Solar Capital had approximately $300 million of debt outstanding.

Had the acquisition of NEF closed on June 30, Solar Capital's pro forma leverage ratio would have been 0.55 times debt to equity.

Accounting for the NEF investment, Solar has over $750 million of available capital under its current credit facilities, subject to borrowing base availability to finance portfolio growth.

Our portfolio continues to perform extremely well as a result of the investment discipline maintained over the last several years of heated market conditions.

We have constructed what we believe is a defensive portfolio of senior secured loans.

We have largely avoided investments in companies operating in cyclical, consumer discretionary, and energy or commodity-based industries.

Credit quality remained strong with no nonaccruals in the quarter.

On a fair market value basis, 100% of the portfolio was performing at June 30, and net asset value at June 30 was $21.79 per share, up $0.04 per share from Q1.

In the second quarter, across all of our strategies, Solar Capital had originations of approximately $110 million and repayments of $226 million.

As Bruce will discuss, over 90% of the originations were in life science and Crystal asset-based investments.

Net investment income for the quarter is $0.38 per share.

We chose not to reinvest in our loans that were either repaid or repriced in Q2 based on tighter pricing elevated risk.

Instead, we focused our efforts on deploying capital into specialty finance investments with the acquisition of NEF, where we believe the current investment opportunity is more compelling.

In addition, we continued to make solid progress in our partnership with PIMCO.

As a reminder, at the end of 2016 our advisors, Solar Capital Partners, formed a joint venture with PIMCO.

This initiative should provide significant long term benefits to Solar.

Through an expected larger investable capital base across the Solar platform, Solar will be more of a full solutions provider, which is expected to result in greater deal flow for Solar and the SSLPs.

Furthermore, the partnership with PIMCO provides Solar with access to the resources of a world class credit manager, which has invested $300 billion in corporate credit and currently employs over 50 credit research analysts.

We are confident Solar Capital's differentiated business lines, together with our SSLPs and joint venture with PIMCO and the Solar Life Science program, give us the necessary tools, resources, and flexibility to successfully navigate the current challenging investment environment.

Solar Capital is well positioned with available capital and diversified sourcing engines to prudently grow and drive an increase in our net investment income.

At this time, I'll turn the call over to our Chief Financial Officer, Rich Peteka, to take you through the financial highlights.

Thank you, Michael.

Solar Capital Limited's net asset value at June 30, 2017 was $920.9 million, or $21.79 per share, compared to $918.8 million, or $21.75 per share, at March 31.

At June 30, 2017, Solar Capital's on balance sheet investment portfolio had a fair market value of $1.22 billion in 57 portfolio companies across 24 industries, compared to a fair market value of $1.32 billion in 61 portfolio companies across 23 industries at March 31.

For the 3 months ended June 30, gross investment income totaled $33.9 million versus $34.4 million for the 3 months ended March 31.

Expenses totaled $17.8 million for the 3 months ended June 30 compared to $18.1 million for the 3 months ended March 31, 2017.

Accordingly, the company's net investment income for the 3 months ended June 30, 2017 totaled $16.1 million, or $0.38 per average share, compared to $16.8 million, or $0.40 per average share, for the 3 months ended March 31, 2017.

This excludes the one-time financing costs related to the private placement of our $100 million in unsecured notes during the first quarter.

Below the line, the company had net realized and unrealized gains for the second quarter of 2017 totaling $2.7 million versus net realized and unrealized gains of $0.8 million for the first quarter of 2017.

Ultimately, the company had a net increase in net assets from operations of $18.8 million, or $0.44 per average share for the 3 months ended June 30.

This compares to an increase of $17.2 million, or $0.41 per average share, for the 3 months ended March 31, 2017.

Finally, our Board of Directors declared a Q3 distribution of $0.40 per share payable on October 3, 2017 to shareholders of record on September 21, 2017.

With that, I'll turn the call over to our Chief Operating Officer, Bruce Spohler.

Thank you, Rich.

I'd like to begin by providing an update on the credit fundamentals of our portfolio.

Overall, the financial health of our portfolio investments remains sound, reflecting our disciplined underwriting and focus on downside protection.

At quarter's end, the weighted average related to 12 months' revenue and EBITDA and interest coverage trends continued to be positive for our portfolio companies.

The weighted average leverage through our investment was 5.2 times, consistent with the first quarter.

The fair value weighted average EBITDA across our portfolio companies was just over $65 million.

The U.S. economic environment, with stable earnings and low defaults, continues to remain favorable for disciplined credit investors.

At June 30, the weighted average investment risk weighting of our portfolio was 2, based on our 1-to-4 risk weighing scale, with 1 representing the least amount of risk.

Approximately 96% of the portfolio is rated 2 or better, again reflecting the portfolio's strong credit fundamentals.

Measured at fair value, 100% of the portfolio was performing at June 30.

On a cost basis, our one legacy investment in Direct Buy is on nonaccrual and accounts for only 0.7% of the portfolio.

The weighted average yields on a fair value and current cost basis are 10.1% and 10.5% respectively, consistent with the prior quarter.

Importantly, Solar was able to maintain its portfolio yield without compromising credit quality or taking on additional risk during this quarter.

Now let me provide some color on the composition of our comprehensive portfolio, which includes Crystal Financial's portfolio of asset-based loans, life science loans as well as our senior secured loan program.

At the end of the quarter, our $1.4 billion comprehensive portfolio included 86 issuers across 34 industries, again with no direct exposure to energy or commodity sectors.

The average investment per issuer is $16 million or 1.2% of our comprehensive portfolio.

Almost 98% of the portfolio consisted of senior secured loans, again consistent with the prior quarter.

The remainder of the portfolio was comprised of 2.3% of equity securities, primarily related to our debt investments.

At June 30, over 96% of our comprehensive portfolio was floating rate.

Before turning to our second quarter investment activity, I'd like to provide some additional information on the NEF acquisition.

By way of background, our team is very familiar with the leasing industry overall, having diligent key market participants in independent lease finance companies in the context of evaluating potential debt and potential control equity investments.

Our investment team continues to review and evaluate specialty finance companies that operate in very attractive lending market niches.

Solar had followed NEF closely for a number of years, given our investment activity in the equipment finance industry.

In addition, senior members of our investment team have longstanding relationships with NEF's executives, as a number of both Solar and Crystal investment professionals trained under NEF's founder and CEO, Phil Carlson, while they were all together at GE Capital.

NEF employs a team of approximately 40 professionals which, in addition to our 80 professionals on the Solar platform, takes us to 120 dedicated professionals focused on midmarket finance.

As Michael mentioned, since their inception NEF has directly originated approximately $1 billion of equipment financings.

Their portfolio is highly diversified, with an average funded exposure per borrower of just over $2 million.

Collateral securing their portfolio consists of long life essential use assets such as trucks, trailers, machine tools, and equipment, all of which can be readily liquidated.

Advance rates are typically less than liquidation value of the equipment, and the lease term is typically 3 to 7 years, with an average life of just over 4 years.

The typical customer of NEF is a privately owned midmarket business with a high investment in fixed assets.

Solar Capital acquired NEF for a modest premium to tangible book value.

We believe the purchase price represents a very attractive entry point and further expands Solar's product offering as a diversified specialty finance company.

With its 100% collateralized loan portfolio, the addition of NEF complements our existing cash flow, asset base, and life science senior secured lending businesses.

We believe NEF's platform is highly scalable and provides Solar access to a midmarket asset class that offers attractive risk-adjusted returns.

Pro forma for the acquisition of NEF, we expect approximately 2/3 of Solar's comprehensive portfolio to be comprised of our specialty finance businesses and the remaining third comprised of our cash flow lending business to sponsor-owned companies.

Now let me provide a brief update on the strategic initiatives.

At quarter's end, our life science portfolio totaled approximately $215 million of first lien senior secured loans across 24 borrowers with an average investment of $9 million.

In the second quarter, the team originated $9 million of senior secured loans and had repayments and amortization totaling just over $8 million.

The weighted average yield of our life science portfolio maintained an 11.5% return at fair market value and 12% at cost.

And this excludes any potential exit, success fees or warrants.

The blended realized IRR on our life science investment through quarter end is 18.4%, including realized value of warrants.

Now let me update you on Crystal, our asset-based lending platform.

At June 30, Crystal had a diversified portfolio which consisted of approximately $370 million of funded senior secured loans across 24 borrowers, with an average loan of just over $15 million.

In the second quarter, Crystal had new investment of approximately $90 million and had portfolio reductions totaling approximately $64 million.

100% of Crystal's investments are senior secured loans and approximately 99% are floating rate.

For the second quarter, Crystal paid Solar a cash dividend of $7.9 million, equating to an 11.3% yield on cost, which is consistent with the prior quarter.

And finally, a quick update on our senior secured unitranche loan program, or SSLP.

In the second quarter, SSLP and SSLP II collectively funded $14 million of senior secured loans, bringing the total portfolio up to $285 million in investments.

SSLPs had senior secured loans to 15 different borrowers with an average investment of just under $20 million.

Both vehicles were 100% performing.

Combined repayments, including contractual amortization, totaled approximately $44 million.

The SSLPs are currently earning approximately a 10% return on equity, and we continue to expect that to creep up into the low teens as the vehicles are fully ramped.

Now let me turn to our second quarter activity.

Including investments and repayments in the SSLPs, we originated approximately $20 million of senior secured floating rate loans across 9 companies.

Investments repaid or sold during the quarter totaled 162 million.

When considering the second quarter activity across all of our strategies, originations were 110 million and repayments were 226 million, with 90% of the new originations being in Crystal asset-based lending and life science investments.

With the NEF acquisition post quarter end, we have essentially more than replaced the cash flow loans that were repaid during the second quarter with investments in our specialty finance businesses, where we believe the current market was extremely compelling.

We invested $5 million into SC Pharma, a clinical stage biopharma company that has developed a combination drug and delivery device to treat a condition related to heart failure.

The loan has a yield to maturity of approximately 11%, which excludes any warrants or final fees.

We also funded add-on investments into portfolio companies for aTyr Pharma and Cianna Medical.

During the second quarter, we were repaid at par on our $28 million subordinated investment in Alegeus Technologies, earning an IRR of 14%.

Alegeus was our last remaining unsecured investment in the Solar portfolio.

We were also repaid on our $34 million investment in the second lien term loan of TierPoint.

We realized an IRR on this investment of approximately 11.5%.

In addition, we were repaid on our $30 million investment in the second lien term loan of U.S. Anesthesia Partners as part of a refinancing.

We realized an IRR on this investment of over 10.25%.

Finally, Solar was repaid on its investment in the stretch first lien term loan of CIBT Holdings.

Here we realized an IRR of just over 8% and decided to pass on participating in a new cov-lite first/second lien structure for the company.

As Michael mentioned, the middle market environment remains frothy given the market technicals.

We are blessed to have diversified origination sources and will continue to be disciplined and prudent in deploying our capital.

Our SSLPs allow us to be highly selective with stretch first lien senior secured sponsor-owned cash flow transactions.

Longer term, we believe the record amounts of private equity dry powder, the retreat of banks from midmarket leveraged lending and the approaching refinancing wave of existing sponsor-owned leveraged companies create an attractive supply demand dynamic for cash flow lending to middle market companies.

Now I'll turn the call back to Michael.

Thank you, Bruce.

From the inception of Solar Capital 11 years ago, our investment and management decisions have been focused on building long-term value, protecting capital and maintaining alignment with our shareholders.

As credit market conditions have steadily deteriorated, we consciously migrated Solar's portfolio to one that is comprised of 98% senior secured loans.

We formed the SSLPs and strategic partnerships with institutional investors, allowing us to invest in lower risk first lien and stretch first lien senior secured loans while utilizing modestly higher leverage in the vehicles to generate attractive return on equities.

We established joint ventures with PIMCO and other partners to enhance origination opportunities and create additional scale.

And importantly, we diversified into specialty finance verticals such as asset-based lending through Crystal, life sciences and equipment finance with the recent acquisition of NEF.

All of these steps were taken to maintain a defensive lower risk and high quality portfolio while building a broader origination platform.

The acquisition of NEF is a significant event.

Today we are a diversified specialty finance company providing solutions across the capital structure to middle market businesses.

Our origination engines are broad and provide us the opportunity to source loans in specialty niches focused on collateral and loan to value lending that are a lot less competitive than traditional cash flow lending.

In addition, the specialty finance strategies are less correlated to the liquid credit markets and have a differentiated risk return profile that is complementary to our cash flow lending.

They afford us the greatest flexibility to stick to our investment discipline and avoid pursuing cash flow transactions in a frothy market environment.

Unlike many of our BDC peers, who are facing declining net investment income given the spread compression in cash flow lending and are contemplating dividend cuts, we are not.

The investment in NEF now gives us 4 distinct engines of growth and enhances our earnings power.

We have a solid foundation with a diversified portfolio of strong credit quality.

The combination of our specialized businesses with available capital places us in a unique position of having the flexibility and opportunity to grow net investment income and potentially increase our dividend in the future.

At 11:00 this morning, we'll be hosting an earnings call for the second quarter of 2017 results of Solar Senior Capital, or SUNS.

Our ability to provide traditional middle market senior secured financing through this vehicle continues to enhance our origination team's ability to meet our clients' capital needs.

And we continue to see benefits of this value proposition in Solar Capital's deal flow.

Thank you very much for your time this morning.

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

(Operator Instructions) And the first question will come from the line of Ryan Lynch with KBW.

First off, congratulations on the NEF acquisition.

I did have a couple questions on that.

First, the $210 million you guys paid, what was the actual size of the portfolio purchased?

And also, how will that be structured on your balance sheet?

Will you guys place a portion of those loans directly on your balance sheet?

Or will they be placed into some sort of like wholly owned sub?

And if you guys are going to split those up, what percentage of the portfolio would go on the balance sheet versus what will be placed into a wholly owned sub?

Sure, Ryan.

The answer is both.

We will have assets on the balance sheet as well as in a wholly owned sub.

I think you should expect the -- and we'll take you through this when we release the third quarter Q. But our intention is to probably have -- the assets on balance sheet will grow faster than the assets in the sub.

But we'll be reporting this as a line of business, as an equipment finance segment.

So effectively you'll see the collapsed view as to how the business is operating.

Okay.

And how big will the portfolio be from initial purchase?

Yes, just about $340 million.

Okay.

And then, will these assets, whether you put them in the sub or whether you put them on the balance sheet, will they be qualified or nonqualified assets?

And if they are…

This entire investment is a qualified investment, regardless of whether it's on balance sheet or in the leasing company.

Okay.

As far as in the leasing company, why would this transaction be qualified assets versus the transaction -- or the investment in Crystal being a nonqualified transaction?

Because the company we acquired originates and manages equipment financings.

And the majority of this portfolio is operating true leases where NEF actually owns the equipment and generates rental leasing payments from its clients.

And given this business model, they're not considering securities under the 40 Act.

And therefore, it's a nonqualifying asset.

It's similar to how some people have invested, as you know in our sector, in airplane leasing businesses.

Right, and there are plenty of those out there that you can look at.

Okay.

That makes sense.

And then you mentioned, post the NEF transaction, about 2/3 of your comprehensive portfolio is now going to be in the specialty finance investments versus kind of the directly originated cash flow back loans to sponsors.

And you guys have done a great job of expanding this and diversifying your portfolio.

Is this where you want to be, this kind of breakdown of 2/3 kind of specialty finance and then 1/3 kind of sponsor backed?

Or would you guys be looking to potentially grow the specialty finance segment in the future?

I think the short answer is, as we have in the past, we expect to grow both.

We had no specialty finance businesses going back to the beginning of 2012 and then were fortunate to bring on the Crystal asset-based lending team, the life science team and now the NEF team.

But we've also, as you know, expanded our cash flow lending business with our SSLP joint venture partners such as Voya as well as our additional capital that we hope to have through our JV with PIMCO dedicated to the cash flow business.

So the mix will vary from quarter-to-quarter based on where we see the best investment opportunities.

But what we find so compelling is that our intention is to grow all 4 verticals and have that diversification across the platform, to your point.

And importantly, as we mentioned, we're sitting on roughly $750 million of dry powder.

So to the extent we do get some volatility in the cash flow lending business, we don't have to rely upon repayments, which won't happen in a volatile market to invest further in the cash flow lending product.

Okay.

And then just one final question, it didn't look like there was any growth or anything funded in the life sciences JV.

Can you just talk about why there were no fundings in there and what is kind of the outlook for growth in that JV?

Yes, I think that we continue to expect to see some fundings either late Q3 or in Q4.

It's just been a little bit slower to ramp, and I think that's just more broadly.

The good news is there’ve been a fair bit of VC capital raised for life sciences, but that takes a little bit of time to get deployed and then to get late stage enough in that deployment in development of the company so that we're comfortable lending because we're often shown opportunities in the early stage of VC investing and we'll say no, let's put that in pipeline and revisit it next year.

So we're seeing the opportunity set build, but there's been a little bit of a delay just as that capital gets deployed by the VC community.

And the next question will come from the line of Rick Shane with JPMorgan.

Ryan asked a lot of my questions, but I really do want to delve back into the NEF acquisition a little bit and part of it is the language in the press release says you've invested approximately $210 million.

Is this -- did you buy the equity or did you buy the assets?

And I'm sort of curious, again, to circle back to Ryan's question.

How does this appear on the balance sheet?

Will there be a new $340 million of assets and then $130 million of financing associated with that to sort of net out that $210 million of equity?

So it'll be a mix.

You’ll see -- on our schedule of investment, you'll see a lot of small leases.

The average investment is $2.3 million, so you'll see a bunch of those.

Then you'll see an investment in NEF Leasing Company that we'll carry as an equity investment.

But as we said, that will be distributing all the earnings out, so that'll be similar to Crystal in structure in that regard.

So it's a hybrid.

And there'll be some financing at the leasing company and there'll be financing the leases on our balance sheet under our revolver as we funded it.

And does your existing revolver allow for you to contribute assets of this type?

And is there any difference in advance rates?

Or is your pricing grid any different related to small ticket leasing?

I guess this isn't small ticket.

Right, exactly.

I was going to say it's large ticket.

And the corporate loans that NEF makes are eligible collateral on the same advance rate and pricing as any other first lien loan.

And importantly, the financing at the leasing company is comparable to our cost of financing on our corporate balance sheet today.

These loans are highly attractive for banks to lend against given the diversification.

And surprisingly to us as we delved into business, it definitely gets treated as investment grade debt from the lenders' perspective.

(inaudible) I'm not commenting on the risk-adjusted margin of this in any way, but from a at least superficial ignoring credit perspective, this allows you to put assets on that are probably earning 200 or 300 bps over cash flow loans and finance them comparably.

Is that the way we should think about this at least from a pure P&L perspective?

Yes, I think we expect kind of asset level returns here of 11% to 12%, and that's net of expected losses.

This business will have small losses here or there given the nature of the collateral and what we're lending against.

The expectation and historical experience has been about 1% loss rate.

And so the stated returns are closer to 13%.

The net returns are -- before expenses are 11% to 12%.

And yes, and then we can finance those at similar advance rates and costs as the cash flow loans and get, as you mentioned, more like 300 to 400 basis points of premium return today to what we're seeing in cash flow.

And is the core collateral yellow metal and trucks?

It's trucks.

It's trailers.

It is yellow metal.

It's transportation equipment.

It's some aircraft.

It's highly diversified given the $2.3 million average investment.

But yes, it's heavy equipment.

Okay.

And I was going to end questions there but you said aircraft.

What type of aircraft, commercial or civilian?

There is some civilian, but it's very small.

(Operator Instructions) And the next question comes from the line of Casey Alexander with Compass Point Research & Trading.

Congratulations on the acquisition.

Most of my questions have been answered but knowing that -- and usually this is in the release, maybe I missed it.

But knowing that a certain amount of these equity investments are really representing senior secured securities, at the end of this quarter what would the breakdown be between senior secured securities versus equity?

Is it like 96% and 4%?

We have really no equity.

It was about 2% of equity.

And the next question comes from the line of Jon Bock with Wells Fargo.

I certainly always appreciate Rick Shane’s comment on loan growth absent worrying about any type of credit losses, so I always love hearing that.

I want to start with one quick question just to make sure I've got it correct because, Bruce, you mentioned that the SSLP ROEs are around 10%.

And I see that, yet that perhaps is one of the most difficult categories to compete in.

And when I think of your originations, I think the largest one being PetVet, which I believe is a Golub deal and several others, syndicated markets continue to drive down spreads.

Do you truly believe that, that 10% ROE is going to be maintained in an environment where there is just a significant amount of competition?

Yes, we do.

Remember we're not fully levered there yet, so we have a little cushion there to take some of the spread compression that you're referring to.

But as you saw in the second quarter, we were pretty disciplined about what we put into the SSLPS, given the environment and given that we have alternative investment channels.

So we think in cash flow lending, Jonathan, that's the best place to be from a risk perspective.

You know us.

We can handle a little spread compression should it continue because we do have these outsized returns in the specialty finance business.

So we're more concerned about some of the elevated risks we're seeing in the structures.

Unitranche is phenomenal, but when you start to push them to 7 times just because a P/E firm paid 14 times, we all know that it's not worth 14 at the time that we need it to be.

So that's where we're really cautious.

We're watching the spread compression.

I think the fact that you see our overall portfolio maintain its yield is really our critical focus across these verticals.

And while they now total 2/3 of our portfolio, in and of themselves they give us a little extra return to balance out the spread's compression we see in the cash flow business.

And Michael, I want to just make sure I repeat what I believe you said in terms of this being a good asset, because that generated a lot of interesting discussion.

I'd imagine it will continue to do so with investors.

So you're saying the fact that NEF owns the equipment itself, right, is what causes this to be looked -- and I get it.

Rich said to look at aircraft leasing.

I get it.

But the fundamental basis is they own what they're leasing and that is what makes it qualified.

I just want to get to the core.

So to contrast it, Crystal's loans are securities for 40 Act purposes.

And that's why Crystal, even though the loans are good assets on our books, the investment in Crystal is about assets because they own securities.

The leasing company we acquired does not own securities.

And I think it's helpful to mention on the record that we do have compliance and legal folks that work at Solar and help Solar out each and every day.

So we definitely work with them, and they help us with any and all interpretations or in fact.

And then just one reason for consistency, because it just -- could you explain how are you going to pick what goes on your balance sheet versus what stays hidden in the sub?

The main motivation or driving factor on what goes in the sub is tax.

So we need to put certain assets in there for tax reasons with a blocker corp so that we don't get taxed at the parent.

But importantly, Jonathan, we own 100% of all of it.

So we're indifferent from return otherwise where it goes, because we, Solar, the BDC, own 100% of all the loans and 100% of the leasing company.

So all the income flows up to our shareholders.

I guess the question would be, as a leasing company, would you be able to get either better or worse financing terms, right?

So is NEF going to their -- or is it all the same, right?

You'll be borrowing at the same rates you do on your current balance sheet?

Similar.

So they're borrowing at L 250.

We're borrowing at L 200 on the margin, right, but we also have our fixed rate debt.

So our average cost of capital is pretty similar.

And somebody asked earlier where are you going to grow.

The answer is in both places.

It's a different product that would result in an asset that would want to go, for tax purposes, into the lease co versus on balance sheet.

But we're indifferent.

NEF is indifferent.

It's just a structuring issue for tax efficiency.

So would you say the real risk that we're going long is effectively construction and residential/commercial real estate, in light of the fact that these trucks are a majority of the portfolio and that's what you'd use this equipment for?

Well, no.

Remember too there's a lot of maintenance, right?

I mean, transportation equipment is also just delivery of goods.

So there is an inherent cyclicality, but underlying this is collateral.

We're not lending just on the cash flows of these borrowers.

And so the key is, very similar to the Crystal team, NEF has this long track record of making sure that they are within liquidation collateral value so that, if they need to, they can liquidate that collateral.

That's the key source of repayment here.

The next question comes from the line of Christopher Testa with National Securities Corporation.

On the equipment financing segment, during times of economic stress, specifically 2008 and 2009, just curious what the loss rates and recovery rates on these types of loans were.

It's actually been very consistent over time.

The 1% annual average loss rate has been consistent through the cycle.

And what type of financing are you getting on NEF?

We have a combination of a credit facility at L 250, as we mentioned, as well they have some securitizations that are winding down.

And I appreciate your comments already on the SSLPs and obviously the unitranche market being frothy.

I guess the question is how much do we have to see spreads kind of back up before it becomes palatable to allocate more capital here with some more leverage to get the ROEs that you're looking for?

Yes.

So we're very comfortable at the 10% ROE.

11% or 12% would be better.

But because we're still under levered in those SSLPs, we have a chance to continue to drive what we think are pretty attractive ROEs.

We're less focused on what's happening from a spread perspective, the dialogue we just had with Jonathan, and more focused on some of the elevated risk that we see creeping into the structures.

Covenant lite, Unitranche, they're the exception, but we've seen a couple of them, and elevated leverage levels.

So we're more focused on risk in terms of driving our desire to continue to invest there.

We have $285 million in the portfolios.

We see growth this quarter, but we're being highly selective.

But fortunately, the yield on our overall business has held up reasonably well in this environment of spread compression across the cash flow business because we do have these other engines that are delivering outsized returns.

So we think about it from a portfolio construction perspective, and then, as you know, first and foremost in any asset class, what's the risk level that we're comfortable with.

25, 50 bps of spread one way or the other is not what's going to drive our portfolio yield, because we do have the ability to put leverage in the SSLPs.

And are you seeing any acceleration of kind of the covenant lite trying to seep into the traditional middle market lending from the broadly syndicated?

Acceleration no.

But we just see it episodically, yes.

In terms of the life sciences, I know the JV hasn't made investments yet.

Just curious if you could talk about the timing, when you expect that to begin, and also how you view the opportunity set in the JV verse your regular life sciences platform.

The opportunity, just for everyone's benefit, and I know you know this, is the same companies.

It's just even a little later stage in the JV because they will have mostly gone public, because, again, this is our way to invest in the non-qualifying assets in life sciences because they may have a greater than $250 million market cap.

So it's the same line of business that our team led at GE Capital.

We just, because of that BDC construct, have divided the businesses into 2 segments.

But that's an artificial designation as the team looks at it.

So they have a similar pipeline in both.

But I think that, as I mentioned earlier, the capital has been forming.

And so the equity comes in first before our credit, and so we're starting to see that pipeline build.

The next question comes from the line of Chris York with JMP Securities.

Most of my questions on NEF have been asked, but are there opportunities to earn syndication fees in these types of financing transactions, either at the sub or on your income statement at Solar?

Sure, that's a great question.

NEF actually has done that in the past where they have underwritten larger transactions and then syndicated to some of the other independent leasing companies out there.

It is something that we will evaluate, because the flipside is NEF now has a much bigger balance sheet to invest off of given the ownership by Solar versus as an independent entity.

So we'll evaluate transaction by transaction what's the best risk-adjusted return.

Do we sell down a little bit or do we take more of the asset?

But I think it's a high class problem from our perspective and the NEF team.

Yes.

And to Bruce's point, given the size of our combined balance sheet, our potential bite size is more than the $2.3 million they've been averaging historically.

And as we shared earlier, one of the big attractions of the NEF platform and the equipment leasing platform is the growth opportunity.

This is an asset class that we think is incredibly scalable, especially when you compare it to our life science business or our Crystal business.

The addressable market here is $275 billion.

And with a portfolio of $330 million, we have a lot of room to grow.

And so I think our expectation is that we will growth this portfolio and see a higher contribution of earnings from it.

On Crystal, I saw that Ward Mooney announced his retirement as CEO recently.

Consequently, do you expect any changes to occur at Crystal maybe operationally as a result of the change?

Yes, great question.

So no, Ward is the founder of the business alongside of Mike Pizette, their Chief Risk Officer, and headed up on the origination side by Steve Migliero.

So the team will remain intact.

Ward's going to be still an active member of the Board and an advisor.

So we look forward to having him continue to be involved in the business.

But the team has been, as a unit, working together for many, many years, so it's business as usual.

Rug Doctor, wanted to spend a couple minutes maybe on that.

Could you comment on the performance there?

We've seen some equity valuation declines for the last couple quarters, so maybe some color on EBITDA maybe on a quantitative perspective, and then maybe qualitatively just in terms of operating conditions.

Yes.

I think, for those of you that don't know Rug Doctor, it's really a rent-a-vac.

Although they also sell machines, the bigger part of the business historically has been machine rental.

And the business to some extent has been feeling pressure from the traditional retail outlets where their machines are available.

You know the secular headwinds being faced by all retailers reduces foot traffic and therefore has had some impact on Rug as well.

They've done a phenomenal job of transitioning some large customers such as Walmart and Home Depot over the last couple years, but it is definitely a business in transition.

Our valuation looks at market comparables on a quarter to quarter basis, so you'll see some volatility there.

But we're sort of evaluating, as the business runs in place a little bit, sort of what the growth opportunity is and what's the best way for us to maximize our value here.

On maintenance, maybe for Rich, what was the gross amount of OID and prepayment fees in the quarter?

And then were there any exit fees or success fees in the quarter?

There was some.

I think it was really on TierPoint primarily.

But I would say it was probably $0.01, $0.015 in total across the business.

And then what was that maybe versus the prior year periods?

Yes.

The prior year period was substantial, quite frankly.

I'm not sure if you recall, but we had that very successful exit with Robbins where we received $4 million in fees at the end, which really drove the earnings a year ago June.

So it's really not a good comparison, compare and contrast.

But this was more the normal.

You'll always have a little bit in and out each quarter, and this was a regular quarter.

And again, the year ago was really driven by Robbins, almost $4 million.

So in the number of the sponsor financed deals that you passed on, either due to competition or your discipline, can you share some details on where maybe the financing is coming from for this new transaction to take you out?

Well, maybe they'll get disclosed in the next week or so as people release their earnings.

But our sense is that a lot of these loans, and this is just speculation, are going to a lot of these newly formed private credit funds who are looking to ramp quickly.

This does conclude today's question and answer session.

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

Thank you all very much for your time and attention this morning and your questions.

We look forward to talk to you soon.

Bye-bye.

Ladies and gentlemen, thank you for participating in today's conference.

This does conclude your program.

You may all disconnect.

Everyone have a great day.