SLR Investment Corp (SLRC) 2018 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the First Quarter 2018 Solar Capital Earnings Conference Call.

(Operator Instructions) As a reminder, this conference is being recorded.

I would now like to hand the conference over to Mr. Michael Gross, Chairman and Chief Executive Officer.

Sir, you may begin.

Thank you, very much, and good morning.

Welcome to Solar Capital's earnings call for the quarter ended March 31, 2018.

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

Rich, before we begin, would you please start by covering the webcast and forward-looking statements.

Of course.

Thanks, 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 Ltd.

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 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 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 Ltd.

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.

Solar Capital results for the first quarter of 2018 extends our long running strong fundamental performance as measured by credit quality, net asset value preservation and earnings power.

At March 31, 2018, our portfolio was 100% performing, and our net asset value was $21.87 per share, up $0.06 per share from the prior quarter.

Fundamental credit performance continues to be strong, supported by continued stable economic conditions and corporate earnings growth.

In the first quarter, Solar generated $0.45 of net investment income per share, up from $0.44 per share in the fourth quarter of 2017 and a $0.41 per share distribution for quarter-- for Q1 2018.

With approximately 80% of our comprehensive investment portfolio in floating rate securities, we're seeing the income benefits of a rising interest rate environment.

In addition, Solar's first quarter net investment income benefited from the first quarter of the voluntary 25 basis point permanent reduction in our management fee which became effective January 1, 2018.

At March 31, 98.2% of our comprehensive investment portfolio was in senior secured loans, which carries significantly less risk than junior debt or equities.

The portfolio is highly diversified across senior secured cash flow and asset-based lending strategies, including nontraditional asset-based lending through Crystal Financial, Life Science lending and equipment finance through NEF.

For the first quarter, over 60% of the contribution to gross investment income was generated from our commercial finance investment strategies.

Our strategic initiatives have diversified and enhanced the earnings power of Solar's portfolio.

While we believe a long term investment thesis for private middle-market cash flow lending remains intact, near term market technicals remain challenging.

Solar's asset-based lending niches enable us to be highly selective in this heated cash flow lending market.

We have the flexibility to allocate capital to the most attractive risk reward investment opportunities and are not forced to chase compromised structures or risky sectors in order to find higher yields.

In addition, our mix of asset classes creates a differentiated portfolio with lower correlation, lower volatility, lower risk and countercyclical protection compared to a pure cash flow loan portfolio.

Equally important, our barbell approach to investing in lower yielding, senior secured, dollar-one cash flow loans and higher yielding, senior secured, asset-based loans has enabled Solar to maintain a weighted average portfolio yield of approximately 10.6% measured on costs without compromising credit quality.

This has been achieved in the face of continued spread compression in sponsor-backed cash flow transactions with questionable structures.

Bruce and I, together with the team, have significant experience managing portfolios through economic cycles, including the Great Recession of 2008.

We have maintained an investment philosophy of assuming that we are always late in the credit cycle, and this mentality seems even more relevant today.

No one knows at this stage of the cycle -- characterized by seemingly inflated enterprise values, loose structures and low pricing, will end soon or persist for several more years.

We believe our differentiated origination platform and diversified portfolio position as well for either outcome.

As a reminder, in response to the company's higher net investment income run rate, our Board of Directors approved an increase in the quarterly distribution to $0.41 per share for the first quarter of 2018, concurrent with the management fee reduction.

This continues our history our shareholder friendly actions, which have included voluntary fee waivers to ensure net investment income coverage over distributions as well as just strength in raising equity capital and increasing portfolio leverage.

Importantly, we believe the shareholder distribution increase is the initial step in aligning our distribution with our increased investment income, and we are confident in our ability to grow Solar's earnings in 2018.

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 Ltd.'s net asset value at March 31, 2018, was $924.3 million or $21.87 per share compared to $921.6 million or $21.81 per share at December 31, 2017.

At March 31, 2018, Solar Capital's on balance sheet investment portfolio had a fair market value of $1.47 billion in 100 portfolio companies, across 33 industries, compared to a fair market value of $1.46 billion in 93 portfolio companies, across 34 industries, at December 31.

The weighted average yield on our income producing portfolio was 10.2% at March 31 compared to 10.1% at December 31, measured at fair value.

At March 31, Solar Capital had $545.5 million of debt outstanding and leverage of 0.58x net debt to equity.

Subsequent to quarter end, the company utilized the accordion feature under its revolving credit facility and expanded commitments by $50 million to $445 million.

When considering available capacity from the company's credit facility, combined with available capital at 3/31 from non-recourse credit facilities at Crystal, NEF and the SSLPs and including the $50 million of expanded balance sheet revolver commitments, Solar Capital has over $500 million to fund portfolio growth, subject to borrowing base limits.

Turning to the P&L.

For the 3 months ended March 31, 2018, gross investment income totaled $39.0 million versus $38.9 million for the 3 months ended December 31, 2017.

Expenses totaled $20.1 million for the 3 months ended March 31, compared to $20.3 million for the 3 months ended December 31, 2017.

Accordingly, the company's net investment income for the 3 months ended March 31, 2018, totaled $18.9 million or $0.45 per average share compared to $18.6 million or $0.44 per average share for the 3 months ended December 31, 2017.

Below the line, the company had net realized and unrealized gains for the first quarter totaling $1.2 million versus net realized and unrealized losses of $1.3 million for the fourth quarter.

Ultimately, the company had a net increase in net assets resulting from operations of $20.0 million or $0.47 per average share for the 3 months ended March 31.

This compares to an increase of $17.3 million or $0.41 per average share for the 3 months ended December 31, 2017.

Finally, our Board of Directors recently declared a Q2 2018 distribution of $0.41 per share, payable on July 3, 2018 to shareholders of record on June 21, 2018.

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

Thank you, Rich.

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

At quarter end, the weighted average investment risk rating of Solar's portfolio was just under 2, measured at fair market value and based on our 1 to 4 risk rating scale, with 1 representing the least amount of risk.

This further indication of the strong underlying fundamentals of our portfolio companies, only 2% of the entire portfolio was on watch list status and 100% of our portfolio was performing at quarter end.

The weighted average yields on our fair value portfolio and current cost basis was 10.2% and 10.6%, respectively consistent with the prior quarter.

At March 31, over 80% of Solar's income producing portfolio was floating rate.

The fixed rate loan exposure principally comes from NEF's short duration equipment financing, with an average life of 2.5 years, and which carry a weighted average yield of just over 10.5% at 3/31.

At the end of the quarter, our comprehensive portfolio totaled $1.8 billion, encompassing over 237 borrowers across 80 industries.

The average investment per borrower was $7.6 million or 0.4% of our comprehensive portfolio.

Also at quarter end, over 98% of our portfolio consisted of senior secured loans, comprised of approximately 79% first lien senior secured loans and approximately 19% of second lien senior secured loans.

Including activity across our 4 business lines, originations totaled approximately $221 million and repayments were approximately $162 million, resulting in net portfolio growth of approximately $60 million for the quarter.

As a result of the heated cash flow market conditions, we intentionally allowed our cash flow portfolio, particularly our second lien cash flow investments, to shrink.

We achieved our portfolio growth during the quarter through our ABL strategies, which currently offer more favorable risk return characteristics.

Now let me provide a brief update on each of our 4 investment verticals.

Our cash flow business invests in senior secured loans, predominantly first lien, to sponsor back companies in the upper mid-market with an average EBITDA of $68 million.

Included in this vertical, are senior secured cash flow loans held both on balance sheet as well as in our SSLPs.

During the first quarter, we originated senior secured cash flow investments of approximately $30 million and had repayments of approximately $64 million.

Our cash flow portfolio was approximately $680 million at quarter end, representing roughly 38% of the overall portfolio.

At 3/31, the weighted average trailing 12-month revenue and EBITDA had grown single digits, reflecting continued positive trends for our underlying portfolio companies.

For the investments in our cash flow segment, leverage to our security was roughly 4.9x, slightly lower than the prior quarter and interest coverage exceeded 2.5x.

The weighted average yield at fair market value of the cash flow portfolio was 9.7%, however due to the growth of our higher yielding specialty finance investments, we've been able to maintain a consistent overall portfolio yield exceeding 10.5% while reducing our overall portfolio's risk profile.

Now let me turn to our asset based lending business.

These loans are made against the realizable liquidation value of a portfolio company's assets and come with meaningful upfront as well as pre-payment fees.

During the first quarter, we funded approximately $70 million of new asset based investments and had repayments of approximately $15 million, resulting in $55 million of net portfolio growth for the segment.

At quarter end, the senior secured ABL portfolio totaled approximately $525 million, representing 29% of our total portfolio.

The weighted average yield at 3/31 for the ABL assets was just over 12%.

This division, through Crystal Capital, paid Solar Capital a first quarter dividend of $7.7 million equating to an 11% yield on cost.

Now let me turn to our equipment finance business, NEF.

Solar entered this business through the acquisition of NEF, which was founded in 2010 by former GE Capital senior executives.

Included in this segment are equipment finance assets held both directly on Solar's balance sheet as well as in NEF Holdings, a 100% owned portfolio company of Solar's, that for tax efficiency purposes hold certain of NEF's investments.

During the first quarter, NEF had new investments of approximately $35 million and had repayments totaling approximately $21 million.

At March 31, our NEF equipment finance strategy had a total portfolio of roughly $322 million to 125 different borrowers with an average exposure of $2.6 million.

The equipment finance asset class represents approximately 18% of our total portfolio.

100% of NEF's investments are first lien loans and approximately $300 million of this portfolio is fixed rate.

Interest rate risk is mitigated here through our relatively short holding period of 2.5 years on average, as well as our efforts to match fund this fixed rate portfolio with our unsecured fixed rate liabilities that total approximately $250 million.

The weighted average yield at cost on the equipment finance portfolio was approximately 10.6%.

During the first quarter, comprehensive net investment income from NEF's portfolio, including the assets on the balance sheet as well as those in NEF Holdings totaled $5.2 million, which equates to an annualized yield on cost of approximately 9.2%.

And lastly, let me give you an update on our Life Science business.

As a reminder, these are first lien senior secured loans and typically come with success fees or warrants.

During the first quarter, the team originated approximately $86 million of new investments.

Repayments totaled approximately $61 million.

Our Life Science portfolio totaled approximately $238 million of first lien senior secured loans across 23 borrowers, with an average investment of just over $10 million.

Our Life Science loans represented 13% of the overall portfolio.

The weighted average yield on the Life Science portfolio was 11.5%, which excludes any exit fees or warrants.

The IRR on our realized investments to date is north of 16% when including warrants.

As Michael mentioned, the middle market cash flow lending environment remains frothy.

We benefit from our diversified origination sources across both cash flow and asset based lending verticals, and we will continue to be disciplined and prudent in deploying our available capital.

Longer term, we believe that the record amounts of private equity dry powder, the retreat of banks from middle market leverage lending and the approaching refinancing wave of existing borrowers creates an attractive supply/demand dynamic for cash flow lenders to middle market companies which will augment our strength in asset based lending.

Now let me turn the call back to Michael.

Thank you, Bruce.

From the inception of Solar Capital nearly 12 years ago, our investment and management decisions have been focused on building long term shareholder value, protecting capital and maintaining alignment with our shareholders.

Solar Capital Ltd.

had a very strong first quarter 2018 highlighted by continued progress on each of these strategic initiatives.

The increase in our quarterly shareholder distribution to $0.41 per share is a direct result of the successful execution of our strategy to expand our commercial finance capabilities.

At 0.58x net debt to equity, we are under levered and have substantial dry powder to deploy via our differentiated investment verticals.

We believe Solar Capital has a clear path to achieving a sustainable run rate, a quarterly net investment income per share in the mid- to upper 40s.

As our earnings increase on a sustainable basis, our Board of Directors will evaluate further increasing our distribution to shareholders.

Now I would like to comment on the passage of the Small Business Credit Availability Act that increases the statutory leverage limitation for BDCs to 2x debt to equity from 1x.

Since the passage of the legislation, we have studied how the increased leverage flexibility could impact the company's strategic priorities and long term value creation for our shareholders, as well as the associated risks and how they can be managed and mitigated.

Additionally, we've had discussions with our principal stakeholders, the rating agencies, our lenders and importantly our shareholders.

We're being extremely deliberate in our analysis and have not yet reached a conclusion regarding our course of action.

As you know, we have never allowed leverage to drive our investment decisions.

Since inception, Solar has averaged 0.23x debt to equity, despite a target of 0.75x.

For Solar, our analysis centers on balance sheet optimization, portfolio and financing flexibility and risk management and not on maximizing leverage.

Because of our strategic focus on acquiring, building and growing specialty finance businesses, the considerations for our platform are somewhat unique.

Importantly, we feel no pressure at all to make changes to our investment strategy in order to "make the dividend math work." We'll do what we determine is in the best interest of our shareholders who know us as conservative portfolio managers.

We invest as principals and are aligned with our fellow shareholders through significant purchased ownership of our stock.

Our performance since inception reflects disciplined underwriting and preservation of capital.

Whether it's exercising constraint in frothy credit markets or waiving fees to ensure net investment income covers our distributions, we have always acted in the best interest of our shareholders.

Likewise, we are applying the same shareholder-friendly, focused conservative approach, as we analyze the best path forward for optimizing Solar's return on equity in an investment landscape that has been altered by the new regulations.

We understand the lack of clarity on this issue creates uncertainty for our shareholders, and so we thank you for your patience as we complete a thorough strategic analysis which this opportunity clearly merits.

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

Our ability to provide traditional middle market senior secured financing through the 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.

We thank you for your time this morning.

Operator, could you please open up the line for questions.

Absolutely.

(Operator Instructions) And our first question comes from the line of Casey Alexander of Compass Point.

A couple of questions.

First of all, related to the Small Business Credit Availability Act.

Don't you think that given the really high quality construction of your portfolio with 79% in first lien senior secured loans that your BDC or your specialty finance company is, actually, particularly well-suited to take on a little bit of additional leverage?

And as a follow-up to that, were you surprised that the rating agencies initially just drew kind of a linear line the sand without regard to the different constructions of various BDCs as it relates to how they expect to manage their ratings?

I think, perhaps we were a little bit surprised at the inception, but we do believe that over time, based on our dialogue with the agencies, they will both begin to analyze each manager based on their performance -- and to your point Casey, the underlying risk in the portfolios and how those portfolios are constructed.

So I think it's still early days, and I think there will be divergence from the agencies in terms of how they look at the individual managers.

I think to your first comment, while our portfolios have always been, to your point, more leverageable than the one-to-one regulation would allow, I think for us, as Michael mentioned, with an average leverage of 0.25 versus a 0.75 target, the strategic benefit is more perhaps in how we utilize that type of provision if we were to do so, along building up our commercial finance strategies, than it is just the [incurrence] of additional leverage.

Given that we are currently only levered 0.58x and we have a tremendous amount of available capital, we don't feel the sense of urgency that we have to get this done immediately so we can access more capital.

Yes.

Well, that led to another follow-up question -- is, that wouldn't access to the additional leverage also potentially assist you, if there was a scale type acquisition of a company that you might like to add to the portfolio?

Absolutely.

That's a big consideration.

And my last question is, as it relates to the cash flow loans, we appreciate the fact that you guys are actually doing portfolio management and judging risk within your verticals and bringing it down.

Is there any type of dynamic shift between what you are carrying in cash flow loans in the shifts versus what you're carrying on balance sheet?

There is no shift there at all.

I think where you see the biggest shift is a continued reduction of second lien exposure in our capital portfolio.

We're down to 19%, we're down 40% year-over-year.

That will continue to come down.

We don't feel the need to reach for yields in second lien structures when we have the engines that we have on specialty finance that are generating double-digit yields.

The assets in the SSLPs are the same assets we put on balance sheet.

(Operator Instructions) Our next questions come from the line of Chris York of JMP Securities.

So Michael, you commented a little bit on this in your second prepared remarks.

I mean, it appears earnings have sustainability at the 44, 45 level now and then the outlook to grow earnings appears solid.

So what do you think the board needs to see to support another increase in the core dividend maybe this year?

A couple more quarters of sustained earnings.

Got it.

Fair enough.

And then, we did see the comprehensive yield on your senior cash flow loans expanded nicely.

I think it was 60 basis points quarter-over-quarter.

Curious, how much of the movement do you attribute to LIBOR via maybe a beta and were there any other variables that explained that increase?

No.

It is predominantly LIBOR because, as Michael mentioned, at the same time, we've been withdrawing from any new second lien investments where you would see some of the higher spreads in the cash flow book.

So it's all LIBOR related.

Got it.

Okay.

And then we noticed Crystal's dividend to Solar declined a little bit from the quarterly run rate, I think, which was like 7.9 and then the mark on the investment in Crystal declined.

So could you help us understand some of the inputs in both of those movements and then maybe whether we should expect the dividend at this new level to be sustained or is that onetime?

Yes.

I think just stepping back for a second, Chris, as you appreciate, Crystal in particular, because of the nature of their capital and the fact that their capital is somewhat expensive to a borrower, we've always seen rather short duration across their portfolio.

So you will see ebbs and flows quarter-to-quarter.

And in Q4, there was meaningful contraction in that portfolio.

I will say, as an aside, Q1 may have begin -- they have begun to ramp as you see in the net growth there and we see a continuation of that trend in Q2.

So the dividend -- we try to hold roughly consistent around that 11%, 11.25%, understanding that the income will average that over the course of a year period, but quarter-to-quarter it will shift.

So there's nothing more substantive there, and again they're rebuilding as we speak.

The other comment around valuation, we look to comparables and, as you know, some of the comparables came down across the sector of finance companies in Q1.

Having said that, we -- meanwhile, as you know, we're an active participant in commercial finance looking at various opportunities to acquire businesses.

I can tell you that acquisition multiples are meaningfully north of where we have that marked.

So we've been looking at it really more on a trading comparable basis as opposed to acquisition multiples where companies are trading closer to 2x book.

Got it.

Makes a lot of sense, Bruce.

And then given the short duration of the assets there at Crystal, I mean, I see total assets are at 413, which have declined the last couple of quarters.

So if we get higher earning assets --I think I've heard in the market, too, some solid transactions there at Crystal, we get maybe to a [4 75] is that needed to get that dividend back up to that [7 9] kind of level we were at for a couple years?

[Not necessarily.] Look the portfolio which we own has bumped around between [3 50] and [5 50] So it does move around a lot.

There are a lot of fees in the business, both when you go in and when you exit and so we try to look at that on a sustainable basis.

We think -- we've looked at the dividend yield over the last several years.

That's a long term sustainable basis and it may move around quarter-to-quarter.

Last one, we've yet to really see expansion in, I think, SSLP I to your targeted ROE of the low to mid-teens and then be, essentially, accretive to Solar's net investment income.

What have been some of the reasons that have precluded the yield expansion there from your goals?

And then, is a low to mid-teens goal still achievable here?

Yes.

I think the low teens is still achievable, I think, mid-teens -- not in the near term.

And I think the constraints in the past year or so have been the relatively low LIBOR as well as the spread compression we have all felt across cash flow lending.

Remember the SSLPs are all stretch first lien cash flow loans.

So they have clearly felt the pressure on the spread compression in the sponsor lending environment that we've been in.

And I think the other dynamic has been trying to optimize the leverage on those assets to drive a little bit more ROE.

And we have been working at doing some things there to improve the leverageability of the underlying assets.

So we see some upside, particularly with LIBOR coming our way, but again, I think that the competitive dynamic is going to keep them more in the low teens than the mid-teens.

(Operator Instructions) Our next question is from the line of Jonathan Bock of Wells Fargo Securities.

This is Fin O'Shea in for Jonathan this morning.

For the private funds you guys are raising, can you kind of -- can you explain if they will have strategies similar to Solar and SUNS with significant commercial finance or specialty finance verticals?

Yes.

I can't really discuss the private capital raise at this time, other than that we have looked at ways to expand our balance sheet alongside Solar Capital so that Solar Capital can continue to scale up across the platform and offer larger solutions to the potential borrower market place, and we accomplished that through some of the JVs that you know we've established with our SSLPs, as well as potential private capital SMAs and funds and so forth.

So the goal is that -- your question, have them co-invest alongside Solar Capital so that Solar can continue to take on larger and larger positions and yet be highly diversified across Solar's portfolio.

Got it.

The question, the follow-up for what I was getting to, sort of relates to -- as opposed to a SSLP, which could kind of take an equity investment in, the fincos are wholly owned, of course, by the BDC and have their own G&A line.

So you know if you were to kind of syndicate down to other funds, would there be economics retained, origination, agent fees, et cetera, by the finco, if they were distributing outside of the BDC?

Well, I'll give you an example.

So for example, in the example for Crystal, as you know, we led a transaction for a large retailer that went through bankruptcy.

It was too large for our balance sheet.

We took the most we possibly could, and we ended up bringing a partner that we were not able to take any fees from.

To the extent we did have private cap on our platform that was allowed to buy that type of stuff, we would be able to take the entire transaction down.

And if it's appropriate, then that other entity may pay a servicing fee to Crystal in exchange for managing the investment.

But the whole goal, to Bruce's point, of bringing on capital alongside is to increase the funnel for Solar, not decrease it and to allow us to participate in transactions that we otherwise would not be permitted to because we would not have the consolidated balance sheet across the platform that would allow us to do so.

Very well.

That is helpful.

And then just one question.

It was probably outlined at some point.

Is there an upper bound on Life Science exposure?

Obviously, that's been very well performing, but I wasn't sure if you had wanted to make that a major dynamic in your -- in the Solar investment opportunity.

Just any commentary there on how much of a venture style BDC you wanted this to be.

Yes.

Well, as you know, today, it's roughly 13%, 14% of the overall portfolio.

That's from a standing start just 4 years ago.

Given the track record of the 16%, 17% realized returns, with no defaults and no losses, clearly, we'd like that portfolio to continue to grow.

But it is a niche, as you appreciate, and our team is extremely disciplined in terms of where they play within the Life Science venture lending niche.

So we would like to scale it, but there are some natural boundaries as to how large we can actually get it.

There are no further questions at this time.

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

Thank you very much.

We have no more comments at this time, but we appreciate all your time and support and look forward to talking to you soon.

Bye bye.

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

This does conclude the program.

You may now disconnect.

Everyone have a great day.