Welcome to the Solar Senior Capital Limited First Quarter 2015 Earnings Conference Call. [Operator Instructions]. I would now like to turn the conference over to Michael Gross, Chairman and Chief Executive Officer. You may begin..
Thank you very much and good morning. Welcome to Solar Senior Capital Ltd.'s earnings call for the quarter-ended March 31, 2016. I'm joined here today by Bruce Spohler, our Chief Operating Officer and Richard Peteka, our Chief Financial Officer.
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 Senior Capital Ltd. and that any unauthorized broadcasts in any form are strictly prohibited. This conference call is being webcast on our website at www.solarseniorcap.com.
Audio replays of this call will be made available later today as disclosed in our 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. The statement are not guarantees of our future performance, financial condition or results and involve a number of risks and uncertainties.
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 Senior 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 would like to turn the call back to our Chairman and Chief Executive Officer, Michael Gross..
Thank you, Rich. Despite the turmoil in the liquid credit markets which led to an almost 19% decline in leverage loan issuance quarter over quarter Solar Senior inked another successful quarter.
From year-end our net asset value increased 2.3% to $16.70 at March 31 driven by a combination of mark-to-market gains in conjunction with the late quarter rally and the fundamental improvement of a couple of investments which recovered in the first quarter.
We anticipate future increases to NAV as our loans marked below par for technical reasons are repaid in full. Including ownership of FLLP, gross originations totaled $33.9 million with our portfolio growth concentrated in FLLP. For the quarter, FLLP's annualized distribution yield was 9.4%, up from 9.1% in the fourth quarter of last year.
We are pleased with the measured ramp of our joint venture with VOYA and are confident in FLLP's ability to drive increases in our net investment income in 2016 with a targeted return on equity in the low teens once fully ramped.
Also during the first quarter, Gemino increased its distributions to us via special dividend from accumulated excess earnings of $225,000 in addition to its quarterly earnings distribution of 11%.
Gemino continues to demonstrate strategic value through its healthcare lending expertise, recurring cash income, diversified portfolio of senior secured assets and differentiated origination platform. Similar to FLLP, we believe the strategic portfolio company will continue to increase its contribution to our net investment income in 2016.
Bruce will provide additional details on both of these strategic initiatives. For the first quarter our net investment income totaled $4.1 million or $0.35 per share. We voluntarily waived $385,000 of incentive fees in the quarter.
As a reminder why we rebuilt the portfolio to a size that will be able to comfortably earn our distributions, we have committed to waive incentive-based fees to the extent necessary for GAAP net investment income to fully cover distributions in 2016.
For the first quarter, funds continue to outperform the overall leverage loan market on a credit quality basis. At the end of the quarter our portfolio was 100% performing compared to the trailing 12-month default rate for liquid leverage loans of just over 2%, a five-year high driven by credit deterioration in the oil and gas and commodity sectors.
In accordance with Solar Senior's investment objective of delivering a stable monthly distribution with an emphasis on principle protection we have always focused our investments on non-cyclical industries. As a result our portfolio continues to have no direct exposure to energy or commodities.
We continue to believe that SUNS is well positioned for the current slow growth economic environment as well as the uncertainty surrounding the timing of interest rate increases. Over 99.9% of our $364 million comprehensive portfolio is in senior secured loans and the entire Company owned portfolio is floating rate.
At March 31, 2016, we had $46 million of unused capacity under our credit facility. When considering the full FLLP equity commitment plus expected available credit, we believe our available capital together with Solar Senior's balance sheet exceeds $100 million subject to borrowing base limitations.
We anticipate growing our portfolio in 2016 via senior secured first lien floating rate loans with better risk-reward characteristics that were available prior to the recent market disruption. We expect to fund these with our over $100 million available capital as well as by cycling out of low yielding assets.
New issue activity has begun to pick up and we're seeing better covenant protection and wider new issue spreads. With visibility on only $7 million of exits in the second quarter we're confident in our ability to continue to grow the portfolio in what we believe will be a better investment vintage than recent years.
Lastly, our Board of Directors declared a monthly distribution for May 2016 of $0.1175 per share payable on June 2, 2016 to stockholders of record on May 19, 2016. At this time I will turn the call back over to our Chief Financial Officer Rich Peteka..
Thank you, Michael. Solar Senior Capital Ltd.'s net asset value at quarter-end was $192.7 million or $16.70 per share. This compares to a net asset value of $188.3 million or $16.33 per share at December 31.
SUNS investment portfolio at March 31 had a fair market value of $312.2 million in 47 portfolio companies operating in 22 industries compared to a fair market value of $306.5 million and 45 portfolio companies operating in 23 industries at December 31.
At March 31, 2016 the weighted average yield on our income producing portfolio excluding Gemino's special dividend from accumulated excess earnings was 7.9% measured at fair value consistent with the yield at December 31, 2015. And 100% of our portfolio investments were performing.
Investment income for the three months ended March 31, 2016 totaled a $6.3 million versus $6.1 million for the three months ended December 31. The increase in investment income was primarily related to Gemino and FLLP's continued contribution to earnings.
Net expenses for the three months ended March 31 were $2.3 million compared to $2.1 million for the three months ended December 31 inclusive of the $385,000 and $311,000 respectively of performance-based incentive fees waived.
Accordingly, net investment income for the quarter-ended March 31, 2016 was $4.1 million or $0.35 per average share consistent with $4.1 million or $0.35 per average share for the quarter-ended December 31.
Below the line, SUNS had net realized and unrealized gains for our first fiscal quarter of $4.3 million compared to net realized and unrealized losses of $8.5 million for the quarter-ended December 31.
Ultimately, the Company had an increase in net assets resulting from operations of $8.4 million or $0.73 per average share for the three months ended March 31, 2016. This compares to a decrease in net assets resulting from operations of $4.4 million or $0.39 per average share for the three months ended December 31, 2015.
At this time I would like to turn the call over to our Chief Operating Officer Bruce Spohler..
Thank you, Rich. Let me begin by providing a portfolio update. Overall the credit fundamentals and financial performance of our portfolio companies remains sound. On average the most recently reported last 12 months revenue and EBITDA across our portfolio of companies was up 7% for revenues and 9.1% for EBITDA respectively versus prior year.
When looking also at the most recent reported quarter-over quarter trends, the results are similar.
At 3/31, the fair value weighted average leverage to our first lien investments including our membership interest in FLLP was approximately 3.8 times leverage and the weighted average cash interest coverage of our first lien investments was approximately three times.
At the end of the first quarter the weighted average revenue and EBITDA of our first lien investments was $360 million of revenue and $65 million of EBITDA respectively.
While the portfolio was broadly diversified across multiple issuers and industries we continue to favor larger mid-market issuers operating in more defensive and non-cyclical industries. We feel confident about the prospects for our portfolio companies and their operating performance over the next year.
As Michael mentioned, at March 31, our portfolio was 100% performing and we continue to have no direct exposure to the oil and gas and commodity sectors. Also at March 31 the weighted average yield of our portfolio was just under 8% when measured at fair value.
Our internal risk assessments on a weighted average of our total portfolio remained at approximately 2 and based on our 1 to 4 risk rating scale with 1 representing the least amount of risk.
As of the end of March, SUNS' roughly $364 million comprehensive portfolio had loans to 51 different borrowers across 25 industries with an average investment size of just over $7 million Close to 100% of the comprehensive portfolio is invested in senior secured loans including our investment in Gemino whose portfolio consists entirely of senior secured loans, in their case to 38 different issuers.
Including our investment in Gemino's portfolio, 100% of our income producing portfolio is floating rate. Now before I give an overview of our first quarter activity, let me provide a brief update on our strategic investments in Gemino and FLLP. As a reminder, Gemino focuses on providing senior secured asset-based loans to small and midsize U.S.
companies operating in the healthcare sector. Gemino's healthcare expertise and asset-based lending platform creates a risk return profile that has a low correlation to SUNS' traditional underwriting of senior secured cash flow sponsored loans.
At quarter-end Gemino's portfolio was stable with just under $130 million of funded loans across 38 issuers with an average balance of $3.4 million. All of Gemino's commitments are floating rate, senior secured cash pay loans.
For 2016 first quarter Gemino paid a distribution of just over $900,000 to SUNS which equates to an 11% annualized distribution yield on our cost. In addition, Gemino paid Solar Senior a special dividend from accumulated excess earnings of $225,000.
Since our acquisition in late 2013 Gemino has steadily grown its ROE to Solar Senior from 9.5% to 11% which excludes this special dividend. We continue to expect future growth in Gemino's ROE in 2016. Now let me provide an update on FLLP.
As a reminder, our strategic partnership with VOYA Investment Management to create FLLP provides us with incremental long term capital from a like-minded mid-market credit investor that expands our origination capacity and allows us to scale the SUNS balance sheet more effectively.
At quarter-end, FLLP had approximately $90 million of first lien senior secured floating rate investments across 19 different issuers with an average investment size of $4.8 million. For Q1, FLLP paid distributions to SUNS equating to a 9.4% annualized distribution yield on the cost of our equity investment which is an increase from 9.1% in Q4.
Once this vehicle is fully ramped we expect it to earn ROEs in the low teens. During the first quarter when we include our ownership of FLLP we made investments of approximately $34 million across eight portfolio companies and had sales and repayments of approximately $19 million.
Before I go into our portfolio activity, let me update you on our investments in Global Tel*Link and Securus, the two prison phone telephone operators that we've been invested in for a number of years. In early March the DC Court of Appeals granted a partial stay on the FCC's rate order that went into effect last fall.
We view the stay as a positive for both GTL and Securus credits which has helped to assuage some of the market's concern around the Company's regulatory environment.
Additionally, both GTL and Securus continue to perform well on an operating basis where they have generated EBITDA growth and consistent deleveraging trends and have also provided the market with solid 2016 operating forecasts.
At the end of last year GTL's leverage was 3 times through its first lien and 4.25 times through its second lien, so already relatively low leverage levels in today's market. At year-end Securus leverage was just over 4.75 times through the second lien, also very conservative.
We added to our GTL exposure during the first quarter with an opportunistic purchase of the Company's first lien loan at a price of $0.73 on the dollar prior to the stay announcement being released.
Including our secondary market purchases of this GTL first lien loan during Q4 our total first lien investment is approximately $1.25 million in par value with an average purchase price of $0.77 on the dollar. As of March 31, this loan was quoted at just under $0.91 on the dollar, representing 15.8% unrealized gain.
As of this morning, the same security is now quoted at $0.935 on the dollar compared to a mark of $0.735 at year-end. Also this morning, our second lien investment in GTL was quoted at $0.78 relative to a $0.70 mark at 12/31. And importantly this morning the Securus second lien investment was quoted at $0.91 compared to our $0.56 mark at year-end.
As a reminder we have a $10 million par investment in this security. We expect the regulatory issues that the companies are facing to be resolved in 2016 and for these investments to repay at par on or before their maturity.
Overall, the risk-reward characteristics of our first quarter originations reflected the improved middle-market new issue environment.
Despite the late first quarter rally, the earlier downturn has translated into 25 to 50 basis points of incremental yield on new first lien middle-market loans as well as higher covenant packages and lower leverage levels. Now let me highlight a couple of our new investments.
Together SUNS and FLLP originated a $7.5 million investment in the first lien term loan of Hilb Group which was split evenly across those two entities. Hilb is an insurance brokerage business which is backed by ABRY Partners.
Pro forma for recent acquisitions the Company generated approximately $30 million of pro forma EBITDA and the loan carries an all-in yield of 6.6%. During the quarter, SUNS and FLLP also funded an 8.75% investment in Veritext's first lien loan in conjunction with Pamplona's acquisition of the business.
The Company is a leading provider of deposition services and litigation support solutions and the loan carries an all-in yield of just over 6.25%.
We also reinvested $5 million of our existing $7 million investment that had been repaid in the first lien loan to Stratose which is a cost management solutions provider for out-of-network health care claims.
The combined EBITDA of the new Company pro forma for recent acquisition is over $60 million which is twice that of what EBITDA had been on a standalone basis for our prior investment. The coupon on the new loan is 50 basis points higher, translating to a new all-in yield of approximately 6.25%.
So in summary in this transaction for Stratose we both derisked our investment by lending to a much larger Company as well as increased our expected return. Clearly a win-win. On the repayment front our only noteworthy exit during the first quarter was our decision to exit our successful investment in Varsity Brands.
We sold our remaining $5 million stake in this low yielding first lien asset above our cost as well as our December mark. We intend to recycle the proceeds into higher-yielding investments given the current improved market environment. The cumulative IRR on our investment which totaled $7 million originally was just over 6.5%.
While we have seen a traditional slow start to the year for new sponsor-driven issuance activity the market disruption has also slowed refinancing transactions which has resulted in muted repayment activity.
As we sit here today, visibility on repayments for the second quarter is only $7 million and we expect additional portfolio growth for SUNS both on balance sheet as well as in FLLP for Q2. We have been patient and highly selective with our investments. Pricing and structure of middle-market transactions has clearly improved.
We believe the investment environment in 2016 is attractive and are thrilled that we have available capital to take advantage of it. Now let me turn the call back to Michael..
Thank you, Bruce. In conclusion, we're pleased with our performance in the first quarter.
In a period of increased uncertainty and volatile markets, SUNS maintained a highly diversified and defensive portfolio that at the end of March is substantially all senior secured floating rate loans, has zero direct energy exposure and continues to be 100% performing.
Additionally, we expect Gemino and FLLP to further increase their contributions for investment income in 2016. As we approach our target leverage for FLLP we anticipate its annualized distribution yield to reach the low teens and we're optimistic about Gemino's ability to increase its return on equity to SUNS.
Also our solid pipeline of cash flow sponsor-backed first lien loan opportunities indicates further portfolio growth as well. Our over $100 million of available capital will enable us to expand our portfolio to these attractive sourcing channels by almost 30% without the need to raise any additional equity.
In accordance with our conservative investment policy and philosophy we believe that even more important than net investment income growth is a preservation of capital. Our 0% non-accrual rate is meaningfully better than the current BDC industry average.
We have constructed a sleep-at-night low-risk portfolio that's comprised predominantly first lien, senior secured loans which attach a dollar onto the capital structure and have a weighted average ending leverage of just 3.8 times. Additionally, our entire portfolio is floating rate and the vast majority of loans have covenant protection.
With a weighted average EBITDA for our first lien issuers of $65 million our investments are clearly in the upper end of the middle-market, companies which have the breadth, scale and the infrastructure to better withstand the downturn.
In our view the quality of our portfolio should merit a premium valuation for SUNS relative to the BDC peer group which is why we continue to buy shares in the open market during the first quarter, bringing our management ownership stake to 7.3% of the common stock outstanding. Thank you for your time this morning.
We look forward to speaking with you next quarter. Please open up the line for questions at this time..
[Operator Instructions]. Our first question comes from the line of Jonathan Bock of Wells Fargo. Your line is now open. .
This is Jamie Sirockman filling in for Jonathan. A couple of quick questions for you guys. You have noted Gemino's strength recently, you talked about the special dividend in the quarter and then you also mentioned that you expect the contribution to NOI to continue.
Do you expect that contribution to come in the way of more special dividends or just a higher regular distribution and higher yield on that investment?.
Yes, good question and I apologize if we haven't highlighted it often enough but Gemino has actually been steadily increasing their return to us as they've grown their business since getting on the Solar platform back in 2013.
So it has been steady as she goes and we see that trend continuing both in terms of organic ROE growth but I think they also do have some accumulated earnings and so from time to time you will also see these special distributions..
One more from me, kind of curious as to you talked about how the market is a little bit more attractive today with higher yield.
Where do you plan on focusing your originations in respect to the FLLP versus on your balance sheet?.
We generally are looking at the same issuers across both balance sheet and FLLP..
You will see a fair amount of overlap between what's on our balance sheet and what's in FLLP..
Okay, so roughly growing both at the same time?.
Yes..
[Operator Instructions]. Our next question comes from the line of Mickey Schleien of Ladenburg. Your line is now open. .
Michael and Bruce, at SLRC we saw you take a little bit of an opportunistic approach with the debt financing at Aeropostale.
With all the dislocation that's occurring in the energy sector, in the commodity sector, in the brick-and-mortar retail sector, notwithstanding the fact that generally SUNS is sort of a risk-averse investment, is there any appetite to do opportunistic things like that at SUNS?.
I think you hit the nail on the head. It is a risk-averse consistent distribution on a monthly basis senior secured traditional portfolio.
Having said that, the short answer is yes, particularly as it relates to the Crystal investments where we feel that you're dealing with current assets that are very liquid and therefore limited risk of principle repayment.
I think we will opportunistically look at that but it is going to clearly be a higher bar at Solar Senior given the investment mandate..
My follow-up question is we're getting such mixed signals from the more liquid both equity and credit markets with meager growth in Europe, deceleration in China, slow growth in Japan, the commodity cycle, etc. and it doesn't seem yet to have trickled down to the middle market per your statistics and other statistics that we see.
What I'm trying to understand is your mindset as to where the credit cycle is in the middle market. And eventually we would expect these issues to trickle down.
So how are you thinking about all of those moving pieces?.
Well, a couple of things. One is by virtue that we're focused on the middle market most businesses we invest in are niche businesses that are for better or for worse and we think in this case for better are U.S. focused and domestic focused. Secondarily, when we think about our underwriting we always pick a negative view.
Look back at our behavior the last couple of years both at Solar and SUNS when you saw huge growth in portfolios we continue to take a negative view which is why we didn't ramp very quickly. So we always run significant downside case to make an investment decision.
And frankly if you look at our portfolio at SUNS where we're leveraged through 3.8 times there is a huge equity cushion beneath us which we obviously take some comfort in..
The flipside to that, Michael, is that you seem to be more comfortable with the risk-adjusted returns that you can get today versus a year or two ago. So in general you like what you're seeing.
Would you agree with that?.
Yes. We like what we're seeing better than what we were seeing before. Deals that we're looking at today are less levered, they have more covenant protection and spreads have widened. So, yes, this is kind of why we marshaled our capital and kept it available for a period of time that we had hoped would become a better investment environment..
But be mindful, Mickey, we're to Michael's point investing extremely defensively, we're looking at consumer staples and stay away from consumer discretionary cyclical businesses. And so we're just looking for consistency of free cash flow.
And the statistics we quoted across our portfolio are nice in that they are showing single-digit positive revenue and EBITDA growth but I would call it sort of a very mundane environment, not something that we get overly excited about, but it does allow us to keep more duration in these nice free cash flowing businesses.
And given our focus across our platform is on first lien risk you do have amortization and the ability to sweep some of that cash flow and derisk your loan. Because to your point at some point there will be a downturn in the midmarket credit cycle..
I understand. I just thought of one more question I'd like to ask which is in the previous earnings call you mentioned that the SLRC portfolio is in the neighborhood of 70% first lien.
Historically the big differentiator between SLRC and SUNS was that weighting but now we're sort of getting to a point where at least from the capital stack perspective these portfolios have similar sort of structures.
What I'm asking is what is the go-to-market strategy? How do you approach borrowers with these two different vehicles so you don't confuse them about the capital you have available to lend to them?.
Sure, I think the simple differentiation is traditional low risk first lien at Solar Senior where you're looking at average leverage ratios in the 3.5 to 3.75 times versus and as a result getting expected returns it's yield to maturities as you heard in 6.5% to 7% range. But these do repay faster than maturities.
So you're seeing 7%, 7.5% returns on traditional first lien midmarket illiquid loans. And then when you go to Solar Senior the first lien is really a stretch senior where the average leverage will be 4.5, 4.75, I'm sorry Solar Capital and you will be seeing yields to maturity of 8% and IRRs closer to 10%.
So we're taking more risk over at Solar Capital than at Solar Senior albeit starting at dollar one..
But also keep in mind when we go to the potential issuers or sponsors they are not confused at all because they at the end of the day they don't care which portfolio their investment falls into. They just care that it's Solar Capital Partners doing the investment.
So we go to market being able to offer all the solutions and we're able to pick where we think the best risk-reward is of a given transaction where to direct the investment..
So Michael, based on what you just said, does that mean that you don't have different teams marketing the two different BDCs capital? It's one team targeting perhaps a specific industry?.
It's one team. And that's why if you think about when you go into a given transaction oftentimes the sponsor does not know what capital structure they are going to want to use.
And so by us having the ability to do stretch senior, traditional senior and unitranche we're invited to more transactions because we can provide a more broader set of solutions..
And the team is really just trying to find generically speaking where they see the best attractive risk-adjusted return in the capital structure. And then to Michael's point, we now have a variety of homes to put those assets in regardless of whether we want to play at the top, the stretch or the bottom..
We've actually gone one step further in that Crystal, Gemino and Fuller people also jointly market and create referrals. We've had a good history over the last year when we started that initiative of getting referrals across the platform into the different asset classes..
[Operator Instructions]. Our next question comes from the line of Mr. Brock of West Family Investments. Your line is now open..
I was wondering with respect to Gemino you mentioned that the ROE has increased from 9.5% to 11% and that you expect further increases.
Could you give us a sense as to the magnitude of increase that you expect in 2016? And similarly for the VOYA you had mentioned the ROE increased from 9.1% in the fourth quarter to 9.4% in 2016 and is the future ROE increase going to increase at a sequential rate at a similar level from the fourth quarter to the first quarter this year? Thank you..
As is always the case in midmarket lending it is not a straight line. But just to address FLLP first, what we're trying to do is match our capital deployment in terms of leveraging our equity as we're making new investments.
So you'll see us take that ROE on our existing equity investment and flip up into the low teens, then we will put more equity capital in and then again lever that up.
So it will be a little bit of fits and starts, vacillating between the high single digits and the low teens as we continue to deploy both equity and leverage capital into FLLP quarter by quarter.
Then I think as it relates to Gemino our target would be over time to migrate to the high 11% to 12%, call it 11.5% to 12% ROE on a sustainable basis with episodic and periodic special distributions hopefully..
Okay but just to clarify a little bit with the VOYA flip, if you're going to ramp up into the low teens what kind of given the current market conditions assuming you don't see a change, but how long is this going to take until you can ramp it to the low teens kind of level?.
The issue is that should happen over the next quarter or so. But then what will happen is we have more equity, we and VOYA, committed to FLLP. So then we will begin to put equity in for subsequent transactions once we get to the low mid-teens..
It will be sustainable at that point..
And then we will continue to try to sustain it at that level. But there will be a little bit of vacillation between the high single digits and teens as the equity is going out..
[Operator Instructions]. I'm showing no further questions. At this time I would like to hand the call back over to Michael Gross for any closing remarks..
No closing remarks. Just thank you for your time and attention this morning. We look forward to continuing our dialogue. Thank you..