Solar Senior Capital Ltd (NASDAQ:SUNS)
Q4 2012 Earnings Call
February 26, 2013 11:00 am ET
Michael S. Gross – President, Chairman and Chief Executive Officer
Richard L. Peteka – Chief Financial Officer
Bruce J. Spohler – Chief Operating Officer
John W. Stilmar – JMP Securities LLC
Vernon C. Plack – BB&T Capital Markets
Good day, ladies and gentlemen, and welcome to the year-end 2012 Solar Senior Capital Limited Earnings Conference Call. My name is Patrick, and I will be your coordinator for today.
At this time, all participants are in listen-only mode. Later, we will conduct the question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.
I would now like to turn the conference over to your host for today, Mr. Michael Gross, Chairman and CEO. Please proceed Sir.
Michael S. Gross
Thank you very much and good morning. Welcome to Solar Senior Capital Limited's earnings call for the year ended December 31 2012. I'm joined here today by Bruce Spohler, our Chief Operating Officer; Rich Peteka, our Chief Financial Officer.
Rich, would you please start off by covering the webcast and forward-looking statements.
Richard L. Peteka
Of course, thanks Michael. I’d like to remind everyone that today’s call and webcast is being recorded. Please note that they are the property of Solar Senior Capital Limited, and that any unauthorized broadcast, in any form are strictly prohibited. This conference call is being webcast on our website www.solarseniorcap.com. Audio replay of this call will be made available later today as disclosed in our press release.
I’d also like to call your attention to the customary disclosures in our press release regarding forward-looking information. Statements made in today’s conference call and webcast may constitute forward-looking statements, which relates 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. 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 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 out 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.
Michael S. Gross
Thanks very much Rich. As we mentioned the earnings call for Solar Capital early this morning, we believe 2012 was a pivotal year for the BDC sector. Despite periods of market volatility, positive economic indicators continued accommodative monetary policy both to the liquid capital markets.
The strong capital inflows impacted the opportunity set on both the asset and liability side of BDC balance sheet. It demonstrated stable capital structure and manager adherence to core investment discipline and discipline are essential to a BDC’s long-term success and value creation for share holders. We also played significant importance on managerial business with an ownership mentality.
The same approach we have maintained since inception as one of the largest investors in SUNS’ common stock. Normally a low yield throughout the fixed income universe have continued to attract capital into the leverage credit sector. The liquid syndicated high yield and bank loan experienced robust demand for new issuance in the fourth quarter and issuers capitalizes the environment to cut spread, increase leverage levels and loosen covenants. In these larger liquid credit market, the relative of value case for bank loans with higher bonds became more compelling over the course of 2012.
By the end of the year, spreads nailed significantly between The Credit Suisse Leveraged Loan Index and The Credit Suisse High Yield Index. In the current environment, the risk reward value proposition of Solar Senior Capital, with its portfolio of middle-market senior secured loans versus higher bonds has become an even more compelling investment proposition given the mid 7% funds yield versus the yield of the Credit Suisse High Yield Index at just over 6%.
Importantly, funds investment are secured by the issuer's assets and have left leverage of being more senior capital structure with better covenant protection than traditional high yield bonds. Spread compression is muted in the less liquid market for middle-market senior secured loans with risk levels slightly elevated from the prior quarter. Against this backdrop, we were highly pro active in investment.
During the fourth quarter we made investments for approximately $60 million of Par in five new and four follow on loan. We have principal repayments of approximately $80 million in the quarter as several issuers refinanced our capital structure on more advantageous terms.
Over the course of 2012, Solar Senior invested approximately $196 million in 19 new and 9 existing portfolio companies. For the full year, we had total repayments in sales of approximately $165 million.
In spite of higher than expected repayments in Q4, Solar Senior has constructed a well diversified portfolio of principally all cash paid senior secured loans across 31 distinct issuers. As of today, we do not see significant additional repayments.
In the second half of 2012, Solar Senior Capital increased the monthly dividend per share by total of 17.5% as the portfolio became more fully invested. In the fourth quarter, SUNS’ net investment income of $0.36 per share exceeded dividends paid of $0.35 per share.
Excluding the one-time expenses of approximately $0.10 per share related to the amendment and extension of our credit facility, SUNS' investment income was actually $0.45 per share, aided by prepayment income from the high level of repayments in Q4.
For the full year, we generated $1.32 per share of net investment income, which exceeded dividends declared of $1.29. We have generated significant cash flow earnings that will help cushion net investment income dividend coverage while we deploy available capital over the next several quarters.
Our net asset value at December 31 is $18.33 per share, declined since the September 30 NAV of $18.60 due to markdown of one challenged credit and one time cost associated with the amendment and extension of our revolving credit facility, partially offset by repayment premiums realized in the quarter. The weighted average yield of the portfolio based on fair value at year end was 7.8% and our portfolio complete continue to be 100% performing at that time.
To the end of first quarter, we have taken important steps to augment and strengthen our balance sheet. On November 7, we announced the amendment of our $200 million revolving credit facility to lower the price in the facility to LIBOR 200 from LIBOR 225. The lower funding costs have helped mitigate some of the spread compression we experienced on our assets.
Equally important, we extended the credit facility maturity to 2017 and gained additional flexibilities to support portfolio growth.
In January of this year, we completed a public offering of 2 million share of SUNS common stock at a price of $18.85 per share which generated net proceeds of $37.2 million. This opportunistic equity rates at a favor evaluation enabled Solar Senior Capital to utilize a portion of the $50 million of incremental borrowing capacity available under the delayed draw feature of our $200 million revolving credit facility.
Our balance sheet is now set with sufficient available capital to build larger, more diversified portfolio. In addition, we believe it is prudent to be a position to take advantage of market dislocations and volatility that is expected to result in continued uncertainty around unresolved economic budget fiscal and market issues.
At the end of the fourth quarter our leverage of 0.22 times debt-to-equity. We had approximately $100 million available to us to invest in new opportunities to reach our target leverage of 0.8 times debt-to-equity.
Adjusted for the proceeds in January equity offerings, pro forma leverage at year-end would have been close to zero with approximately $170 million investable capital, again based on our targeted 0.8 times debt-to-equity ratio.
In summary, 2012 represents a year of significant progress for Solar Senior Capital. We believe we have enhanced long-term shareholder values with the steps we took to optimize our capital structure into a disciplined approach to portfolio growth. Looking forward, we are focused on sourcing senior secured cash-pay investments that meet our very strict underwriting standards.
Lastly our board of directors declared a monthly from March of $11.75 per share payable on April 2, 2013 to shareholders of record of March 21, 2013.
At this time, I’d like to turn the call over to our Chief Financial Officer, Rich Peteka.
Richard L. Peteka
Thank you, Michael. Solar Senior Capital’s net asset value at December 31, 2012 was $174.1 million or $18.33 per share compared to $176.7 million or $18.50 per share at September 30 and compared to $172.4 million or $18.15 per share at December 31, 2011.
Our investment portfolio had a fair market value of $212.6 million on December 31, 2012 compared to $235.0 million at September 30 and compared to $177.7 million at December 31, 2011. The portfolio decrease from the third quarter resulted principally from approximately $80 million in exits versus approximately $16 million of portfolio investments. The increase in our portfolio year-over-year resulted primarily from approximately $34 million in net investment growth.
At December 31, 2012, we had investments in 31 portfolio companies in 17 industries totaling $212.6 million at fair value. The portfolio was invested 97% in senior secured loans and 3% in unsecured, measured at fair value and over 98% of the portfolio at fair value is comprised of floating rates securities.
The weighted average yield on our investment portfolio at share value is 7.8% at December 31, 2012. This is compared to 8.1% at September 30, 2012 and 8.5% at December 31, 2011.
For 2012, gross investment income totaled $20.5 million, a significant increase over the $7.9 million in 2011, primarily due to our ramp to a larger average investment portfolio for 2012.
For Q4, our gross investment income was $6.1 million versus $4.9 million in Q3, due to significant amount of pre-payment income during the quarter. Please note that our taxable income typically exceeds our GAAP income, thus providing a cushion in covering our dividend when we experienced portfolio prepayments.
Expenses totaled $8.0 million for 2012 compared to $5.3 million in 2011. The increase in expenses is primarily due to year that saw a significant growth in our portfolio of assets and business in general, as compared to a partial first year of operations in 2011.
Net investment income totaled $12.5 million or $1.30 per average share, compared to $2.6 million or $0.30 per average share for 2011. For the fourth quarter, net investment income was $3.4 million or $0.36 per share versus $3.0 million or $0.32 per share in Q3 2012.
Net realized and unrealized gains for fiscal 2012 totaled $1.4 million versus net realized and unrealized losses of $2.85 million for fiscal 2011. Net increase in net assets resulting from operations totaled $13.9 million for fiscal 2012 versus a decrease of $250,000 for fiscal 2011. Basically earnings per share totaled $1.46 for 2012 compared to a loss of $0.03 in 2011.
At this time, I’d like to turn the call over to our Chief Operating Officer, Bruce Spohler.
Bruce J. Spohler
Thank you Rich. In general, earnings are steady or improved across our portfolio during the fourth quarter with a 100% of our assets performing. Outside of one stress credit engineering solutions, which I will discuss in a moment, we remained pleased with the overall credit quality of the SUNS’ portfolio.
As Michael mentioned, there was significant activity in the portfolio with respect to both originations, follow-on investments as well as repayment during Q4. In spite of larger than expected redemptions, our portfolio ended the year well diversified with investments in 31 distinct issuers across 17 different industry groups. The weighted average investment size is approximately $7 million.
In light of the property credit market conditions that we’ve experienced, I’d like to reiterate our patient and prudent investment philosophy. We will continue to be disciplined in building the SUNS’ portfolio and prudent in deploying our available capital selectively into only those investments that will meet our strict underwriting standards.
The weighted average investment risk rating on the portfolio is measured at fair market value at the end of Q4, as we remain steady at approximately 2 based upon our 1:4 risk rating scale with 1 representing the least amount of risk.
Other than ESP, there is nothing else in the SUNS’ portfolio that keeps us (inaudible) from a credit perspective. The weighted average yield of the portfolio based on fair value was 7.8% as compared to 8.1% at September 30.
Secured loans account for approximately 97% of the fair value of the portfolio at quarter’s end and over 98% of the assets at fair value, fair interest at a floating rate. For our first lien investments, the weighted average leverage through our investment is in the mid three times while cash interest coverage is a healthy 3.3 times.
Now let me touch on engineering solutions. We’ve made our initial investment in the second quarter of 2011. ESP provides professional and technical support services for the armies mission-critical command, control, computer and reconnaissance system with a particular focus on communications.
While these backbone systems remain the top priority for the department of defense, ESP as well as its peers are facing considerable headwinds due to the mandatory defense budget cuts, sequestration risk, and wind down of Iraq and Afghanistan operations.
Our current situation remains fluent. We and our co-lenders are actively engaged with the sponsor as well as management in an effort to achieve a recapitalization. We will keep you posted on our developments.
During the fourth quarter, we originated approximately $60 million PAR value in five new and four existing portfolio companies. We also received repayments and amortization of approximately $77 million during the quarter. And lastly, we took advantage of the strong market conditions to sell $4 million of an investment in an opportunistic transaction at a premium to our cost.
We exited several investments over the course of the quarter. Let me highlight a couple. First off, we repaid in full on our original 2011 and then subsequent follow-on 2012 investments in ATI Physical Therapy in connection with the sale of the company.
We were also repaid at par on our first lien term loans, (inaudible). Solar Capital are sister fund originally invested in the company’s unsecured senior notes of this leading distributor of heavy duty truck parts back in ’06.
Given our teams extensive experience with both the company as well as the sponsor, we initiated a SUNS’ position in the senior notes through an opportunistic secondary transaction during 2011. Those notes were subsequently redeemed at a premium to par and SUNS then participated in a new first lien term loan that was used to refinance the prior senior notes. Our first lien term loans that were redeemed in Q4 2012 were redeemed at a premium and resulted in an IRR in excess of 11%.
We also redeemed out of our investment in T&D Solutions at a premium to par. Solar Senior and our sister company Solar Capital invested together in a unit trans security in July of 2012. The IRR in this realization exceeds 19%. Additionally, our first lien term loan in Six3, a leading provider of intelligence services for U.S. government agencies was redeemed at par, as part of recapitalization. Our IRR realization here given the short investment period was in the mid 8%. Importantly repayments have slowed significantly in the first quarter today.
Let me highlight a few of our fourth quarter investments. We funded $10 million investment in first lien term loan of Hearthside Foods, as part of the Company’s recapitalization. Hearthside is a leading contract manufacturer of cereal, granola and baked goods, and extremely familiar credit for us. We originally invested in Hearthside, in 2011, or repaid at par in the middle of 2012 when the company refinanced its Cap structure.
Total and net leverage through our new investment approximately 4 times for the yield in the mid 6% range. We also invested $10 million in the first lien term of TriNet core, a leading professional employer organization with over a 160,000 work site employees. Proceeds were used to refinance the Company’s capital structure as well as funding acquisitions. Leverage through our investment is less than 2.5 times with the yield approximately 6.6%.
Additionally, we funded a $10 million investment in the first lien term loan of Confie Seguros to aid every partner in their acquisition of the company. Confie Seguros is a leading insurance broker serving primarily the U.S. Hispanic population. Leverage to our first lien term loan is approximately four times over the yield in the high 6% range.
Finally, we are able to capitalize on extensive knowledge and credit history with Endurance International to invest in their second lien term loan as part of a transaction that we capitalized the business and fund in an add on acquisition. This acquisition c catapults Endurance to the number one market share position, providing web hosting and demand registration services.
During the quarter, our first lien and second lien investments from early 2012 were repaid at a premium to par. Over the course of three first lien and one second lien investment in Endurance from October 2011 to December 2012, SUNS has generated mid-teen IRR on its investments into Endurance.
Our recent $5 million investment along side our sister fund Solar Capitals’ $25 million investment in the same second lien term loan of Endurance represents the fifth time we have investment in this credit over the last couple of years and is an example of successfully leveraging an incumbent relationship with familiar issuers that offer many of the important underwriting credit carrier we look for, particularly dominant market share, high free cash flow generation, high recurring revenues from embedded relationships and importantly strong sponsorship.
Since our first investment in 2011, Endurance’s EBITDA has more than doubled. The yield on our new second lien investment exceeds 10%. The weighted average yield at cost on our new investments for Q4 is approximately 7% representing 650 basis points spread over current LIBOR with a weighted average leverage in the mid to high 3s through our SUNS’ investment tranche.
Importantly, the weighted average loan to value on these investments continues to be under 50% loan to value.
Over the course of 2012, several of our existing portfolio companies took advantage of strong operating performance as well as investor demand to refinance their capital structures. Solar Senior’s knowledge of these issuers and experience with the management teams as well as the sponsors has enabled us to re-underwrite these credits and selectively upsize our investments.
In addition, we took advantage of our platform synergies to migrate select assets from Solar Capital over to Solar Senior. Issuers including Asurion, Endurance, National Vision, Shoes for Crews and FleetPride represents SUNS with an opportunity to extend our duration and stay involved with familiar credits that continue to meet our strict risk reward refinements.
Now, I’d like to turn the call back to Michael.
Michael S. Gross
Thank you, Bruce. 2012 was a very important year for Solar Senior Capital. We took advantage of opportunities to enhance the capital structure and to position the company for long term sustainable growth. Our efforts resulted in longer cost to capital, sustaining the maturity of our credit facility and increase our capital base to support further portfolio investments and diversification.
We continued to demonstrate our ability to leverage the Solar platform to store, attract investment. In addition, we have taken advantage of opportunities to migrate familiar credits from Solar Capital to Solar Senior Capital. These transactions provide extended duration of familiar investments, having attractive credit profile and allow us to amortize the due diligence and monetize our experience with certain issuers.
Since the IPO of Solar Senior Capital on February 24, 2011 and through year end 2012, we invested over $450 million in 42 different portfolio companies. Over the same period, we completed transactions of more than 30 different financial sponsors. With now over $2 billion of investable capital across both Solar Capital and Solar Senior Capital, we believe they are meaningful partner to financial sponsors.
The expected synergies are working. With increased scale of funds we expect the ultimate larger, average sized investments and to be in a position to drive pricing in turn. Since inception new investments have averaged approximately $50 million per quarter and we are comfortable with the pay of approximately $200 million in annual originations.
Importantly we have sufficient dry powder from the January equity rates and access to the delay drop each of our credit facility to fund investments and further diversify our portfolio. We are focused on delivering long term shareholder value for building business to scale, to deliver stable income in the form of consistent monthly dividends from a diversified portfolio of senior secured cash pay loans or continuing to manage our downside risk.
Middle market loans continue to be mid-priced relative to syndicated bank loans and high yield bonds. Weighted average asset level yield in the SUNS portfolio are approximately 7.8% or the current dividend yield of our stock in the mid 7%. With the Credit Sussie High Yield and the Credit Sussie Leverage Loan Indexes recently yielding 6.05% and 5.64% respectively, we believe that the risk adjusted absolute return profile of our investments represents significant compelling relative value.
In addition to the liquidity premium of portfolio floating rate securities also provide protection in a rising industry environment. Middle market direct lending can be a lumpy business and it’s difficult for us to control the exact timing of investments and repayments.
We believe it will take several quarters to invest available capital to a level that NII will fully support our dividend and we will use our taxable earnings as a possible cushion in the interim.
As significant owners and principal of this business, you can be assured that we will continue to take a prudent and patient approach to deploying our available capital in new issues and select secondary market transactions that meet our rigid investment criteria.
We believe continued M&A and refinance activity will drive investment opportunities for SUNS in 2013 and we expect further diversification of the portfolio growth for a target 0.8 times debt to equity ratio.
We look forward to speaking to you next quarter. Operator, at this time, will you please open up the lines for questions.
(Operator Instructions) Your first question comes from the line of John Stilmar with JMP Securities. Please proceed.
John W. Stilmar – JMP Securities LLC
Good morning gentlemen. Just really quickly following up on the first same question that I asked on the last call with regards to sequestration, obviously your comments were pretty detailed with regards to your one credit, but I think there is other different name that’s in the SUNS’ portfolio, how should we be thinking about that as well?
And then is there any corollary kind of fill over that we should be thinking about for the rest of the portfolio if the sequestration becomes a bigger issue?
Michael S. Gross
No. I think in the SUNS portfolio issue, no it’s predominantly secured assets and the majority of which are first lean assets of $1 risk in the capital structure. So to the extent that we’re going to face any headwinds, I think we’re well positioned across the portfolio. We do have certain assets in SUNS such as AmeriQual that makes ready-to-eat meals for the military. That has been a rather stable performer, so are leveraged. I highlight that because it’s contrasted with engineering specialty products, not every government service business has created equivalence.
It’s really going to be I think going forward, one is going to have to really pick their spots, whether it’s cyber security or steady need such as ready-to-eat meals. So I think that historically everybody felt that defense services was a sector that was extremely favorable, broadly speaking and as you know, we hit on a fair business sector in our sister portfolio with Solar Capital.
So I think that engineering specialty does provide some critical services, but I do think there is going to be some delay there given what’s going on in Washington right now as well as the fact that as we mentioned we need to sit down with a sponsor and management and try to recapitalize the balance sheet. But I think there is no broad themes other than you should expect us to be highly selective as we look at government services going forward, given the current environment.
Bruce J. Spohler
Okay, great. And then in terms of the assets that were ported over from Solar to SUNS, can you remind me about one of the criticisms of sharing assets between institutions is that there is a difference at least in terms of the inner creditor agreement or ownership of different classes. Correct if I am wrong? Solar and SUNS is the same class, correct?
Bruce J. Spohler
Yeah, just to be clear, yes. You are right on. What we were trying to highlight was really the way the platform has been able to leverage the knowledge that we have with issuers as they migrate into other asset classes of the issuer. What I mean by that and fleet price for example as I touched on, historically they had junior capital outstanding, the business outperformed, and then went to the bank market. So we were able to at Solar Senior leverage the Solar Capital’s history and knowledge of that issuer to go in and underwrite bank deals. Solar Capital did not participate. They were exited out of their prior investment, because it’s not appropriate, first lean is really just over Solar Senior.
To your corollary question, there are occasions where we will invest in the exact same security in both funds at the same time, and that would tend to be something like a second lean as you see in a issuing where we are able to leverage our historical knowledge of that business and invest a little bit in both platforms in the exact same security.
John W. Stilmar – JMP Securities LLC
Got it, very helpful. Thank you.
(Operator Instructions) Your next question comes from the line of Vernon Plack with BB&T Capital Markets. Please proceed.
Vernon C. Plack – BB&T Capital Markets
My questions have been answered. Thanks very much.
Michael S. Gross
At this time, there are no additional audio questions. I will now turn the call back over to Mr. Michael Gross for closing remarks.
Michael S. Gross
Thank you for all your time and attention this morning. We look forward talking to you at the end of Q1 in early May. Thank you.
Ladies and gentlemen that concludes today’s conference. Thank you for your participation. You may now disconnect. Have a great day.
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