Solar Senior Capital's CEO Discusses Q3 2013 Results - Earnings Call Transcript

| About: Solar Senior (SUNS)

Solar Senior Capital Ltd (NASDAQ:SUNS)

Q3 2013 Earnings Call

October 31, 2013 11:00 am ET


Michael Gross - Chief Executive Officer, President and Chairman of the Board of Directors

Rich Peteka - Chief Financial Officer

Bruce Spohler - Chief Operating Officer and Director


Chris York - JMP Securities

Jon Bock - Wells Fargo Securities


Good day, ladies and gentlemen, and welcome to the Third Quarter 2013 Solar Senior Capital Limited Ltd Earnings Conference Call. My name is Britney and I will be the operator for today's conference. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. (Operator Instructions)

At this time, I would now like to turn the call over to your host for today, Chairman and CEO, Michael Gross. Please proceed, sir.

Michael Gross

Thank you and good morning. Welcome to Solar Senior Capital Limited's earnings call for the year ended September 30, 2012. I am joined here today by Bruce Spohler, our Chief Operating Officer and Richard Peteka, our Chief Financial Officer.

Rich, please start off by covering the webcast and forward-looking statements.

Rich Peteka

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 Senior Capital Limited, and that any unauthorized broadcast, in any form are strictly prohibited. This conference call is being webcast on our website at Audio replay to this call will also be made available later today as disclosed in our press release.

I would 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.

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 not 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.

Michael Gross

Thank you, Rich for most of the third quarter, the market continue to be soft in our view. Trends of issuers refinance their capital structure with low yielding securities continued, putting downward pressure on the portfolios across the loan investor universe. Against that backdrop, Solar Senior remained prudent and strategic in its portfolio management.

Our acquisition of Gemino, Senior Secured Healthcare Finance, coupled with our traditional senior secured loan originations, which were partially offset by repayments, resulted in the net portfolio growth of approximately 10% for the quarter.

During the third quarter, we originated approximately $77 million of new investments, $32 million of which was invested in Gemino. We valid this opportunity for close to a year and believe it offers a superior risk return profile. We acquired approximately 96 % of the outstanding equity of Gemino. The company focuses on providing senior secured asset-based loans to small to mid size U.S. companies in the healthcare industry.

Gemino's senior management team, which demonstrated its commitment to the business by acquiring the other 4% of the equity, has an average over 15 years of healthcare finance experience as originated more than $1.3 billion of financing commitments. In addition to the recurring current cash income, we expect to earn out of this investment that has significant strategic value to us.

Gemino's origination platform has little overlapped with our own, providing us with assets with new opportunities set that that is correlation with our existing portfolio. Their team's expertise broadened Solar Senior Capital's spectrum of financing solutions and our permanent capital enhances their ability to meet its client needs. Additionally, our capital allocated with long-term investment will not be subject repayment risk and thus will continue to extend the duration of our portfolio.

Bruce will provide additional color on Gemino's asset-based loan portfolio later in this call.

Doing the diligence and negotiations for the (Inaudible) of Gemino, we leveraged our experience in both, the healthcare and specialty finance industries. Our sister fund, Solar Capital's prior investment in MidCap financial and asset-based lender to the healthcare industry, which resulted in a realized IRR 16% from inception provide us with the invaluable insight into this niche market.

The asset base helped our loan space provides a compelling market opportunity relative to the risk reward profile of traditional leverage loans. Additionally, we benefitted from our experience with other specialty events company advancements, particularly Solar Capital's acquisition of Crystal Capital at the end of 2012.

At the end of the third quarter, the weighted average yield of the portfolio based on fair value was 7.4%, up slightly from 7.3% at June 30th. In comparison, the average price from LCDX, which represent the liquid leverage loan market, was 103.8% of par with the implied yield of 5.1% at September 30th. Our NAV September 30, 2013 was $17.91.

During the quarter, we generate net investment income of $0.29 per share consistent with the prior quarter. With the benefit of a full quarter of owning Gemino, we currently anticipate narrowing the differential between our net investment income and dividends in the fourth quarter.

At the end of Q3, pro forma for the Gemino acquisition, we would have borrowings outstanding of approximate $68 million, resulting in a net debt to equity ratio of 0.29 times and capital available to invest of $80 million. With our long-term focus, we deploy our capital in a disciplined and prudent matter as we continue to move towards our leverage target.

Lastly, our board of directors declared a monthly deliver for November of $11.75 per share payable on December 3rd to stockholders of record on November 21, 2013.

At this time, I would like to turn the call over to our Chief Financial Officer, Rich Peteka.

Rich Peteka

Thank you, Michael. Solar Senior Capital's net asset value at September 30, 2013 was $206.3 million, or $17.91 per share. This compares to a $207.6 million or $18.03 per share at June 30, 2013. Our investment portfolio had a fair market value of approximately $276.3 million on September 30th, compared to $250.2 million at June 30th, which represents an increase of 10%, primarily driven by positive net originations.

For the third quarter, gross investment income was $4.9 million versus $4.7 million in the second quarter 2013. The increase was primarily driven by a larger average investment portfolio. Expenses totaled $1.6 million of the third quarter, compared to $1.4 million for the second quarter.

For the three months ended September 30, 2013, our net investment income was $3.3 million, or 29 per average share consistent with the three months period ended June 30, 2013. Investment, sales and repayments in the third quarter totaled $50.5 million; a net realized loss for the quarter was $0.5 million.

For the second quarter, the net realized gain was $0.2 million and net unrealized depreciation for the third quarter totaled $0.2 million. This compares to net unrealized depreciation of $2.0 million for the second quarter 2013.

At the time, I would like to turn the floor over to our Chief Operating Officer, Bruce Spohler.

Bruce Spohler

Thank you, Rich. Overall, our portfolio of companies continue to experience steady operating performance. We are pleased with the credit quality. Fair value weighted average investment risk rating the portfolio at the end of our quarter remained at approximately 2 based on our 1 to 4 risk rating scale, with one representing the least amount of risk.

Our third quarter portfolio activity resulted in a further diversified and enhanced portfolio. At September 30th, we had 36 portfolio of investment operating across 22 industries, with the largest single exposure representing approximately 12% fair value.

Excluding our strategic investment in Gemino, the weighted average position size was $7 million. At quarter's end secured loans together with our investment Gemino senior secured healthcare finance, accounted for approximately 98% of the fair value to portfolio. Approximately 93%, including Gemino was invested in floating-rate securities.

Additionally at quarter's end, over 98% of the fair value of the portfolio was performing. Our first lien investments, the weighted average leverage to our investment is in the mid-three times. EBITDA and the average cash interest coverage across the portfolio exceeds three times. The weighted average yield on our portfolio at fair value was 7.4% as compared with 7.3% at the end of Q2.

On the origination front, we saw senior secured loan investment totaling approximately $44 million. Together with our strategic acquisition of Gemino, our originations totaled in excess of $75 million for Q3.

Let me touch on a couple of our investments. As Michael mentioned, at the end of the quarter, we acquired Gemino's senior secured healthcare finance and funded $32.8 million of equity on the first day of Q4.

Gemino is commercial finance company whose primary financing products include revolving lines of credit secured by borrowers' accounts receivable as well as secured term loan secured by all other assets.

At quarter's end Gemino's portfolio totaled approximately 162 million of asset-based loan commitments, which are $106 million were funded. The funded portfolio consisted of 33 different issuers with an average loan balance outstanding of $3.2 million at an average all-in yield approximating 12%.

At quarter end, Gemino had total leverage on its portfolio of approximately 2.4 times debt to equity. We believe this asset offers a highly attractive risk return profile given the cash pay, senior secured asset based nature of its underlying assets. We expect this investment to pay us a cash dividend, which will be included in our net investment income going forward.

Additionally, we funded $10 million investment in the first lien term loan of Trident Health Services a portfolio of company of Audax. The company is sole national provider of mobile diagnostic healthcare services to post-acute facilities. Proceed to the tranche will be used to fund their acquisition of an additional business with provides hospice services across throughout states.

The net leverage to our investment is approximately four times and our all-in yield is close to 6.7%. We at Solar have extensive knowledge and experience with the company and its operating performance based upon the higher investment through Solar Capital.

In addition, we originated $9 million investment in the first lien term loan of Jacobson which is the leading third-party supply chain logistics company which is owned by Oak Hill Capital Partners. This loan was issued as a part of the refinancing of the company's existing capital structure.

Net first lien leverage was four times and all-in yield is approximately 7.25%. Additionally, we invested $7 million in the first lien term loan of Miller Heiman, which is a leading global provider of sales performance services. The tranche refinance the existing capital structure of the company and funded a tuck-in acquisition. Net leverage to our investment is 3.6 times and our all-in yield approximates 7%.

During the quarter, repayments amortizations and sales totaled approximately $50 million. We received repayments and amortizations of approximately $43 million and took advantage of strong market conditions to opportunistically exit one investment.

Let me highlight a few of these transactions now. We repaid on our $4.5 million first lien term loan investment in Bellisio at par which resulted in IRR of 8.5%. During the quarter a $4 million first lien term loan investment in Boulder Brands formerly known as Smart Balance was also repaid at par. We realized in IRR in excess of 9.5%.

During Q3, we chose to exit a $7.4 million investment in Sotera, defense technology and engineering solutions firm serving the U.S. national security community. We were able to exit above our Q2 mark.

Now I will turn the call back to Mike.

Michael Gross

Thank you, Bruce. In conclusion, the third quarter was the successful one for us, during which we further grew and diversified portfolio the strategic investment in Gemino provides us with new source of net investment income, which will increase our net investment income in the fourth quarter. We believe this investment offers a highly attractive long-term risk reward profile.

Given the heated market conditions over the past year, terms under which one to become more issuer friendly. We believe that now more than ever it behooves investors to understand the underlying risk in credit portfolios. Our portfolio which consists of all of entirely senior secured floating-rate loans provides greater downtime protection in high-yield or mezzanine investments.

We have adhered to underlying principles and have been unwilling to compromise credit quality for the sake of higher yield. With the average leverage through our charge of four times and the average portfolio yield of 7.4% compared to 5.1% for the LCDX as of September 30th, we believe Solar Senior offers a compelling investment proposition.

Post the funding of our $33 million investment in Gemino, we had over $80 million of available capital to prudently invest as we manage our portfolio to achieve an appropriate-like leverage target, given the underlying risk reward portfolio of our senior secured loans.

Although the Fed delayed the abatement of its quantitative easing program is steepening of the yield curve reflects the market expectation that interest rates will continue to rise. With the floating-rate nature of our portfolio, we are positioned to benefit from such an environment and we believe we provide investors with an attractive way of gaining exposure to this asset class.

We forward to speaking with you next quarter. Thank you for your time this morning. Operator, please open up the line for questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from the line of Chris York, representing JMP Securities. Please proceed.

Chris York - JMP Securities

Good morning, guys. Just one question for me this morning, so SLT Environment was written down by roughly $600,000 the quarter talk about that write-down and any expectations for performance going forward?

Rich Peteka

Sure. I think that is the one investment that we are watching closely in addition to the one investment on non-accrual ESP. We are making progress on ESP and hope to have that resolved this quarter just as an aside.

SLT, we market down. You may recall we had sold half of our position, close to par in Q2, so we have fair value close to just over $4 million in SLT. They had struggled. That's a project-driven business and projects have been pushed out given the government funding challenges around the world, so we did take the mark down to reflect where we knew a trade had occurred at 86 level. There have been some trades in the 90s since quarter end and we are actively working on that one and feel good about the potential outcome.

Chris York - JMP Securities

So actively working on and how come you potentially might exit the investment. Is that kind of the thinking?

Rich Peteka

Well, that’s always an opportunity across any of our investments, but no, that's not the implications. Implications, we feel good about what realizable value is.


(Operator Instructions) Your next question comes from the line of Jon Bock, representing Wells Fargo Securities. Please proceed.

Jon Bock - Wells Fargo Securities

Thanks again for taking my question still. More of a global one as it relates to dividend coverage and then tie with an equity issuance-related question. What is your view on covering the dividends, right? I know you have made an effort too. You covered it in December from the net operating income and then subsequently have not been able to. Part of that’s market force-driven and so we are curious as to coverage and where you think over time you would be able to effectively cover the $0.35 on rate dividend from true earnings.

Rich Peteka

Yes. I think, to your point, Jon, we had covered it up through December of last year as we matched our dividend with our NII as we grew the portfolio post the initial public offering. As you know, we were blessed or burdened depending on your perspective with substantial repayments to your point in Q4 of 2012, which we had been working prudently, but diligently to the deploy this year.

I think it's fair to say that Gemino, which will be in Q4 as of day one shall make a meaningful impact on NII all things being equal beyond that for Q4 in terms of getting closer to that dividend coverage, so our hope is without being precise any given quarter that we will continue to grow that NII closer to dividend with the big step taken forward this quarter.

Jon Bock - Wells Fargo Securities

Fair enough. I guess, one additional, Bruce, that some guys would that would maybe want to debate is that at the equity issuance in March of 2 million shares, just so did perhaps put out the threshold of full dividend coverage much, much further which as a result of timing, I mean, no one can be perfect. Would it be fair to say that you are not interested in doing the same thing as happened last March of '13 when you raise additional equity and that you are effectively full from an equity issuance standpoint?

Bruce Spohler

I think until we are very close, our target debt to equity…

Jon Bock - Wells Fargo Securities

Would the operating close to your target debt to equity and necessarily imply that one would be able to cover the $0.35 dividend?

Bruce Spohler


Jon Bock - Wells Fargo Securities

Now one additional question on Gemino, which is a very unique and glad to see these types of transactions entering the BDC portfolios. As it related to the portfolio yield, is there an opportunity to perhaps increase it over time or would you happen to think that market forces there are significant enough to kind of keep it steady even though that's still a great return. I was trying to get a sense of the potential yield upside as you go in and in and continue to rationalize and also become additive value points to that business.

Bruce Spohler

I think the yield upside there is not necessarily increasing price or yield on the underlying assets. It's taking advantage of the leverage capacity we have there, so we have ability to growth portfolio by close to $20 million. $20 million with no additional equity, so all that income effectively falls to our bottom line with just the permanent low cost borrowing, so I think you are going to see our return, our ROE increase being result of achieving the target leverage at that vehicle, if you will.

Jon Bock - Wells Fargo Securities

Okay. Then right now in terms of the all-in rate that one is seeing or perhaps participating in a loan re-fis, Can you give us a sense as to a real coupons that are out there for true attractive taper you know that's 3 to 3.5 times levered, so it's kind of in your wheelhouse and how that rate compares to what you were seeing a quarter ago and a year ago.

Rich Peteka

Sure. I wouldn't say things have changed much over the last quarter and maybe that’s encouraging and that it feels like spreads have sort of chopped here. It's hard to say definitively, because there has obviously been a lot of noise contributed by Washington and the rest of the world over last quarter, but I would not say that pricing has changed much other than last quarter. We are sort of seeing taper that we like, anywhere from 5.5% to 6.6%. That's a wide range, but it depends on the sector and on the asset, less on the leverage level necessarily.

Jon Bock - Wells Fargo Securities


Bruce Spohler

So, I think we are up from 5.5% to 6.5%, and importantly if you look back, good news/bad news the effective yields they can go through some of our exits that we discussed is actually higher, because we are obviously underwriting on a yield to maturity.

Given this environment people are refinancing in a within 6, 9, 12 months of consummating a transaction, so that will give you a higher IRR to the extent that you brought taper in at a 98.5% map 99% OID.

Our effective yields have been higher, but obviously that's resulted in using paper and then re-underwriting, debating whether we want to stay in on the new risk adjusted returns.

Jon Bock - Wells Fargo Securities

Would you guys consider that the current velocity that we are seeing, not necessarily a repayment from old issued. I think everybody understands that that's the new norm, but perhaps even in some of the newer issues that have come out inside the last six or even 12 months that is repaid, very, very quickly. Is that velocity at which offers you additional upside to the extent you buy at 99? Is effectively a new, I would say, paradigm for the time being in senior secured lending?

Bruce Spohler

Yes. Remember the call protection in senior secured loans is to de minimis if at all. There might be softball for the first six months or so, so it does other than the cost of the transactions of legal et cetera, it does allow somebody very low barriers as an issuer to go back and try to re-price their deals and take pricing down, so it is the new norm, but it’s been that way I would say for the last 18 months, and as you have seen - since you follow both portfolios, it has given us the opportunity to extend our duration as we move up or down the capital structure in a given transaction for a credit that we have known lived with for some period of time, so it hasn’t been all bad assuming that you have a new opportunity to report that you found attractive.

Jon Bock - Wells Fargo Securities

Yes, and always appreciate stick with credits that you know, so much appreciate. Those were all my questions. Thank you.

Bruce Spohler

Thanks, Jonathan.


There are no further questions in the queue at this time.

Michael Gross

Okay. Thank you, everyone, for your participation this morning. We appreciate your continued support. We will talk to you soon.


Ladies and gentlemen, that concludes the presentation for today's conference. You may now all disconnect and have a wonderful day.

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