Solar Senior Capital Ltd. (NASDAQ:SUNS)
Q4 2013 Earnings Conference Call
February 26, 2014 11:00 am ET
Michael Gross - Chairman & CEO
Bruce Spohler - COO
Richard Peteka - CFO
Greg Nelson - Wells Fargo Securities
Vernon Plack - BB&T Capital Markets
John Bach - Wells Fargo
Good day, ladies and gentlemen, and welcome to the Solar Senior Capital Limited Fourth Quarter 2013 Earnings Conference Call. My name is Celia and I will be your operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a 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.
Thank you very much and good morning. Welcome to Solar Senior Capital Limited's earnings call for the year ended December 31, 2013. I am joined here today by Bruce Spohler, our Chief Operating Officer and Richard Peteka, our Chief Financial Officer.
Before we begin Rich, would you please start off by covering the webcast and forward-looking statements?
Of course. Thanks, Michael. I 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 www.solarseniorcap.com. Audio replay to 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.
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.
Thank you, Rich. 2013 was a productive year for Solar Senior Capital. We successfully leveraged our deep and longstanding relationships with sponsors and intermediaries to source senior secured floating rate cash-pay loans having attractive risk return profile. We completed the strategic acquisition of Gemino Senior Secured Healthcare, a portfolio investment that provides differentiated access to senior secured investment opportunities in the growing healthcare segment. And we're successful in recapitalizing our one credit that had been on non-accrual.
As we mentioned in the earnings call for Solar Capital early this morning, nominally low yields across fixed income universe, rising interest rates, and below trend default rates, drove capital leveraged credit sector from a broader group of retail, institutional, CLO and relative value investors. The slowly improving fundamentals and strong leverage loan technicals drove record amounts of refinancing and recapitalization activity resulted in tighter spreads, lower yields, higher leverage, and a significant percentage of covenant light loan structures for syndicated issuers.
The middle market direct lending environment was also affected by the near-term supply demand imbalance characterized by excess liquidity and relatively low volume of M&A transactions, despite an uptick in Q4 LBO activity. Pricing appears to stabilize but we are not yet convinced that competitive structures have fully abated particularly in the absence of a robust M&A demand. Against the backdrop of a more challenging lending environment Solar Senior Capital remain disciplined and highly selective in its investments
During the year, we originated over $200 million in investments across 26 portfolio companies, while experiencing approximately $148 million repayment in sales for net portfolio growth for the year of approximately 26%.
Our December 31, net asset value is $18.04 up slightly from our $17.91 net asset value at September 30. The weighted average yield of the portfolio based on fair value was 7.5%, at December 31, 2013. In comparison, the implied yield of LCDX, which represents the liquid loan market, was just 4.94% at 12/31/13.
For the fourth quarter, net investment income was $0.32 per share versus $0.29 per share in the third quarter. The increased net investment income from Q3 to Q4 was largely driven by the incremental dividend income from our strategic investment in Gemino, which we had the benefit of our first three months of operations as a SUNS portfolio company.
Credit quality of our diversified portfolio remained strong. During the quarter, we completed the recapitalization of our one investment -- of our investment in engineering solutions and products. Bruce will provide additional information on the Q4 portfolio activity.
The SUNS portfolio today is 100% performing. At December 31, our leverage was 0.3 times debt-to-equity and we had approximately $90 million of available capacity for new investment opportunities. We are long-term focused and shoulder alignment to the senior management teams over 6% ownership positions. We will continue to deploy capital in a prudent and discipline manner.
During the year, we took several important steps to increase our assets required for investments with risk reward characteristics are differentiated and more attracted than those available in the liquid credit markets, including the strategic acquisition of Gemino noted earlier.
In addition to recurring cash income anticipated in the investment the asset a significant strategic value for SUNS through its unique and differentiated origination platform with virtually no over loss to solar and access to asset based senior secure investments that have a low correlation with a traditional cash flow base loans.
We also added 13 origination investment professionals and SUNS is already reaping the benefit of these long standing relationships sponsors and intermediaries.
Lastly, our board of directors declared a monthly dividend for March of $11.75 per share payable on April 1st, 2014 to stockholders of record on March 20th, 2013.
At this time, I would like to turn the call over to our Chief Financial Officer, Rich Peteka.
Thank you, Michael. Solar Senior Capital's net asset value at yearend was $208.0 million, or $18.04 per share versus $206.3 million or $17.91 per share, a $0.13 increase per share where net asset value at September 30. As of December 31st, we had investments in 36 portfolio companies in 23 industries totaling approximately $267.9 million at fair value, down slightly from September 30th, where we also had investments in 36 portfolio companies with a fair market value totaling approximately $276.3 million in 22 industries.
At September 31, the weighted average yield on our income producing portfolio increased slightly to 7.5% negative fair value versus 7.4% at September 30. Gross investment income to the three months ending December 31 totaled $5.7 million versus $4.9 million for the three months ended September 30.
Gross investment income increased quarter over quarter primarily due to the increase in the company's average income producing portfolio. Total expenses to the three months ended December 31were $2 million compared to $1.6 million to the three months ended September 30. So that expenses increased during our fourth quarter primarily from interest expense associated with the timing of trade settlement as well as general and administrative expenses.
Ultimately, net investment income for the quarter ended December 31, 2013 with $3.6 million was $0.32 per average share versus $3.3 million with $0.29 per average share for the quarter ended September 30th. Net realized and unrealized gains for the fourth fiscal quarter totaled $2.0 million versus losses of $0.7 million for Q3. Net realized and unrealized losses to the full fiscal year 2013 totaled $0.8 million.
Lastly, given the completed recapitalization of our investment in engineering solutions to products during the fourth quarter, today all investments are current on their interest.
With that, 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. We continually pleased with the financial performance of our portfolio companies and our management teams continued to be optimistic about their businesses and their prospects. As lenders, a slow growth economic environment is benign as long we are disciplined and prudent in underwriting capital structures at the appropriate level of risk reward. At 12/31 the weighted average yield in our portfolio was 7.5% based on fair value. The weighted average investment yields rates entered a fair market value at the end of Q4 has remained steady at approximately 2 based on our 2 to 4 risk rating scale with one representing the least amount of risk. We retain investments in the part of 2011, pleased with the overall credit quality of the SUNS portfolio.
Our portfolio was invested 84% in senior secured loans just under 13% in Gemino such the finance companies that has build a diversified portfolio of senior security asset backlogs. Just over 2.5% in unsecured loans and less than 1.5 of 1% in equity we measured in fair value. For personal investments the weighted average leveraged to work investment charge in mid the refines with our cash interest coverage on the investments is a healthy 3.2 times. Before I give an overview of our fourth quarter activity, I would like to spend the moment on some portfolio developments.
As Michael mentioned, we closed down the recapitalization of ESP during Q4 with SUNS and other lenders converting their existing first lien debt into a combination of 1st and 2nd lien debt as well as common equity. Today the business is stable. We believe the appropriate capital structure has been put in place to support the company on a go forward basis.
As a remainder, SUNS made initial investment in the company in the early part of 2011. ESP provide professional and technical support services for the army's mission critical command, intelligence in reconnaissance systems. While these background communication systems continue to be a top priority for the department of defense in ESP and its peers face considerable headwinds resulting from both budget cuts, sequestration ratio and wind down of our operations in Iraq and Afghanistan.
Subsequent to the end of the quarter, we sold our remaining roughly $3.5 million investment in SLT Environmental at a 13% premium toward 12/31 mark. In Q2 of last year, the opportunity that we sold $5 million of our position in SLT in excess of our cost. Our blended IOR in this investment was just under 2%. We are pleased that our investment in Gemino performed well in its first quarter of operations on the SUNS ownership. At year-end, Gemino had approximately $117 million of committed, revolver and term loans with approximately $109 million invested under those facilities.
Portfolio is highly diversified with 34 separate issuance having an average loan balance of approximately $3.2 million. Origination efforts have been restarted during the quarter and the pipeline of opportunities is rebuilding after having stalled during the company sale process.
At the end of the Q4, Gemino paid a dividend of approximately $780,000 to SUNS which equated to 9.5% annualized dividend yield on the cost of our investment. In addition, Gemino had $83 million outstanding on $100 million credit facility at December 31. Cost with credit facility is L250. 100% of Gemino's loans are performing in all our senior secured floating rate assets.
In the fourth quarter, SUNS made investment of approximately $29 million in six portfolio companies and we had principal repayments of sales of approximately $40 million. In spite of larger than expected redemptions, our portfolio ended the year well diversified with investments in 36 issuers across 23 industry groups. Our weighted average position side is approximately $6.5 million. Now let me highlight a couple of our Q4 investments. We funded a $7 million investment in a $100 million first to the interim loan issued by FX Healthcare Services, which is a leading provider pediatric home nursing therapy.
Webster Capital had acquired I think in 2010. Company has experienced significant growth both organically as well as through a previous company acquisitions. Our first lien term loan has leveraged to 3.5 times and it's yielding just about 6.8%. In addition SUNS under the $10 million investment in Authentic brands new $115 million first lien term loan in support of the company's recapitalization. Of any brand, Leonard Brands is a leading brand licensing company owned by Leonard Green & Partners. The all senior structure has levered through 3.3 times and has a yield just about 6.2%.
During Q4, we had repayments in sales of approximately $40 million. Over the course of Q4, we opportunistically sold our remaining $9.5 million portion of our $15 million original investment in the first lien loan in the Asurion, a leading self-owned insurance provider. The Solar Capital franchise through FLRC was an original investor in Madison Dearborn acquisition of the company back in 2007 and to date has invested over $140 million in four different transactions.
(inaudible) reached size such that has able to secure cheaper financing in the liquid credit markets and, therefore, this investment represent a transitional paper for SUNS. We took advantage of selling our low yielding first lien (inaudible) 325 of profit and continue to hold $3 million of a (inaudible). The IRR for (inaudible) investment was just under 6%.
We also received repayment of our second lien term loan investment in DJ's Wholesale Warehouse Club that we had made in Q3 of 2012. Our $5 million position was repaid at a premium to par and we earned a 13% IRR on the investment. In addition, we paid the premiums so far at our $5 million investment in the second lien term loan of Endurance International Group. Sponsored Warburg Pincus and Goldman Sachs took the public company in October and used to proceeds of the IPO as well as the new loan to repay our second lien term loan. The position represented the fifth investment in Endurance since our original investment back in Q4 2011. We earned a 14% return on our investment.
According to S&P capital IQ, the weighted average senior debt EBITDA ratio for middle market transactions by issuers under $50 million was 4.5 times for senior leverage in 2013, which represents leverage level not experienced since 2007. In light of continued elevated risk levels, I would like to reiterate our patient and prudent investment philosophy. We continue to find the attractive investment opportunities and we will remain disciplined in building the portfolio and prudent in deploying our available capital selectively with only those investments that will meet our strict underwriting standards.
Now I would like to turn the call back to Michael.
Thank you, Bruce. As long term veterans of leverage lending industry, we have navigated through multiple credit cycles. Our experience with products remain disciplined in our investment process particularly in liquidity driven market such as the one we're experiencing today. Protecting principal and being fairly competitive for risks remain the top priorities of our underwriting philosophy. Our goal is to build and manage a diverse site portfolio of attractive credits and will generate steady and stable dividend stream for our shareholders all the while protecting capital. Since our IPO in February 2011, we've originated $605 million northern loans with
Portion of our $15 million original investment in the first interim loan in the share again for leading self-owned insurance provider. The sole capital franchise through FLRC was an original investor, with (inaudible) soon be avoiding acquisition to company back in 2007 and to date has invested over $140 million in four different transactions. (inaudible) size such that has able to secure cheaper financing in the liquid credit markets and therefore this investment represent a transitional paper facades. We took advantage of selling our low yielding personally in (inaudible) 325 of profit and continue to hold $3 million of a share in (inaudible). The IOR mature investment was just under 6%.
We also received repayment of our second intern loan compassionate in DJ's wholesale wear (inaudible) club. That we had made in Q3 of 2012. Our $5 million position was repaid at a premium to par and we earned a 13% IOR in the investment. In addition, we paid the premiums so far at our $5 million investment in the second term loan of Endurance International Group. Sponsored global (inaudible) and Goldman Sachs is the public company in October and used to proceeds of the ITL which was a new to repay our next in term loan. The position represented the safe investment endurance since our original investment back in Q4 2011.
We earned a 14% return on our investment. According to S&P capital IQ, the weighted average in your debt EBITDA ratio for middle market transactions (inaudible) was under $50 million with 4.5 times for senior leverage in 2013, which represents leverage level not experienced since 2007. In light of continued elevated risk levels, I would like to reiterate our patient and proven investment philosophy. We continue to find the attractive investment opportunities and we will remain discipline in building the portfolio including in deploying our available capital selectively with only those investments that will need our straight underwriting standards.
Now I would like to turn the call back to Michael.
Michael Gross - Chief Executive Officer, President and Chairman of the Board of Directors
Thank you, Bruce. As long term veterans in the lending industry, we have navigated the multiple credit cycles. Our experience with products remain disciplined and investment process particularly in (inaudible) such as the one we experiencing today. Protecting principal and being fairly competitive for risks remain the top priorities of our underwriting philosophy. Our goal is to build and manage a diverse site portfolio of attractive credits and will generate steady and stable dividend stream for our shareholders all the while protecting capital. Since our IPO in February 2011, we've originated $605 million loan with 59 different portfolio companies and that's completed transactions with more than 40 different financial sponsors. Funds with average approximately $50 million originated per quarter. We continue to take advantage of opportunity extend the ratio of known credits across the fund and solar platforms allowing us to grow with our clients and leverage our due diligence in knowledge of the (inaudible).
SUNS made steady progress in 2013, we are clearly disappointed by both the significant volume of repayments resulting slowing our portfolio growth as anticipated as well as yield compression at the asset level that has slowed the growth in the investment income. Through the strategic acquisition of Gemino at the end of the third quarter, we have further diversified our portfolio and added a less correlated asset class and growth engine to the portfolio. The general investment positively impact in net investment income in the fourth quarter as we expect to make further progress on driving the investment growth as the portfolio growth we are able to more fully utilize our credit facility.
We believe the senior security middle market asset class remains attractive on both the relative and absolute basis. The risk reward value proposition of an investment Solar Senior Capital with its diversified portfolio of middle market directly originated senior secured loans is compelling when compared to the liquids indicated high yield and bank loan markets.
A yield of approximately 7.7% sounds SUNS compared safely to the 5.4% yield of the Barclays higher incorporated index to the CDX with an implied (inaudible) of 6.1.5% and to a 6.29% weighted average yield on a representative sample up close end sample of funds.
We thank you for your time this morning and look forward to speaking in next quarter.
Operator, please over the line for questions.
(Operator Instructions) Your first question comes from the line of Greg Nelson, Wells Fargo Securities. Please proceed.
Greg Nelson - Wells Fargo Securities
Guys thanks for all the commentary and thanks for taking my questions. Real quick on Gemino, I saw you guys took $780,000 dividend there at the end of the quarter. As you guys switched I believe $13 million of the investment into a loan. How that dividend going forward as more than income gets shifted in to the low loan or is that dividend can explained at that level?
The way the things of the aggregate income we take out of it in terms of the interesting and plus the dividend should approximate that same number.
Greg Nelson - Wells Fargo Securities
Okay. Great. And then just on the pipeline in Gemino I think you guys added roughly $8.6 million commitments and only $2.6 million of funding. You guys have heard that as a growth engine just give your thoughts about where you think it's going to go?
I think as you know from covering us it's all about net portfolio growth and so one of the advantages in Gemino is that the provider of working capital facilities the most of its insured. There is not as much repayment. There might be a little bit of volatility in terms of draw downs and borrowings under this facility quarter to quarter but we don't see the same degree of repayment. So it's a very stable foundation, and so it doesn't take a lot to answer that as they reramp their origination network. So as you mentioned in our comment it is typical the sales process management was focused on strategic alternatives and less so on new business development additionally the owner is in that phase of the business we would work investing the platform and acquiring the team with capital to growth.
So the expense for the last two months sort of restarting the origination engine and we are pleased with some of the early returns and I know the pipeline is building. So we do expect to see additional growth there this year.
Greg Nelson, Wells Fargo Securities
Okay. That's great to hear. And then a quick one obviously you have talked a lot about spread compression of environment and I think this quarter we especially in the portfolio, we started to see this and stuff. We're alone even the high quality senior security stuff starting getting re-priced. We saw some LIBOR go from 450 to 400 in some of your loans, 525 to 450. And then you know some of which you kept on the blocks and some of which isolate. What's your feeling here and how are you feeling about the rest of that in the portfolio and how to use that once again keep on the books and once you are going to get rid of?
Yes, a good question. We re-underwrite every time there is a reprising on an existing name and sometimes we might decide, we want to move into a different part of the capital structure whether t was Trident and or land debt you have seen us gone first to second, second to first. So we look at as a fresh underwriting when we try to asses what's the appropriate risk return in today's market and what our comfort level. And I think as you know while we don't amortize the upfront fees day one rather amortize over a holding period. We do look at the all-in expected return and what I mean by that is if some the agreed pricing alone, but there is a small fee associated with it and we think that based on our dialog with sponsor as they are going to effectively take this out next year to through either a sale or an IPO then we might decide to stay in because when you amortizing that fee over a shorter period of time, our expected return might hit our bogey. So it's very situational. First and foremost, based on the underwriting risk return. And then secondarily we look at the expected return
Greg Nelson, Wells Fargo Securities
Great. Finally, just looking at the equity issuance going forward I think leverage came in at the end of the quarter around 0.3. would Gemino be funded on there and then some assets coming back at you. So just curious to get your thoughts how you're getting (inaudible) going forward?
We're not right because we've $90 million of availability in our credit facility. So we would have to get materially invest to that 40 to even considerate it.
(Operator Instructions). The next question comes from the line of Vernon Plack of BB&T Capital Markets. Please proceed.
Vernon Plack - BB&T Capital Markets
Thanks, and you may have touched on this but just curious in terms of your thoughts for this year in terms of your exists and repayments at least what you hope that numbers will be or a feel for what that number would be. I think in '12 it was $160 million, in '13 it was $150-plus million. Are you expecting that levels of exits and repayments for '14?
I think we would expect something closer to $100 million but again we don't have great visibility on that.
The next question comes from the line of John Bach, Wells Fargo. Please proceed.
John Bach - Wells Fargo
Yes, just a quick follow up to Greg's questions and guys I appreciate your time for taking mine. So when we talk about equity issuance I know that sometimes even having undrawn revolved capacity never really kept us from issuing equity earlier. And so if I'm going to walk through the numbers and this is just how I see it, and guys please tell me if I'm wrong but at a 7-ish dividend yield plus let's say you leverage between 0.2 to 0.5 at a cost of debt 2.68 and we charge fees on this model or roughly about 200 basis points that full base and incentive, we're taking about a 8.5 to 9-ish type of required rate of return that one needs to hit to just break even on the dividend. And while you're not levered to make sense but even in the environment where looking at returns in the market nowhere near that particularly on senior secured loans, well, maybe I'm wrong please reeducate me, is this even a time if you were leveraged, Michael, to be issuing equity in light of the fact that spreads are so tight?
The answer is we would only issue equity if we thought at the cost rate of equity we can do it in a way that would be able to drive net investment income per share higher.
John Bach - Wells Fargo
Thank you, I appreciate that very much. Thank you very much.
And be mindful also that our return in Gemino this quarter was 9.5% for asset based loans.
John Bach - Wells Fargo
Which in that case, would absolutely make sense that you would be happy to fund that. I absolutely understand that and thank you for taking the questions.
(Operator Instructions). The next question comes from the line of (inaudible).
I wanted to touch on remaining investment in the Asurion. My understanding is that they're looking to refinance their debt. Do you expect to be taken out this quarter and on what were the terms?
Yes, we do. They're call protection before that piece of paper expires at the beginning of March next week, and so that's obviously the timing and they're going to market, and that's expected to be taken out at 102.
Bruce or whomever, could you again break out fee income in the fourth quarter?
We did have a little bit of fee income, not that much, maybe about $0.02 on a gross basis.
And lastly , in terms of the quality of the deals flow, was it mostly sponsored and to what extent was there any syndicated business in the flows that we started in the fourth quarter?
Yes, it was mostly sponsored bait. Again, I think as we talked about when we look at, Asurion is a great example, the name that you brought up. Obviously we will continue to evaluate the new transaction that they are in the market with a second lien transaction. As you know, we've been anywhere from first lien, second lien, holdco with this company over the last six, seven years. And so, if we were to participate hypothetically in that new transaction, I guess on paper it might look like a syndicated deal but from our perspective given our relationships with the underlying sponsor group, Madison Dearborn Partners, and Welsh, Carson, a direct dialog with the CFO, we have pretty inside diligence access and so, I would not term that syndicated. So as you think about --to answer your question specifically, the work that we did and the new originations and so with senior were generally deals where we have direct access for due diligence and they were predominantly sponsored based aside from the activity at Gemino.
At this time, we will turn the call back over to Mr. Michael Gross for final remarks.
We have no final remarks this time, but thank you for all your time. We look forward to speaking to you next quarter.
Ladies and gentlemen, that ends today's conference. Thank you for your participation. Have a great day. You may now disconnect.
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