December 18, 2012: News worthy new deal by Solar Capital (NASDAQ:SLRC): the large cap Business Development Company ("BDC") acquired Crystal Capital Financial Holdings ("Crystal Financial"), an asset based lender with $400mn in assets and $20bn in deals undwerwritten over a twenty year history.
It's rare for any BDC to acquire another lender. Prospect Capital (ticker: PSEC) recently acquired a retail oriented lender, Medallion Financial ("TAXI") owns a bank (!), and Kohlberg Capital ("KCAP") has acquired asset managers for it's CLO managing subsidiary. Still, this is the first acquisition of a commercial asset based lender.
As you'd expect, the press release does no tell us much about Crystal Financial, and we have no prior knowledge of the company. We do note that the $400mn in existing assets is spread out over only two dozen borrowers. This relative concentration is similar to Solar's own approach.
Solar's press release says the new acquisition will have $145mn of unused availability to use for new loans at closing. This suggests Crystal Financial could easily balloon to over $0.5bn in assets in a short period,and with Solar Capital as a parent, the sky is the limit for total loan assets. No wonder Solar says the new investment is immediately accretive to earnings and will permit Solar to finally leverage itself up to it's target debt to equity. "If not now when ? " must be the question being asked in the halls of Solar Capital. With the economic expansion in it's fourth year, an under-leveraged balance sheet seems more like a poor strategic choice than the wise and conservative choice it might have been before. Targeting asset-based lending is a creative, and unusual, approach, especially for a BDC with the bulk of it's existing investments in subordinated and unsecured loans.
Still, there are questions any interested investor should ask:
First, we need to know what kind of "asset based and other secured financing solutions" Crystal Financial is involved in, what the loan yields are, and what is the direction of average yields. We'd expect the yields would be north of 9.0%. Most plain vanilla asset-based lending (which is still dominated by the big banks) is a low margin business. We doubt Crystal Financial is in that category, so what risks are they taking ? Is it security on very hard to value assets, or going long term on loans (unlikely) or is it lending to troubled or bankrupt borrowers who have good asset coverage, etc. ?
Second, we need to understand what financing arrangement has with it's own lenders. Besides the rates charged we need to know what covenants they have signed up for. When credit problems occur in the portfolio, the terms of Crystal Financial's borrowing arrangement might be the difference between Solar Capital's receiving distributions or not for a period.
Third, we'd be interested in reviewing the credit performance of the new acquisition since 1993. With Solar mentioning the volume of deals done over time, and clarifying that the Crystal Financial management team will continue to manage the portfolio, it begs the question: how have they done in good times and bad ? This is usually an item that gets stuffed deep into the footnotes, but deserves scrutiny for obvious reasons.
Finally, we'd be interested to know if Solar will be charging it's standard management fees on the total assets of Crystal Financial or just the $275mn of equity invested in the company.
NOTE: We bought SLRC today on the news.
Disclosure: I am long SLRC.