February 26, 2013: We reviewed the 10-K for senior lender BDC Solar Senior Capital ("SUNS") to review credit quality, and give the portfolio a grade, for ease of comparison with it's peers and over time.
PORTFOLIO CREDIT BREAK-DOWN:
At December 31, 2012, the Company had 31 loans in portfolio, and no material equity investments.
Of the 31 borrowers, 30 were performing normally, none was on our Watch List (we place on the Watch List any loan written down from Cost to Fair Market Value of 5%-25%), and 1 was Under-Performing (written down by 25% or more but still paying interest and principal). There were no loans on non-accrual.
The only Under Performing borrower was Engineering Solutions & Products, a defense related company. The $9.7mn cost loan was written down to $5.5mn. Engineering Solutions' value has been coming down through 2012, and took a major write-down this quarter, representing essentially all the Unrealized Depreciation for the fourth quarter. The loan was booked in 2011. Click here for a link about the original deal, which has some quality names involved. As explained on the CC, the Company and the sector are under pressure from defense cut-backs. Management is talking about a recapitalization of the balance sheet.
On the Conference Call, management expressed no concerns about any other credit and pointed out that EBITDA coverage of debt service (or was it interest expense ?) was 3.3x, which is a healthy level and typical for the middle market.
SUNS has another portfolio company which provides ready to eat meals to military, which is performing adequately.
POTENTIAL IMPACT OF POTENTIAL NON PERFORMING LOANS:
The Engineering Solutions loan yields 8.5%. If the company were to go on non-accrual and written down 100%, we estimate the net impact on SUNS distributable income (using the year end stock count,which does not include a recent equity issue) would be 6 cents, or 3 cents if the current FMV valuation holds.
Looking at the Company's unused capital capacity and assuming new loans are made at a yield of 7.5%, and assuming maximum debt to equity goes to 0.7 to 1.0 (we are just guessing that's the self imposed limit of SUNS, but it may be higher) we calculate that the Company can still earn 27 cents a share (again, without considering the new equity). To give a sense of proportion, the annualized Net Investment Income in the IVQ 2012 was $1.44.
Assuming the income from Engineering Solutions is lost, but SUNS maxes out it's borrowing capacity, Net Investment Income could rise to $1.65. That's a very pro-forma number given the numerous assumptions involved about the Company's yields (under pressure like all leveraged debt); the amount of leverage to be used, operating expenses for running the enterprise etc.
We grade every BDC review on the curve. An A grade is reserved for a BDC which has no non performing or under-performing loans,less than 5% on the Watch List and the credit outlook for a similar level of quality to continue. Last quarter SUNS credit rating was an A.
This quarter, Solar Senior Capital gets an A-, given that there are no non-performing loans, the only 1 Under Performing loan (which they call "stressed") was decently structured with a 36% equity contribution from management and Berkshire Hathaway as owners, and financial troubles appear to have more to do with Washington than the company itself. We would not be surprised if SUNS achieved a full recovery over time, based on the few facts we know. We are also encouraged that SUNS has no loans on Watch List, and by management's low key but evident confidence in their credit outlook.
Given that SUNS' strategy is to focus on "safer" senior secured loans in return for lower yields, and with no equity investments to buoy Net Asset Value over time, maintaining very high credit quality is critical for this BDC. To date, and admittedly we are living in a benign credit environment and the Company's history as a public company is short, Solar Senior Capital is performing well, despite the drop from A to A-.
Disclosure: I am long SUNS.