Time To Sell Solar Senior Capital
Summary
- I recently sold my position in SUNS for the reasons discussed in this article.
- The company will announce results in 5 weeks with likely a 1.7% decline in its book value.
- SUNS is still a good company and I will likely repurchase at lower prices.
- This idea was discussed in more depth with members of my private investing community, Sustainable Dividends. Get started today »
Introduction
I rarely issue 'Sell' recommendations for business development companies ("BDCs") as investors can sit back and collect dividends while waiting out market pullbacks and temporary credit issues.
However, on September 27, 2019, I issued a 'Sell' for Solar Senior Capital (NASDAQ:SUNS) to subscribers of Sustainable Dividends for the reasons discussed in this article. SUNS is thinly traded with around 40,000 shares per day prior to my announced sale:
What Is A BDC?
Business Development Companies ("BDCs") were created by Congress in 1980 to give investors an opportunity to invest in private small and mid-sized U.S. companies typically overlooked by banks. Most BDCs are publicly traded with a highly transparent structure subject to oversight by the SEC, states and other regulators, providing investors with higher than average dividend yields (most between 7% and 13% annually) by avoiding taxation at the corporate level. This allows them to pass along ordinary income and capital gains directly to the shareholder. SUNS is typically among the lower yield BDCs due to having lower-yielding and safer investments but still has a much higher yield and overall returns than the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) and the SPDR Barclays Capital High Yield Bond ETF (JNK) as discussed in "Search For Yield: Bond Funds Vs. BDCs."
It should be noted that TPVG is usually higher yield but currently aggressively priced in my opinion.
Upcoming Volatility And General Market Pullback?
As mentioned in "Balancing Your Portfolio With BDC Baby Bonds," I have been making select purchases of BDC baby bonds and preferred shares as I believe there will likely be a general market and/or BDC sector pullback in Q4 2019 for multiple reasons including seasonal as well as taking profits (selling and locking in gains). The average BDC was down around 3.5% during the first 3 days of Q4:
SUNS Risk Profile Update
During Q2 2019, SUNS's net asset value ("NAV") per share decreased slightly by $0.06 to $16.34 per share due to net unrealized losses including additional markdowns of its investment in American Teleconferencing Services and mostly writing off its only non-accrual investment TridentUSA Health Services. SUNS had net realized gains of $0.1 million primarily related to the exit from its investment in Mavenir Systems, Inc.
TridentUSA Health Services (cost of $7.0 million, fair value of $0.1 million) was previously added to non-accrual status and mostly written off during the recent quarter. Trident now accounts for 0.0% of portfolio fair value and is the only portfolio company with an "Internal Investment Rating 4" implying that the investment is "performing well below expectations and is now anticipated to be repaid in full."
The following is from the recent earnings press release and my primary concerns are the "Internal Investment Rating 3" which are investments "performing below expectations, may be out of compliance with debt covenants":
Our internal risk assessment maintained an approximately two rating when measured at fair market value based on our one to four risk rating scale with one representing the least amount of risk. And at June 30, our watch list represented approximately 4% of our portfolio.
Source: SUNS Management on Q2 2019 Results - Earnings Call Transcript
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The following table shows my watch list investments which are likely the same "Internal Investment Rating 3" investments included in the previous table.
I believe that American Teleconferencing Services ("ATS") is likely overvalued and will contribute to upcoming NAV declines for the reasons discussed at the end.
Second-lien positions account for less than 2% of the portfolio and management is expecting this to decline over the coming quarters:
Approximately, 98% of our portfolio consisted of senior secured loans of which approximately 55% are in first lien cash flow loans and approximately 43% are in first lien asset-based loans with only 1.6% in second lien cash flow loans and we expect this to continue to decline over the coming quarters. Our equity exposure increased slightly in the quarter to 0.5% of the portfolio as a result of the fair value appreciation of this equity investment.
Source: SUNS Management on Q2 2019 Results - Earnings Call Transcript
Also, the company has access to a higher quality credit/origination platform supported by PIMCO and Deerfield Management.
Solar Capital Partners previously announced the closing on private credit funds with total equity commitments of over $750 million. Included in new funds expected leverage are existing SMAs and our two BDCs with their increased investment capacity, the FCP platform now has over $5.5 billion of investable capital. The increased scale of capital across our platforms strategically positions us to be a solutions provider with an ability to speak for as much as $200 million in a given transaction while still maintaining our strict conservative diversified portfolios. We expect this greater enhanced investment capacity across the platform to result in more investment opportunities for SUNS, with an enhanced ability to negotiate terms and meet our stringent underwriting criteria. The SUNS platform is in a strong liquidity position.
Source: SUNS Management on Q2 2019 Results - Earnings Call Transcript
SUNS Dividend Coverage Update
Management has committed to waiving fees to support the dividend. For the quarter ended June 30, 2019, SUNS hit its base-case projections covering its dividend only due to continued fee waivers. Another concern is the continued increase in the amount of fee waivers needed to cover its dividend over the last three quarters (see details below).
There is the potential for improved dividend coverage as the company increases its use of leverage and grows its investment in North Mill Capital ("NMC") that recently acquired the $40 million portfolio of Summit Financial Resources:
We are pleased to announce that at the end of the second quarter, North Mill acquired Summit Financial Resources, a leading provider of asset-based lending and factoring services across the US, with a strong West Coast footprint. The acquisition, which is highly complementary to North Mill's existing platform, drove our second quarter portfolio growth and the resulting increase in our exposure to asset-based loans to approximately 43% of our comprehensive portfolio. In conjunction with the transaction, the team who originated these loans has joined North Mill, providing North Mill with a broader geographic footprint, particularly on the U.S. West Coast. Additionally, the acquisition enhances North Mill's factoring capabilities which provide further diversity to SUNS' portfolio as well as yield given factory loans tend to carry higher returns.
During the second quarter, we funded $56 million of new investments and had repayments of $9 million. Including the $40 million factoring portfolio that we acquired with Summit Financial, the portfolio now consists of 151 issuers with an average funded loan size of just over $1 million. The weighted average asset-level yield at North Mill was 13.5% compared to 13.1% for the quarter -- the first quarter. This increase was driven by the acquisition of Summit. We are pleased with the increased issuer and geographic diversification that Summit brings to North Mill. Additionally, we view factoring as a highly attractive asset class, and this portfolio as well as the addition of the Summit team increases North Mill's exposure to an expertise in factoring. Summit's strong Midwest and Western U.S. presence complements North Mill's existing footprint. The Summit team has a strong credit culture consistent with North Mill's, and we anticipate that the addition of Summit will result in continued portfolio growth for North Mill.
Source: SUNS Management on Q2 2019 Results - Earnings Call Transcript
Also, management has mentioned the possibility of additional acquisitions:
The asset coverage modification approved last year provides SUNS with additional flexibility and capacity to make controlled equity investments in specialty finance businesses and we're actively evaluating additional portfolios of asset-based loans and special lending platforms to acquire.
Source: SUNS Management on Q2 2019 Results - Earnings Call Transcript
As mentioned in previous reports, shareholders approved the reduced asset coverage ratio allowing for higher leverage and the immediate integration of its First Lien Loan Program ("FLLP"). SUNS will target a range of 1.25 to 1.50 debt-to-equity and took on additional debt associated with the FLLP but its debt-to-equity is still around 0.84 (net of cash is 0.81).
At June 30, Solar Senior is in a strong liquidity position with net leverage of 0.81 times debt to equity. We intend to move close to our target leverage of 1.25 times to 1.5 times debt to equity by growing our portfolio over time.
Source: SUNS Management on Q2 2019 Results - Earnings Call Transcript
Previously, SUNS announced that it had amended its credit facilities' leverage covenants to allow for the asset coverage ratio minimum of 150%. At June 30, 2019, SUNS had $81 million of unused borrowing capacity under its revolving credit facilities. However, including NMC and Gemino non-recourse credit facilities, the company had approximately $157 million of unused borrowing capacity under its revolving credit facilities as of June 30, 2019.
When considering the combined credit facility of SUNS' balance sheet and the North Mill and Gemino, there's $157 million of available debt capacity across the SUNS platform subject to borrowing base limitations. We'll continue to be highly disciplined in deploying our available capital.
Source: SUNS Management on Q2 2019 Results - Earnings Call Transcript
Reasons to Sell/Trim SUNS
- Likely NAV decline announced in Q3 2019 due to American Teleconferencing Services.
- Recently increased reliance on fee waivers.
- Current pricing.
I believe that investors should sell or at least trim current positions and be ready to re-purchase at lower prices. I sold my position at an average price of $17.67 on September 27, 2019, due to likely NAV per share decline of 1.7%, increased reliance on fee waivers, current pricing and RSI of over 70 as shown in the BDC Google Sheets.
SUNS will report results after the close of the markets on November 4, 2019, and the company will likely report lower NAV per share discussed next.
There is a good chance that American Teleconferencing Services ("ATS") is still overvalued as other BDCs have the same investment valued at an average of 62% of cost compared to SUNS at 96% of cost. I am expecting additional unrealized losses in Q3 2019 related to this investment which will likely result in a 1.7% decline in NAV per share unless there are positive developments with this investment. However, it should also be pointed out that CSWC, MAIN and PFLT have conservative valuation practices as mentioned in their respective reports.
ATS operates as a subsidiary of Premiere Global Services ("PGi"), offering conference call and group communication services. On January 28, 2019, Moody's downgraded PGi's debt to Caa2:
Moody's: "The downgrade of the CFR reflects Moody's view that PGi's EBITDA will deteriorate significantly over the next 12 months. Given PGi's challenges, Moody's believes that the company's ability to meet covenants beyond 2Q 2019 is highly uncertain and the capital structure is unsustainable. The risk of default and debt impairment is high given the continuing erosion in revenues and EBITDA. PGi has proposed amendments to its existing credit agreements to waive the total leverage covenant for 2Q 2019 and a potential going concern qualification requirement in its 2018 financial statements. The company also expects to complete the sale of certain non-core assets in the near term, which management believes, along with the equity support, will provide the company adequate liquidity through 2019 to execute on its plans to commercially offer a new UCaaS offering. The continuing support from financial sponsors' is credit positive. However, Moody's believes that the proposed amendment and equity infusion will only improve PGi's liquidity on a short-term basis."
Source: Moody's Ratings
The information in this article was previously made available to subscribers of Sustainable Dividends, along with:
- SUNS target prices and buying points
- SUNS dividend coverage expectations and worst-case scenarios
- SUNS rankings and risk profile
- Real-time changes to my personal BDC positions
This article was written by
BDC Buzz is a professional money manager with over a decade of experience generating institutional-quality research.
He is the leader of the investing group Sustainable Dividends where he provides investors live portfolios with real-time updates, weekly BDC sector updates, company projection reports, baby bond reports, and live chat access to answer questions. Learn more.Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (32)
----------------------------------------And...."Including the $40 million factoring portfolio that we acquired with Summit Financial, the portfolio now consists of 151 issuers with an average funded loan size of just over $1 million. ""How can any BDC try to keep track of, and follow the success and failure of 151 issuers? How many issuers does the average BDC have?
You always offer some wonderful information and charts. I do not own SUNS, but knowing you would buy back in is a reason to keep it on a watch list. I find your sage advise tucked in the articles about other BDCs and the comments too! So much fun to read and learn.
Still long ARCC, TCPC (added some on the recent dip), PFLT, CGBD and hold a tiny amount of FSK. I will wait for those Oct-Nov dates to do anything more or one of your articles that reveal so much vision. Best, Rose :))
