Oaktree Strategic Income Corporation
Q2 2016 Earnings Call Transcript

Published: 11 May 2016

[Operator:]

Good day, ladies and gentlemen and welcome to the Q2 2016 Fifth Street Senior Floating Rate Corporation Earnings Conference Call. [Operator Instructions] I would now like to introduce your host for today’s conference, Ms. Robyn Friedman. Ma’am, you may begin.

[Robyn Friedman:]

Thank you, Eric. Good morning and welcome to Fifth Street Senior Floating Rate Corp’s second quarter 2016 earnings call. I am joined this morning by Ivelin Dimitrov, Chief Executive Officer; Todd Owens, President; and Steve Noreika, Chief Financial Officer. Before we begin, I would like to note that this call is being recorded. Replay information is included in our May 10, 2016 press release and is posted on the Investor Relations section of Fifth Street Senior Floating Rate Corp’s website which can be found at fsfr.fifthstreetfinance.com. Please note that this call is the property of Fifth Street Senior Floating Rate Corp. Any unauthorized rebroadcast of this call in any form is strictly prohibited. Today’s conference call may include forward-looking statements and projections that reflect the company’s current views with respect to, among other things, future events and financial performance. Forward-looking statements may include statements as to the future operating results, dividends and business prospects of Fifth Street Senior Floating Rate Corp. Words such as believe, expect, seeks, plans, should, will, estimate, projects, anticipates, intend and future or similar expressions are intended to identify forward-looking statements, although not all forward-looking statements include these words. These forward-looking statements are subject to the inherent risks and uncertainties in predicting future results and conditions. Certain factors could cause actual results to differ materially from those projected or implied in these forward-looking statements. New risks and uncertainties rise over time and it is not possible for the company to predict those events or how they may affect it. Therefore, you should not place undue reliance on these forward-looking statements. We ask that you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these forward-looking statements and projections. To obtain copies of our latest SEC filings, please visit our website or call Investor Relations at 203-681-3720. We undertake no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise, except as required by law. The format for today’s call is as follows. Ivelin will provide introductory remarks, an overview of our results and a market update and Steve will summarize the financial results. Then we will open the line for Q&A. I will now turn the call over to our CEO, Ivelin Dimitrov.

[Ivelin Dimitrov:]

Thank you, Robyn. For the quarter ended March 31, 2016, FSFR generated $0.20 of net investment income per share, below our quarterly dividend of $0.225 per share. Our net investment income was impacted by low origination volumes, limited portfolio turnover and higher professional expenses related to preparation for FSFR’s annual meeting. In the quarter with only $15 million of originations, we are pleased that our net investment income would have covered our dividend on a per share basis for the third consecutive quarter if adjusted to exclude the incremental professional fees. This gives us considerable confidence that even in quarters marked by limited origination volumes, our dividend has been set to a level that we can regularly meet or receive. In addition, the credit quality of our portfolio was stable and we operated within our targeted leverage range of 0.8 times to 0.9 times debt to equity. Owing to the trends observed in 2015, the middle market experienced its weakest quarter for sponsored loan volume in 6 years. Sponsored issuance was down 45% from the December quarter and 31% on a year-over-year basis. New volume during the quarter was mainly driven by leverage buyouts and other M&A transactions as there were very few refinancings that occurred. Several factors contributed to the slowdown in the March quarter, including volatility in the energy and commodity sectors as well as in the credit markets generally slowing global growth in an uncertain economic outlook. Many of our private equity sponsors took a wait-and-see approach in the quarter given the life of quality deals in last evaluations. As we stated earlier and as a result of the broader market environments, we experienced loan origination volumes closing $15.5 million of investments across four transactions. We also experienced substantially lower than normal turnover in our portfolio. While January and February were particularly slow, we were encouraged by an increase in activity as the quarters were to a close and they are optimistic for an uptick in deal flow in the quarters ahead. Turning to our portfolio, FSFR continues to leverage the Fifth Street origination platform and remains focused on maintaining a diverse portfolio of senior secured floating rate loans. As of March 31, 2016, our portfolio consisted of senior secured floating rate loans spread across 62 companies in 29 industries with our largest non-controlled investment accounting for 4.9% of total assets. Overall, the credit quality of the portfolio remains healthy with approximately 89% of our portfolio consisting of senior secured floating rate debt investments. Overall – already a component of our overall portfolio over the next few quarters, we hope to continue increasing the proportion of our investments that are sourced by the Fifth Street origination platform. FSFR employs rigorous underwriting standards and a conservative approach on selecting positions. We employ a high degree of selectivity investing in credits with strong underlying fundamentals, including a focus on high cash flow sectors and specifically shying away from cyclical sectors such as energy. We are pleased that our energy exposure remains minimal at only 0.6% of total investment to fair value in just one portfolio company. Additionally, as we have previously mentioned, our portfolio does not have any CLO investments either debt or equity. As we look at the credit profile of our portfolio, we are pleased with the overall quality of our loans and underlying performance of our portfolio companies. As of March 31, 2016, although we did not add any new investments in non-accrual, we had two investments remained on non-accrual status, which comprised 2.6% of our debt portfolio at fair value. As we have previously mentioned, we placed Ameritox on non-accrual status in the December quarter. Our portfolio management team worked closely with the company and sponsor owners to restructure the investment. And subsequent to the end of the March quarter, we entered into a restructuring agreement, where we exchanged our debt investments for debt and equity securities in the restructuring entity. We feel comfortable with our current valuation of the investment and anticipate moving it off non-accrual in the next quarter. We remain excited about our joint venture with the Glick family and its ability to drive returns for FSFR shareholders. As a reminder, the joint venture expands FSFR’s investment capacity to originate and underwrite senior secured middle-market loans and also provides an efficient way to finance assets that enhance return of our shareholders. During the March quarter, our joint venture continued to make progress towards anticipated size of $300 million. As of March 31, 2016, the joint venture had $211 million in assets, including senior secured loans across 33 portfolio companies. The joint venture generated $2.1 million of income for FSFR during the quarter representing a 14% weighted average annualized return on our investment. The low-teens yield on our investment in the joint venture has been instrumental in driving an increased yield on FSFR’s overall portfolio. We remain enthusiastic about the prospects for the joint venture and its ability to continue driving value for FSFR’s shareholders. As we described earlier, we incurred higher than normal professional expenses in the March quarter primarily related to preparation for our annual meeting. Excluding these incremental expenses, we would have covered our dividend for the third consecutive quarter. Our management team and Board of Directors have continued confidence that our net investment income will meet or exceed our dividend. Looking ahead, we expect professional expenses to be modestly higher than typically in the June quarter and then declined to more normal levels. Additionally, we held our annual meeting of stockholders in early April and are thankful to our shareholders feedback and patience over few months. With the annual meeting behind us, we look forward to returning our undivided focus to our business as we continue to successfully execute on the company’s strategy. With that, I would now like to turn the call over to our Chief Financial Officer, Steve Noreika to discus our financials in more detail.

[Steve Noreika:]

Thank you, Ivelin. We ended the second quarter of 2016 with total assets of $629.1 million, down from $697.7 million at our fiscal year end. Portfolio investments totaled $575.4 million at fair value and were spread across 62 companies at March 31, 2016. At the end of the March quarter, we had $36.7 million of cash and cash equivalents on our balance sheet. Net asset value per share was $11.18 as compared to $11.36 at the end of the December quarter, driven mainly by credit and spread related write-downs. I would like to note that while the high yield market rallied prior to the close of the March quarter, the index we utilize in our mark to market process the LCD Middle Market index generally lags the broader market and therefore was down slightly for the quarter. Subsequent to quarter end, we have seen the LCD index follow the broader market in a positive direction. For the three months ended March 31, 2016, we generated total investment income of $13.2 million which was relatively flat compared to the prior quarter and net investment income of $5.8 million or $0.20 per share. During the quarter we closed $15.5 million of investments in two new and two existing portfolio companies and funded $20.5 million across new and existing portfolio companies. We also received $9.8 million in connection with the forward payments of two of debt investments also which were exited at par and an additional $33.4 million in connection with other pay-downs, syndications and sales of debt investments. As of March 31, 2016, 89.3% of the portfolio consisted of senior secured voting rate loans and 10.5% of the portfolio consisted of investments in the subordinated notes and equity interests in FSFR-Glick JV. We continue to build a well diversified portfolio and have our largest exposures in the software and healthcare industries. At March 31, the average size of our portfolio debt investments was $9.2 million and average portfolio company EBITDA was $58.9 million. Credit quality was strong once again with over 97% of the portfolio on accrual status. As Ivelin previously stated, I would also like to point out that one of the loans in category four and on non-accrual which is Ameritox was restructured subsequent to quarter end and we expect that it will return to accrual status in the June quarter. Ameritox represented 2.2% of our debt portfolio at fair value at March 31. The weighted average yield on our debt investments including the return on the JV was 8.4% as of March 31, 2016 and included a cash component of 8.3%, up from 8.0% and 7.8% respectively during the December quarter. As we mentioned on our last call in January, FSFR announced the closing of the $25 million senior secured revolving credit facility with East West Bank. The facility matures in January 2021 and will accrue interest at LIBOR or prime plus a variable margin. As Ivelin mentioned during the March quarter, we operated within our target leverage range ending the quarter at 0.89x debt to equity. As of March 31, we have $180 million of notes payable outstanding related to our securitization and $112.9 million drawn on our Citibank and East West Bank credit facilities. Last week, our Board of Directors declared monthly dividends of $0.075 per share for June, July and August. We expect that our Board of Directors will continue declaring monthly dividends on a quarterly basis, subject to various factors including company performance, capital availability as well as general economic and market conditions. And I will now turn it back over to Robyn.

[Robyn Friedman:]

Thank you for joining us on today’s call. Eric, please open the lines for questions.

[Ivelin Dimitrov:]

Thanks to everyone for joining us on the call today.

[Operator:]

Ladies and gentlemen, thank you for participating in today’s call. This does conclude the program. You may all disconnect.