Oaktree Strategic Income Corporation
Q3 2014 Earnings Call Transcript

Published: 10 Sep 2014

[Operator:]

Good day, ladies and gentlemen and welcome to the Fiscal Q3 Fifth Street Senior Floating Rate Corp. Earnings Conference Call. My name is Whitley and I will be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this call is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Ms. Robyn Friedman, Vice President of Investor Relations. Please proceed.

[Robyn Friedman:]

Thank you, Whitley. Good morning and welcome to the rescheduled fiscal third quarter 2014 earnings call for Fifth Street Senior Floating Rate Corp. or FSFR. We apologize for having to reschedule, but the original call is scheduled while our recent follow-on equity offering was in progress and therefore needed to be postponed. I am joined this morning by Leonard Tannenbaum; Bernard Berman, Chairman of the Board; Ivelin Dimitrov, Chief Executive Officer and Richard Petrocelli, Chief Financial Officer. Before we begin, I would like to note that this call is being recorded. Replay information is included in our August 25, 2014 press release and is posted on the Investor Relations section of Fifth Street Senior Floating Rate Corp. 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 includes forward-looking statements and projections. 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. We do not undertake to update our forward-looking statements unless required by law. To obtain copies of our latest SEC filings, please visit our website or call Investor Relations at 203-681-3720. The format for today’s call is as follows. Len will provide introductory remarks, Ivelin will provide an update on the quarter’s performance, Bernie will discuss our recent equity raise, and Rich will summarize the financials. Then we will open the line for Q&A. I will now turn the call over to Len Tannenbaum.

[Leonard Tannenbaum:]

Thank you, Robyn. I recently made the decision to resign as Chief Executive Officer and the Director of FSFR. I will continue to be the Chief Executive Officer of both Fifth Street Finance Corp. and Fifth Street Management, which is the investment advisor to FSFR. With FSFR gaining scale, the Board has decided to hand off the day-to-day operations and promote Ivelin Dimitrov to Chief Executive Officer, well-deserved. As CEO of our investment advisor, I will remain actively involved with Fifth Street’s overall platform. Prior to his appointment as CEO, Ivelin has been serving as President and Chief Investment Officer, where he has been responsible for all investment activities at FSFR since its inception in July 2013. Additionally, he has been instrumental in leading our senior loan strategy. I am extremely excited about the future of FSFR and know that I am leaving FSFR in great hands with Ivelin as our CEO for many years to come. This transition reflects the great confidence that I have in Ivelin’s leadership as well as the depth and breadth of our team. As he has since its inception, Ivelin will be instrumental in executing the strategic vision in growing FSFR into a leading senior floating rate focused BDC. By the way, Ivelin has been instrumental over the last 10 years and he is coming up on almost 10 years with us at Fifth Street. And if you really understand the leadership at Fifth Street, Ivelin on the inside perspective has been leading the firm for many years already. In addition to promoting Ivelin further enhancing the FSFR management team, the Board has appointed Todd Owens as President. Todd’s appointment is effective on September 29 where he joins the firm after spending 24 years at Goldman Sachs. As a Managing Director and a partner at Goldman Sachs, he has held various positions, including Head of the West Coast Financial Institutions Group for 15 years, Head of the Specialty Finance Group for almost a decade, and a senior member of the bank group. Todd’s experience spans a broad range of financial service sectors, including commercial finance, asset management, alternative asset management, commercial banking and business development companies. Our relationship with Todd dates back to 2007. When in 2008, he and Goldman Sachs took our first BDC public. We are very excited for him to join the Fifth Street team. I will now turn the call over to Ivelin Dimitrov, our new Chief Executive Officer.

[Ivelin Dimitrov:]

Thank you, Len. I would like to thank Len for leading FSFR as its Chief Executive Officer since its July 2013 IPO and we look forward to his continued guidance as Chief Executive Officer of our investment advisor. We have worked together for almost 10 years and shared the same outlook on the investment front. So, I do not expect much to change. As FSFR has recently scaled and has the ability to grow into the largest senior floating rate focused BDC, I am very excited to transitioning to my new role as CEO. I have been intimately involved with FSFR since its inception in July 2013 as its Chief Investment Officer and then later also as President examining every investment and thinking strategically about the direction of FSFR. My experience as Chief Investment Officer and heading up our senior loan strategy will be important as we continue to execute on our plans to grow FSFR into a market leader. I am very excited about this opportunity, very enthusiastic about FSFR’s future, and look forward to having the chance to meet many of our analysts and investors over the coming months. I also want to congratulate the team on Fifth Street Senior Floating Rate Corp.’s one year anniversary. Since July of last year, we successfully deployed over $200 million in a diversified portfolio of senior secured floating rate loans. Our initial ramp and subsequent portfolio optimization have allowed FSFR to consistently increase net investment income per share since inception. For the quarter ended June 30, 2014, FSFR generated $0.28 of net investment income per share, which represents its fourth consecutive quarter of growth in net investment income per share. We ended the June quarter invested in a diverse group of senior secured floating rate loans across 42 portfolio companies. Looking at the underlying trends in our portfolio companies from a macro perspective, we feel that we are on solid footing as exhibited by the stability in year-over-year sales and profitability growth. We have focused on building a portfolio of recession-resistant businesses, which will protect our downside in the event of market volatility. This view drives our underwriting decisions as well as we are disciplined around adding assets to the portfolio that fits the criterion standards on which we have based our underwriting culture, strong credit protection, tie documentation, capable and seasoned management teams and doing business with relationship oriented middle-market sponsors. FSFR remains well positioned to target the attractive floating rate senior secured asset class due to our access to invest on opportunities from Fifth Street’s origination platform and our lower fee structure and lower cost leverage compared to many other BDCs. To-date, FSFR has leveraged Fifth Street’s relationships with sponsors, investment banks and other lenders to access 5 million to 10 million participations in middle-market and upper middle-market senior secured floating rate loans. With the increased capital base from the August 2014 follow-on equity offering, FSFR is now in position to underwrite and commit to larger hold sizes for senior loans directly originated by the Fifth Street platform. This should lead to greater diversity across our holdings and allow us to take a lead investor role in most transactions similar to our affiliated BDC Fifth Street Finance Corp. As one of the leading middle market lenders the Fifth Street platform sees a tremendous amount of deal flow. We have been increasingly busy working with our sponsor partners to underwrite new investment opportunities focusing on senior secured loans. We are utilizing the benefits of the origination platform and sourcing deals from new sponsors as well as partners with which we have accomplished multiple transactions. As we head into the December quarter, which is historically our strongest quarter, our investment pipeline is at its highest level since FSFR’s inception. We are confident that the equity capital that we raised during our recent offering will be fully invested by mid-October. We are also confident that our investment in underwriting teams well staffed and prepared to handle additional growth in FSFR’s portfolio. I will now turn the call over to Bernard Berman, our Chairman of the Board to provide some detail around our recent equity offering.

[Bernard Berman:]

Thanks Ivelin. In May 2014, FSFR filed a proxy calling for a special meeting of stockholders, whereby stockholders were asked to vote on the proposal that would allow the company with approval of its Board to sell shares of its common stock below its then current net asset value per share subject to certain limitations outlined in the proxy statement. On July 10, 2014, at the special meeting the company stockholders approved the proposal with over 85% of the overall votes caste in favor and over 77% of the unaffiliated votes cast in favor. After many conversations and diligence completed by the Board of Directors, the Board determined that it was in the best interest to shareholders to execute on a follow-on equity offering and authorized the company to do so at a predetermined price range. On August 14, 2014, FSFR priced a public offering of 22.8 million shares of its common stock at a price of $12.91 per share. With our enhanced scale and liquidity gained through the follow-on equity offering, we are well positioned to take advantage of the attractive senior loan market dynamics to continue growing FSFR into a market leader. We believe we have ample liquidity to execute on all of our current strategic initiatives and fund our growing pipeline. As a result we have no plans to sell additional equity for low book value. There are many benefits to FSFR’s increased scale including the ability to commit to larger hold sizes, which will allow us to originate and hold middle market senior loans, the ability to fund joint ventures such as the announced partnership between FSFR and GF Funding, enhanced liquidity for shareholders and substantially increased G&A leverage. We initially used the portion of the proceeds from the equity offering to pay down our revolving credit line with the intention to redraw after we invest the equity proceeds in our growing pipeline of attractive floating rate senior secured assets. I would now like to turn the call back over to Ivelin.

[Ivelin Dimitrov:]

Thanks Bernie. We are pleased to announce the yesterday we have received final approval from the SEC of our exempted application to co-invest with other funds managed by our investment advisor. Also our investment advisor now has capacity to hold up to $250 million of any particular investment across the platform. Sharing deal flow with other funds managed by our investment advisor should allow us to deploy capital and differentiate us from competitors due to an increased hold size which is important in the middle market. With this approval we plan on investing some of our assets into potentially higher yielding unitranche loans originated through the Fifth Street platform which we would expect to be accretive to net investment income per share. Lastly we are very enthusiastic about our strategic partnership with GF Funding 2014, an entity to be controlled by the Glick family to establish a joint venture to co-invest primarily in senior secured loans. This strategic partnership should allows FSFR to enhance the returns on its invested equity, growing its investment opportunity set and improve its long-term growth potential. Once fully ramped, we believe this partnership could generate an estimated mid-teens return on FSFR’s invested equity, which would be accretive to net investment income per share. This partnership is expected to be structured similar to Senior Loan Fund, JV 1, a recently formed joint venture between FSC and a subsidiary of Kemper Corporation. Going forward, we believe that funding the pending joint venture with a great family, deploying the proceeds from our equity raising to attractive senior secured floating rate loans in our investment pipeline, and adding higher yielding (long-term) investments should allow FSFR to continue generating stable and consistent net investment income per share. I will now turn the call over to Rich Petrocelli, our Chief Financial Officer.

[Richard Petrocelli:]

Thanks, Ivelin. We generated total investment income of $3.8 million and net investment income of $1.86 million or $0.28 per share for the quarter ended June 30, 2014. Net investment income increased 4% from $1.79 million or $0.27 per share in the prior quarter. We ended the June quarter with portfolio investments of $191.5 million at fair value. During the quarter, we had gross originations of $79.7 million in 19 new and 1 existing portfolio companies and funded $77.3 million across new and existing portfolio companies. We also received $65.4 million in connection with payoffs and open market sales of 19 debt investments. As of June 30, 2014, a 100% of the portfolio consisted of senior secured floating rate loans. Weighted average cash yield on our debt investments was 7%, which increased from 6.6% as of December 31, 2013. Our portfolio consisted of 42 companies with our largest exposures in the healthcare and software industries. We continue to build a well-diversified portfolio. And at June 30, the average size of a portfolio investment was $4.6 million and average portfolio company EBITDA was $62.9 million. Credit quality was strong once again as 100% of the portfolio remained on accrual status as of June 30, 2014. Turning to our capital structure, as of June 30, we had fully invested our July 2013 IPO proceeds of $100 million as well as $89.8 million of leverage from our Natixis credit facility, bringing our leverage ratio to 0.89 times debt to equity at quarter end. As a reminder, our Natixis facility carries a very attractive interest rate of commercial paper plus 190 basis points per annum. In May, our Board of Directors declared a September quarterly dividend of $0.30 per share to stockholders of record on September 15 reflecting an annualized run-rate of $1.20 per share. This week, our Board of Directors expressed its confidence in our business by keeping the December quarterly dividend consistent with the September quarterly dividend at $0.30 per share, which represents a run-rate of $1.20 per share. The December quarterly dividend demonstrates our policy to provide a consistent and stable dividend, which will be available to stockholders of record on December 15. Now, I would like to turn the call back to Robyn.

[Robyn Friedman:]

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

[Operator:]

(Operator Instructions) Your first question comes from the line of Christopher Nolan with MLV Company. Please proceed.

[Christopher Nolan:]

Hi, guys. Ivelin, congratulations on your promotion.

[Ivelin Dimitrov:]

Thank you. Very excited.

[Christopher Nolan:]

What is the timeframe to fully deploy the capital that was raised in this recent follow-on?

[Ivelin Dimitrov:]

We have a number of deals in the pipeline right now that we are working on. We think most of them will get through our investment process in close by the end of September. A few of them will probably slip into October. And so we are confident by mid to late October, we should beat through the GAAP.

[Christopher Nolan:]

So – and then how about the associated debt capital on that, when do you anticipate to get back to a fully leveraged balance sheet?

[Ivelin Dimitrov:]

Probably by – it will be in the December quarter most likely.

[Christopher Nolan:]

So, we should anticipate that the leverage ratio, so the company should ramp up by fourth quarter 2015, so September 2015, is this correct or am I misinterpreting?

[Ivelin Dimitrov:]

By the end of the – so, the December quarter historically across the platform is our busiest quarter. So, we expect we will need a fair amount of additional capital. We are in conversations with our partners in Natixis and also other lenders to obtain efficient financing for the vehicle and we are highly confident we will be able to get something done with them and continue to optimize the leverage for the vehicle.

[Christopher Nolan:]

Okay. So, we should anticipate, I am sorry to ask in just different ways, but just anticipate a fully leveraged capital structure by the end of the December quarter?

[Ivelin Dimitrov:]

That’s correct by December 2014.

[Christopher Nolan:]

Okay, great. Thank you for clarifying that.

[Operator:]

Your next question comes from the line of Chris Kotowski with Oppenheimer & Company. Please proceed.

[Chris Kotowski:]

Yes. Can you just remind us how large is the current credit facility and any idea of what you hope to expand that to?

[Ivelin Dimitrov:]

The current facility with Natixis is a $200 million facility.

[Chris Kotowski:]

Okay.

[Ivelin Dimitrov:]

I am sorry, I apologize the $100 million facility.

[Richard Petrocelli:]

And we will expand it to $200 million.

[Chris Kotowski:]

To $200 million, okay. And….

[Richard Petrocelli:]

I am sorry, it’s an expandable facility and something that when we underwrote the original facility with Natixis they had more capacity to provide to us. Given the size of our balance sheet, we only used up $100 million of capacity available, but we feel we should be approved expeditiously for the expansion.

[Chris Kotowski:]

Okay. And have you disclosed this size of the commitment to GS funding?

[Ivelin Dimitrov:]

We have not yet. That’s something that we are in conversations with our partners, but you will look substantially similar to – in its structure to what we did at FSC with Kemper Corporation.

[Chris Kotowski:]

Okay. And the all-in net asset value post offering that we have calculated somewhere around $12.80, is that right?

[Ivelin Dimitrov:]

That number is we have seen that number in a few analyst reports, that’s….

[Chris Kotowski:]

Okay. Alright, that’s it from me. Thank you.

[Operator:]

That concludes our Q&A. I will now turn the call back over to management for closing remarks.

[Ivelin Dimitrov:]

As we mentioned in the call so far, we are very excited about the recent equity offering and the future of the company. Thank you everyone for participating on today’s call.

[Operator:]

Ladies and gentlemen that concludes today’s conference. Thank you for your participation. You may now disconnect. Have a great day.