Oaktree Strategic Income Corporation
Q1 2015 Earnings Call Transcript

Published: 9 Feb 2015

[Operator:]

Good day ladies and gentlemen and welcome to the quarter one 2015 Fifth Street Senior Floating Rate Corporate earnings call. My name is Karen and I’ll be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question and answer session towards the end of the conference. If at any time during the call you require assistance, please key star, zero and an operator will be happy to assist you. As a reminder, this call is being recorded for replay purposes. I would now like to turn the call over to Robyn Friedman, Vice President of Investor Relations. Please proceed.

[Robyn Friedman:]

Thank you, Karen. Good morning and welcome to Fifth Street Senior Floating Rate Corp.’s fiscal first quarter 2015 earnings call. I am joined this morning by Ivelin Dimitrov, Chief Executive Officer; Todd Owens, President; 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 January 9, 2015 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. 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

[Ivelin Dimitrov:]

Thank you, Robyn. For the quarter ended December 31, 2014, FSFR generated $0.35 of net investment income per share. During the quarter, we deployed all of the remaining capital raise during our August 2014 follow-on equity offering and utilized leverage provided by our $200 million credit facility with Natixis to close $466 million of investments across 23 new and two existing portfolio companies. Historically, the December quarter has been the most active for new originations. As a sponsor of [indiscernible] direct origination platform, in the normal course of business we typically see a handful of transactions slip from one quarter to the next. Unlike previous years, we closed all of the deals in FSFR’s pipeline that were expected to fund before calendar year-end, and even closed a few deals that were projected to fund in the March quarter. As a result, our origination totals for the December quarter surpassed our expectations and going forward we expect our deal flow and quarterly originations to normalize. Despite broader capital markets volatility, the overall middle market lending environment remains healthy. During periods of volatility, borrowers rely less on the syndicated market which creates more opportunities for senior tranche and one-stop solutions. As part of the larger Fifth Street origination platform, FSFR is well positioned to take advantage of these opportunities. Fifth Street’s distinction as a leading middle market lender and its strong relationships with private equity sponsors creates a wide funnel of investment opportunities. This allows FSFR to selectively invest in opportunities with attractive risk-adjusted returns. Additionally, our SEC co-investment approval provides us with an effective way to deploy capital, enhance portfolio diversity, and commit to larger hold sizes when underwriting transactions, which is a key differentiating factor in the middle market. As we continue to grow by leveraging the Fifth Street origination platform, we anticipate that we will proactively rotate into higher yielding assets, which should provide us with a sustainable and steady portfolio yield. In the short term, this may introduce some volatility around weighted average yield and portfolio composition. FSFR remains focused on building a diverse portfolio of senior secured floating rate loans through our direct origination efforts and disciplined underwriting process. The credit quality of the portfolio continues to be strong with not investments in non-accrual, and we continue to see positive underlying trends across our portfolio companies. Investments in our portfolio are spread across 57 companies in 28 industries. We get focused on investing in defensive and high cash flow generating sectors while limiting our exposure to commodities risk, including the energy sector. As of December 31, FSFR’s exposure to the energy sector was only 0.8% of investments at fair value, and was comprised of one senior secured loan in the oil and gas equipment services sector. Our largest position is in the internet software and services sector, which accounted for 10% of total investments at fair value as at December 31. We have since syndicated a portion of that transaction and it is currently comprised of 6% of the investments at fair value. Our capital markets team remained active during the December quarter. We currently have several investors evaluating additional syndication opportunities which may increase the velocity of our portfolio. Our capital markets capabilities allow us to optimize hold size, manage portfolio diversification, and mitigate concentration risk. Additionally, by committing to larger hold sizes and then syndicating down, we may potentially generate enhanced yields on certain investments. For example, FSFR initially held $68 million in our co-investment transaction to support Veritas Capital’s acquisition of BeyondTrust, Inc. While BeyondTrust currently remains a top 10 position, we syndicated our exposure down to $39 million at December 31. We are currently in conversations with multiple providers to obtain leverage for FSFR Glick JV LLC, our joint venture with an entity controlled by the Glick family. We anticipate closing leverage for the joint venture in the coming months. As a reminder, the JV expands FSFR’s investment capacity to originate and underwrite senior secured middle market loans and provides an efficient way to finance assets that can enhance returns for our shareholders. We are enthusiastic about the opportunity provided by the joint venture and believe this partnership will be fundamental in driving long-term earnings and should ultimately be accretive to net investment income. We believe we are well positioned to take advantage of attractive investment opportunities, and I look forward to providing continuous updates as we execute on our initiatives. I would now like to turn the call over to our President, Todd Owens.

[Todd Owens:]

Thank you, Ivelin. As Ivelin mentioned, FSFR deployed all of the remaining capital raised during this August 2014 follow-on equity offering and utilized its $200 million Natixis credit facility in the December quarter. Since the end of the December quarter, we have closed on a $175 million credit facility led by Citibank. This credit facility provides FSFR with additional capacity to provide flexible floating rate senior secured loans to private equity sponsor-backed companies. We believe FSFR should benefit from the diversification of institutional lender relationships, attractive borrowing costs, and ample capital. As of December 31, 2014, we were operating at 0.5 times leverage ratio, but believe the additional capacity provided by the Citibank facility should allow us to reach our targeted leverage range of 0.8 to 0.9 times debt to equity in the March quarter. The Board has decided to move from a quarterly to a monthly dividend to provide our shareholders with more frequent distributions. As a reminder, our board of directors declared a $0.30 per share dividend payable on April 15 to shareholders of record on April 2. Additionally, the board of directors has declared a monthly dividend of $0.10 beginning in May through August of 2015, representing an annualized run rate of $1.20 per share. As Ivelin described earlier, due to the continued ramp of FSFR and originations above our expectations, we believe that our net investment income per share for the December quarter is higher than sustainable levels. As we finish deploying the new capital, we expect to have additional clarity around our steady state earnings power. It is our intention to set our dividend at a sustainable level, and our board of directors are presently comfortable with $0.30 per share per quarter. As we have stated, going forward we intend not to issue stock below net asset value at FSFR. We recently mailed our 2015 proxy to shareholders, which did not include a request for authorization to issue stock at prices below NAV per share. After our annual meeting on March 18, our current authorization to issue stock at prices below NAV will expire. I will now turn the call over to our Chief Financial Officer, Richard Petrocelli.

[Richard Petrocelli:]

Thank you, Todd. We generated total investment income of $15.9 million and net investment income of $10.4 million or $0.35 per share for the quarter ended December 31, 2014. Total investment income increased from $6.3 million and net investment income increased from $3.8 million or $0.22 per share in the prior quarter. Net asset value per share was $12.53, which was a $0.12 decrease from the prior quarter. The decline in net asset value was driven by a $0.17 per share change in the market value of the portfolio due to yield movements, which was offset by $0.05 from generating net investment income in excess of our dividends. We ended the December quarter with portfolio investments of $596 million at fair value, which represented 100% quarter-over-quarter increase. During the quarter, we had gross originations of $466 million in 23 new and two existing portfolio companies, $443 million of which was funded at close. We also received $142 million in connection with full or partial payoffs and sales of 22 debt investments, all of which were exited at or near par. Our portfolio consisted of 57 companies with our largest exposure in the healthcare and software industries. We continue to build a well diversified portfolio, and at December 31, 2014 the average size of a portfolio investment was $10.4 million and average portfolio company EBITDA was $58.6 million. Credit quality was strong once again as 100% of the portfolio remained on accrual status as of December 31, 2014. The weighted average cash yield on our debt investments was 7.1%, which increased from 6.6% at December 31, 2013. Turning to our capital structure, as of December 31 we had drawn $185 million on our $200 million Natixis credit facility and have additional debt capacity from our recently closed $175 million credit line with Citibank. The Citibank credit facility has a three-year reinvestment period and a final maturity of January 2020. Borrowings will accrue interest at LIBOR plus 200 to 225 basis points per annum. I will now turn it back over to Robyn.

[Robyn Friedman:]

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

[Operator:]

[Operator instructions] Your first call comes from the line of Christopher Nolan from MLV & Company. Please go ahead.

[Christopher Nolan:]

Hey guys. Todd, the reason for the--you think the quarter’s net investment income is not sustainable. Could you go into more specifics, please?

[Todd Owens:]

Sure. The quarter we just had, we were deploying a substantial amount of capital that we raised in the follow-on offering, so the origination income that we had in the December quarter was substantially above what we would expect in a kind of sustainable case, so that really is the issue. We are going to have--we should have again the March quarter a reasonably strong origination quarter given the ability to continue levering the vehicle, but still, the December quarter was substantially in excess from an origination sheet perspective of what we would expect to see going forward.

[Christopher Nolan:]

Great, and then strategically, what are you guys thinking about fixed rate debt in terms of you’re adding on all these bank credit facilities which are all floating rate, and I guess that matches on the asset side, but any thoughts about possibly doing fixed rate debt or you sort of missed that window in terms of yields--or coupons, I should say?

[Ivelin Dimitrov:]

This is Ivelin. As part of our initiatives, we’re very active in the capital markets. We look at all the options out there, and right now given where the bico [ph] is and given where initiatives are, that opportunity is just not available to us, given the cost of capital that would be available. We can get better execution through some of our more traditional sources. But we are looking at all the options - the Natixis line, the Citi line. We’re looking at leverage out there for the Glick JV, which we expect to get shortly. So across those lines, we’re pretty active in the capital markets.

[Christopher Nolan:]

And then my final question is, why not do share repurchases, given the discount of the stock price?

[Todd Owens:]

Chris, it’s Todd. I’ll address that question. I do want to just offer--we are very pleased with the operation of FSFR from a profitability perspective right now, and although the December quarter was higher than what we expected, we’re optimistic about how that will look going forward. We feel very good about the portfolio, we feel good about the originations, and as we lever it up, we’re optimistic about where we can take this vehicle. On the topic of share buyback, obviously we just did a substantial capital raise and are deploying that capital. As we ramp this up and really get it to a more steady state and sustainable basis, which ought to happen over the course of this quarter, we will evaluate--as we said in our last call, we will evaluate all of the alternatives in front of us, including a share buyback. But right now, it doesn’t make sense for us to buy back stock in this vehicle.

[Christopher Nolan:]

All right, well it just seems to me - and I’ll finish up with this, but it just seems to me that given that you do have dry powder, you do have a substantial discount in your share price for whatever reason, the opportunity is here as opposed to a quarter from now when the balance sheet would be fully levered and invested. I would think that you’d probably get a higher yield with the repurchases, even compared to the SLF. I mean, is that an accurate--am I missing something here?

[Todd Owens:]

No, again I would say we have had over the course of a little bit in the September quarter but substantially in the December quarter and again in the March quarter, we are working on putting the capital to work and getting ourselves into a position where there is good visibility into the profitability and the strength of this portfolio, so it feels premature to go through the type of calculation that you just described. But once we have done that, then I think we will consider some of the things that you’re saying and evaluate whether a share buyback makes sense.

[Christopher Nolan:]

Okay, thanks for taking my questions.

[Todd Owens:]

Thank you.

[Operator:]

Thank you for your questions. Now I’d like to turn the call over to management for closing remarks. Go ahead, please.

[Ivelin Dimitrov:]

Thanks everyone for joining and we look forward to continue updating you on the next call.

[Operator:]

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.