Oaktree Strategic Income Corporation
Q2 2015 Earnings Call Transcript

Published: 12 May 2015

[Operator:]

Good day ladies and gentlemen and welcome to the Q2 2015 Fifth Street Senior Floating Rate Corp.’s Earnings Conference Call. My name is Julie and I will 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. [Operator Instructions]. As a reminder this call is being recorded for replay purposes. And now I’d like to turn the call over to Robyn Friedman, Vice President of Investor Relations. Please proceed. Thank you.

[Robyn Friedman:]

Thank you, Julie. Good morning and welcome to Fifth Street Senior Floating Rate Corp.’s fiscal second 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 April 6, 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 that reflect the company’s current views with respect to among other things future events and financial performance, words such as belief, expect, will, estimate, projects, anticipates and future or similar expressions are intended to identify forward-looking statements. These forward-looking statements are subject to the inherit uncertainties and predicting future results and conditions. Certain factors could cause actual results to differ materially from those projected in these forward-looking statements. New risks and uncertainties arise over time and it is not possible for the company to predict those events or how they may affect us. 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 Dimitrov:]

Thank you, Robin. For the quarter ended March 31, 2015 FSFR generated $0.23 of net investment income per share, which was the result of lower than expected origination volume given a December quarter in which FSFR closed all of the deals in its pipeline that were expected to fund. During the March quarter, we closed $110 million worth of investments across eight new and one existing portfolio companies. We also received $129 million in connection with full or partial payoffs in sales of 20 of our debt investments. As we discussed in our last conference call, origination totals at FSFR for the December quarter surpassed our expectations, which partially contributed to our lower volume of originations during the March quarter. Going forward, we expect our deal flow and quarterly originations to normalize. Despite lower than expected originations during the March quarter and subsequent to the end of the quarter, we made progress on right sizing FSFR’s capital structure, which Todd will provide additional details on. FSFR continues to focus on building a diverse portfolio of floating rate senior secured loans. We maintained rigorous underwriting standards and employ a high degree of selectivity investing in credits with strong underwrite fundamentals. As a result, the credit quality of the portfolio remains healthy with no investments in non-accruals as we tend to focus on investing in high cash flow sectors and limit out exposure to the energy sector and other cyclical sectors. Investments in our portfolio are spread across 59 companies in 26 industries with our largest investment accounting for 6.5% of total assets. Additionally as if March 31, 2015 investments in the energy sector accounted for less than 1% of total assets at fair value in one portfolio company. Weighted average yield of the portfolio increase from 7.2% at December 31, 2014 to 7.4% as of March 31, 2015. During the March quarter we experienced an increase in weighted average yield as we proactively exited certain portfolio companies and redeployed the capital to investments with stronger risk adjusted returns. As a reminder, in October we’ve closed FSFR Glick JV LLC a joint venture with an entity controlled by the members of the Glick family to invest primarily in senior secured loans. The JV expands FSFR’s investment capacity to originate in underwrite senior secured middle market loans and provides an efficient way to finance assets that enhance returns for our shareholders. We are happy to report that since the end of the March quarter FSFR Glick JV closed on a $200 million line provided by Credit Suisse and gets funded a portfolio of $93 million. The joint venture has an anticipated investment capacity of $300 million, comprised of $100 million of subordinated notes in equity from FSFR and the Glick family as well as a $200 million credit facility. We believe that the joint venture should be accreted to earnings and generate the low teens return on FSFR investment, which is higher than the return on FSFR’s current portfolio. We expect to leverage Fifth Street direct origination platform to continue funding the joint venture to its targeted size of $300 million over the next few quarters. I look forward to providing additional updates as the joint venture continues to ramp. Despite slower M&A activity and loan issuances in the March quarter the middle market lending environment remains healthy and should benefit from a large amount of private equity dry powder. And ongoing concern amongst some investors is the potential rise in interest rates and the impact it will have on the middle market. If interest rates rise above 100 basis points, FSFR has the 100% falling rate BDC would benefit from that increase. On the underwriting side which stress test our investments against the rising interest rates in the area and feel comfortable with the positioning of our portfolio. The announcement that GE selling the bulk of the GE Capital Financing unit including its $16 billion sponsored finance portfolio is implications for both of the middle market and the Fifth Street platform. FSFR stands to benefit from the GE Capital’s exit from the market in several ways. First, the uncertainty of who will acquire the GE Capital’s sponsor’s business provides an opportunity for the Fifth Street platform to win new deals at advantageous pricing. Second, we are experiencing an influx of cost from our existing book of business as private equity sponsors seek to limit their exposure to GE Capital. As sponsors seek to refinance deals given our stronger relationships and reputation as one of the leading middle market lenders, we have been a partner of choice to potential lead their transactions. Finally as individuals consider leaving GE Capital, we have the ability to take advantage of potential talent acquisition opportunities, which we believe could further enhance the Fifth Street platform. I would now like to turn the call over to our President, Todd Owens.

[Todd Owens:]

Thank you, Ivelin. As Ivelin mentioned since the beginning of the calendar year we’ve been optimizing FSFR’s capital structure to position it for improved profitability. In January we closed on a $175 million credit facility provided by Citibank, which provides FSFR with the necessary leverage to reach our target leverage range of 0.8 to 0.9 times debt to equity. Additionally we continue to evaluate securitization option for FSFR’s balance sheet. Turning to the joint venture, the FSFR Glick JV entered into a $200 million credit facility with Credit Suisse, which provides the joint venture with the ability to lever up to 2 to 1 times debt to equity. As of March 31st we were operating at a 0.57 times net leverage ratio net of cash and believe that we should approach our targeted leverage range of 0.8 to 0.9 times debt to equity in the next quarter. We continue to utilize Fifth Street’s origination platform to deploy leverage and rotate in the higher yielding assets, which should provide FSFR with a steady and sustainable portfolio yield. As we reach and maintain our target leverage range this normalized portfolio should reduce some of quarterly earnings volatility and provide us with clarity on FSFR’s steady state earnings power. In regard to the dividend, the intention of the Board of Directors is to set the dividend at a level which is consistent with our sustainable earnings, FSFR’s Board of Directors presently believe that the $0.30 per share dividend is appropriate. I think it’s important to understand the broader context of our earnings trend. This quarter our net investment income was negatively impacted by seasonal fluctuations in originations. Our December quarterly net investment income of $0.35 per share was conversely positively impacted by the same seasonality. View together we’d have under earned our dividend by $0.02 per quarter. Our earnings volatility in each quarter has been driven by the origination cycle. As we complete the ramp up of our portfolio and increase our net leverage from 0.57 times to our targeted range of 0.8 to 0.9 debt to equity, the impact of the origination cycle will diminish and we should have a better picture of our steady state earnings levels. Despite our earnings this quarter we remain very optimistic about our ability to ramp FSFR and fund the joint venture while building a high quality portfolio. 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 $11.9 million and net investment income of $6.7 million or $0.23 per share for the quarter ended March 31, 2015. Net asset value per share was $12.46, which was a $0.07 decrease from the prior quarter. The decline in net asset value was driven by dividend distributions in excess of net investment income. We ended the March quarter with portfolio investments of $583.6 million at fair value, which represented a 2.1% quarter-over-quarter decrease. During the quarter we had gross originations of $110 million in eight new and one existing portfolio companies. We also received $129 million in connection with full or partial payoffs and sales of 20 debt investments, all of which were exited at or near par. We continue to build a well-diversified portfolio and at March 31, 2015 the average size of portfolio investment was $9.9 million, and average portfolio company EBITDA was $64.9 million. Credit quality was strong once again as the 100% of the portfolio remained on accrual status as of March 31, 2015. The weighted average cash yield on our debt investments was 7.4% as of March 31, which increased from 7.2% at December 31, 2014. Turning to our capital structure, as of March 31st we had drawn $183.4 million on our $200 million Natixis credit facility and have drawn $96.7 million from our recently closed $175 million credit line with Citibank and have $78 million of cash on the balance sheet. I will now turn it back over to Robyn.

[Robyn Friedman:]

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

[Ivelin Dimitrov:]

Thanks everyone for joining the call today.

[Operator:]

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