SLR Investment Corp.
Q4 2020 Earnings Call Transcript

Published: 25 Feb 2021

[Operator:]

Ladies and gentlemen, thank you for standing by. And welcome to the Q4 2020 Solar Capital Earnings Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please note that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Mr. Michael Gross, Chairman and Co-CEO. Please go ahead sir.

[Michael Gross:]

Thank you very much, and good morning. Welcome to Solar Capital Limited's earnings call for the fiscal year ended December 31, 2020. As we'll discuss on this call, last night we announced a rebranding of the Solar Capital Partners platform to SLR. Effective today with SLRC change its name to SLR Investment Corp. SRC's adviser changed its name to SLR Capital Partners, the company ticker will remain SLRC.

[Rich Peteka:]

Of course. Thank you, Michael. I would like to remind everyone that today's call and webcast are being recorded. Please note that they are the property of SLR Investment Corp. and that any unauthorized broadcast in any form are strictly prohibited. This conference call is being webcast from the Investors tab on our website at www.slrinvestmentcorp.com. Audio replays of this call will be made available later today as disclosed in our earnings press release. I would also like to call your attention to the customary disclosures in our press release regarding forward-looking information. Statements made in today's conference call and webcast may constitute forward-looking statements, which relate to future performance or our -- future performance or financial condition. These statements are not guarantees of our future performance, financial condition or results and involve a number of risks and uncertainties. Additionally, as performance is not indicative of future results, actual results may differ materially as a result of a number of factors, including those described from time-to-time in our filings with the SEC. SLR Investment Corp. undertakes no duty to update any forward-looking statements unless required to do so by law. To obtain copies of our latest SEC filings, please visit our website or call us at 212-993-1670. At this time, I'd like to return the call back to our Chairman and Co-Chief Executive Officer, Michael Gross.

[Michael Gross:]

Thank you very much Rich. Good morning everyone, and thank you for joining us today. A year ago, when we reported our fourth quarter and full year results 2019, none of us could imagine that we are on the eve of a global pandemic that would result in a tragic loss of so many lives, a severe economic contraction and a complete disruption to our daily lives and routine business and social interactions. In spite of an extraordinarily challenging year that negatively impacted the functioning of literally every government business and community organization across our country, Solar -- SLRC performed well reflecting our long-standing disciplined approach to managing the company's assets and liabilities. We are grateful to our employees, clients, lenders and service providers for their tireless efforts despite the stress and personal hardship this pandemic has caused. At December 31, 2020, 100% of our portfolio is performing. The credit quality supports our investment thesis that asset-based loans in niche markets and first lien cash flow loans to upper middle market companies operating primarily in non-cyclical segments provide meaningful downside protection during challenging economic periods.

[Rich Peteka:]

Thank you, Michael. SLR Investment Corp.'s net asset value at December 31, 2020 was $852.0 million or $20.16 per share compared to $851.1 million or $20.14 per share at September 30 2020. And at December 31, 2020 SLRC's on-balance sheet investment portfolio had a fair market value of $1.53 billion in 105 portfolio companies, across 25 industries, compared to a fair market value of $1.35 billion in 105 portfolio companies across 26 industries at September 30th, 2020.

[Bruce Spohler:]

Thank you, Rich. Good morning, everybody. First and foremost, SLRC's portfolio is 100% performing and has shown remarkable durability throughout the economic slowdown and the current stages of recovery. Our performance is a tremendous complement to the financial sponsors and portfolio of companies that we have invested in. In addition, SLRC's performance supports our thesis of minimizing the risk of loss by investing at the top of the capital structure in first, lien cash flow loans to non-cyclical industries and allocating a significant proportion of our exposure to collateralized loans through our specialty finance lending verticals.

[Michael Gross:]

Thank you, Bruce. In closing, we're pleased with how our portfolio weathered 2020 and we're confident in our ability to continue to grow our portfolio and net investment income over the coming quarters. We are starting the New Year with a strong portfolio foundation that is 100% performing and has allocated over 86% of specialty finance assets that carry attractive pricing and terms with strong protection in the form of covenants and collateral coverage. The addition of Kingsbridge to SLRC further expands our origination engines. With over $700 million of available capital and low leverage, we believe SLRC is positioned to originate attractive new investments. Our patience and willingness remain underinvested during last year provides us with the foundation to grow. With over $7.5 billion of investable capital across the platform, SLR scale has enabled SLRC to participate in the higher volume of large transactions which we believe will accelerate the growth of our portfolio in 2021. We believe that the improved investment opportunity set will persist for a while as companies require financing solutions for liquidity M&A and growth initiatives. Sponsor activities on the upswing and the PE industry is armed with significant dry powder SLRC is in a great position to capitalize on this opportunity and we fully expect growth in our sponsor finance, cash flow business, as well as across our specialty finance verticals. We look forward to continuing to execute our commercial finance strategy now under one unified brand, which will enable us to further enhance our collaborative origination efforts. We go to market with a comprehensive solution set across the capital structure that can be customized to the needs of each borrower and offer certainty and scale of capital in each investment vertical. 2020 was a challenging year for all of us. We hope that all of you are in good health. We would like to thank you for your time today and your support of our company. At 11 o'clock this morning we'll be hosting an earnings call for the fourth quarter and 2020 results of SLR Senior Investment Corp. or SUNS, which was previously named Solar Senior Capital. Our ability to provide traditional middle market senior secured financing through this vehicle continues to enhance our origination team's ability to meet our clients' capital needs and we continue to see benefits of the value proposition and SLRC's deal flow. We appreciate your time this morning. Operator, would you please open the line for questions at this time.

[Operator:]

Your first question comes from the line of Paul Johnson with KBW.

[Paul Johnson:]

Good morning, guys. Thanks for taking my questions. Congratulations on the rebranding. I guess this marks the exit of your exit from the solar business. I had to say that. But anyway, I was hoping you could maybe help me understand or help us understand just the fundamentals behind the driver of what's the demand for the type of financing that comes from your Kingsbridge business. I know -- I just imagine that's obviously a very different type of borrower from some of your other verticals. So, is there any type of maybe common economic driver for the demand of leasing those assets versus owning?

[Bruce Spohler:]

Yes. This is Bruce. Thanks for the question. It's really just the purchasing agents sitting at these large investment-grade companies. As you know, we cover everyone from a Cardinal Health to a Bank of America, and they're making buy versus lease decisions just as you may with your car. And the economic climate might drive that. As Michael mentioned, these are longer duration leases at the opening contract. And then, very often what we find particularly in an environment like this with uncertainty is, they may say, we're going to put off purchasing new equipment. Let's just extend the existing lease that we have with Kingsbridge. So it's really driven by the economic environment and what's going on at the company in terms of how they want to optimize their CapEx dollars between purchases and leases.

[Paul Johnson:]

Okay. That makes sense. And then you mentioned that it's an attractive environment today. Could you maybe just talk about what verticals you might see the most favorable risk-adjusted opportunities in the market for your portfolio today?

[Bruce Spohler:]

Yes. I think that from a high-level perspective, as you know, the life science business has consistently generated the best risk-adjusted returns. That's not just for us, that's just as an asset class. And in particular, our team, as you know, has never had a loss. So they still tend to get outsized returns. Having said that, all of our strategies across the platform and consistent with the marketplace broadly has felt spread compression and also the reduction of LIBOR. So, we have felt pressure on pricing across all of the strategies relative to their historic returns. But I think that we're actually -- as we look at the portfolio of investment strategies that we have, we're finding that they all are seeing good opportunities for similar reasons coming out of what we hope is coming out of the pandemic here and the economic recovery that we're experiencing is in front of us. And so, companies whether it's Kingsbridge to your prior question, where companies are looking to extend leases or enter into new leases, has been looking to figure out how best to deploy their capital into this economic recovery. We're seeing the same thing in life science lending activities picking up as you're coming out of so many businesses in this segment being tied up with COVID-related products. They're now shifting the focus back to other drugs and devices that were in process and need to be developed in addition to the COVID crisis. And you're then going to the same way as you go across the platform. Our ABL strategy had the best quarter in the fourth quarter in terms of originations. We still see a lot of need for capital against assets for companies that are in transition during this economic period as companies are trying to transition and figure out what projected cash flows look like. They're borrowing more and more against assets, particularly in the retail sector where that team has had strong long-standing expertise. And then in the cash flow market, we're seeing activity pick up there. As we mentioned sponsors in sectors that have been resilient during the crisis that have proven themselves last year and have rebounded quickly are attracting additional private equity dollars, which needs lending dollars alongside that to leverage the equity investments. And so, we're as we mentioned doing delayed draw undrawn acquisition facilities to fund add-on acquisitions. They don't get drawn always day one, but tend to get drawn over six, nine, 12 months to fund acquisition pipeline. So, there's no one segment. In summary, I would just say that we see opportunity in all of them and our obviously blessed and thrilled to have multiple strategies to take advantage of the changing economic climate.

[Paul Johnson:]

Okay. Thanks for that. Sounds very positive for the BDC. And then just one last small question. I realize, it's a very small investment in your portfolio, but it's been there for a long time. I just have to ask why do you guys hold a -- it's a small, I guess, equity position, common equity position in B. Riley Financial.

[Michael Gross:]

That's actually -- that’s a fair question. I think it's just sitting there. It's had a little upside and eventually we'll exit this year.

[Paul Johnson:]

Okay. Thanks. Those are all my questions.

[Michael Gross:]

Thank you.

[Operator:]

And your next question comes from Mickey Schleien with Ladenburg.

[Mickey Schleien:]

Good morning, Bruce and Michael. I wanted to follow-up with a question on the competitive landscape. We're sort of in this strange world where there's a lot of capital in the market chasing yield. And at the same time we have the federal government already having provided a lot of support last year and looking to provide a lot more support this year, both to individuals and to businesses. Can you help us understand how that may impact the demand for loans and investments in all of your segments?

[Bruce Spohler:]

Sure. I'll take a first shot at that Mickey. I think that it's a great question. It's a bit of a high-class problem to have your borrowers have, to your point, so much liquidity available to them. So in terms of the existing portfolio companies that, obviously, is a benefit. It's obviously part of why our portfolios have performed so well. I think as we look at the opportunity set it does -- you do have to look at it sector by sector or strategy by strategy. In general, the investment-grade companies that Kingsbridge is financing, really, are not benefiting from that. They are high-quality barrowers and they're just going through their ordinary CapEx plans. So it doesn't really have an impact at Kingsbridge. It does have an impact at our equipment finance vertical. These are smaller businesses, as you know, where we're lending against critical use equipment for those businesses. Many of them are not private equity owned, the vast majority. And so they are eligible. And so that has helped our portfolio, but it's definitely a bit of a headwind for growth. Having said that, we consciously tried to downsize that portfolio and take it down from its peak of $400 million down to just under $320 million last year, because that is a portfolio that can see some susceptibility to cyclicality. So we purposely shrunk it. The team is actively looking to grow with slightly higher quality borrowers that may benefit a little bit less from the government stimulus. So we see an opportunity there to grow. The budget that the team has put forth for this year is not quite back to the $400 million, but it's meaningfully above the $318 million in the ended the year with. So we do see an opportunity to grow albeit will take a little bit of spread compression, because we'll go to higher-quality borrowers there to stay away from the issue that you're raising. And I think in the ABL businesses, on the margin, it will help and create a headwind for that team. But again, that team has always been looking for companies in transition, not all of which have access to government's stimulus money. It has helped some of our portfolio there, but we do see good opportunities, particularly given some of the structural headwinds that the retail sector faces. And again that's a strong suit for that team. Our portfolio churns quickly, but at the moment roughly a-third of it is across retail ABL, where we have very liquid working capital assets. So we still see good opportunity there. And clearly, in both lender -- life science and cash flow lending, where these are venture capital or private equity owned businesses, they generally do not qualify for government stimulus to date and we have seen increased activity in both segments.

[Mickey Schleien:]

Thank you for that, Bruce. I appreciate the detail and that's really, really helpful. Bruce, it sounds like you're not very concerned about liquidity on your borrowers' balance sheets given all the programs that have been in place and the ability of private equity to write checks. But that started about a year ago. Looking out into this year, do you have any concerns about borrower liquidity?

[Bruce Spohler:]

We don't because particularly in our cash flow business, these businesses have in many cases because of the sectors we're lending to health care, financial services, recurring software. We've seen real operating performance rebound as we got into really the summer particularly in health care as people were able to get back into elective surgeries and other deferred health care visits. And definitely into Q4, where we actually saw businesses where we were getting repaid on our loans at par or better that we had seen zero revenues earlier in the year as we were all locked down. So for our segments think about it, if you're the owner you're not going to put good money after bad, but you're sure as heck going to support your quality investments. We have seen very little need for liquidity at our portfolio of companies. But sponsors are quick to put it up. And the same is true in our life science business. The VC community has been very supportive of those investments, if anything paying down our loans to make sure that they have substantial liquidity, because those are still burning cash as they get to commercial adoption.

[Mickey Schleien:]

I understand, and thank for that. Bruce, my last question is about the right-hand side of your balance sheet. You have a variety of unsecured notes. Some of them are due next year and there's been tremendous demand for that kind of paper. Are you looking to refinance some of your unsecured debt and potentially also reduce the credit facility balance that you have outstanding?

[Michael Gross:]

I think, look, we're constantly looking at our balance sheet and we obviously recognize that the margin is really favorable. So it's something we keep looking at. And I think you should expect at some point during this year we put in place refinancing for that and potentially adding to our unsecured debt stack. We're big fans of having unsecured debt on our balance sheet.

[Mickey Schleien:]

I appreciate that. Thank you, Michael. Those are all my questions this morning.

[Michael Gross:]

Thank you, Mickey.

[Bruce Spohler:]

Thanks, Mickey.

[Mickey Schleien:]

Thanks.

[Operator:]

And your next question comes from Casey Alexander with Compass Point.

[Casey Alexander:]

Hi. This is really just a maintenance question, based upon your comments of Crystal and Kingsbridge and you kind of control the toggle on the dividend that they pay. Am I right in thinking that the go-forward run rate of dividends should be somewhere between $9 million and $10 million a quarter taken together?

[Bruce Spohler:]

So, let me just take those in into components. I think that – a great question. Kingsbridge obviously early days, but we have been a lender for a few years now. Kingsbridge is a very steady Eddy business. Dividend there should be relatively consistent. We've targeted kind of the $20 million number for this year. It is pretty evenly distributed throughout although I would tell you the fourth quarter is closer to 30%, 33% of the year's income with quarters one through three being equally distributed. So I think that will be a rather predictable dividend. As you know, historically, Crystal has had a little bit more volatility quarter-to-quarter because of the nature of their assets being short duration. High churn generating either origination fees or prepayment fees. For example in the fourth quarter, we distributed $6 million although they had earned $8 million. So we try to smooth their dividend out at roughly that $6 million a quarter, until we see significant growth or significant traction.

[Michael Gross:]

And Bruce just one point of clarification, the $20 million a year that we expect out of Kingsbridge is a combination of the dividends and the interest income on the loan we have seen. So it's not just -

[Casey Alexander:]

Right. That's what I was just going to say $6.4 million of that is interest income when it comes from the loan.

[Michael Gross:]

Right. Correct. Correct.

[Casey Alexander:]

So you're kind of expecting there a $13.5 million dividend at the cadence that Bruce just suggested.

[Michael Gross:]

Correct. Yes.

[Bruce Spohler:]

Quarterly interest, yes.

[Casey Alexander:]

Yeah. Okay. Great. That was my question. Thank you.

[Michael Gross:]

Thank you.

[Bruce Spohler:]

Thank you, Casey.

[Operator:]

Your next question comes from Robert Dodd with Raymond James.

[Robert Dodd:]

And funnily enough, I had the same kind of questions. When I look at Crystal obviously, I mean the portfolio looks good. The lease reserves this year grew a lot in the fourth quarter, but I mean the book was down on the on-balance sheet book at Crystal was at about 23% year-over-year which just obviously cutting -- trimming that dividend back from 7.5 to kind of 6. What are your expectations I guess full growth of -- at the loan book at Crystal? Because obviously if that can get back to where it was a year ago we could obviously see the dividend increase. But if it stays here, yes we might stay at 6. I mean so it really goes to the expectations of how much that on balance sheet book, can grow and drive net income or cash flow from ops or whatever we want to look at a Crystal. But what's your optimism there?

[Bruce Spohler:]

So what I would say is -- and this goes across all the strategy -- or most of the strategies. We've talked a lot over the last couple of years Robert, how we've increased the scale of the platform. And that allows each of these strategies to co-invest with private pools of capital and basically scale up their ability to go to market and take larger hold sizes across the platforms and then take their pro rata share on a diversified basis. And so Crystal for example, has been doing loans in the $75 million, $100 million size, bidding on things up to $150 million that they weren't going after a couple of years ago. Most of their book had an average loan size of $20 million to $30 million, $40 million at the high end. So what we're seeing is that that is a driver for growth for them. It's same with life science. You've seen that book grow. Leaving COVID aside, we were all on hold for a little bit. But same thing, average loan size at the life science business has also gone up and importantly at the cash flow business where we're routinely taking down $100 million, $150 million in an investment across the platform with Solar taking the lion's share of that. But again, the scale has allowed them to speak for that size to the prospective borrowers. So I think that that's a dynamic that creates an opportunity for Crystal to grow its book. In addition they put some excise -- I'm sorry some extra on our balance sheet as well up at Solar. So we do have some deals where you see both on their balance sheet, as well as on the parent company's balance sheet. So I think that's going to be the opportunity for Crystal to regrow is to not only stick to their knitting on the 20s and 25s but to do some of these larger deals that they've been active in in the last couple of months. I think you didn't have but another opportunity. Rob my -- Robert?

[Robert Dodd:]

Sorry my -- I smacked my headphones.

[Bruce Spohler:]

Robert just one other point I would make is -- you didn't ask it, but I think there's also as we get deeper into 2021 an opportunity for NEF to increase its dividend as well. And so that's another potential driver on that NII growth.

[Robert Dodd:]

Got it. I appreciate that and another kind of angle. I mean one of your comments earlier in the Q&A obviously is, there has been pressure on felt on LIBOR and spreads which does to a degree make verticals like life sciences, where you can get exit fees or other verticals where there's the potential for fee income which can obviously offset, right? If you can get a 13% IRR on a 9% yield that's because of fees and other sources of income. So what other avenues are there with your various verticals to get that kind of yield enhancement in a spread compressed environment?

[Michael Gross:]

So let me answer that a couple of ways. One is, if you look at our different businesses as you hit a nail on the head life science really is not impacted by spread compression where LIBOR is. Neither is, what used to be called Nations Equipment Leasing because those are all fixed rate leases. Neither is Kingsbridge which has really no relation of LIBOR. So a big chunk of our business today truly is not impacted by the concern you've raised. Crystal does have that issue with LIBOR-based loans but they -- there we do make it up on fees as well. And because the duration tends to be 18 to 24 months and the fees get amortized over a quicker period that's why the returns are consistently above 10%. So it's really the cash flow business that is the most impacted by what you're talking about. And there it is difficult because the fees are limited to one point to two points and there's very rarely prepayment penalties on these floating rate loans.

[Robert Dodd:]

Got it. Thank you.

[Operator:]

And your next question comes from the line of Melissa Wedel with JPMorgan.

[Melissa Wedel:]

Good morning, guys.

[Bruce Spohler:]

Hi, Melissa.

[Melissa Wedel:]

Thanks for taking my questions. A couple of follow-ups. I think a lot of my questions have already been addressed. But, I guess, just to put a finer point on it when you look at some of the cash flow loan opportunities that might result from higher M&A activity how are you thinking about yields on new deals comparing to the, sort of, high 8% -- 9-ish percent yield on the investments you currently have in the portfolio?

[Bruce Spohler:]

Yes. I think that it's a great question Melissa. We're underwriting today -- again these are generally going to be upper mid market larger EBITDA businesses where our loan will be drawn to fund an acquisition, which takes EBITDA even larger. So we're looking at $75 million to $150 million EBITDA companies that are adding on to fund additional acquisitions. So the first equation for us as you know is always about the risk. We feel like we're seeing better risk in terms of the businesses that are looking for our capital right now. I think from a spread perspective in a yield. We're targeting a minimum of 8%. As you know, these things get repaid early if they execute well. And so the early repaid of accelerating some fee income so close to mid 8s. So a little bit of compression but not material.

[Melissa Wedel:]

Okay. Got it. I appreciate that context and you actually touched on my next follow-up which was around repayment activity and sort of, what you guys are expecting in terms of repayment environment, I guess, in the near term but also throughout, sort of, the course of the 2021?

[Bruce Spohler:]

So we're not expecting much in the near-term. But I think thematically, we would expect some as you get deeper into the economic recovery. I'm not sure if that's the late 2021 or into 2022. But clearly as more and more companies right-size their cash flow streams in the life science businesses get to market you will start to see repays I think accelerate. But we don't see that in the near-term.

[Melissa Wedel:]

Great. Thank you so much.

[Bruce Spohler:]

Thank you, Melissa.

[Operator:]

And your next question comes from the line of Finian O'Shea with Wells Fargo.

[Jordan Lawson:]

Hi. Good morning. This is actually Jordan Lawson calling in for Finian O'Shea. Most of my questions have been asked and answered, but I just wanted to look at maybe a portfolio company that's new to your balance sheet at least this quarter I see a basic fund was on balance sheet. I think this is also a loan that maybe Crystal will participate in. I was wondering if you could give us some color on the loan you gave there and basically how you're deciding between putting half or part of that loan on Solar's balance sheet versus carrying into Crystal?

[Bruce Spohler:]

Yes. As I touched on the Crystal balance sheet -- all of our balance sheet stepping back obviously, we're very focused on maintaining our diversification. Typically, we're in a 2% type of hold position. And so Crystal may take a loan on their balance sheet and have excess either to some of our private funds, but first up to Solar the parent company. And so we'll take some of the excess and still on a consolidated basis with what Crystal is holding keep our whole level in that sort of 2% -- 2.5% hold position for the consolidated Solar. It's generally balance sheet management just from a diversification perspective. They have their own credit facility which is -- again has diversification requirements separate apart from what we have at our parent company.

[Jordan Lawson:]

Okay. Cool. That one was just interesting because it looks like it has an unfunded commitment there. So I didn't know what was into it. That's very helpful. Thank you.

[Bruce Spohler:]

Thank you.

[Operator:]

I would now like to turn the conference back over to Mr. Michael Gross, Co-CEO for closing remarks.

[Michael Gross:]

We thank you for your time this morning and all of your insightful questions. And as always we're more than willing to follow-up one-on-one if there are more questions. And for those of you who are participating in what is now called SLR Senior Investment Corp. call we'll talk to you in a couple of minutes. Thank you. Bye-bye.

[Operator:]

Ladies and gentlemen, this does conclude today's conference call. Thank you for your participation. You may now disconnect your lines.