Sunrise Realty Trust, Inc.
Q1 2013 Earnings Call Transcript

Published: 8 May 2013

[Operator:]

Good day, ladies and gentlemen, and welcome to the Quarter One 2013 Solar Senior Capital Limited Earnings Conference Call. My name is Matthew 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 this conference. (Operator Instructions) As a reminder, this call is being recorded for replay purposes. And now I would like to turn the call over to Mr. Michael Gross, Chairman and CEO. Please proceed sir.

[Michael Gross:]

Thank you very much and good morning. Welcome to Solar Senior Capital Limited’s earnings call for the quarter ended March 31, 2013. I am joined here today by Bruce Spohler, our Chief Operating Officer and Richard Peteka, our Chief Financial Officer. Rich, could you please start off by covering the webcast and forward-looking statements.

[Richard 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 Solar Senior Capital Limited, and that any unauthorized broadcast, in any form are strictly prohibited. This conference call is being webcast on our website at www.solarseniorcap.com. Audio replay of this call will also be made available later today as disclosed in our press release. I would 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 events 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. 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. Solar Senior Capital limited undertakes not 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 would like to turn the call back to our Chairman and Chief Executive Officer, Michael Gross.

[Michael Gross:]

Thank you, Rich. At Solar Senior Capital, as credit investors, who invest not only our shareholders money but our own, we believe our long-term success is measured as much by the loans we pass on as is by the loans in which we invest. In the first quarter of this year, total liquid loan volume climbed to $185 million, just shy of the second quarter 2007 record of $188 million. The bulk of this activity supports refinancings, repricings and dividend recap rather than new leverage buyouts. By the end of the quarter, the average new issue clearing the old liquid leverage loan had fallen 90 basis points from December 2012, resulting in an average new issue yield of just 5%. Although, the sloppy market conditions are not as pronounced in the middle market with the average new issue yield over 70 basis points higher than that available in the more liquid loan market, we exercised restrain. We invested only in those loans with acceptable credit risk and yield commensurate with that risk. As a result of established relationships with sponsors and extensive familiarity with repeat issuers, we were able to source several new investments that met our stringent underwriting criteria during the first quarter of 2013, resulting in management portfolio growth that increased the defensive nature and diversification of our overall portfolio. This trend is continuing into the second quarter as we speak. Due to the strong prepayment activity we experienced in the fourth quarter of 2012, our average earnings assets in the first quarter were lower than in the fourth quarter, resulting in net investment income per share of $0.28. The prepayment fees and acceleration to always be in the repayments in Q4 provided excess cash for earnings which allowed us to more than fully cover our first quarter dividend, while maintaining our prudent approach to redeploying those funds. As one of the large investment stock we relentlessly are focused on preservation of capital. We’ll now straighten our investment philosophy for the sake of asset accumulation during the overheated credit markets. During the first quarter, we made investments of approximately $49 million in six portfolio companies; Bruce will provide color on these investments. During the quarter, we have principal repayments of approximately $22.5 million all at par or higher. This amount marked a slowdown from the high level repayment activity we experienced in the fourth quarter 2012 of $80 million. As we continue to grow the portfolio, the diversification remains a key thing. We have constructed a well diversified portfolio of substantially all senior secured loans across 33 distinct issuers in 20 industries with an average loan size of $6.8 million on a fair value basis. Importantly, our January equity raise further facilitates this goal. The opportunistic issuance at a favourable valuation enabled Solar Senior to utilize a portion of the $50 million of incremental borrowing capacity available under the delayed draw feature of our revolving credit facility. With over $130 million of available capital based on a 0.8 times net debt to equity leverage target, we are well positioned to build a larger more diversified portfolio; because of senior secured tranches for middle market issuers are generally three to four times the size of the subordinate tranches, the market opportunity for SUNS is significantly larger than that for the typical BDC focused on senior debt investments. This translates into an ability to more easily scale the business. With larger capital base we can take bigger piece of our investment tranche while staying within our diversification parameters. This results not only in operating efficiencies, but in greater influence on the pricing and structuring of our investments. At March 31, our net asset value is $18.25 per share; a decline from the December 31st, NAV of $18.33 per share is due to the incremental mark down of one challenge credit which we placed on non-accrual status. Bruce will provide more detail on our efforts to resolve this situation. The rest of our portfolio is performing well; excluding that one investment of non-accrual, the fair value weighted average mark on our first lien investments was 99.9%. In comparison, the average price on the [CDX] which represents the liquid loan market was 103% at March 31st. At the end of the quarter, our leverage was just 0.1 time net debt to equity and we have over $131 million available to invest in new opportunities to reach our target leverage of 0.8 times net debt to equity. In summary, the first quarter 2013 marked a period of rescaling the portfolio and the heavy repayments we experienced in the fourth quarter. With our long-term investment focus, we deploying our available capital in a disciplined manner and we are quite pleased with the measure of growth we achieved in Q1 and in Q2 thus far. Lastly, our Board of Directors declared a monthly dividend for May of $0.1175 per share payable on June 3, 2013 to stockholders of record on May 23, 2013. At this time, I will turn the call over to our Chief Financial Officer, Richard Peteka.

[Richard Peteka:]

Thank you, Michael. Solar Senior Capital’s net asset value at March 31, 2013 was $210.1 million or $18.25 per share compared to a $174.1 million or $18.33 per share at December 31, 2012. Our investment portfolio had a fair market value of $239.6 million on March 31st, an increase of approximately 13% when compared to our investment portfolio of $212.6 million at December 31st. At March 31, 2013, we had investments in 33 portfolio companies, in 20 industries. The weighted average yield on our income producing portfolio of investments with 7.0% at March 31, 2013 measured at fair value. For Q1, 2013, gross investment income was $4.5 million versus $6.1 million for Q4 2012. The decline was primarily driven by greater repayment activity in the Q4 of 2012 quarter, which had generated significant income in that period. Expenses totaled $1.3 million for the first quarter compared to $2.7 million in Q4 of 2012. The decrease primarily stems from the recognition in Q4 of approximately $1 million of one-time charges related to our credit facility amendment to which we extended the maturity and reduced pricing. For the three months ended March 31, 2013, our net investment income was $3.1 million or $0.28 per share versus $3.4 million or $0.36 per share for Q4, 2012. Net realized and unrealized losses for Q1 2013 totaled $223,000. The net unrealized loss was primarily attributable to one investment, Engineering Solutions & Products which we've decided to place on non-accrual status during the quarter. At March 31, this investment represented approximately 2% of the fair value of our investment portfolio. For Q4, net realized and unrealized losses totaled $2.7 million. Ultimately, our net increase in net assets resulting from operations totaled $2.9 million for the quarter ended March 31, 2013, [versus] an increase of $0.8 million for Q4. Earnings per share totaled $0.26 per share for the March quarter compared to $0.08 per share for Q4 2012. At this time, I would like to turn the call over to our Chief Operating Officer, Bruce Spohler.

[Bruce Spohler:]

Thank you, Rich. In general, the operating performance helped steady or improved across our portfolio of companies at SUNS. We remain pleased with the overall credit quality of the SUNS portfolio. Our growth during Q1 further diversified our portfolio, with investments in 33 issuers across 20 industry groups. Our average investment size is approximately $6.8 million. In light of this recent spread compression in the new issue market, I would like to reiterate our patient and prudent investment philosophy. We will continue to be disciplined in deploying our available credit capacity and to only those investments that meet our strict underwriting standards. The weighted average investment risk across our portfolio measured at fair market value at the end of Q4 has remained steady at Q1 at approximately 2 based on our 1-to-4 risk rating scale with 1 representing the least amount of risk. The weighted average yield of our portfolio based on fair value was 7% on March 31, as compared to 7.8% at 12/31. The impact of the reduction in yield is somewhat offset by the 25 basis points reduction in our borrowing costs on our underlying credit facility, which was reduced as part of our November 2012 amendment. In the portfolio secured loans account for approximately 97% of fair value at the end of the quarter and 98% plus of the assets at fair value bear interest at a floating rate. For our first net investments, the weighted average leverage to our investment charge is in the mid 3 times and the average cash interest coverage across our portfolio is a healthy 3.3 times. As Rick mentioned during the quarter, we placed ESP on non-accrual. At quarter end, the investment had a fair value of 4.9 million representing 2% of our portfolio’s total fair value. ESP provides mission-critical professional and technical support services for the U.S. Army. While these back loans systems and services remain a top priority for the Department of Defense, the industry broadly is under considerable pressure due to mandatory defense budget cuts, ongoing sequestration risk and the scaling back of the U.S. involvement in Iraq and Afghanistan. We remain actively engaged with both the sponsor and management of ESP and working towards potential resolution. During Q1, we originated approximately $49 million of senior secured loans in six portfolio companies. For two of these investments, we participated in refinancings that repaid our existing investment. Rolling into these new tranches in these credits extended our duration in familiar investments offering attractive credit profiles and allowed us to capitalize on our prior underwritings. We also received repayments and amortization of approximately $17 million during the quarter. In addition, we took advantage of the strong market conditions to sell $5 million in one investment, resulting in realized gains. Let me highlight a few of our first quarter investments. As part of the company’s refinancing we funded a $14.5 million first lien term loan in Asurion, the leading cell phone insurance provider. In conjunction with these refinancing, we subsequently sold 5 million of our first lien term loan investment at a gain. The Solar platform through Solar Capital was an original investor and managing [Dearborn’s] acquisition of this company back in 2007, and today has invested approximately $140 million across four different transactions since 2007. The Solar Capital platform has been redeemed or sold $117 million of this, $140 million investment at weighted average sale price in excess of 102. The company has now reached a size such that it will be able to secure cheaper financing in the liquid credit markets. And therefore, we anticipate this being a transitional investment for us at this time. We will continue to rotate out of these investments at higher yielding opportunities. We have had great success over the past six years investing alongside Asurion and still hold a $3 million position in the company's holding company floating rate term loan, which is currently yielding in excess of 11.5%. During Q1, we made a $9.5 million first lien term loan investment in Koda Distribution, a leading specialty chemical distributor in North American which is owned by Audax. The proceeds of this refinancing were used to refinance the company's existing capital structure. Our all in yields on the investment exceeds 6.5% and we are invested through approximately four times leverage. Additionally, we invested $5 million in the first lien term loan of ATI Holdings which operates outpatient physical therapy clinics in the Midwest. The acquisition financing funded KRG Capital’s buyout of the company from GTCR. In anticipation of the transaction, we had an existing $13 million investment which was repaid in full last year at a premium to our original cost. Leverage on our investment tranches in the mid 3 times. During Q1, we also funded a $7.4 million investment in the first lien term loan for Bain Capital’s acquisition of Apple Leisure Group. The company sells vacation packages and manages 32, all inclusive resort in Mexico and Caribbean. Net leverage on our investment is approximately 3.5 times and the yield on this asset is 7.2%. We also invested $7.5 million in the second lien term loan of Advantage Sales & Marketing which is owned by Apax Partner. The company provides outsource sales and marketing and merchandising services to manufacturers and producers of consumer packaged goods in the U.S. Our yield on this investment is 8.25%. We also invested $5 million in the new first lien term loan for ABB CONCISE Optical as part of the company's refinancing. In conjunction with this transaction, we will be repaid on our prior $4 million investment at a premium to our cost. We re-underwrote the credit and decided to reinvest in the new capital structure. As a reminder the company is the largest distributor of optical products in the US. As we continue to focus on risk, it’s important to note that at cost the weighted average leverage through our investment tranche for these new assets is in the high 3 times. Equally important the weighted average loan to value on these investments is meaningfully below 50%. Our repayment activity slowed in both Q1 and Q2 to-date from the spike that we had experienced in the fourth quarter. In addition to our repayment of ABB and Asurion in conjunction with their refinancings, we also repaid at par on our $5 million first lien investment in Citadel Plastics and above par on our $2.5 million investment in AmWINS. Origination activity in the second quarter to-date has been consistent with our pace in prior quarters. Following unforeseen repayments we anticipate further growth in our portfolio. Now I would like to turn the call back to Michael.

[Michael Gross:]

Thank you, Bruce. As evidenced by Bruce's commentary, on our first quarter portfolio activity, the middle market senior secured loan space has been robust with near record volumes in the first quarter, a large portion of which was issuance in connection with refinancing. In periods of heightened activity like these, we believe manager discipline is even more crucial. When the issuer in our portfolio refinances, we use the transaction as an opportunity to re-underwrite the credit or reinvest all in the new loan if the investments’ risk reward profile continues to be compelling. Our total knowledge of these companies in relationships with management and the sponsors including our experience at Solar Capital gives us an edge on the underwriting process. In situations where we don't feel the deal term appropriately compensated the credit risk we pass new investment opportunity. We believe the refinancing wave is lessening as rates at absolute lows. In the event of a market dislocation we stand ready to reap, leverage our familiarity with the credits which we passed under new refinancing by buying on that better value in the secondary market. Since inception our new investments have averaged approximately $50 million per quarter and with our current capital base we are comfortable with a pace of approximately $200 million in annual originations. Importantly we have sufficient dry powder from the January equity raise and assess toward delayed draw feature of the credit facility to fund portfolio growth. Although spreads have tightened in credit with the (inaudible) we continued to find attractive opportunities in the senior secured space for commercial banks to become less active. We believe middle market loans continue to be mis-priced relative to syndicated bank loans and high yield. Year-to-date the 20 (inaudible) of inflows into floating rate, bank loan mutual funds equate to a 25% increase in the funds assets. This increased demand for the product has compressed yields and liquid loan markets resulting in implied yield on the LCDX at March 31, 2013 of 5.1% compared to our portfolio yield of 7%. In general leverage loan issuers in the middle market are less levered and offer better credit protection than those associated with the large liquid loans with this trend continuing in the first quarter. In the new issue market during the first quarter, the average debt multiple for liquid highly levered loans was 4.7 times and the new and the average new issue yield was 5% resulting in a yield of less than 1.1% for debt multiple of EBITDA. For our Q1 investments and the fair value weighted average basis, the leverage through our security was just 3.9 times and the yield was 6.2%, which equates to a yield of 1.6% for each step multiple of EBITDA. Thus on a risk return basis, our most recent investment activity is yielding over 50 basis points more for each unit of risk defined as one debt multiple EBITDA, than that on new liquid leverage loans during the exact same period. On an absolute basis, the average yield on new investments was 1.2% higher than the new liquid leverage loans with almost one less debt multiple of EBITDA. This discrepancy between middle market leverage loan terms and those for liquid leverage loan has resulted in a sound portfolio which we believe is attractive on a relative basis to fund and invest in the liquid loan leverage loan market. We look forward to speaking with you next quarter. Thank you for your time this morning. Operator, can you please open up the line for questions?

[Operator:]

Thank you. (Operator Instructions) And your first question comes from the line of Mickey Shlen from Ladenburg. Please proceed.

[Mickey Shlen:]

Help me understand the trajectory of NOI per share. I comprehend raising equity capital when the window opens and sometimes the window opens because the market is frothy like we saw in the first quarter but the downside is that there are apparently not enough investments opportunities in the quarter for you to put all the money to work. So we saw your debt to equity drop to only 0.1 times. So in my model, I can’t see how SUNS can earn its dividend from NOI without meaningfully increasing its leverage, but given the current spreads in the market, where and how faster we go from here and are you more inclined to increase leverage or to adjust the dividend to reflect the portfolios earnings power?

[Michael Gross:]

The answer is more inclined, showing to be more inclined to increased leverage and a couple of examples I wanted in Q1, when we just went through there, we were able to increase the portfolio by 13%, at yield that we thought were quite attractive 6.2% compared to leverage, liquid loan market of 5%. That’s trend continued again this quarter, so you should expect to see similar portfolio growth, so we think we will grow back into similar portfolio level that we experienced at year-end really rapidly and get NII back close to (inaudible).

[Richard Peteka:]

The other thing I would mention Mickey is that as you know as part of our equity raise we also have already pre-matched that with available credit capacity under our delay drop facility. So our expectation when we raise this capital in January with the position the company to continue to increase the leverage as we continue to invest the portfolio over the course of this year. So as Michael mentioned we are comfortable with what we have done in Q1 and Q2 to-date, and you should see that trend continue. I think that the repayment activity we saw in Q4 which was outstanding relative to any other quarter, at SUNS has also abated. So we expect that portfolio growth and as you know in the meantime, given the substantial NII beat in Q4, we do have carry over taxable income to cover the dividend, while we ramp in the portfolio.

[Mickey Shlen:]

Bruce, what portion of the deal flow in the first quarter would you consider broadly syndicated loans, of the loans that you invested in?

[Bruce Spohler:]

I think by name Asurion is the one asset that is clearly broadly syndicated given that they have a $4 billion of capital structure, the other is more mid-market and as we highlighted a couple of situations like ABB were situations where we were existing investors and we under rode, things like the Asurion we have been investors, we touched on since ‘07 and really in Asurion this was an opportunity to get an asset that if that was issued in the 99 that is currently quoted north of one of one, and as we mentioned in Q1 we exited five of that $15 million and we will continue to transition out of that, that’s a good transition asset given our history with the company and really our value there was given our strong relationship with the company we were given allocation that others were not able to get even though it is a large liquid loan. So today if you want to buy Asurion you have to come to us and paid close to one or one and a half and we are on that two points lower, but long term that is lower yield and so we will transition out of that. But beyond that we see it is mid-market when ABB and ATI were re-underwriting interesting credits where the new names of the portfolio.

[Mickey Shlen:]

Okay, just quick follow up question perhaps for Rich, can you give us the sense of how much fee income was included in the fourth quarter and in the first quarter as oppose to straight interest income?

[Richard Peteka:]

Fourth quarter Mickey was really a mixed bag, there was the $80 million that came out that did generate significant amount of call premiums, but we also had the refinancing of our own credit facility which had a lot of one time cost to which kind of offset that.

[Michael Gross:]

But Rich if I recall in Q4 before the repayment of the credit facility cost we were up in the 40s.

[Richard Peteka:]

We had $0.10 of loan and charges related to that credit facility. So while we finished at $0.36 or $0.46 without that. So we did have significant much higher than where our dividend $0.10. So a huge percentage increase. For Q1 I think it was more normal activity, every quarter we will have a little bit. We had a 22 million come out this quarter of the 22 I should say 17 came out all the way, 5 was from sales maturity that Bruce mentioned, but that equates to about $0.03 [$0.035] for Q1.

[Operator:]

(Operator Instructions) And your next question comes from the line of Jonathan Bock from Wells Fargo Securities. Please proceed.

[Jonathan Bock:]

To follow up on Mickey’s point of leveraged use and may be just looking back historically understands that your target leverage is 0.8, which makes total sense given the collateral and we’ve been no where near that amount which hopefully now time is changed right, and you’ve got attractive opportunities in your drilling. The question is not really if you will end up covering the dividend, eventually you can if you lever but more of a function of when, and is it reasonable to assume that one might see leverage and portfolio go to a point where this dividend could be covered in two quarters or is it four to six quarters.

[Michael Gross:]

I think just to step back as you know as we’ve ramped this portfolio, we have always covered the dividend. We walked this dividend up to manage and match our growth in the portfolio given that this was a approval cash when we closed the original IPO. And so we've continued to walk it up and have always covered it. And I think the anomaly here is that in Q4 as Rich just took you through, we had $0.10 of prepayment fee income that flow through the NII in connection with that $80 million of repayments. So fortunately that did give us excess taxable that is allowing us to rebuild the portfolio. I think that as Michael mentioned, we continue to think the $200 million a year origination pace, call it $50 million on average across the quarter with $60 million in Q4. It was in the 40s in Q1. So I think that's a fair pace as we think about the ramp here and really the thing that's a little bit unpredictable is that repayment activity which was closer to $20 million in Q1 which we see is more normalized. It’s our expectation that at some point later this year we will have rebuild this to the point that it’s back to the [11.75] and depending on market yields, you should see an opportunity to even grow beyond that.

[Richard Peteka:]

Jonathan, this is Rich. I'll just add to that, keep in mind that given the asset class and the size of SUNS, we do get upfront fees which we’re amortizing, but for tax in taxable income we are getting the cash in the door day one, that's taxable income, that supports the dividend, but for GAAP we are amortizing that. And then again just to reiterate, this is the first quarter I think the midst and I think that's just timing due to the repays in Q4. So this is a different asset class. We feel good about the portfolio growth. I think we talked about it in some of the other parts of the script.

[Bruce Spohler:]

And be mindful also now that we are larger we can take larger investment sizes in each investment, which also accelerates the pace of rebuild here. As we started with a pool of cash, we're investing $4 million and $5 million on average today, our investment size is 10 plus and so you will see us deploy that remaining capital, I think rather consistently.

[Jonathan Bock:]

I appreciate that. And Rich, I completely agree that amortizing upfront fees over the life loan, obviously a very conservative practice and happy to see that. I guess the question was essentially historically in terms of how you cover the dividend, but the fact that a capital rate at such a low level of leverage close to point when you have significant repayments kind of puts you a little further behind the Apple, but I guess what you are saying now is that there is an ability now that you have a little bit more scale to grow beyond that and maybe raise at that level while it might not necessarily be earnings accretive immediately can end up benefiting people over time. Is that a fair statement?

[Richard Peteka:]

Yeah, I think that’s a fair statement. Obviously it was accretive from an ad perspective issuing above book and I think in any quarter, it's going to be difficult to replace your capital. I would argue you don’t want your management team doing that, you wanted to be patient particularly in this environment, but we believe that we set the balance sheet for the year and that you will continue to see more growth as we did in Q1.

[Michael Gross:]

And I think it's pretty typical of [BDC] to raise capital as they expect, given their pipelines to be able to deploy in the short to medium term, generally one to two months but some other things that happen, but from our perspective, we're comfortable with that timeframe.

[Operator:]

Thanks for your question. I would now like to turn the call back over to Michael Gross for closing remarks.

[Michael Gross:]

Thank you all for your time this morning. We look forward to talking to at the end of next quarter or if you have questions in turn, please give us a call. Thanks.

[Operator:]

Thank you for joining today’s conference. Ladies and gentlemen, this concludes the presentation. You may now disconnect. Good day.