Sunrise Realty Trust, Inc.
Q2 2013 Earnings Call Transcript

Published: 2 Aug 2013

[Operator:]

Good day, ladies and gentlemen, and welcome to the Q2 2013 Solar Senior Capital Limited Earnings Conference Call. My name is Karen 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. I would like to turn the call over to Michael Gross, Chairman and CEO. Please go ahead.

[Michael Gross:]

Thank you and good morning. Welcome to Solar Senior Capital Limited’s earnings call for the quarter ended June 30, 2013. I am joined here today by Bruce Spohler, our Chief Operating Officer and Richard Peteka, our Chief Financial Officer. Rich, please start off by covering the webcast and forward-looking statements.

[Richard Peteka:]

Thanks 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 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 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. During the second quarter, historically low yields throughout the fixed income universe motivated investors to allocate additional capital to the leverage loan and high yield markets. Syndicated loan issues took advantage of strong demand, light supply from M&A and an investors preference for floating rate securities to complete refinancing, repricings and dividend recap. The June market disruption caused by the Federal Reserve’s commentary caused a short-lived pullback which has since been brushed off by the credit markets. Against this backdrop Solar Senior generated net investment income of $0.29 per share in the quarter ended June 30, 2013, up sequentially from $0.28 per share in the first quarter. Our originations totaled approximately $47 million which is consistent with our general pace of $50 million per quarter. Bruce will discuss these investments in more detail, but I’d like to highlight that these additions to our portfolio speak to our origination platform’s ability to source investments with attractive risk reward profiles, even in challenging market conditions. Primarily resulting from the continued refinancing wave, we have principal repayments and sales of approximately $35 million during the quarter. While it’s unfortunate to lose the earnings power of high quality assets, as credit investors, we never lose sight of the fundamental objective when making investments, which is to get repaid in full. Additionally, repayments at par and investments that were issued recently with OID provide incremental investment income. Our second quarter portfolio activity resulted in an increase in the portfolio by approximately 5%. As we’ve stated before, the origination business tends to be lumpy, and the same can be said for redemptions. Based on current visibility in the third quarter, we anticipate greater net portfolio growth than resulted in the second quarter. As fundamental credit investors and significant shareholders in SUNS, we placed a high emphasis on investing only in opportunities with strong risk reward characteristics. At June 30, 2013, the fair value weighted average mark on our first lien investments was 98.3% and the weighted average yield of the portfolio based on fair value is 7.3%. In comparison, the average price on the [LCBX] which represents the liquid leverage loan market was 102.8% with an implied yield of just 5% at June 30th. The spread compression in the leverage loan market resulting from the strong capital inflows presents challenges for investors. Specifically at Solar Senior, in this market environment, we are focused on utilizing our strong origination platform which its proprietary relationships and knowledge of repeat issuers to source opportunities where we have an information edge. As a result, we are continuing to make investments with acceptable yield and strong credit characteristics. At the end of the second quarter, Solar Senior Capital had $110 million of available capital capacity to invest in new opportunities. With our long-term focus, we will continue to deploy capital in a disciplined and prudent manner. Lastly, on July 31st, our Board of Directors declared a monthly dividend for August of $11.75 per share payable on September 4th to stockholders of record on August 22, 2013. At this time, I would like to turn the call back over to our Chief Financial Officer, Rich Peteka.

[Richard Peteka:]

Thank you Michael. Solar Senior Capital’s net asset value at June 30, 2013 was 207.6 million or $18.03 per share compared to 210.1 million or $18.25 per share at March 31st. our change in book value is driven primarily by a markdown to the fair value of two investments in the defense segment and the difference between our net investment income and dividends for Q2. Our investment portfolio had a fair value of approximately 250.2 million at June 30, 2013 compared to 239.6 million on March 31, 2013. For Q2 2013, gross investment income was 4.7 million versus 4.5 million in Q1. The increase was primarily driven by a larger investment portfolio and slightly higher weighted average yield. Expenses totaled 1.4 million for the second quarter compared to 1.3 million for the first quarter. For the three months ended June 30th, our net investment income was 3.3 million or $0.29 per share versus 3.1 million or $0.28 per share for Q1. Investment sales and repayments in Q2 totaled 35.4 million. The net realized gain for the quarter was $181,000, primarily related to modest sales of select assets. For Q1, the net realized gain was $22,000. And net unrealized depreciation for Q2 totaled 2.0 million, primarily attributable to markdowns in two investments, Engineering Solutions & Products and Sotera Defense Solutions. This compares to net unrealized depreciation of 245,000 for Q1 2013. At June 30th, we had 39.4 million in borrowings outstanding on our credit facility and the 110.6 million of unused capacity subject to borrowing base limits. This equated to a debt to equity ratio of 0.19 times. The credit facility also contains a delayed draw feature which provides an additional 50 million of unused capacity. At this time I’d like to turn the call over to our Chief Operating Officer Bruce Spohler.

[Bruce Spohler:]

Thank you Rich. In general, the operating performance held steady across our portfolio companies during Q2. Our issuers remain cautiously optimistic in the context of a flat to slow growth economy. As debt investors, we don’t underwrite growth but rather we stress test potential portfolio companies’ ability to delever in a flat to declining economic environment. Therefore, we are pleased with the steady financial performance of the majority of our portfolio companies. We view our issuers cash flow generation and principal amortization payments as an ordinary course means of reducing risk across our portfolio. The fair value weighted average investment risk rating of our portfolio at the end of Q2 remains steady at approximately 2 based upon our 1-to-4 risk rating scale with 1 representing the least amount of risk. Our Q2 portfolio activity further diversified and enhanced the composition of our portfolio. At June 30th, we had 36 portfolio companies operating in 21 industries. The weighted average investment sides had fair value 6.4 million with no single issuer representing more than 6.5% of fair value. Secured loans accounted for approximately 97% of the fair value of the portfolio and 92% of the fair value was invested in floating rate loans. For our first lien investments, the weighted average leverage to our tranche is in the mid 3 times and the average cash interest coverage across the entire portfolio is a healthy 3.3 times. The weighted average yield on our portfolio based on fair value was 7.3% at June 30th as compared to 7% at March 31st. We believe that our portfolio provides a compelling risk reward profile, especially when compared to the liquid senior loan closed end funds, a comparison that Michael will highlight a little bit later. Before going into the portfolio activity, I would like to give you an update on ESP which we placed on non-accrual in Q1. At June 30th, the investment had a fair value of 4.5 million representing just under 2% of our portfolio’s total fair value. We are currently actively engaged with the sponsor and management of ESP and expect to have a resolution during the second half of the year. Turning to originations. We were active in the second quarter with 9 new investments totaling approximately 47 million, all of which were senior secured. Now let me take you through a couple of these. We funded a $15 million secondary purchase of a unitranche term loan on Fulton Holding company, which is the parent company of Paradies Shops, which is one of the largest airport retailers here in the States. Our investment team is intimately familiar with this company having participated in prior financings on behalf of Solar Capital dating back 2009. Our loan has modest leverage at 2.8 times with a yield to maturity of approximately 9%. This proprietary investment allows us to invest in an attractive and well known credit to Solar Capital platform. We also funded a $10 million investment in the 140 million second lien term loan of Securus Technologies in support of Abry Partners acquisition of the business. Securus is the number two provider of inmate telecom services in the U.S. and serves over 2200 correctional facilities across 45 different states. The loan carries an all-in yield of approximately 9.2%. Additionally, we made a $6 million add-on investment in the incremental $100 million first lien term loan of TriNet, which is targeted to fund future acquisitions. Owned by General Atlantic, TriNet is a leading professional employer organization, with over 160,000 worksite employees. SUNS had made an initial $10 million investment in Q4 2012. The first lien leverage is under 2.5 times and carries a yield of approximately 6.5%. This add-on investment brings our TriNet position to approximately $16 million. Repayments, amortizations and sales totaled $35 million in Q2. We received repayments and amortization of approximately $21.5 million and we took advantage of strong market conditions to opportunistically sell approximately $14 million in two investments, resulting in a modest realized gain. Let me highlight a couple of these transactions. Our $14 million investment in KIK Custom Products which was the portfolio company for CI Capital was repaid in May as part of a recapitalization. The investment generated an 11.5% IRR for SUNS. In addition, we were repaid on our $5 million first lien term loan investment in ABB/Concise at a premium to par. As a reminder, SUNS made this investment back in February as part of a refinancing and add-on acquisition for ABB, which is the largest optical distributor in the U.S. SUNS had originally invested in ABB back in the fall of 2012 in support of New Mountain Capital’s purchase of the company. The IRR in this first lien investment is 10.5%. Turning to exits. During Q2, we took advantage of market conditions to sell our $9 million position in Things Remembered. Solar Senior had invested in Things Remembered back in May of 2012 in support of Madison Dearborn’s buyout of the business. as part of a proposal to upsize the loan in February and increase the risk, Solar Senior elected to sell our position at par, resulting in an IRR of 10.7% on this investment. Thus far in the third quarter, our origination activity has been consistent with our $50 million per quarter historical pace. However, we’ve also been notified of some potential redemptions. Barring any unforeseen additional repayments, we do anticipate further portfolio growth in Q3. Now I’d like to turn the call back over to Michael.

[Michael Gross:]

Thank you Bruce. In conclusion, we believe that we’ve constructed a diversified high quality portfolio of senior secured floating rate loans and we are focused on increasing the size of earnings power via the prudent deployment of our $110 million of available credit capacity. As one of the largest shareholders of SUNS, we are truly active principals when we make these investment decisions. As long-term veterans of the leveraged lending industry, spanning multiple credit cycles, our senior management team believes that its imperative to remain absolutely disciplined in our investment process in the current liquidity driven market conditions. Protecting principal and being adequately compensated for risks remain the top priorities of our underwriting philosophy. We believe Solar Senior Capital remains well positioned to continue to source senior secured middle market loans at wider spreads, lower leverage and better covenant protections than what is available in the larger syndicated bank loan marketplace. Currently our pipeline remains strong, so we believe it’s prudent to have dry powder ahead of what could be a volatile second half and hopefully a more active M&A environment. We believe that middle market bank loans provide a more defensive approach for investors to gain leverage credit exposure than by investing in a high yield market based on seniority in the capital structure, lower levels of leverage, shorter duration and built-in interest rate protection. In addition, bank loans have a low correlation to other fixed income assets given the floating rate structure. Importantly, middle market senior loans continue to be attractive on a relative and absolute risk return basis when compared to syndicated high yield and leverage loans. Our portfolio today currently has a weighted average yield of 7.3% with weighted average leverage in the mid 3s at the asset level. In contrast, the Barclays U.S. Corporate High-Yield Index yields 6.1% with average leverage in the range of 5 times and a universe of 14 different closed-end senior loan funds we track trade at a current weighted average yield of 6.4% with average portfolio leverage of 30%. Middle market lending continues to offer an illiquidity premium that favorably impacts risk adjusted returns. With the record issuance of leverage loans in the first half, it is clear that demand for floating rate secured assets is a priority with investors at what may be an inflexion point for the direction of interest rates. The June correction in place [in terms] appear to be a blip; however, it is demonstrative in terms of what may happen when the Fed changes course. We look forward to speaking with you again next quarter, so operator please at this time, open up the line for questions.

[Operator:]

(Operator Instructions) The first question we have comes from the line of Jonathan Bock with Wells Fargo. Please go ahead.

[Jonathan Bock:]

Good afternoon again and thank you for taking my question. Michael, Bruce, one item does it relate to dividend policy, you guys have shown yourself very adept not to pay a dividend out of NAV as evidenced by the recent reduction at Solar. And given the fact that the investing environment broadly speaking, Michael to your point, isn’t as favorable as one would assume, one could assume that you’re going to be conservative and likely fall below that dividend as you have for quite a while, at least for the last quarters at least. And so what say you to the possibility of reconciling the dividend to a more appropriate level rather than continue to pay it out of NAV, particularly as NAV suffers from some credit marks to the downside?

[Michael Gross:]

Yeah, I think that, as you look at Solar, obviously, as we’ve talked about in the past, we were burdened with substantial repayments all at once which created that shortfall. I think SUNS is a different situation. We saw some meaningful repayment in Q4 of last year, which is when we then came into Q1 of this year and said, we had some rebuilding of the portfolio to accomplish. Again, always good to get repaid particularly when we’ve been repaid at premiums to our original cost, not mention par. So I think here it’s just been rebuilding, the origination pace has been steady at just around 50 million a quarter. I think that it’s a little bit slower going given the pace of repayment, then we would have liked or anticipated. But we feel good about the pace of originations and I think that’s a more consistent origination pace in this asset class than you would see in the assets over at Solar, where it tends to be a little bit more lumpy. And so I think we feel good about our ability to re-ramp the portfolio here and it’s really a matter about when and not if. And as I mentioned, feel good about the pace at which we’re investing here in Q3. Go ahead.

[Richard Peteka:]

Let me just add that I guess Q4 we actually beat our dividend which significantly brought over $0.10 or so into this year taxable income. So the business is lumpy as you know and then in addition, we raised some equity in January here which increased the share. So that’s just being – taking our time to redeploy again some of those headwinds on the repayments. And then lastly, just as a reminder, we are actually, while it looks like we’re under earning our dividend on a tax basis, we are getting fees consistently upfront on these, and we’re amortizing those into our earnings and NAV effectively. But we’re actually getting cash upfront in the door and so we’re actually in a much better I think position all in than we are. So we have the ability to be patient and prudent and just focus on the credit risk.

[Jonathan Bock:]

Appreciate the discussion of book and tax differences. One other item I really appreciated the discussion on SUNS relative to what is out there available in the high yield as well as other closed end funds. And part of the differentiator I’m trying to reconcile is the fact that you do focus on proprietary transactions, middle market transactions that are a little harder to uncover, a little harder to understand and give you a good risk adjusted return. And so I guess the question is if you look at some of the transactions, let’s say Securus or Global Tel, walk us through what makes those transactions proprietary on this current environment relative to the other bank loan funds that you mentioned?

[Michael Gross:]

Sure. I think as you look at things like Securus and Global Tel, first of all, proprietary – as we think about Paradies or Fulton for example, is in that we’ve owned this at Solar Capital for the last four years. Proprietor, when you think of a Global Tel or a Securus is that fact that we have close relationship with Abry, the owner of Securus and we have done direct deep dive due diligence on these two companies over the last couple of years in various incarnations. So for us it’s about having the ability to get in there and really feel like we understand what we are owning as opposed to going through a syndication process. We’re not looking to check a proprietary box; we’re looking to underwrite and get good risk adjusted returns and really feel like we have the ability to do our due diligence.

[Jonathan Bock:]

Great. Thank you very much.

[Richard Peteka:]

Thanks Jonathon

[Operator:]

Thank you for your questions. (Operator Instructions) Next question we have comes from the line of Mickey Schlein of Ladenburg. Please go ahead.

[Mickey Schlein:]

My question was already answered. Thank you.

[Operator:]

Thank you. (Operator Instructions) The next question we have comes from the line of Christopher York of JMP Securities. Please go ahead.

[Unidentified Analyst:]

Good morning, this is [Ken Chow] for Chris York. I just have two quick questions. There was a slight drop in fair value for Sotera and Engineering Solutions also continued to dip. Do you think this was a defense industry trend or are these effects more like company specific?

[Michael Gross:]

No, I think there is always a company specific reaction to what’s going on in the sector. But to your point it is clearly sector driven and I’ve mentioned, we’ve been working actively on ESP. we are getting more active on Sotera, but very different business. Sotera does have a core business focused on cyber security which is obviously getting a lot of attention from the government. But clearly spending under contracts has been delayed. So these businesses are both getting and winning new contracts but as you know it’s about getting – granting of funding on those contracts and that has been delayed broadly across the government services and in particular defense sector. So they are definitely both facing some headwinds from that perspective.

[Unidentified Analyst:]

Okay. I appreciate your comment and also your floating rate investment has decreased quarter over quarter by 6%. Is this a indication of a change in portfolio mentality or is it just a momentary change?

[Michael Gross:]

No, it’s actually just a momentary change. The investment – good question, the investment in Fulton is actually structured as a fixed rate investment. So that’s the only thing that’s changed. Everything else has been floating rate for us. But we felt that that was a great risk adjusted return at 9% for 2.5 times leverage.

[Unidentified Analyst:]

Great, that’s what I expected. Okay, thank you very much.

[Michael Gross:]

Thank you.

[Operator:]

Thank you for your question. (Operator Instructions) That looks to be all the questions. I’d now like to turn the call back over to Michael Gross for closing remarks.

[Michael Gross:]

Thank you for your attendance this morning and have a great day.

[Operator:]

Thank you. Thank you for joining today ladies and gentlemen, that concludes your presentation. You may now disconnect. Have a good day.