Sunrise Realty Trust, Inc. (SUNS) Q3 2014 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Third Quarter 2014 Solar Senior Capital Ltd. Earnings Conference Call. My name is Glen, and I'll be your Event Manager for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Chairman and CEO, Mr. Michael Gross. Please proceed.

Thank you, and good morning. Welcome to Solar Senior Capital Ltd. Earnings Call for the Quarter Ended September 30, 2014. I'm joined here today by Bruce Spohler, our Chief Operating Officer; and Richard Peteka, our Chief Financial Officer. Rich, would you please start off by covering the webcast and forward-looking statements.

Thank you, Michael. I'd like to remind everyone that today's call and webcast are being recorded. Please note that they are the property of Solar Senior Capital Ltd. and that any unauthorized broadcast in any form are strictly prohibited. This conference call is being webcast on our website at www.solarseniorcap.com. A replay of this call will be made available later today as disclosed in our press release. I'd also like to call your attention to the customary disclosures in our press release regarding forward-looking information. Statements made in today's 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 Ltd. 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 turn the call back to our Chairman and Chief Executive Officer, Michael Gross.

Thank you, Rich. Our third quarter was a successful one, and that positive momentum is continuing into the fourth quarter. During the quarter, we experienced portfolio growth and an increase in our quarterly net investment income. We also announced a strategic joint venture with which we were making significant underwriting progress. On the margin, the overall market volatility has been a positive for our business. The outflows in the high yield and liquid leverage loan markets, albeit dampened by CLO issuance have had a trickle-down positive effect on the middle market. Additionally, we anticipate that the fed's recent decision to end its quantitative easing program will ultimately make conditions in the middle market more lender-friendly as capital becomes more scarce. On September 10, we announced that Solar Senior Capital formed a joint venture with Voya Investment Management to create a First Lien Loan Program, or FLLP, who which we've been very pleased with our progress thus far. As a reminder, the FLLP invest primarily in senior-secured, first lien term loans to middle-market companies predominantly owned by private equity sponsors or entrepreneurs consistent with our core strategy. Solar Senior and Voya committed $50 million and $7.25 million, respectively, to the joint venture. In the fourth quarter, we've begun underwriting potential investments, and we anticipate beginning to fund the JV early in the first quarter of 2015, as well as closing on a third-party credit facility that's expected to enable the JV to achieve a debt-to-equity ratio of approximately 2x once the portfolio is ramped. The strategic partnership with Voya provides incremental long-term capital from a like-minded credit investor and is an important growth initiative that will expand our origination capacity and allow us to scale the Solar Senior balance sheet more efficiently. Once ramped, we expect the joint venture to generate a return on equity in the low- to mid-teens and be accretive to Solar Senior's net investment income. We believe the additional scale will enhance our value to the sponsor community. In the third quarter, portfolio activity resulted in new investments of $46.1 million across 9 portfolios and sales repayment of $32.4 million. At September 30, the credit quality of our diversified portfolio of senior secured [indiscernible] rate loans remained strong. The weighted average yield of the portfolio based on fair value was 7.2% at September 30, 2014. In comparison, the S&P/LSTA U.S. Leveraged Loan 100, which tracks the 100 largest loans to the broader index, held a yield to maturity of just 4.8% at September 30. Our investment in Gemino Healthcare also continues to demonstrate strategic value to its recurring cash income, diversified portfolio and differentiated origination platform. Bruce will provide additional information on Gemino and our third quarter portfolio activity. At the end of the quarter, Solar Senior Capital had approximately $99 million of undrawn credit capacity subject to borrowing base limits. Our pipeline investment opportunities, which includes the loans we are potentially underwriting for our JV with Voya, remains strong. Lastly, our Board of Directors declared a monthly distribution for November 2014 of $0.1175 per share, payable on December 2 to stockholders of record on November 20, 2014. At this time, I'd like to turn the call over to our Chief Financial Officer, Rich Peteka.

Thank you, Michael. Solar Senior Capital's net asset value at September 30, 2014, was $203.6 million or $17.65 per share compared to $205.9 million or $17.85 per share at June 30. Our investment portfolio at September 30 had a fair market value of $278.0 million in 39 portfolio companies across 21 industries. This compares to the fair market value of $265.9 million in 37 portfolio companies across 20 industries at June 30, 2014. For the 3 months ended September, gross investment income totaled $5.3 million compared to $5.1 million for the 3 months ended June 30. Expenses totaled $1.8 million for the third quarter compared to $1.7 million in the second quarter. This excludes the $972,000 charge related to our Q2 amendment and extension of the company's credit facility. Accordingly, the company's net investment income for the 3 months ended September 30, 2014, totaled $3.5 million or $0.31 per average share versus $3.4 million or $0.29 per average share to Q2, again, excluding that $972,000 charge related to the Q2 amendment and extension of the credit facility. Net realized and unrealized loss for the 3 months ended September 30, 2014, totaled $1.8 million compared to net realized and unrealized loss of $0.5 million in the -- for the 3 months ended June 30, 2014. Ultimately, the company had net increase and net assets resulting from operations of $1.7 million or $0.15 per average share for the 3 months ended September 30. This compares to $1.9 million or $0.17 per average share for the 3 months ended June 30. At this time, I'd like to turn the call over to our Chief Operating Officer, Bruce Spohler.

Thank you, Rich. Let me begin by providing a portfolio update. Overall, the financial performance of our portfolio companies remained steady to improving. While the portfolio is broadly diversified across a variety of industries, we continue to favor issuers operating in more defensive, noncyclical industries. At September 30, our performance -- our portfolio is performing well, and we feel confident about the prospects of our company's operating results going forward. At Q3, the weighted average yield on our portfolio was 7.2% based on fair value versus 7.4% at Q2. Our internal risk assessments on a weighted average value of our portfolio remains at approximately 2 based on our 1:4 risk rating scale with 1 representing the least amount of risk. SUNS ended the second quarter with investment in 39 issuers across 21 industry groups. Our average issuer exposure is approximately $7 million. The portfolio is invested in: 86% senior secured loans; 12% in Gemino senior secured healthcare, whose portfolio is comprised 100% of senior secured loans; 1.5% in unsecured loans; and 0.3% in common equity, excluding our investment in Gemino's loan portfolio and measured at fair value. Including our investment in Gemino at 100% floating rate, over 93% of our income-producing portfolio is floating rate and just under 7% is fixed rate when measured in fair value. During Q3, SUNS made investments of approximately $46 million across 9 portfolio companies and had sales and repayments of approximately $32 million. Before I give an overview of our Q3 investment activity, let me provide a brief update on our investment in Gemino. At quarter-end, Gemino had $112 million of funded senior secured revolving or term loans across 37 different issuers with an average loan balance of approximately $3 million. All of the commitments at Gemino are floating rate senior secured cash paid loans. During the third quarter, Gemino originated new funded loans of approximately $15 million and had excess of just over $5 million. For Q3, Gemino paid distributions to SUNS of $820,000, which equates to a 10% annualized distribution yield on the cost of our investment. This is consistent with the annualized distribution yield for Q2. In addition, Gemino had $83 million outstanding under its $110 million credit facility at quarter-end. Now let me highlight a couple of our Q3 investments. We funded a $10 million first lien investment to help finance Silver Lake's leveraged buyout of Quorum Business Solutions, which is a leading ERP software provider for the oil and gas industry. Total leverage on the company is 4.5x, and our all-in yield is approximately 6%. In addition, we made a $7.5 million investment in the first lien loan for Innovative XCessories & Services, which was acquired by Olympus Partners during Q3. Leverage through our tranche is approximately 4x. We also funded a $5 million investment in the first lien term loan of SkinnyPop Popcorn to support TA Associates' buyout of this company. SkinnyPop is a leading brand in the ready-to eat, better-for-you popcorn segment. Leverage to our first lien tranche is 3.3x, and the yield on our first lien loan is approximately 5.8%. Additionally, we made a $4 million investment in the first lien term loan of tradeMONSTER, which is a leading independent online broker in the retail options trading market, which was acquired by General Atlantic during Q3. The pro forma leverage is 2.6x, and our all-in yield on the investment is 7%. Now let me highlight a couple of our repayments during the third quarter. We were repaid on our $8.5 million investment in the first lien term loan of Jacobs Companies in conjunction with the sale of the business. The IRR on our investment since -- made in July of 2013 was approximately 8.7%. Additionally, our $4 million investment in Marshall Retail was redeemed as part of the sale of that company. As a reminder, Solar Senior invested in Marshall Retail back in October 2011. Our IRR in this investment was just over 8.25%. We were also repaid a par on our $7.25 million investment in the first lien term loan of INSIGHT Pharmaceuticals in connection with the sale of that business. And finally, we exited our remaining $3.5 million investment in the first lien term loan of Catapult Learning, which resulted in IRR of approximately 9%. Based on our fourth quarter activity to date and current visibility for the remainder of the quarter, we are expecting additional portfolio growth in Q4. Now I'll turn the call back to Michael.

Thank you, Bruce. In conclusion, we are pleased with the performance in the third quarter and expect additional growth in the fourth quarter, both in terms of the size and breadth of the portfolio and our net investment income. Our joint venture with Voya is off to a solid start. We're actively underwriting attractive senior secured loans for the initiative, as well as working with third-party lenders to secure debt financing in the first quarter. As significant shareholders of this business, we've taken a selective approach to growth over the past 2 years, and we believe this strategy has positioned us well for prudent portfolio expansion over the coming quarters as the market implications of the fed shift in policy begin to crystallize. We have adequate available capital to take advantage of the modest improvements in terms following the recent market volatility. As fellow shareholders, our primary focus remains on preservation of capital to the careful selection of investments with attractive risk reward characteristics. This will continue to be our guiding principle as we continue to expand our investment portfolio. We believe the senior secured middle market asset class remains attractive on both a relative and absolute basis. SUNS currently has a well-diversified portfolio of primarily senior secured floating rate loans. At last night's closing price of $15.38 per share, SUNS trades at 0.87x book value and yields approximately 9.2% and has ample capital to make additional investments. The risk-reward value proposition of an investment in Solar Senior Capital Ltd. is compelling when compared to liquid-syndicated high-yield and bank loan markets. SUNS yield of approximately 9.2% compares favorably to the 5.8% yield of the Barclays high-yield corporate index and a 6.4% weighted average yield on a representative sample of closed-end bank loan funds. Thank you for your time this morning. We look forward to speaking to you next quarter. Operator, please open this line up for questions.

[Operator Instructions] Your first question comes from the line of Ron Jewsikow, Wells Fargo Securities.

I appreciate the color you guys provided on the kind of the ROE potential of -- from the FLLP. But just kind of as we model that for like leverage costs at 2:1 leverage and given that these are senior secured loans that you'll be making, kind of what would be a ballpark for the cost on that facility? I know you haven't finalized anything yet.

Sure, I think L [ph] 250 to 275 is a good range.

Okay. And then these assets, just for clarification, are substantially the same as the ones you kind of originate now at SUNS -- just larger hold sizes?

They're exactly the same.

Okay. And then one last question, and then I'll jump back in the queue, kind of with the dislocation we saw in the market in late September, early October. Is there the potential kind of for maybe -- usually, we have -- see a back-weighted quarter. Is there a potential for maybe a more front-loaded quarter as far as originations this quarter?

I think Q4, to the extent that we ever have seasonality in our business, it tends to be a little bit in Q4. I don't think it's dictated by the volatility that we saw in the beginning of the quarter. It's more just people trying to get transactions closed by year-end. So I think that's the bigger driver. And as you know, at SUNS, it's actually been a rather consistent pace of $50 million-or-so originations per quarter, and we continue to see us marching on that pace.

[Operator Instructions] And your next question comes from the line of Mickey Schleien. Mickey M. Schleien - Ladenburg Thalmann & Co. Inc., Research Division: I wanted to follow up on Voya. I'm trying to understand what they bring to the table. It's not a lot of money that they've committed. The first lien product is something that you already do on your own. So could we just step back and remind us why do the Voya joint venture in the first place?

Yes. Good question, Mickey. I think that from our perspective, obviously, as significant shareholders in SUNS, what we want to do is continue to leverage the origination platform that we have in place. And what Voya does is, as the last questioner highlighted, allows us to take larger positions of loans that we're already underwriting and yet, on a consolidated basis, still have the appropriate diversification that we're looking for across the portfolio. It has the added benefit of moving that incremental investment off balance sheet in a joint venture structure, where, obviously, they have a veto. But additionally, it allows us to leverage these assets separately at pretty low leverage ratios, as you know, for senior secured assets up to 2x in contrast with CLOs who will put anywhere from 5x to 8x leverage on a senior loan. So it gives us a little bit more leverage ability and efficiency of our financial structure. We're leveraging our origination, taking bigger positions of the exact same assets and yet still expanding our first lien portfolio. And I think fair to say, we'll probably ramp this faster because of those efficient dynamics. As Michael touched on, we expect ROEs on that JV to be in the low- to mid-teens once ramped and into the leverage. And so clearly, when you run the math, it's pretty accretive from an NII perspective. Mickey M. Schleien - Ladenburg Thalmann & Co. Inc., Research Division: Okay, I understand. And could either of you just give us a sense of how you would characterize the refinancing risk in the portfolio today? My guess it's fairly low, given how much turnover you've had. But is there anything large expected to pay-off in the near term?

No, there isn't. As you know, the average position is around $7 million. It's pretty diversified. There's couple positions in the 10 to 15, and we expect, with Voya, to take those -- more of those positions going forward. But no, there is nothing significant. The only thing that I guess I would speak to that was in a public market was Attachmate, which was refinanced this quarter in the public market. So that was a $12 million position for us. But so far, not a lot of visibility on repayments. And I think what I would echo is what we commented on Solar conference call, that a lot of the drivers right now seem to be more M&A-driven, so it's more sale of companies. And if you look at the repays that we just had in Q3 at SUNS, it was more sale of companies-driven than it was refis or recapitalizations. And the nice thing about the M&A transactions is -- generally speaking, we're given an opportunity to look to reinvest in that new capital structure for an issuer that we've been underwriting for a number of years. And so long as we like the risk return, either in the senior or the junior, we generally will try to capitalize on that.

[Operator Instructions] At this time, we have no further questions. I will now turn the call over to Mr. Michael Gross for closing remarks.

No closing remarks. Just thank you, all, for participating this morning, and we look forward to talking to you at another time. Thank you.