Sunrise Realty Trust, Inc. (SUNS) Q2 2015 Earnings Report, Transcript and Summary

Welcome to the Second Quarter 2015 Solar Senior Capital Limited Earnings Conference Call. My name is Shantalay and I will be your facilitator for today's call. [Operator Instructions]. I would now like to turn the conference over to your host for today, Mr. Michael Gross, Chairman and Chief Executive Officer. Please proceed, sir.

Thank you very much and good morning. Welcome to Solar Senior Capital Limited's earnings call for the quarter ended June 30, 2015. I'm joined here today by Bruce Spohler, our Chief Financial Officer and Richard Peteka, our Chief Financial - excuse me, 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?

Sure. Thanks 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 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 replays of this call will 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 event or our future performance and 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 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 would like to turn the call back to our Chairman and Chief Executive Officer, Michael Gross.

Thank you Rich. We're pleased to report solid operating performance for Solar Senior Capital in the second quarter of 2015, including our financial performance, net originations and portfolio credit quality. We believe Solar Senior's predominantly first lien senior secured floating-rate portfolio is well-positioned to protect invested capital in today's continued frothy credit environment and provides an attractive floating-rate oriented investment solution in a rising interest rate environment. Overall, middle-market issuance in the second quarter was up sequentially from the first quarter but remains at low levels with year-to-date issuance down approximately 50% from the first half of 2014. Against this challenging backdrop, we had gross originations of $58.6 million and repayments and sales of $34.2 million in the quarter, including our investment activity through our First Lien Loan Program. As a reminder, FLLP is a portfolio company through which SUNS co-invests with VOYA Investment Management in first lien senior secured loans. Through June 30, FLLP has deployed approximately 1/3 of its projected $160 million of investment capital when fully ramped. Across SUNS' third-quarter date, we currently expect a low-level prepayment and we anticipate continued net growth from originations. We believe our progress in the second quarter with the ramp of our First Lien Loan Program and contributions for investment in Gemino creates a continued runway for investment income growth through the second half of 2015. We also expect a higher return on equity for investments in FLLP as the portfolio grows and approaches target leverage of 2.0 times debt to equity. In the second quarter, Gemino maintained its 10.5% distribution yield to SUNS, up from 10% in 2014. And we believe this investment has additional earnings upside potential. Bruce will provide additional information on developments at FLLP and Gemino later in the call. Excluding nonrecurring expenses related to the amendment and extension of our credit facility, second quarter net investment income was $4.2 million or $0.36 per share. Our net portfolio growth, including FLLP, has now boosted the earnings power of our portfolio to cover our monthly distributions to our shareholders. At June 30, our broadly diversified portfolio comprised predominantly of senior secured floating-rate loans continued to be 100% performing and we have no direct exposure to the energy sector. During the second quarter, SUNS amended its $175 million credit facility in order to provide greater investment flexibility, add additional lenders and extend the maturity to June 2020. The interest rate remains at LIBOR plus 200 basis points. At June 30, SUNS had approximately $32 million of unused credit facility capacity subject to borrowing base limitations. In addition, FLLP had approximately $52 million of unused credit capacity on its existing $75 million facility. We anticipate increasing the size of the FLLP credit facility later this year to accommodate committed equity capital to the joint venture. When considering anticipated 2 to 1 debt to equity leverage on SUNS' full $50 million equity commitment to the FLLP, our incremental investment capital is over $100 million, subject to borrowing base limitations. Lastly our Board of Directors declared multi-distribution for August 2015 of $0.1175 per share payable on September 1 to stockholders of record on August 20, 2015. At this time, I would like to turn the call back over to our Chief Financial Officer, Rich Peteka.

Thank you Michael. Solar Senior Capital Limited's net asset value at June 30, 2015 was $202.4 million or $17.55 per share, compared to $203.5 million or $17.65 per share, at March 31, 2015. The slight decline in NAV was predominantly due to the expenses associated with the amendment and extension of our credit facility. Our balance sheet at June 30, 2015 had an investment portfolio with a fair market value of $347.4 million in 47 portfolio companies operating in 25 industries compared to $345.4 million in 46 portfolio companies operating in 26 industries at March 31. At June 30, the weighted average yield on our income producing portfolio increased slightly to 7.0% measured at fair value versus 6.9% at March 31. And 100% our portfolio investments are performing. SUNS also had $143.4 million in borrowings outstanding on its $175 million credit facility at June 30, resulting in a net debt to equity ratio of 0.69 times. This compares to $140.9 million and a net debt to equity ratio of 0.67 times at March 31. Gross investment income for the three months ended June 30 totaled $6.7 million versus $6.1 million for the three months ended March 31. Expenses for the three months ended June 30, including the $0.8 million of nonrecurring expenses related to the amendment and extension of our credit facility, totaled $3.3 million compared to $2.3 million for the three months ended March 31, 2015. Accordingly, net investment income for the quarter ended June 30 was $3.3 million or $0.29 per average share, versus $3.9 million or $0.34 per average share for the quarter ended March 31. Excluding the nonrecurring expenses related to that credit facility amendment, the company's net investment income would've been $4.2 million or $0.36 per average share for the quarter ended June 30. Over the line, we had a net realized and unrealized loss for the three months ended June 30 totaling $0.5 million, compared to a net realized and unrealized gain of 0.0 - excuse me, $0.2 million for the quarter ended March 31. Ultimately, the company had a net increase in net assets resulting from operations of $2.9 million or $0.25 per average share, for the three months ended June 30. This compares to $4.1 million or $0.35 per average share, for the three months ended March 31, 2015. 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 credit fundamentals and financial performance of our portfolio of companies remains strong. As Michael mentioned, we continue to have no direct exposure to the energy sector. At June 30, our portfolio was 100% performing and we feel confident about our company's ability to continue to deleverage. On a weighted average basis and measured at fair value, our internal risk assessments remained at approximately 2, based on our 1-to-4 risk rating scale, with 1 representing the least amount of risk. At June 30, the weighted average yield on our portfolio was 7%, up from 6.9% at the end of the first quarter. While it is too early to confirm a trend, it does feel like yield compression has bottomed out. SUNS' portfolio ended Q2 with investments in 47 portfolio companies across 25 different industries. SUNS' average issuer exposure is just under $8 million when including our ownership position of loans held in FLLP. At June 30, our portfolio was invested roughly 99% in senior secured loans, including 80% in senior secured loans across 45 portfolio companies, 10% in Gemino Healthcare Finance, whose portfolio consists entirely of asset-backed senior secured loans and 8% in FLLP, whose portfolio also consists entirely of first lien senior secured loans. In addition, we have approximately 1% in unsecured loans and 0.1% in common equity, excluding Gemino and FLLP. Including our investment in Gemino and FLLP, 95% of our income producing portfolio was invested in floating-rate assets and 5.5% was invested in fixed rate when measured at fair value. During the second quarter, we had gross originations of just over $58 million of first lien senior secured floating-rate loans across nine different issuers. Of the total originations, $40 million of investments was directly on SUNS' balance sheet and $18 million was across five investments in the FLLP program. During that same period, gross loans repaid or sold totaled approximately $34 million. Before I give an overview of our Q2 activity, let me provide an update on our First Lien Loan Program as well as our strategic investment in Gemino Healthcare Finance. As a reminder, our strategic partnership with VOYA Investment Management to create the FLLP provides incremental long-term capital from a like-minded credit investor that expands our origination capacity and allows us to scale the SUNS balance sheet more effectively. At June 30, when measured at fair value, the FLLP had approximately $55 million of senior secured first lien floating-rate loans across 12 issuers with an average loan balance of just over $4.5 million. During the second quarter, FLLP invested approximately $18 million in senior secured loans across five portfolio companies while loan repayments were negligible. For the second quarter, FLLP paid distribution to SUNS equating approximately to a 6% yield on the cost of our investment. Portfolio growth will allow FLLP to more fully utilize its credit facility. When fully ramped, we expect our distribution yield from FLLP to be in the low teens. At June 30, FLLP had $22.5 million of borrowings outstanding under its $75 million revolving credit facility, equating to a debt to equity ratio of 0.6 times. We will upsize our credit facility there with an expected debt to equity ratio of up to 2 times as the portfolio ramps, driving further ROE. Now I will turn to Gemino. At quarter end, Gemino had $121 million of funded senior secured revolving or term loans across 36 issuers with an average loan balance of approximately $3.4 million. During Q2, Gemino had originations totaling just under $11 million and prepayments totaling just under $9 million. All of the loan commitments at Gemino are floating-rate, asset-based senior secured and cash pay, consistent with the first quarter. For Q2 Gemino, paid a distribution to SUNS equating to a 10.5% annualized yield, consistent with the distribution paid for Q1. We continue to believe that Gemino has upside potential to drive a higher return on equity over the second half of this year. In addition, Gemino had $90 million outstanding under its $110 million credit facility. Now let me highlight a couple of our Q2 investments. We invested $10 million in the first lien term loan of LegalZoom which is majority owned by Permira. LegalZoom is the leading provider of online legal services to small businesses and consumers in the U.S.. The $156 million unit tranche was underwritten by a small club of investors as attractive covenant package and call protection. Our all-in yield on this investment is just under 9% and total leverage is 4.2 times. SUNS also invested $6 million in the first lien term loan of Pet Supplies Plus which is the third largest specialty pet retailer in the U.S. backed by Irving Place Capital. The all senior first lien net leverage is 3.7 times and the all-in yield is approximately 6% on this investment. In addition, we invested $10 million in the $100 million first lien term loan issued by Salient Partners, a leading diversified asset manager with approximately $37 billion of AUM. First lien leverage to our tranche is 2.65 times and our all-in yield is approximately 8%. Finally, we funded $15 million in the first lien term loan of Pet Supermarket in support of Roark Capital's acquisition of the company. Pet Supermarket is one of the largest pet specialty retailers in the U.S.. The first lien tranche was just under $200 million, underwritten by small public investors and carries and all-in yield of just under 7%. I'll now highlight a couple of our repayments during Q2. Solar Senior was repaid at a premium to par on its second lien term loan investment in Ikaria in conjunction with Madison Dearborn's sale of the business. Our IRR was 10.8%. We were also repaid at a premium to par on our $5 million investment in IPC Systems' first lien term loan. The company conducted a repricing transaction that we elected to not participate in. We originally invested in Q1 2015 as part of Center Bridge's buyout of the company. Though short-lived, our IRR in this investment was just under 25%. SUNS has also repaid on our $8 million first lien investment in Genoa pursuant to the company's sale to Advent Partners. Solar Senior originally invested in Genoa in the second quarter of last year as part of Nautic's combination of this country's two largest mental health pharmacies. Our IRR on this investment is just over 6.25%. In addition, Solar was repaid at par on its $9 million investment in the first lien term loan of Pro Mach in connection with a repricing amendment which we declined to participate in. SUNS had originally invested in Pro Mach back in 2014 in connection with AEA's acquisition of the company. Our IRR on this investment was 7.5%. And lastly, we were repaid at a premium to par on our $4.5 million second lien investment in Blue Coat Systems. The IRR on this investment was just under 12%. Thus far in third quarter, we have visibility on only $10 million of repayments across the SUNS portfolio. We continue to source attractive investment opportunities and we're optimistic about our ability to generate incremental investment income at both FLLP and Gemino as we further deploy our available capital. Now I'll turn the call back to Michael.

Thank you Bruce. In conclusion, the credit quality of our existing well diversified portfolio is strong and we expect a steady earnings stream from our core portfolio of 100% performing senior secured loans. More efficient utilization of our balance sheet through our strategic investments and steady net portfolio originations has now raised lower portfolio income to cover our distributions. We anticipate that growth to investment income in the second half will be driven primarily by higher returns on equity contributions from FLLP and Gemino. While it is clear that we have benefited from our sourcing efforts, it is a critical priority to achieve growth and net investment income without incurring undue risk. We will continue to be highly selective in our originations and maintain our disciplined focus on capital preservation and a credit market that continues to be frothy. We believe FLLP with its first lien mandate and regal target leverage in Gemino represent the best risk-adjusted path forward to growing SUNS' investment income. From our perspective, the senior secured middle-market loan asset class remains attractive on both a relative and absolute return basis. At June 30, the weighted average yield of the SUNS portfolio based on fair value was 7% and on a weighted average basis leveraged our first lien securities is in the mid-3s% with interest coverage at over three times. In comparison, the S&P/LSTA U.S. leverage loan 100 which tracks the 100 largest loans in the broader index, had a yield to maturity of 5.1% at June 30. We also believe the risk-return profile of an investment in Solar Senior Capital's stock is compelling when compared to the syndicated high-yield and bank loan markets. SUNS' 9.2% yield compares quite favorably to the 7.4% yield to worst of the Barclays high-yield corporate index and also to a 6.6% weighted average yield on a representative sample of 14 close-end bank loan funds. And at last night's closing price of $15.30 per share, SUNS trades at 0.87 times book value. Since our IPO in February 2011, we have invested approximately $900 million in over 90 different portfolio companies with 60 different financial sponsors. The IRR on our investments over this time period was 9.4%. We believe directly originated senior secured middle-market loans continues to offer attractive risk-adjusted returns, given the illiquidity premium of the asset class. As the second largest shareholder of SUNS, our interests are closely aligned with our shareholders. And we will continue to be patient, prudent and opportunistic in deploying our capital. Thank you very much for your time this morning. We look forward to speaking to you again next quarter. Operator, please open up the line for questions.

[Operator Instructions]. Your first question comes from the line of Fin O'Shea of Wells Fargo Securities. Please proceed.

I just first have a general question. Now that we're entering a level of comfortable dividend coverage as driven by the FLLP ramp, how should we look at the incentive fee and waivers going forward?

Yes, I think now that we already covered our dividend, I think you should expect that we're in position - we're comfortable taking incentive fees again and so you should be seeing us take incentive fees in the third quarter.

And just on the credit facility amendment, was that more driven by creating more depth there or the extension?

It was a combination of both pushing it out a year, as well as building in some more flexibility into the basket as we diversify our sourcing engines.

Okay. And one more. On both Gemino and the FLLP, I think there were incremental write-ups. Were those due to sub-portfolio holdings or your general view on those programs?

On the FLLP, those loans are disclosed in our Q. They are actually just whatever those values are in the market, they are just the same positions that are held in SUNS. So whatever those markets are, they are and they were up slightly. As far as Gemino, I think it's more reflective of their business, the success of their business and additional cash flows that they received in income and fees this quarter.

[Operator Instructions] At this time, there are no additional questions in the audio queue.

Thank you very much for your participation this morning. We look forward to speaking with you again next quarter to report another strong quarter. Thank you.