Sunrise Realty Trust, Inc. (SUNS) Q3 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Solar Senior Capital Limited Q3 2015 Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today’s conference, Mr. Michael Gross, Chairman and Chief Executive Officer. Sir, you may begin.

Thank you very much and good morning. Welcome to Solar Senior Capital Limited’s earnings call for the quarter ended September 30, 2015. I am joined here today by Bruce Spohler, our Chief Operating Officer and Rich Peteka, our Chief Financial Officer. Rich, would you please start off by covering the webcast and forward-looking statements?

Sure. 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 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 events or our future performance of financial conditions. 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 the 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. During the quarter of bad times extremely volatility in the liquid capital markets, Solar Senior Capital continued to deliver solid operating performance. Our net investment income, up $0.35 per share covered our dividend and our portfolio remains 100% performing. In addition, we continue to have no direct exposure to energy. Since our inception in 2011, our objective is to construct and maintain a portfolio of predominantly first lien senior secured floating rate loans, which we believe will provide us with greater downside protection than investments mowing the capital stack. As of September 30, our ownership of the loans in the first lien loan program and Gemino’s full portfolio, 91% of the fair value of our portfolio was we invested in first lien loans and our investment process continues to be centered on businesses with strong free cash flow in non-cyclical sectors. The 2.8% decline in our third quarter net asset value predominantly reflects mark-to-market changes, not a deterioration in credit quality. At September 30, the yield to worst on the S&P high yield B rated corporate index of 7.8% was over 200 basis points wider than its yield at June 30. In accordance with GAAP and our conservative valuation procedures, we took this deterioration and the liquid capital markets into account when fair valuing our portfolio. Since the end of the third quarter, the high yield B index has reversed course and tightened by almost 100 basis points. As a result of the broad volatility, third quarter middle-market new issue volumes was 11% lower than the year-to-date average and 90% lower than the third quarter last year. In line with our objective of increasing the first lien component of our portfolio, our origination efforts during the third quarter were entirely focused on first lien senior secured loans with covenant protection. We invested approximately $27 million, including activity in the first lien loan program, or FLLP, in four new portfolio companies and one existing company. Against the modest repayments of approximately $8 million, net originations totaled approximately $19 million. We are very pleased with the progress on ramping the FLLP, our portfolio company though which SUNS co-invests with VOYA Investment Management in first lien senior secured loans. Through September 30, FLLP had originated approximately $76 million. When fully ramped, including leverage, we expect to have approximately $160 million of investible capital in the joint venture. At September 30, FLLP had an annualized distribution yield of 7.6% on cost, which we expect to increase to the low-teens as we utilize our credit facilities and approach the target leverage of FLLP of up to two times debt to equity. Also during the third quarter, Gemino had strong growth and increased distribution of SUNS resulting in an annualized distribution yield of 10.75%, up from 10.5% at June 30. We expect additional upside on our earnings contributions from Gemino in the fourth quarter. Bruce will provide additional detail on Gemino as well as FLLP. At September 30, our net leverage was 0.72 times. Combined with our available capital at the FLLP, we had approximately $120 million of capital available to invest. Lastly, our Board of Directors declared a monthly distribution for November 2015 of $0.1175 per share payable on December 1, 2015 to stockholders record on November 19, 2015. At this time, I would like to turn the call back over to Chief Financial Officer, Rich Peteka.

Thank you, Michael. Solar Senior Capital Limited’s net asset value at September 30, 2015 was $196.8 million or $17.06 per share, compared to $202.4 million or $17.55 per share at June 30. The decline in NAV was primarily related to net unrealized depreciation in the value of our investments from general mark-to-market conditions. At September 30, Solar Senior’s balance sheet had an investment portfolio with a fair market value of $339.6 million in 47 portfolio companies operating in 24 industries. This compared to the $347.4 million in 47 portfolio companies operating in 25 industries at June 30. Additionally, the fair value of our first lien loan program’s investment portfolio was $75 million at September 30. This portfolio consisted of senior secured loans to 15 different borrowers and had a weighted average yield of 6.3% measured at fair value. At September 30, the weighted average yield on Solar Senior’s income producing portfolio increased to 7.2% measured at fair value versus 7% at June 30 and 100% of its portfolio is performing. Solar Senior also had $146.8 million in borrowings outstanding on its $175 million credit facility at September 30. This resulted in a net debt to equity ratio of 0.72 times. This compares to $143.4 million and a net debt to equity ratio of 0.69 times at June 30. Moving on to our income statement, gross investment income totaled $6.5 million for the quarter ended September 30 versus $6.7 million for the quarter ended June 30. Net expenses totaled $2.4 million for the September quarter compared to $3.3 million for the quarter ended June 30. This included $0.8 million of expenses related to the amendment and expansion of our credit facility last quarter. Solar Senior’s net expenses for the quarter ended September 30 also reflects the investment advisors’ voluntary waiver of approximately $115,000 in its performance-based incentive fees. Accordingly, net investment income for the quarter ended September 30, 2015 was $4.1 million or $0.35 per average share versus $3.3 million or $0.29 per average share for the quarter ended June 30. Again, which excluding expenses related to the amendment extension of our credit facility last quarter, net investment income would have been $4.2 million, or $0.36 per average share that quarter. Below the line, Solar Senior had a net realized and unrealized loss of $5.6 million for the quarter ended September 30. This compares to net realized and unrealized losses of $0.5 million for the quarter ended June 30. Ultimately, Solar Senior had a net decrease in net assets resulting from operations of $1.5 million, or $0.13 per average share for the quarter ended September 30. This compares to a net increase in net assets of $2.9 million or $0.25 per average share for the quarter ended June 30. With that, I will 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 portfolio performance remains solid. As Michael mentioned, we continue to have no direct exposure to the energy sector. At December 30, our portfolio was 100% performing and we feel confident about our company’s ability to continue to deleverage. Including our ownership of the FLLP loans, leverage to the first lien securities in our portfolio is 3.7 times and interest coverage ratio is 3.2 times. In addition, our internal risk assessments of our portfolio remains at approximately 2 based on our 1 to 4 risk rating scale, with 1 representing the least amount of risk. At September 30, the weighted average yield on our portfolio was 7.2% a fair value up from 7% at the end of Q2. As a result of the turmoil in the liquid credit markets, the middle market has experienced a marginal spread widening. The SUNS portfolio including loans held within FLLP, and this is the third quarter with investments in 49 companies across 27 industries. Our average issuer exposure one including our ownership position of loans held in FLLP is $7.7 million measured at fair value. At quarter’s end first lien senior secured loans represented over 88% of the total fair value of our portfolio, which consisted of 70% in first lien senior secured loans, 10% at Gemino whose diversifying portfolio consists entirely of asset-backed first lien senior secured loans. And just over 8% in FLLP whose portfolio also consists entirely of first lien senior secured loans. Second lien loans across the SUNS portfolio accounted for 10% of fair value and we continue to cycle this exposure out of second lien loans and into first lien loans. The remaining portfolio of fair value was comprised of 1% unsecured debt and less than 0.10% in common equity excluding our investments in Gemino and FLLP. Including our investment Gemino and FLLP approximately 95% of our income producing portfolio was floating-rate. Before I give an overview of our third quarter activity, let me provide a few updates on our existing portfolio. As a reminder, our strategic partnership with VOYA investment management to create our First Lien Loan Program 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 September 30, FLLP had approximately $75 million of first lien senior secured floating-rate loans across 15 different issuers with an average investment balance of $5 million. During the third quarter FLLP invested approximately $21.5 million in first lien senior secured loans across three new portfolio companies, while repayments were negligible. In the third quarter FLLP paid the distribution to SUNS equating to 7.6% annual distribution yield on our cost of our equity investment, compared to 6.1% at Q2 when our portfolio was less ramped. Portfolio growth should allow FLLP to more fully utilize its credit facility, when fully ramped we expect the distribution yield to be in the low teens to SUNS. At September 30, FLLP had $36 million of borrowings outstanding under its existing $75 million revolving credit facility. We intend to upsize that credit facility subset, the portfolio will have a net debt to equity ratio of up to 2 times once fully ramped. Now, let me turn to Gemino. At quarter end, Gemino had a $120 million of funded senior secured revolving or term loans across 34 issuers, with an average loan balance of approximately $3.5 million. During the third quarter, Gemino had originations totaling $5.5 million and repayments totaling $6.5 million. All of the loan commitments from Gemino are floating rate asset based senior secured and cash paid consistent with the second quarter. In addition, Gemino had $89 million outstanding under its $110 million credit facility at September 30. For the third quarter, Gemino paid a distribution to SUNS equal to 10.3% annualized yield up from 10.5% in Q2. Given their strong performance, we expect Gemino to increase the distribution to SUNS again in the fourth quarter. Now let me turn to our portfolio activity. During the third quarter we had gross originations of approximately $26.8 million in first lien senior secured floating-rate loans across five issuers. Of the total originations just over $5 million of investments was directly on SUNS balance sheet and just over $21 million which was across three investments in the FLLP program. During that same period, gross loans repaid or sold totaled just over $8 million, power of our investment that were originated this quarter were first lien loans with covenants. Now, let me highlight a couple of our Q3 investments through the FLLP we originated an $8 million first lien investment in JAB Wireless, which is one of the largest grow wireless internet service providers in the U.S. Proceeds from the financing, we used to fund future acquisitions, leverage to our tranche is 1.7 times and our yield is approximately 6.2%. Our strategic partner in FLLP, VOYA Investment Management, provided the remaining $16.5 million of the tranche. Our ability to collectively speak for the entire $25 million in conjunction with VOYA enabled us to achieve more attractive terms on this investment. We also invested via FLLP, $5.5 million first lien term loan to Telular Corporation, which is a leading developer of hardware and services that provides machine-to-machine data connectivity, which has both residential and commercial applications. Leverage to our investment is just over 4 times. In the FLLP, we also funded a $7.9 million investment in the first lien term loan of Smart Start, which is a provider of alcohol monitoring technology including ignition interlock devices for vehicles. And this was done in connection with Avery Partners acquisition of the business. Our yield on this investment is just over 6%. During the quarter, we also funded $5 million investment in the first lien term loan of the American Seafoods Group, which is one of the largest harvester of wild-caught fish we knew in conjunction in this space. The yield of this investment is over 6.25%. In the third quarter, we had only one full repayment, which is our $4 million investment in the second lien loan issued by Waddington. It was repaid as a – at a premium in conjunction with the acquisition of the company Jarden Incorp. Our IRR from inception to realization was 9.5% and our multiple invested capital 1.2 times. We continue to source attractive investment opportunities as we further deploy our available capital and we are optimistic about our ability to generate incremental investment income for both FLLP and Gemino. Now, I would like to turn the call back to Michael.

Thank you, Bruce. In conclusion, we are pleased with origination efforts this year, as well as to continue performance of our existing portfolio. We expect Gemino and FLLP, which both increased their contributions of investment income in the third quarter to continue both of the long-term earnings power of the substantially all floating rate secured portfolio. With significant available capital and moderate leverage, we believe we are well positioned to succeed in the phase of either continuing market volatility or stabilizing market environment. New interest spreads have come off their lows to this credit cycle. We have the dry powder take advantage of this improvement. From our perspective, the senior secured middle market loan asset class remains attractive on both the relative and after return basis. At September 30, the weighted average yield of the SUNS portfolio based on fair value was 7.2%. In comparison, the S&P/LSTA U.S. leverage loan 100, which tracks the largest loan, 100 largest loans in the broader index, had a yield to maturity of just 5.9% at September 30. We believe the risk return profile of an investment in Solar Senior Capital is compelling when compared to syndicated high yield and bank loan markets. SUNS 9.2% dividend yield compares favorably to the 7.4% yield to worst of the Barclays high yield corporate index and also to a 6.9% weighted average yield and a representative sample of 14 closed end bank loan funds and at last night’s closing price to $15.26, SUNS trades at 0.89 times book value. Since our IPO on February 2011, Solar Senior Capital, including the FLLP, has invested approximately $937 million in 97 different portfolio companies, with more than 65 different financial sponsors. We believe directly originated senior secured middle market loans continue to offer attractive risk adjusted return given the illiquidity premium of the asset class. As one of the largest shareholders 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 for your time this morning. We look forward to speaking to you again next quarter. Operator, please open the line for questions at this time.

Thank you. [Operator Instructions] And our first question comes from the line of Mickey Schleien with Ladenburg. Your line is now open.

Good morning, Michael and Bruce.

Good morning, Mickey

My first question is regarding spreads, I think in both the previous call and this call you’ve mentioned that, they widened last quarter, but I just want to clarify, were you referring to the high yield market or to the loan market in that comment?

The high yield market is clearly widened out, the loan market less so, but as we look at specifically for Solar Senior loans that we’re putting on today are anywhere from 25 to 50 basis points wider than we saw just a couple of months ago.

Okay, so you – first lien loan spreads have continued to widen this quarter where else the last quarter?

Yes.

Okay. So, I’m – you’ve been careful and to avoid, I mean what I guess is generally been called a Friday market over the last couple of years. Despite having plenty of capital available, and now it just seems that the credit cycle was in its later stages, I know that’s anecdotal and, we could have a philosophical argument about it. But now you’ve launched JVs at both of the BDCs that provides even more capital. So, can you help me understand why you’re adding liquidity into a market that, seems more likely than not to be on the downhill side of the curve?

Yes. Well the, as you know both JVs were launched last year. So, and we had continued to be prudent as to how we deploy capital into those JVs, obviously we wanted them up in running and make sure that we were positioned to take advantage at this location. But both JVs in focusing on Solar Senior for a moment focus on first lien dollar one risk and that is where you’ve seen us migrate our portfolio at both entities over the last couple of years and at Solar Senior we’re migrating towards a 100% first lien. So, we think that’s the place to be and as you – to your point, we continue to be highly selective in terms of where we deploy the capital.

And importantly, both asset class of the JVs those are all loans they have covenants in that.

Understand, understand. Going back to the spread question, you’ve given that where you’ve mentioned that spreads have widened this quarter in first lien loans would have be then safe to assume that we would see pressure on NAV this quarter relative to last quarter?

Well that’s what we reflected at quarter end, you saw that we took our NAV down both entities, but on Solar Senior 2% to 2.5% approximately to reflect predominantly technical. There are one or two situations where they also have some fundamental headwinds, but it’s predominantly technical. And so too soon know that Q4, but we do think we reflected that in Q3.

Okay. And my last question is you marked down Gemino and the FLLP, well was that due to technical, was that the comparables or was there something else going on that causes marks to decline?

No, no that was technical; I mean the Gemino specifically like we saw them increased their distribution towards from 10.5% to 10.3%. As we mentioned, we expect additional increase in Q4 from that and we did not perform into either entities, all technical.

Okay, thank you for your time.

Thanks, Mickey.

Thank you. And our next question comes from the line Jonathan Bock with Wells Fargo. Your line is now open.

Hi, this is actually Jamie Strother I’m calling in for Jonathan. I just have a couple of quick questions on specific holdings here. I see slow markdown in Securus and in other smaller and Global Tel Link after quarter closed there was an announcement about a reduction in the camp that these guys can charge for phone service to prison, and late loans are both trading significantly lower, just curious how you guys view these positions after that announcement and where you are seeing, if you talk to the management as companies about the valuations and how securities, positions are?

Certainly good question. So to your point, we don’t believe that the mark at September end reflects the full uncertainty for both situations. Everybody is benefited both Securus and Global Tel Link are duopoly controlling roughly 80% of the management of the telephone services into prisons. I would say Global Tel Link just, a little bit granular much of their business is already within the caps that are being proposed by the SEC for interest rate calls which would be announced when you are referring to and as secured they diversify their business roughly 40% or so, is not in making calls, its things like angled price lists and ATM cards, ecommerce service and so forth. So both businesses are over a 150 EBITDA and have a reason for living. We do believe that there is some uncertainty as to potential pressure on margins. But that’s going to take 18, 24 months to play out. So, we expect continued volatility in the close, we really haven’t seen much in the way of real trading. To your point, we have moved this to top names, to the watch list, but fortunately they are substantial in size at a 115 plus of EBITDA each and have dominant market position and importantly from our perspective deleveraging materially from our initial investment, because they are strong cash flow generators. So Securus has come down from what was close to 6 times to just over 5 times and Global Tel Link has come down to 6 times to close to 4.5 times. So even if we are under some pressure there, we think the market is going to be pressured until there is more resolutions on how these companies work things out with the SEC. But we believe that, our risk of impairment is de minimis and they have good liquidity to continue to form interest of payment while they work through this with the SEC. As a side note, it did have a similar experience albeit on a smaller part of the business couple of years on interstate calls and net resolution once they got through the 18 month period of working through it with neutral positive for both companies. So, we’re not underwriting that, we underwrite to the downside, if you know we feel comfortable with our investments.

Awesome, thanks. That really helps. And one more quick question here so, giving stock trade that, discount today, I mean your investing fairly liquid collateral, have you thought about possibly selling assets to buyback stock at this discount today?

First of all, our cloud is really is not liquid, these are all directly originated club loans and bank facilities that are $120 million. So, it is in part of the strategy, so yes.

Awesome, I think that helps. And that is all from me.

Thank you very much.

Thank you very much.

Thank you. And our next question comes from the line of Andy Ellner with JMP Securities. Your line is now open.

Good morning and thank you for taking my questions. Last quarter you commented on the possibility of increasing the size that will be FLLP credit facility with the additional of $21.5 million invested through the FLLP this quarter, can you give us an update on when you expect to increase the facility?

Yes, I think the, we could have increased that already, the reason we have not is because, we obviously didn’t want to pay for facility until we’re ready to use it. So, you just see it increase at some point over the next couple of quarters.

Okay great, thanks. And just one more, while we expect some write-downs from market conditions, we did not some relevant moves in the fair value on your scheduled investments, are there any specific investments that are written down due to deterioration in operating performance?

I think that we just touched on two of the names that have some uncertainty, because of the discussions of the SEC notably Global Tel Link and Securus. I think that where we see potential for covenant breaches, our past practice has been to more things down until we work to those covenant breaches some of which, are – our favorite, because they allow us to re-price the risk. So, but there is nothing significant out there that’s keeping us up in that.

Okay, great and that’s all from me. Thank you.

Thank you.

Thank you. [Operator Instructions] And our next question comes from the line of Robert Schweich with Burnham Securities. Your line is now open.

Thank you. I am wondering what percentage of the unrealized loss was related to widening of the spreads and what you could call technical in nature. And if that spread is less as of December 31 would there be an offsetting change in the unrealized loss with a reversal of that?

That’s exactly right. I think 90% plus of our move in the third quarter was because of spreads widening and technically mark on the portfolio and then the extent of the indices came back, you can see us write it back up again. And certainly, when loans get repaid, you don’t realize part of them. So, it will eventually happen, just the matter of timing.

Now, second, thank you, because this is very important from a standpoint of what the book value is and if it’s technical and it’s really sort of move into some degree, the widening of spreads, does that – will that lead to higher returns in the fourth quarter, in the first quarter next year?

I think look this is a substantially all floating rate portfolio. So, over time as rates increase, we should benefit from that. We do have LIBOR floors on many of our investments that will create a gap from a timing perspective to potentially get through those floors. We also mentioned our floating rate loans at Gemino. We expect to increase our distribution there this quarter and we also as we continue to ramp, the FLLP, you will see us be able to drive our distribution up there as well. So, we do see upside.

So, we would need to go through that GAAP period and greater use of leverage by the company probably for a considerable period of time before we are likely to see an increase in the dividend rate? That’s the question.

I think I can’t put the time period on it, but I think that the real drivers here are a combination of growing our investment in the joint venture with VOYA, the FLLP as well as growing the distributions at Gemino, both of which we have been in the process of doing this year and we expect that to continue. And then on the core portfolio, it’s really just more about continuing to take advantage of spreads widening out if that trend continues. It’s hard to put [indiscernible]. We are making progress on it quarter-by-quarter as you can see.

Thank you very much.

Thank you for your time.

Thank you. And I am showing no further questions at this time. I would like to turn the conference back over to the Chairman and CEO, Michael Gross.

Thank you all for your time, patience and support. We look forward to talking to you again soon.