Sunrise Realty Trust, Inc. (SUNS) Q4 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Solar Senior Capital Ltd. conference call for the Quarter and Fiscal Year Ended December 31, 2015. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to the Chairman and Chief Executive Officer, Michael Gross. Please begin.

Thank you, operator and good morning. Welcome to the Solar Senior Capital Ltd.’s earnings call for the quarter and year ended December 31, 2015. I’m joined here today by Bruce Spohler, our Chief Operating Officer; and Richard Peteka, our Chief Financial Officer. Richard, would you please start off by covering the webcast and forward-looking statements?

Of course. 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. Audio replays 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 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 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. 2015 was a very productive year for Solar Senior. We maintained our high selective approach with new investments throughout the year. Including our membership interest in the First Lien Loan Program or FLLP, SUNS had originations of approximately $120 million of loans and prepayments in sales of approximately $104 million during 2015. In the fourth quarter, originations were approximately $14 million with sales and repayments of approximately $40 million. Today, SUNS in a very good position to take advantage of the current favorable investment environment to redeploy our available capital into investments at wider spreads and lower leverage levels in the loan we are exiting. The credit fundamentals and financial performance of our portfolio companies remain very strong. At December 31, 2015, our portfolio was 100% performing and we have zero direct energy exposure. Given the slow growth environment and uncertainties surrounding the direction of interest rates and domestic economy, SUNS portfolio is positioned defensively and right where we want it to be. Approximately 99% of our comprehensive portfolio exposure including FLLP in Gemino is in secured loans, and 99% of company’s portfolio is comprised of floating rate investments. Technical pressure in the liquid leverage credit market rolled over into the middle market in late third quarter and fourth quarter, resulting in a mark-to-market decline in our net asset value to $16.33 per share at December 31, 2015. We view the unrealized depreciation in NAV in the second half of 2015 as temporary and expect to fully recoup the tactical write-downs when these loans get repaid. During 2015, we made significant progress with strategic investments in Gemino Healthcare Finance and FLLP, our joint venture with VOYA Asset Management. Gemino continues to demonstrate strategic value to its healthcare lending expertise, recurring cash income, diversified portfolio of senior secured assets, and differentiated origination platform. FLLP provides incremental long-term capital from a like-minded credit investor that expands origination capacity and allows us to scale the Solar Senior balance sheet more efficiently. As these portfolios grew during 2015, the contribution of SUNS net investment income from these strategic investments increased meaningfully and we expect further growth in 2016. Bruce will provide additional details in his comments. For the full year 2015 and excluding approximately $800,000 of non-recurring expenses related to the amendment and extension of our credit facility, SUNS net investment income totaled $16.2 million or $1.40 per share. We voluntarily waived $700,000 of incentive fees for the year ended December 31, 2015. While we believe we have built the portfolio to a side to be able to comfortably earn our distributions over the year, we are committing to waive incentive based fees to the extent necessary for GAAP net investment income to fully cover distributions in 2016. At the end of the year, the company had $59 million of unused capacity under its revolving credit facility and $31 million of unused capacity in the VOYA joint venture. When considering the combined $58 million FLLP equity commitment plus expected available credit, we believe our available capital for FLLP together with Solar Senior’s balance sheet approaches $130 million, subject to borrowing base limitations. With substantial capital available to take advantage of the current favorable investment environment, we believe SUNS is well positioned as a clear path to grow investment income in 2016. Lastly, our Board of Directors declared a monthly distribution for March 2016 of $0.1175 per share payable on April 1, to shareholders of record on March 24. At this time, I’d like to turn the call back over to Chief Financial Officer, Rich Peteka.

Thank you, Michael. Solar Senior Capital Ltd.’s net asset value at year-end was $188.3 million, or $16.33 per share, as Michael noted earlier. This compares to net asset value of $196.8 million or $17.06 per share at September 30. Our investment portfolio at December 31 had a fair market value of $306.5 million in 45 portfolio companies operating in 23 industries. This compares to a fair market value of $339.6 million in 47 portfolio companies operating in 24 industries at September 30. At December 31, the weighted average yield on our income producing portfolio increased to 7.9% measured at fair value versus 7.2% at September 30. And 100% of our portfolio investments are performing. Gross investment income for the three months ended December 31 reflected a slightly smaller portfolio and totaled $6.1 million versus $6.5 million for the three months ended September 30. Net expenses for the three months ended December 31 were $2.0 million compared to $2.4 million for the three months ended September 30. Accordingly, net investment income for the quarter ended December 31, 2015, was $4.1 million or $0.35 per average share versus $4.1 million or $0.35 per average share for the quarter ended September 30. Below the line, SUNS had realized and unrealized losses for our fourth fiscal quarter at $8.5 million, compared to realized and unrealized losses of $5.6 million for the quarter ended September 30. Ultimately, the company had a decrease in net assets resulting from operations of $4.4 million or $0.39 per average share for the three months ended December 31. This compares to a decrease in net assets resulting from operations of $1.5 million or $0.13 per average share for the three months ended September 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 the portfolio update. Overall, the credit fundamentals and financial performance of our portfolio companies remains sound. At year-end, the fair value weighted average leverage through our first lien investments, including our ownership in FLLP, was approximately 3.7 times and the weighted average cash interest coverage of our first lien investments was approximately 3.1 times, consistent with the prior four quarters. At the end of the fourth quarter, the weighted average revenue and EBITDA of first lien investments in SUNS portfolio, including FLLP, was over $370 million of revenues and over $60 million of EBITDA. While the portfolio is broadly diversified across multiple issuers and industries, we continue to favor larger mid-market issuers, operating in more defensive non-cyclical industries. We feel confident about the prospects of our portfolio companies’ operating performance in 2016. In the fourth quarter, the majority of NAV decline of approximately 4% was due to technical mark-to-market write-downs resulting from the sell-off in the liquid loan market and the remainder was predominantly related to our positions in the prison phone companies, Securus and Global Tel*Link, which I will discuss shortly. As Michael mentioned, we expect to fully recoup the mark-to-market adjustments when these loans are repaid. Equally comforting, at year-end, our portfolio was 100% performing and we have no direct energy exposure to the oil and gas or commodity sectors. At year-end, the weighted average yield on our portfolio was 7.9% when measured at fair value. Our internal risk assessment on a weighted average basis remains at 2 times when measured in fair value and based upon our 1-to-4 risk rating scale, with 1 representing the least amount of risk. SUNS’ comprehensive portfolio, which includes loans in FLLP, attributable to SUNS at 87.5% ownership and investments across 47 issuers in 25 different industries with an average issuer exposure of just over $7 million at year-end. Approximately 99% of the portfolio is invested in senior secured loans, including Gemino, whose portfolio consists entirely of senior secured loans. Of the remaining portfolio, 1% is in unsecured debt and there is a negligible equity exposure, excluding our investments in Gemino and FLLP. When including our investment in Gemino as 100% floating rate, roughly 99% of our portfolio carry a floating rate and 1% carries a fixed rate at fair value. Before I give an overview of our fourth quarter activity, let me provide an update on our strategic investments in both Gemino and FLLP. As a reminder, Gemino focuses on providing senior secured asset-based loans to small and mid-sized US companies in the healthcare sector. Gemino’s healthcare expertise and asset-based lending platform creates a favorable risk return profile that has a low correlation to SUNS’ traditional underwriting senior secured cash flow loans. At year-end, Gemino had $130 million of funded senior secured loans across 36 issuers, having an average outstanding balance of approximately $3.6 million. All of the commitments from Gemino are floating rate senior secured [cash paid] loans. During 2015, Gemino funded approximately $28 million of investments across nine portfolio companies and had full repayments of approximately $24.5 million from 11 portfolio companies. For the fourth quarter, Gemino paid us a distribution of $900,000, which equates to an 11% annualized distribution yield on our cost. The distribution from Gemino increased from 10% annualized distribution at the end of 2014. Gemino had approximately $99 million drawn under its $110 million credit facility at year-end. Now, let me provide an update on FLLP. As a reminder, our strategic partnership with VOYA Investment Management to create FLLP provides incremental long-term capital from a like-minded credit investor that expands our origination capacity and allows us to scale SUNS’ balance sheet more efficiently. At year-end, FLLP had approximately $74 million of first lien senior secured floating-rate loans across 15 issuers with an average loan balance of approximately $5 million. For the fourth quarter, FLLP paid distribution to us equating to a 9% annual distribution yield on our cost versus 7.6% in the prior quarter. 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. At year-end, FLLP had approximately $30 million of available capital under its existing $75 million credit facility. We intend to increase the size of FLLP’s credit facility such that portfolio can have a net debt-to-equity ratio of up to 2 times once fully ramped. Before I go into our fourth quarter portfolio activity, let me make a couple of comments about our investments in Global Tel*Link and Securus, the two prison telephone companies. We have a 1% position at cost in the second lien term loan of Global Tel*Link, which was marked at 70.5% at year-end, and a 3% position at cost in the second lien term loan of Securus Technologies, which was marked at 57% of par at year-end. Together, these two companies comprise approximately 80% of the market for secured telephone and related services to the US prison population. In late 2015, the SEC passed a vote and drafted an order capping interstate and intrastate call rates and fees for these companies. In response, both companies are currently seeking a stay and appeal of the order. The industry experienced similar challenges a couple of years ago, which resulted in neutral to positive outcomes for both companies. While it will take time to work through the legal and regulatory process, the respective management teams are focused on navigating through these rate and fee proposed changes. Based on our current understanding, we believe there is great upside in our investments at both issuers. In fact, we added to our GTL exposure in the fourth quarter with an opportunistic purchase of approximately $1 million of GTL’s first lien term loan at an average price of just under 78% of par. Both companies recently held lender calls to review their 2016 strong budgets. This morning, GTL’s first lien was quoted in the low 80s and the second lien is quoted in the low 70s. Secured second lien was quoted in the mid-60s, up 15% from our year-end mark. As Michael mentioned, we had muted origination activity in the fourth quarter, with investments of approximately $14 million across five portfolio companies, and had sales and repayments of just under $40 million. Thus far, the downturn in liquid leveraged loan market has translated into approximately 100 basis points of incremental yield and new first lien loans, as well as importantly better covenant packages and lower leverage levels. For SUNS, the weighted average yield was over 7% of our originations in the fourth quarter, compared to just over 6% in the third quarter. We believe this is going to continue to be a great environment to invest. And fortunately, we have the dry powder to capitalize on these conditions. Thematically, we have seen select investment opportunities with current portfolio companies that are seeking add-on loans to finance acquisitions that typically would have been underwritten by banks. As a result of our more cautious approach to leverage lending, we have seen opportunities to upsize select investments and reprise some of our existing loans at higher prices and lower leverage levels, as well as having growth in EBITDA from the acquisitions. Recent transactions in the SUNS portfolio that reflect this type of add-on re-pricing opportunity include Acrisure, Stratose and Shoes for Crews. Now, let me highlight a couple of our fourth quarter investments. We funded $6 million investment in the first lien term loan in Shoes for Crews. As a reminder, Shoes for Crews is a leader in slip resistant footwear for the quick-serve restaurant workplace. We have deep experience with this credit and have been a lender to the company since 2010 both at Solar Capital as well as SUNS. In the fourth quarter, we were repaid on our $3 million investment in the first lien term loan and elected to participate in the new senior secured financing. The yield on our new investment is approximately 6.3%, up 50 basis points from our prior investment. We also funded $5 million investment in the first lien term loan of Edelman Financial Services. This was acquired by Hellman & Friedman at a purchase price multiple of over 16 times. Our leverage is just over four times and the yield on our investment is approximately 7%. As I mentioned previously, we purchased approximately $1 million of Global Tel*Link’s first lien loan at 78% of par and a yield of just under 12%. Since the end of the quarter, that loan has been quoted up. And as I previously mentioned, it is currently quoted in the low 80s. I’ll now highlight a few of our fourth quarter repayments. We were repaid at par on our remaining $10.5 million investment in AmeriQual up on the sale of the company. SUNS originally invested $14 million in 2011, and we realized 7.7% IRR in this investment. We were also repaid on our $50 million first lien investment in Paradies Shops. Paradies is a leading player in US airport newsstands under the CNN brand. The IRR on our investment was just over 9%. As a reminder, our sister company, Solar Capital, had originally invested in Paradies in 2010 in support of the acquisition by Freeman Spogli back then. Having deep knowledge and experience with this credit and having the flexibility with both Solar and SUNS platforms provides us opportunities to create longer duration investment opportunities as an incumbent lender where we have great knowledge. Finally, we were repaid at par on our $10 million first lien term loan at KODA, a large specially chemicals distributor. SUNS originally invested in KODA in 2013 and participated in add-on acquisition in 2014. The IRR on our investment was 6.6%. While we’ve seen a traditional slow start to the year of new issuance activity, the market disruption has also slowed refinancing transactions resulting in unit repayment activity. Visibility on repayment to-date in this quarter is approximately $13 million. We have been extremely patient and highly selective with our investments. The pricing levels and structures of middle market senior loans has definitely improved. We believe this investment environment is extremely attractive and are thankful that we have the available capital to capitalize on this environment. Now, I’d like to turn the call back over to Mike.

Thank you, Bruce. In conclusion, we are pleased with our operating results and progress in 2015. SUNS successfully navigated a challenging investment environment during the year and stayed true to our investment discipline. In a period of increased uncertainty and volatile markets, SUNS maintained a high diversified and defensive portfolio that at December 31 was comprised of 99% senior secured loans, has no direct exposure to energy and is 100% performing. Distributions from Gemino and FLLP contributed to net investment growth in 2015. With substantial capital to take advantage of the current favorable investment environment, we believe SUNS is well positioned as a clear path to grow investment income in 2016. This month marks the fifth anniversary of Solar Senior as a public company. Since inception in 2011, our investment priorities and disciplines have remained steadfast. Invest prudently as principles, protect capital, build and maintain a diversified portfolio of predominantly first lien senior secured floating rate loans, which we believe will provide downside protection and generate steady distribution to our shareholders. We’ll continue to be highly selective of our investments, while maintaining our focus on issuers and structures that we believe can protect capital and provide favorable risk-adjusted returns. To be clear, while our fundamentals are strong, we are not at all pleased with the price performance of SUNS. We are frustrated that I’m sure many of our fellow shareholders are that our efforts to drive fundamental performance, earn the dividend and maintain a diversified portfolio of strong credit quality is not positively impacting our stock price. We appreciate the patience of our shareholders, many of whom have been SUNS’ investors since inception. During the year, the senior management and investment team increased its ownership position to approximately 7.1%. In addition, we waived incentive fees in 2015 in order for the GAAP net investment income cover our dividend and are making a similar commitment for 2016. We believe our investment team is tightly aligned with shareholders and we continue to be focused and doing everything we can to build long-term shareholder value. We will be adding to our SUNS’ position as well throughout the year. At last night’s closing price of $13.37 per share, SUNS trade at 0.82 times book value, yielding over 10.5%. We’ve approximately $130 million of available capital to make additional investments. SUNS’ yield of approximately 10.5% compares favorably to the 7.6% weighted average yield on a representative sample of 14 closed end bank loan funds. At current prices, we believe SUNS is a very compelling investment opportunity. Thank you for your time this morning. We look forward to speaking to you again next quarter. Operator, can you please open the line for questions at this time?

[Operator Instructions] And the first question is fro Andy Ellner of JMP Securities.

Given the relatively attractive market conditions and what’s historically seen to be a seasonally more active quarter, we were surprised to see gross originations at one of the lowest levels since inception. Can you give us some color as to what caused the muted origination activity and your expectations for portfolio growth in 2016?

We actually did not see obviously a lot of things that we liked in the fourth quarter. Additionally, some of those were pushed into Q1. As you can imagine, given the volatility they got elevated in the latter part of the fourth quarter, many borrowers decided to try to hold off if they could until Q1 to see if market conditions improved. Obviously, they did not. So you should see an increase in originations in Q1, which is typically a seasonally slow quarter. So it’s a bit of a shift.

And how about for growth in 2016?

We think that we’re extremely well positioned as we head into 2016 with our available capital of $130 million, both on and off balance sheet in our FLLP joint venture. So our goal is to deploy lion’s share of that if this market environment continues.

[Operator instructions] And the next question is from Jonathan Bock of Wells Fargo Securities.

This is [Jamie] dialing in for Jonathan. Was VOYA now a partner in both off balance sheet entities at Solar as well as SUNS? Can you shed a little light on the relationship between these two entities?

Sure. The relationship is very similar. We target the same investment team at VOYA for both opportunity set. I think the one thing I would highlight is that VOYA likes to invest alongside of both of these joint ventures. And I think in this market environment, where pricing has moved, VOYA does not invest on a levered basis. They’re looking at exclusively unlevered returns and returns are moving their way. So their appetite to grow these verticals has increased and they are very attractive to both first lien and stretch first lien asset classes.

But the relationship is very tight and very strong. We’ve now done close to 20 deals across both vehicles and we only expect them to grow.

[Operator instructions] There are no further questions at this time. I’ll turn the call back over to Michael Gross for closing remarks.

Thank you all for your time and patience of investors. We look forward to reporting back to you in two months to report on Q1 about our continued growth. Thank you.