Sunrise Realty Trust, Inc. (SUNS) Q1 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the First Quarter 2017 Solar Senior Capital Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to Chairman and CEO, Mr. Michael Gross. Please go ahead.

Thank you very much and good morning. Welcome to Solar Senior Capital Limited’s earnings call for the quarter ended March 31, 2017. I am joined here 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?

Of course. Thank you, 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 Ltd. and that any unauthorized broadcast, in any form, are strictly prohibited. This conference call is being webcast on our website, 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 or 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 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. The first quarter of 2017 marked another solid quarter of operating performance for Solar Senior Capital. Our diversified portfolio of senior secured floating rate loans continues to perform well and is 100% performing at March 31st. Net asset value was stable at $16.81 per share, up a $0.01 from the fourth quarter. And GAAP net investment income of $0.35 per share fully covered our distributions. In a period of elevated repayments, SUNS’ portfolio grew modestly quarter-over-quarter. Most importantly, we have maintained our investment discipline, the continued heated market conditions have remained highly selective in our new investments. Our strategic initiatives, both at SUNS and across the solar platform have enabled Solar Senior to successfully navigate through a challenging underwriting environment. New issued middle market leverage loan volume increased in the first quarter from the fourth quarter’s anemic levels, but remained muted on historical basis, and loan volume has been dominated by refinancings. The near-term supply demand imbalance has resulted in a tinier [ph] spreads by 25 basis points and compromising structures appears to have stabilized for now. While activity levels are higher, the quality of deal flow has been mixed. And we’ve got to look deeper to find good investment opportunities that meet our stringent underwriting requirements. The first quarter was an active quarter for SUNS with gross originations including FLLP of approximately $72 million and repayments of $60 million. Our investments in the first quarter represent a combination of new portfolio companies, incremental first lien term loans to existing portfolio companies and select participation in refinanced transactions [technical difficulty] credit profile. Bruce will provide additional details of our portfolio activities. As mentioned in our last earnings call, we finalized a new life science lending joint venture with our sister company, Solar Capital who affiliates the joint venture between Solar Capital Partners and PIMCO and with Deerfield Management. This life science JV is expected to invest majority of its assets in first lien loans traded companies in life science industry and will be incremental to our existing life science loan strategy. The JV will seek to invest primarily in larger enterprise value life science companies with proven assets to public equity markets. Aside from the expected large enterprise value of the targeted companies, the business model is consistent with the loans currently being originated by Solar Capital Partners’ life science team. Solar Senior’s committed $75 million of the total $350 million of equity commitment to the JV. With anticipated leverage of up to 1:1 debt to equity, the JV is expected to have total investable capital of $700 million. Once fully ramped, this JV is expected to generate a mid-to-high teens return on equity and one of the meaningful impact on SUNS net investment income. At quarter-end, our strategic initiatives including FLLP and Gemino Healthcare Finance, represent approximately one-third of SUNS’ comprehensive portfolio. The distributions from FLLP and Gemino have enabled SUNS to increase the weighted average yield of portfolio in Q1 by approximately 20 basis points in a very challenging market environment of tighter spreads and comprised structures. Going forward, the new life science initiative will enhance the umbrella of the strategic investments, provide a differentiated growth opportunity in niche asset class and attractive characteristic and will increase SUNS investment income. Also, as a reminder at the end of 2016, our advisor Solar Capital Partners formed a joint venture with PIMCO. This initiative should provide significant long term benefits to SUNS. With expected larger investable capital base across the solar platform, SUNS will be more of a full solutions provider, which should result in greater deal flow for Solar Senior and our first lean loan program. Furthermore, the partnership with PIMCO provides SUSN access to the credit research resources of a world-class credit manager, which has invested $300 billion in corporate credit and currently employs over 50 credit research analysts. At March 31, 2017, SUNS had over $110 million of unused capacity under our revolving credit facility. When considering the unused debt capacity of our off balance sheet and off balance sheet strategic initiatives including FLLP and Gemino, available capital is approximately $180 million subject to our borrowing base limitations. As we allocate the majority of our available capital through strategic initiatives, we anticipate growth in net investment income over the current quarters. Lastly, our Board of Directors declared a monthly dividend for May 2017 of $0.1175 per share payable on June 2, 2017 to stockholders of record on May 18, 2017. At this time, I would like to turn the call over to our Chief Financial Officer, Rich Peteka.

Thank you, Michael. Solar Senior Capital Limited’s net asset value at March 31st was $269.5 million or $16.81 per share. This compares to a net asset value of $269.1 million, or $16.80 per share at December 31st. Solar Senior’s investment portfolio at March 31st had a fair market value of $373.1 million in 49 portfolio companies operating in 21 industries compared to a fair market value of $365.5 million in 51 portfolio companies operating in 22 industries at December 31st. At March 31, 2017, the weighted average yield on our income producing portfolio was 8.0% measured at fair value, up from 7.8% to the prior quarter. And 100% of our portfolio of investments is performing. At March 31, net leverage decreased modestly to 0.28 times from 0.32 times at December 31st, and Solar Senior’s target leverage continues to be 0.8 times. From a P&L perspective, gross investment income for the three months ended March 31st totaled $7.5 million versus $7.2 million for the three months ended December 31st. Net expenses for the three months ended March 31st were $1.8 million compared to $1.5 million for the three months ended December 31st. In both Q1 2017 and Q4 2016, the Investment Advisor waived $0.9 million of management and performance-based incentive fees. Accordingly, net investment income for the quarter ended March 31, 2017 was $5.6 million or $0.35 per average share, consistent with the prior quarter. Below the line, Solar Senior had net realized and unrealized gains for the first fiscal quarter totaling $0.3 million, consistent with the quarter ended December 31st. Ultimately, Solar Senior had an increase in net assets resulting from operations of $5.9 million or $0.37 per average share for the three months ended March 31st. This compares to an increase in net assets resulting from operations of $6.0 million or $0.37 per average share for the three months ended December 31, 2016. Lastly, I would like to note that in January of 2017, lender commitments increased on Solar Senior’s credit facility by $25 million, bringing the facility’s total commitment size to $200 million. At March 31st, Solar Senior had approximately $110 million of unused capacity under its revolving credit facility. At this time, I would like to turn the call over to our Chief Operating Officer, Bruce Spohler.

Thank you, Rich. Let me begin by providing a portfolio update. At 3/31, the credit fundamentals and financial performance of our portfolio companies remained solid, reflecting our disciplined underwriting, seniority in the capital structure and focus on downside protection. We are seeing a continuing, steady, slow growth environment that remains constructive to prudent lenders. At the end of the first quarter, the weighted average EBITDA on our first lien investments, including our ownership in FLLP, was $77 million. Additionally, on a fair value weighted average basis, leverage to our investment was 4 times and interest coverage was 2.7 times. Our latest 12-month revenue across our portfolio of companies grew just over 6%, and EBITDA was stable during this time period. Although portfolio is broadly diversified across multiple issuers and industries, we continue to favor larger, upper mid market issuers operating in the more-defensive non-cyclical industries. As Michael mentioned, our portfolio is 100% performing. We continue to have no exposure on the direct basis to the oil and gas or commodity sectors. Our internal risk assessments remained at approximately 2, measured at the fair market value and based on our 1 to 4 risk rating scale with 1 representing the least amount of risk. Also at quarter’s end, the weighted average yield of our portfolio was 8% up from 7.8% in the prior quarter. While spreads fairly compressed during the first quarter and the sponsor-backed cash flow market, we were able to increase our weighted average yields primarily through the growth in our dividend from FLLP as that portfolio continues to ramp. At the end of the first quarter, SUNS $440 million portfolio, which includes the loans held in FLLP had 54 different loans across 23 industry groups with an average investment just over $8 million, or just under 2% of the portfolio. Virtually, 100% of portfolio is invested in senior secured loans including our investment in Gemino whose portfolio consists entirely senior secured loans. Our income producing portfolio is 97% floating rate. The senior secured and floating rate composition of our portfolio is defensively positioned against capital losses in a rising rate environment. Before I give you a review of our first quarter investment activity, let me give you a brief update on our strategic investments. As a reminder, Gemino focuses on providing senior secured asset based loans to small and mid-sized U.S. companies in the healthcare industry. Gemino’s healthcare expertise and asset-based lending platform creates a risk return profile that has a low correlation to SUNS’ traditional underwriting of senior secured sponsor-backed cash flow loans. At quarter’s end, Gemino’s portfolio totaled just over $107 million of funded loans across 33 borrowers, with an average balance of $3.3 million. All of the commitments at Gemino are floating rate senior secured cash-pay loans and a 100% of portfolio is performing. For the first quarter, Gemino paid a distribution of just over $920,000 to SUNS, equating to an 11.25% annualized distribution yield on our average cost. We continue to believe there is additional upside in Gemino’s dividend yield. Now, let me provide an update on FLLP. At quarter’s end, FLLP reflected modest growth just over $124 million of first lien senior secured floating rate loans to 26 borrowers, with an average balance of just under $5 million. FLLP’s portfolio is also 100% performing. The annualized return on average equity for the first quarter was just under 10% for FLLP, which is an increase from the prior quarter. Over the last four quarters of steady ramp, FLLP’s quarterly distributions have increased steadily. We have deployed approximately $40 million of our $50 million equity commitment. Once this vehicle is fully ramped, we expect FLLP to earn a low double-digit ROE. Now, let me touch on Solar Life Science Program, our new life science joint venture. As Michael mentioned, this new JV enables our life science team to include public, later stage, larger enterprise value companies in their target market. Our life science team frequently financed companies in this vertical while employed at GE Capital. In our opinion, these larger companies present an attractive investment opportunity, because of their more advanced product pipeline as well as their access to public equity capital. Importantly, we are already seeing benefits of Deerfield’s expertise in the public healthcare sector and believe that they are an optimal partner for us in the center. We expect the new JV to begin investing as early as late Q2 and are confident in our ability to earn mid to high teens ROE once we fully ramp the joint venture. In the first quarter including our ownership of FLLP, we made investments of approximately $73 million across 13 companies and have access of approximately $60 million. Our investments in the first quarter primarily represent a combination of incremental, first lien term loans through existing portfolio companies and very select participation in refinancing transactions where we are comfortable with the credit fundamentals as well as the structure and the pricing. Now, let me highlight a couple of our first quarter investments. We originated an $11 million investment in the first lien loan of PDI, a market-leading provider of the ERP software to convenience store resellers. Across the solar platform, we invested just under $17 million in this loan, leverage is just under 5 times and our yield is approximately 7%. We also increased our investment in the first lien term loan of WIRB in support of the company’s acquisition of two incremental businesses. First lien leverage is approximately 4.25 times and the yield is 6.35%. In addition, we invested $7 million in the add-on first lien term loan of PGi, a leading provider of audio conferencing. Across the solar platform, we invested $27 million in this add-on loan agreement; our total position on the platform is just under $70 million. This transaction is a good example of how SUNS benefits directly from the enhanced underwriting scale across the solar platform and our ability to continue to speak for larger amounts of given loan tranche. First lien leverage on this investment is 3.5 times and it carries a yield just under 8%. SUNS also funded approximately $5 million of the new first lien term loan in support of Harvest Partners buyer, TFS Miner, a provider of material handling equipment. This new first lien term loan leverage is approximately 4 times and the yield is just under 6.5%. The SUNS had originally invested in TFS Miner back in 2014 and was repaid as part of this transaction earning an IRR of 6.6%. Now, let me touch on couple of our first quarter exits. Examples of repayments where we elected to not participate in the refinancing include: We repaid thus far on our $5 million investment in Mediware Information Systems in connection with TPG’s acquisition of the company, returning an [ph] IRR just over 9%. We were also repaid at par on our $4.8 million investment in Epic Health Services as part of the company’s acquisition by Bain. SUNS again chose not to participate in the [Indiscernible] refinancing and we’re happy to have earned 6.7 return IRR on our prior investments. Finally, we repaid at par on our $6 million investment in Apple Leisure upon the acquisition of the company by KKR. Our IRR in this investment was just over 7.5%. Our priorities are to protect our capital first and earn a fair return for the risk we are willing to underwrite. In competitive and frothy credit market environments like today, it is essential that we remain disciplined, opportunistic and patient. Looking forward, we are feel confident that through our multiple origination engine including the addition of the new life science JV with Deerfield as well as the enhanced scale across our platform, we will be able to grow the SUNS portfolio prudently through investments that have an attractive risk award profile. With our 100% performing and well-diversified portfolio, we believe we have a solid foundation and the available capital to grow our net investment income. Now, I turn the call back Michael.

Thank you, Bruce. In the fourth quarter, we delivered another solid quarter results. With a comprehensive investment portfolio that’s 100% performing, close to 100% senior secured and over 97% floating rate, we believe we are positioned for strong performance as we look ahead. Importantly, our solid foundation coupled with the earnings potential of our strategic initiatives provides us the clear path to generating incremental investment income as we carefully and opportunistically deploy our available capital. In what are currently challenging credit market conditions, we feel confident that through our proprietary sourcing channels, we can continue to expand SUNS comprehensive portfolio of floating rate senior secured cash pay loans. We are excited about the new Solar Life Science Program JV’s potential to further boost our investment income, as well as the incremental investment opportunities we expect to arise from our advisor’s joint venture with PIMCO. As we deploy our approximately $180 million of available capital from existing credit facilities, we expect SUNS investment income to increase. We are confident that once we are invested to our targeted leverage, our portfolio generates quarterly investment income that exceeds our current distributions. The Investment Advisor agreed to waive incentive and management fees through June 30, 2017 as necessary to ensure that quarterly GAAP net investment income fully covers the distribution. Since the third quarter of 2016 follow-on offering, we have waived $2.3 million incentive fees and management fees. We view these waivers as a shareholder-friendly action to protect our shareholders during the ramping of our strategic initiatives and manage the portfolio to target leverage. We believe our ongoing efforts to responsibly steward our shareholders’ capital will result in both NAV preservation and net investment income growth. At last night’s close of $18.05, SUNS trades at 7.8% yield, which represents a significant discount to the 4.5% implied yield of the S&P, LSTA Leveraged Loan 100 Index and the 6% yield of a representative sample of 14 closed end loan funds. Given the credit quality of SUNS diversified portfolio, our differentiated origination engines, our disciplined investment philosophy and our low fee structure, we believe SUNS represents an attractive investment on both the relative and absolute value basis. We thank you for your time this morning. We look forward to speaking to you next quarter. At this time, we will open up the line for questions.

[Operator Instructions] And our first question comes from the line of Allison Taylor Rudary with Oppenheimer. Your line is now open.

Guys, thanks for all of the color in your prepared remarks. I was hoping you could discuss the life science lending market in the current environment there, since this is a pocket of the market that has harder for us to see. Does this market function similarly to the broader loan market or is this something unique about life science that makes it more uncorrelated? I’d like to get a sense of what atmosphere would be most favorable for you as you look to grow this venture?

Sure, great question. So, the dynamic is very different from what I’ll contrast with sponsor marketplace where you have a number of not only private equity firms who are looking to raise capital but clearly a number of lenders who are looking for ways to differentiate the providing capital to those portfolio companies. In the life science sector, there is really a handful of competitors. To your point, the barrier is really the combination of the industry expertise in the healthcare arena. As you know, these are late stage healthcare companies but yet still free cash flow, they may have revenues, they not but they are definitely free cash flowing. And so, you are looking at predominantly where we focus in drug and device development. And so, you need real expertise in underwriting the value of that intellectual property. You’ll also need longstanding relationships with not only venture capital firms and unlike PE the sense of the investments from a group or consumption of VC [ph] firms where we need relationships that are long standing, as well as management teams. Very often these companies are run by serial entrepreneurs who have been successful in developing other healthcare platforms and they have a real say and meaningful ownership in deciding who their financing partners will be. And so those create a lot of barriers. Additionally because these are free cash flowing businesses by and large, you don’t have banks playing in this marketplace. These would be difficult assets for them to put on balance sheet. There are couple of banks who do partner with us but really because they want access to the cash management, income opportunities given that most of these businesses are cash rich to prefund, the remaining burn before they get cash flow breakeven, so the competitive dynamic is very favorable with significant barriers. The joint venture that we have set up that SUNS has maybe commitment to with Deerfield, leverages not only Deerfield industry expertise but their presence in the public healthcare investing arena. And this JV is focused on public, late-stage life science companies. So, they are even later stage than stage and that they have access to public equity market but have not quite yet gotten to cash flow positive or breakeven. And so, we feel that these, as I mentioned, are some of the lower risk opportunities. The team which has a phenomenal track record having started this business back at GE some 15 years ago has always focused on both public and private life science companies. But here, particularly given Deerfield’s expertise and the JV structure, the SUNS exposure will be almost exclusively to the lower risk public life science companies where again we think that the competition exists but it’s only a handful of people who have both the relationships and the expertise to underwrite these credits.

[Operator Instructions] Our next question comes from the line of Jonathan Bock with Wells Fargo Securities. Your line is now open.

Good morning. Joe Mazzoli filling in for Jonathan Bock. The first question relates to the fee waiver. And certainly SUNS’ shareholders have benefitted significantly from the larger solar platform as I think only about a $150,000 or $160,000 of management fees were paid to the advisor this quarter. But just to confirm this will be waived to the extent necessary to support NOI in line with the dividend through the end of 2017. Is that correct?

What we said is through the June 2017 quarter, we will obviously revisit quarter-by-quarter after that.

June 2017? Okay, got it. Now, the second question, you mentioned the competitive environment and even with some of the refinancings from the existing portfolio, you decided not to recommit. And of course we’re all familiar with what’s going on in the syndicated market with aggressive incremental, MSN, cash flow sweeps, things of that nature. But, even in the lightly syndicated middle market, we have seen the emergence on the cuts of some covenant light deals and I think you mentioned one of the deals you touched on was covenant light. Could you give some color as to whether there are any covenant light deals in the portfolio or whether you would commit to a deal without maintenance covenants?

Sure. So, we have a small bucket of covenant light deals, call it 10%, 15%, 20% depending on where we are and what we see. We generally use that for companies where we have underwritten and as they have grown up so to speak, and they tend to be in the larger end of EBITDA than even our private deals where we find some dislocated risks. I mean, you saw things like the GTL first lien loan where we had been in the second and took advantage of what we thought was dislocation in the market not representing fair value and bought that at a discount; that was covenant light for example, has moved to par. We purchased it mostly in the 70s. So, we will use that opportunistically but it tends to be in the larger company, it’s a small bucket and tends to be in some of the more liquid situations where we can get out quickly, if you would like to rotate into better opportunities in the private market. And they tend to be very diversified positions, call it $3 million to $5 million.

And so handful, it means, it’s not the full 20%, that’s a basket that we think about as we look at opportunities.

And just to kind of follow up on that. It seems that most of the new investments this quarter I believe were more of private clubbed nature versus maybe a bank-led which are still club, but maybe it’s a broader -- slightly broader syndication process. Would you talk about the opportunities there and also if you agree with the way I am segmenting that?

Yes, I think -- and just to clarify on your prior question. So in the -- what I’ll call traditional private club deals, we are -- there are an occasional club like deal that is not where we will use our cub light basket. So, we are not going yet in those private deals where we view ourselves as buy and hold long term investors. I think the dynamic, broadly speaking and where we are focused and blessed to have these strategic joint ventures, both in the life science asset class with Deerfield, expanding our capital base and in the not too distant future, on the senior secured cash flow club loan with our PIMCO joint venture will expand our capital base. And so, what’s happening is there -- today, we are taking down 20, sometime up to $40 million. With this PIMCO joint venture, we will be able to take up to a $100 million in one of these club loans and that matters in terms of not only having access to the opportunity but then in terms of driving better terms and better structures. So, we continue to try to take larger and larger hold position and that is definitely a differentiator, particularly in the traditional lower yield, first lien clubby mid market loans. There are few people who are taking close to a $100 million in tranche on those.

Thank you for that. That’s helpful. And just finally, how quickly should we expect the LSLP to ramp? I think you mentioned the back half of the second quarter and then into the third quarter will start to see deployments. Is this a fairly slow growth -- or we know your life sciences team has delivered very strong results with the sister funds. So, do you think this is something that could ramp fairly quickly?

I think it will be slow and steady to be honest you. I don’t -- the nature of the opportunities that they are constant. So, I think it will be a measured growth. We did get a little bit benefit if you recall at our sister company for the private life science opportunities because the team’s prior portfolio from GE became available once it was purchased by Cap One. And so that accelerated our ramp there. We’d love to be able to repeat that but that’s not going to happen here. These are bigger holds, these are larger tranches, so that will allow us to ramp on a more accelerated basis than if we were just standing from a standing start in the private loans where the tranche sizes are smaller. So, these are $30 million to $50 million loan sizes. So that will help us grow but I don’t want to give you the impression that it’s going to be two quarters and done; it’s going to take us a good 12 months or so.

[Operator Instructions] And I’m showing no further questions at this time. So, with that said, I would like to turn the conference back over to Chairman and CEO, Michael Gross, for closing remarks.

Thank you all for participating in our first quarter call this morning. If you have any other questions or any need information please feel free to give a call. Thank you.