Sunrise Realty Trust, Inc. (SUNS) Q1 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the First Quarter Solar Senior Capital Limited Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded today. I would now like to introduce your host for today’s conference, Michael Gross, Chairman and Chief Executive Officer. You may begin.

Thank you very much and good morning. Welcome to Solar Senior Capital Limited’s earnings call for the fiscal quarter ended March 31, 2018. 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?

Of course. 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 condition. These statements are not guarantees of our future performance, financial condition or results and they 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 2018 marked another solid quarter of operating performance for Solar Senior Capital. Our comprehensive portfolio grew approximately 5% in the prior quarter with net positive portfolio activity across all business units. Overall, our diversified portfolio of senior secured cash flow and asset-based loans continue to perform well. Net asset value was $16.84 per share at March 31, 2018, consistent with the prior quarter and GAAP net investment income of $0.35 per share fully covered our distributions. At March 31, 97.5% of our comprehensive portfolio was in first lien senior secured cash flow and asset-based loans. Over 40% of our portfolio is now comprised of first lien senior secured asset-based loans with the remainder primarily in first lien senior secured cash flow loans. Importantly, we believe the risk-adjusted return profile and our asset-based lending initiatives, is currently more attractive than much of the cash flow opportunities we are seeing. North Mill enhances our flexibility to originate across multiple business lines in order to find the best risk reward investments or not being exclusively reliant on the sponsor cash flow segment. We believe the expansion of traditional asset-based lending to the SUNS platform enhances portfolio risk management, creates broader portfolio diversification and increased the earnings power of SUNS. During this extended period of frothy credit markets, Solar Senior has not changed its priorities and remains disciplined with its new investments. Our first priority is to preserve capital, protect net asset value through sourcing senior secured investments that meet our strict, risk return requirements. We have been focused on leveraging our strategic initiatives in FLLP and asset-based lending to enhance Solar Senior’s weighted average yield, effectively utilizing a barbell approach that combines lower yielding, lower risk, first lien senior secured cash flow loans with higher yielding first lien senior secured asset-based loans. We will continue to seek investment opportunities that can expand our specialty finance capabilities in senior secured lending initiatives that are less competitive, offer attractive risk-adjusted returns and have lower correlations with liquid leverage loan market. And lastly, we seek to always invest with principles. As 5.3% owners of SUNS, management is fully aligned with our fellow shareholders and focused on building a long-term value. While we continue to believe that the long-term investment thesis for private middle-market lending remains intact, we cannot predict how long the current challenging environment in capital lending will persist. We have maintained an investment philosophy of always assuming that we are late in the credit cycle and this discipline seems even more relevant today. No one knows that the stage of the cycle will end soon or persist for several more years. We believe our investment discipline, differentiated origination platform and diversified portfolio positions SUNS well for either outcome. At March 31, 2018, when considering the unused debt capacity of our balance sheet and strategic initiatives, SUNS had approximately $140 million on unused borrowing capacity to invest subject to our borrowing base limitations. Lastly, our Board of Directors declared a monthly distribution for May 2018 of $0.1175 per share payable on June 1, 2017 to stockholders of record on May 23, 2018. 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 of March 31 was $270.0 million or $16.84 per share. This compares to a net asset value of $270.1 million or $16.84 per share at December 31. Solar Senior’s investment portfolio at March 31, 2018 had a fair market value of $424.2 million in 46 portfolio companies, operating in 21 industries compared to a fair market value of $408.1 million in 45 portfolio companies, operating in 20 industries at December 31. At March 31, the weighted average yield on our income-producing portfolio was 8.9% measured at fair value consistent with the prior quarter. During the quarter, we placed our investment in Metalogix on non-accrual status that this investment representing 1.8% of the SUNS portfolio at cost and 0.9% at fair value. At March 31, 2018, over 98% of Solar Senior’s portfolio investments at cost are performing. At March 31, 2018, net leverage increased to 0.51x from 0.45x at December 31 and Solar Senior’s target leverage continues to be 0.75x to 0.85x. From a P&L perspective, gross investment income from the three months ended March 31, 2018 totaled $9.3 million versus $9.0 million for the three months ended December 31. Net expenses for the three months ended March 31, 2018 were $3.7 million compared to $3.4 million for the three months ended December 31. In the first quarter of 2018, the investment adviser voluntarily waived $0.3 million of performance-based incentive fees versus $0.3 million in Q4 2017. On a cumulative basis since SUNS’ IPO back in 2011, the investment adviser has waived management and performance-based incentive fees and covered equity offering costs totaling approximately $10 million. Ultimately, net investment income for the quarter ended March 31, 2018 was $5.7 million or $0.35 per average share consistent with the prior quarter. Below the line, Solar Senior had net realized and unrealized losses for the first fiscal quarter 2018 totaling $0.1 million compared to $0.6 million of net realized and unrealized gains for the quarter ended December 31, 2017. Accordingly, Solar Senior had a net increase in net assets resulting from operations of $5.5 million or $0.34 per average share for the three months ended March 31, 2018. This compares to a net increase in net assets resulting from operations of $6.2 million or $0.39 per average share for the three months ended December 31, 2017. At this time, I would like to turn the call over to our Chief Operating Officer, Bruce Spohler.

Thank you, Rich. Before delving into the details of our portfolio, I would like to a moment to provide an overview of our origination platform. As many of you know, we have spent the past several years building and acquiring niche businesses across our platform to advance our strategic objective of becoming a diversified specialty finance company. As a result of those efforts, SUNS today has three principal lines of business. First, our cash flow business, which invests in senior secured, predominantly first lien loans, sponsor-backed companies in the upper mid-market. Included in this segment is our first lien program, or FLLP through which we invest in first lien loans in a joint venture with Voya. Second, we have a healthcare asset-based business, which provides first lien senior secured loans to midsize companies, operating exclusively in the healthcare industry through Gemino. These loans are secured by a borrower’s accounts receivable. And then lastly, our North Mill asset-based platform, which provides first lien senior secured loans to midsized companies, which operate primarily in the manufacturing, services and distribution industries. North Mill’s financing solutions primarily include asset-based loans and factoring agreements, which are secured by our borrower’s accounts receivable. At SUNS, we take a holistic approach to potential transaction and evaluate the relative attractiveness of financing a particular borrower’s cash flow and/or its assets. We believe that this flexibility to offer a borrower a wide range of financing solutions provides SUNS with the best opportunity to preserve capital and enhance the risk-adjusted returns over an economic cycle. Michael spoke briefly about our barbell portfolio approach, which combines lower yielding first lien senior secured cash flow loans with higher yielding asset-based loans from both North Mill and Gemino. At quarter end, SUNS’ weighted average asset level yield was 8.9%. This is approximately 100 basis points higher than our cash flow only yield would be, speaking to the advantage of having our ABL businesses alongside our cash flow business. Loan structure remains a key part of risk management in both our cash flow and asset-based businesses. Gemino and North Mill have asset-based loans which are typically working capital facilities in the form of highly structured revolving credit structures, collateralized by current assets that are turning frequently and have financial as well as borrowing-based covenants. The historical default loss experience for both Gemino and North Mill is extremely low given their disciplined underwriting, highly structured nature of their loans and rapid turnover of the underlying receivable collateral. Their performance through previous cycles supports our conviction that disciplined investing in these niche ABL businesses can preserve capital to a full economic cycle and generate extremely attractive returns. In the aggregate at quarter end, our investments across these three businesses totaled approximately $675 million, encompassing over 170 borrowers. The average investment per borrower was approximately $4 million or 0.6% of the total portfolio. Measured at fair value just under 100% of SUNS portfolio consisted of senior secured loans, of which 57% are first lien senior secured cash flow assets, 40% are first lien senior secured asset-based loans, and only 2.5% are second lien cash flow loans. In addition, approximately 94% of the loans carried a floating rate coupon, which should continue to benefit our performance in a rising rate environment. Including investments and repayments across our three business lines, first quarter originations totaled approximately $70 million and repayments were approximately $38 million, resulting in a net positive portfolio activity of $32 million. Now, I would like to end with an update on credit quality and earnings power of our portfolio. During the quarter, we placed our investment in Metalogix on non-accrual status. We are working closely with our co-lenders and the sponsor to maximize our recovery on this investment and look forward to reporting progress next quarter. As a reminder, this is our only investment on non-accrual. At quarter end, 98.2% of SUNS’ portfolio at cost is performing and just over 99% is performing at fair value. We continue to have no direct exposure to the oil and gas or commodity sectors. Our internal risk assessment on a weighted average basis is approximately 2, based on our 1 to 4 risk rating scale, with 1 representing the least amount of risk. SUNS’ weighted average yield on a fair value and cost basis are 8.9% and 9.1% respectively compared to 8.9% in the prior quarter. Importantly, SUNS was able to maintain its portfolio yield without compromising credit quality or taking on additional risk during the quarter. Now, let me provide a brief update on our three investment verticals. In the cash flow segment, our portfolio, which includes loans held in FLLP, totaled $402 million, representing 60% of SUNS comprehensive portfolio. The cash flow portfolio is comprised of loans to 49 borrowers with an average loan of $8.2 million. The weighted average yield on this portfolio is 7.9%. As I mentioned, approximately 90% of the cash flow portfolio is in first lien senior secured loans and we have steadily migrated out of our second lien exposure, which now represents only 2.5% or $17 million of the total portfolio. At quarter end, the weighted average EBITDA of our first lien cash flow investments was over $75 million. On a fair value basis, leverage to our security was 4.5x and the interest coverage was over 2.5x. In addition, the weighted average LTM revenue had grown 8% and EBITDA had grown just under 4% at quarter end, reflecting continued positive trends in our portfolio company fundamentals. During the first quarter, we originated senior secured cash flow investments of $44 million and had repayments of $26 million. Now, let me turn to North Mill. At quarter end, the North Mill portfolio totaled approximately $162 million, representing 24% of SUNS’ total portfolio. This includes loans to 95 different borrowers with an average loan size of $1.7 million. The weighted average asset level yield at North Mill was 12.9%. During the first quarter, we funded just over $17 million of new loans and had repayments of just under $7 million. Since the acquisition of North Mill in the beginning of the fourth quarter last year, they have grown their portfolio by over 30%. In the first quarter, North Mill paid SUNS a cash dividend of $1.4 million equating to an 11.2% annualized yield on our cost. We believe North Mill is a unique platform due to the top tier, quality, experience and track record of the North Mill management team as well as their ability to scale the platform. Now, turning to Gemino, at quarter’s end, Gemino’s portfolio was $110 million, representing 16% of SUNS’ total portfolio. The portfolio is comprised of loans to 28 borrowers with an average loan of approximately $4 million. The weighted average yield at Gemino was 9.6%. During the first quarter, we funded $8 million of new loans and have repayments of $5 million. For the quarter, Gemino paid SUNS a cash dividend of just under $1 million, equating to an annualized yield of 11% on cost. When making investment decisions, we always assume we are in the late stages of the credit cycle and correspondingly, we strive to maintain a lower risk portfolio. In today’s competitive and frothy credit markets, it is essential that we remain disciplined, opportunistic and importantly patient. Looking forward, we feel confident that through our multiple origination engines and enhanced scale, we will be able to grow SUNS portfolio prudently through investments, which offer an attractive risk reward profile. We are confident that the solid foundation of our portfolio, combined with the available capital and our ability to originate across multiple lines of business, will allow SUNS to grow their investment income going forward. Now, I will turn the call back to Michael.

Thank you, Bruce. In my opening remarks, I reiterated our long-term priorities for Solar Senior Capital. From the inception of SUNS, our investment and management decisions have consistently been focused on building long-term value, protecting capital, maintaining alignment with our shareholders. We have been conservative in this phase of sustained frothy credit markets and remain patient and disciplined and not compromising credit quality for yield. Given the challenging environment of persistently low rates and elevated risk and sponsor cash flow lending, we pursue strategic initiatives that allowed us to both enhance and diversify the earnings power of SUNS while we are maintaining our strict investment discipline. The acquisition of North Mill allows SUNS to further evolve to a diversified specialty finance company with expertise in several market niches including senior secured cash flow and asset-based lending. The asset-based lending strategies are less correlated liquid credit markets and have a differentiated risk return profile that is complementary to our cash flow lending. Importantly, earnings from our strategic initiatives have helped increase the weighted average portfolio yield and increased SUNS’ investment income. Now, I would like to comment on the passage of Small Business Credit Availability Act that increases the statutory leverage limitation for BDC to 2x debt-to-equity from 1x. Since the passage of the legislation, we have studied how the increased leverage flexibility could impact the company’s strategic priorities and long-term value creation for our shareholders as well as the associated risks and how they can be managed and mitigated. Additionally, we continue to have discussions with our principal stakeholders, including our lenders and importantly, our shareholders. We are being extremely deliberate in our analysis and have not yet reached a conclusion regarding our course of action. As you know, we have never allowed leverage to drive our investment decisions or strategy. Since inception, SUNS has averaged 0.35x debt-to-equity despite a target of 0.75x to 0.85x. For SUNS, our analysis centers on balance sheet optimization, portfolio and financing flexibility and risk management and not on maximizing leverage. Because of our strategic focus on acquiring, building and growing specialty finance businesses, the considerations for our platform are somewhat unique. Importantly, as evidenced by our willingness to waive fees, we feel no pressure to make changes to our investment strategy in order to make the dividend math work. We will do what we determined is in the best interest of our shareholders who know us as conservative portfolio managers. We invest with principles and are aligned with our fellow shareholders through significant purchase ownership of our stock. We believe our performance since inception reflects our disciplined underwriting, whether it’s exercising constraint and frothy credit markets are waiving fees to ensure net investment income covers our distributions, we have always endeavored to act in the best interest of our shareholders. Likewise, we are applying the same shareholder-focused conservative approach as we analyze the best path forward for optimizing our return on equity in a competitive investment landscape that has been altered by the new regulations. We understand that a lack of clarity on this issue creates uncertainty for our shareholders. And so we thank you for your patience as we complete a thorough strategic analysis which this opportunity clearly merits. At last night’s close at $16.92 per share, Solar Senior trades at an 8.3% dividend yield, which represents significant discount to the 5.2% implied yield of the S&P/LSTA leveraged Loan 100 Index and the 5.9% yield of a representative sample of 13 closed end loan funds. Given the overall credit quality of our diversified portfolio, the differentiated origination engines and our disciplined investment philosophy, we believe SUNS represents an attractive investment in both the relative and absolute value basis. We thank you very much for your time this morning and we look forward to speaking to you next quarter. Operator, at this time, would you please open the line for questions?

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

Good morning, Michael and Bruce. My first question relates to potential additional verticals that you might add to the Solar Senior platform. Just broadly speaking, are there any type of other businesses out there that you think might be a good tuck-in sort of vertical that would help you diversify the portfolio and provide good risk-adjusted returns?

Yes. I think, Mickey, as you know, we have a dedicated team that is looking for other commercial finance verticals. I think one of the things that is unique is that given that we now have both Gemino and North Mill on the SUNS platform, we are viewed as a strategic buyer. So there are not only new verticals, but tuck-in opportunities, portfolios, new regions. As you know, North Mill operates predominantly in the Midwest and the East Coast. There is opportunities to expand their platform, the same for Gemino. So we are looking at both more of the same as well as other asset-based lending verticals.

Okay, thank you for that, Bruce. And just one follow-up question, you may have mentioned in the prepared remarks, but I am not quite sure I caught it. Can you give us a sense within the cash flow sponsored finance business, what is the average borrower EBITDA and what is the portfolio’s average leverage?

Yes. The EBITDA, I did mention that but it’s over $75 million on average. The median is in the mid-60s.

And that’s in the sponsored business, correct?

Yes, that’s in the sponsored cash flow business. And then our leverage is average about 4.5x with interest coverage exceeding 2.5x.

The 4.5x, is that reflecting a decent portion of unitranche business there?

No. Unitranche as you know, Mickey, is leveraged north of 6x typically as we see it. So, it’s predominantly leverage in the high 3s to high 4s averaging in that mid-4s.

Okay. What I was referring to there you could skew the average with some unitranche?

No, we really don’t do much unitranche at all over at SUNS. We will do a little bit of stretch senior to use some different nomenclature, where you might be 4.75, but this really is concentrated in the 4s, low 4s to mid 4s.

Alright. That’s helpful. That’s it for me. Thank you.

Thanks, Mickey.

Thank you. And our next question comes from the line of Allison Rudary from Oppenheimer. Your line is open.

Good morning, guys. I was wondering if you could remind me on your total platform, how much of your assets are cash flow lending versus the other verticals and asset-based lending that you guys do?

Inside the total platform.

Actually both. That would be great if you could actually – if you could break it down between BDCs and your entire universe.

So at SUNS, it’s about 60% of the portfolio is cash flow, portfolio is about $675 million, so about $400 million is cash flow. And as we mentioned, only 2.5% or $17 million is second lien. So, it’s really a first lien portfolio with roughly 60% in cash flow at SUNS, which has been coming down as we have been growing the ABL business, particularly North Mill.

And across the platform we are more than 50% non-cash flow today.

Okay, great. That’s great color. And then I was wondering if you could give us an update about the life science JV and that was announced kind of I want to say in early 2017 kind of when might that start to build up and what you expect there in the early days and early innings of that business?

Sure. I think from a high level, our life science business has been active both mostly as you know at solar, but also at Solar Senior in finding good private and smaller public company investments. The JV was really focused exclusively on large public opportunities, which in fairness we have not seen as many of, but we are beginning to and as part of the analysis that Michael mentioned in his prepared remarks about the 2 to 1, we are evaluating whether that’s something we should also think about doing more on balance sheet than in JV. So, I would say more to come.

Great. Thanks for the color, guys.

Thank you.

Thank you. [Operator Instructions] And our next question comes from the line of Jonathan Bock from Wells Fargo Securities. Your line is open. Fin O’Shea: Hi, guys. Fin O’Shea on for Jonathan again this morning. Thanks for taking our question. A lot has been covered here most asked and answered, but I will expand a bit on leverage, appreciating your prudence and the approach here on both solar and SUNS in slow playing the hand, we certainly appreciate that. However, SUNS seems to present an almost uniquely favorable situation. It’s a floating rate, so low base fee 50% catch up, you have small hold sizes in cash flow which you could expand or draw on. So, can you just kind of give us a little more thought as to why not push forward with SUNS on higher leverage?

Yes, I think the answer is we continue to evaluate it. I don’t want to spend much time talking about Solar, but the dynamics are actually similar, because that is a predominantly stretch first lien. This is, as you know, it’s SUNS a more traditional first lien portfolio, commercial finance assets in both platforms. So, I think the dynamics are similar. And our strategic focus is less about putting more leverage on the same assets as it is evaluating what opportunities might be there for us to grow our commercial finance businesses here at SUNS. So that they are more leverageable, you are right, but that is never really what drives our investment behavior. It’s more about strategically what opportunities might be open to us on behalf of our shareholders to expand our commercial finance presence.

And again sitting here today with about 100% available capital, we don’t have a need to rush to make the decision, because we have access to capital and as you know, we are underlevered compared to our peers dramatically today. Fin O’Shea: Okay, thank you very much guys and we will speak this quarter or next.

Thank you, again.

[Operator Instructions] And I am not showing any questions at this time. I would now like to turn the call back over to Michael Gross, Chairman and Chief Executive Officer, for any closing remarks.

Thank you very much. We have no further comments at this time and we appreciate the dialogue and look forward to talking again soon.