Sunrise Realty Trust, Inc. (SUNS) Q1 2019 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Solar Senior Capital Ltd. First Quarter 2019 Earnings Conference Call. [Operator Instructions]. As a reminder, this conference call is being recorded. I would 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's earnings call for the first quarter ended March 31, 2019. I'm joined here today by Rich Peteka, our Chief Financial Officer; and Bruce Spohler, our Chief Operating Officer and Solar Capital Partners' co-managing partner. Rich, would you please start off by covering the webcast and forward-looking statements?

Of course. Thanks, Michael. I'd like to remind everyone that today's call and webcast are being recorded. Please note that they are the property of Solar Senior Capital 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 condition. These statements are not guarantees of our future performance, financial condition or results and involve a number of risks and uncertainties. Additionally, past performance is not indicative of future results. 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 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. Solar Senior Capital reported solid operating performance for the first quarter of 2019. Net asset value was $16.40 per share at March 31, a $0.10 per share increase from the prior quarter. In addition, GAAP net investment income of $0.35 per share fully cover distributions for the quarter. At quarter end, our comprehensive portfolio was just under $600 million, an increase of approximately 3% from the prior quarter due to net originations and the increase in the fair market value of certain portfolio companies. The fundamentals of our portfolio coverage remains strong. At March 31, over 98% of Solar Senior's comprehensive portfolio is invested in first lien senior secured loans with 39% of the portfolio in first lien senior secured asset-based loans and the remaining 59% primarily in first lien cash flow loans. Our diversified portfolio of senior secured cash flow and asset-based loans is 99.8% performing at 3/31 on a fair value basis with only one loan on nonaccrual status. Middle market cash flow lending continues to be extremely competitive. The general market consensus is that we are late in the credit cycle, and we see some evidence that the margin is moderating earnings growth. Our defensive positioning in first lien loans and our niche ABL verticals should enable us to perform well either in today's strong economic environment or during a downturn. During the first quarter, approximately 44% of SUNS comprehensive portfolio of gross originations came through our asset-based lending businesses, Gemino Healthcare and North Mill Capital, whose senior secured loans are backed by collateral and have strong structural protection. These specialty finance businesses have achieved double-digit asset-level IRRs and continue to originate investments that are highly attractive on both an absolute and relative-value basis. The remainder of our originations come from first lien senior secured cash flow loans to upper middle market sponsor-owned companies. Our cash flow business continues to be focused on first lien senior secured loans with covenants to upper middle-market companies operating primarily in defensive, noncyclical industries that we believe are better resourced and positioned to navigate in economic downturn should one arise. Late last year, Solar Senior's investment adviser, Solar Capital Partners announced the closing of private credit funds with total equity commitments of over $750 million, bringing the combined investment capital across all fund mandates to approximately $5.5 billion, including expected leverage. The increased scale across the platform strategically positions Solar Capital Partners to be a full solutions provider, with an ability to speak for up to $200 million in the given transaction while maintaining diversified portfolios across each of the funds. The greater hold capacity across the platform has already resulted in more attractive cash flow investment opportunities for SUNS. We are pleased with the progress we have made on efforts to evolve SUNS into a diversified niche specialty finance company. The asset coverage modification approved late last year by our shareholders provides SUNS with additional flexibility and capacity to make controlled equity investments in specialty finance businesses, and we are actively evaluating portfolios of asset-based loans and special lending platforms to acquire. At March 31, Solar Senior is in a strong liquidity position with net leverage or 0.78x debt to equity, up from 0.63x at 12/31/18. We intend to move closer to our target leverage of 1.25x to 1.5x debt to equity by growing our portfolio over time. When considering the combined credit facilities of SUNS' balance sheet and the North Mill and Gemino, there's approximately $225 million of available debt capacity across the platform subject of borrowing base limitations. We'll continue to be highly disciplined in deploying our available capital. At this, I'd like to turn the call back over to our Chief Financial Officer, Rich Peteka.

Thank you, Michael. Solar Senior Capital Ltd.'s net asset value at March 31, 2019, was $263.1 million or $16.40 per share. This compares to a net asset value of $261.4 million or $16.30 per share at December 31, 2018. Solar Senior's balance sheet - investment portfolio at March 31, 2019, had a fair market value of $467.7 million in 49 portfolio companies, operating in 21 industries compared to a fair market value of $450.1 million in 47 portfolio companies operating in 20 industries at December 31, 2018. At March 31, 2019, SUNS' net leverage increased to 0.78x debt to equity from 0.63x at December 31, 2018. Solar Senior's target leverage is 1.25x to 1.5x debt to equity under reduced asset coverage requirement. From a P&L perspective, gross investment income for the three months ended March 31, 2019, totaled $10.2 million versus $10.0 million for the three months ended December 31, 2018. Net expenses for the three months ended March 31, 2019, were $4.6 million compared to $4.4 million for the three months ended December 31, 2018. Net investment income for the quarter ended March 31, 2019, was $5.7 million or $0.35 per average share as compared to $5.6 million or $0.35 per average share for the three months ended December 31. Below the line, Solar Senior had a net realized and unrealized gain for the first fiscal quarter totaling $1.7 million compared to a net realized and unrealized loss of $8.2 million for the three months ended December 31. Accordingly, Solar Senior had a net increase in net assets resulting from operations of $7.4 million or $0.46 per average share for the three months ended March 31, 2019. This compares to a net decrease in net assets resulting from operations of $2.6 million or $0.16 per average share for the three months ended December 31, 2018. Lastly, our Board of Directors declared a monthly distribution for May 2019 of $0.1175 per share payable on June 4, 2019 to stockholders of record on May 23, 2019. At this time, I'd like to turn the call over to our Chief Operating Officer, Bruce Spohler.

Thank you, Rich. As Michael highlighted, our intention is to expand our portfolio by investing in our three core investment strategies: first lien senior secured cash flow loans to upper mid-market sponsor-owned companies; first lien asset-based loans secured by accounts receivable to midsized companies, which operate exclusively in the health care sector through our Gemino holdings portfolio companies; and lastly, first lien asset-based loans in factoring facilities secured by accounts receivable to midsized companies that operate primarily in manufacturing services and distribution industries through our North Mill subsidiary. In addition, we are actively evaluating opportunities to further expand our specialty finance business lines. Now let me turn to the portfolio. In the aggregate, at quarter end, our investments across our three business lines totaled just under $600 million, encompassing a 162 issuers. The portfolio is highly diversified with an average investment of approximately $3.7 million or 0.6% of the comprehensive portfolio. Measured at fair value, 98% of the portfolio consists of senior secured loans, of which 59% are in first lien cash flow loans, 38% are in first lien asset-based loans and only 1.7% are in second lien cash flow loans with a de minimis amount in equity. SUNS' weighted average yield on a fair value basis was 9.8%. Including investments and repayments across our 3 business lines, gross originations totaled $56 million and repayments were $37 million, resulting in portfolio growth of just under $20 million. Now let me provide an update on the credit quality and earnings power of our portfolio. At quarter end, 99.8% of the portfolio on a fair value basis was performing with only one investment on nonaccrual. Our internal risk assessment on a weighted average basis of our loan portfolio remained at approximately two with 1 on our 1 to 4 risk rating scale being the least amount of risk. At quarter end, our watch list was approximately 3.6% of a comprehensive portfolio. Now let me provide an update on our 3 investment verticals. First, cash flow. At quarter end, our cash flow portfolio totaled $364 million, representing 60% of the overall portfolio. This portfolio is comprised of 46 loans with an average loan size of just under $8 million. The fair value weighted average asset-level yield of the portfolio was just over 8%, consistent with the prior quarter. Our second lien cash flow exposure represents only 1.7% or less than $10 million of the $600 million portfolio and is expected to continue to decline in the coming quarters. At quarter end, the weighted average EBITDA of our first lien cash flow investments was over $100 million. On a fair weighted - fair value weighted average basis, first lien leverage through our investment was 4.5x and interest coverage was 2.4x, representing a much lower risk profile than the liquid leveraged loan market. Additionally, the weighted average revenue growth was just over 5%, and the weighted average EBITDA growth was also approximately 5% through the quarter end, reflecting continued positive trends in the fundamentals of our portfolio of cash flow companies. During the first quarter, we originated cash flow investments of just over $30 million and had repayments of just over $15 million. Thematically, we are continuing to increase our investments in existing credits that are performing well through adding incremental financings. Now let me turn to North Mill. At quarter end, North Mill had a $118 million portfolio, representing 20% of the overall SUNS' portfolio. It consisted of loans to 80 different borrowers with an average investment of $1.4 million. The weighted average asset-level yield at North Mill was just over 13%. During the first quarter, we funded just over $15 million of new investments and had repayments of just over $18 million. And lastly, for the quarter, North Mill paid a cash dividend of $1.4 million up to SUNS. Now let me conclude with Gemino, our health care ABL portfolio company. At quarter end, Gemino had a $115 million portfolio, representing just under 20% of comprehensive portfolio. It was comprised of loans to 35 borrowers with an average investment of $3.3 million. The weighted average asset-level yield for Gemino is was over 11.5%. During the first quarter, we funded just under $10 million of new investments and had repayments of approximately $3 million. For the quarter, Gemino paid a cash dividend up to SUNS of just under $1 million. As Michael mentioned, the middle market cash flow lending environment remained frothy. We benefit from our diversified origination sources across cash flow and asset-based lending verticals, allowing us to allocate capital to investments that meet our strict underwriting criteria. In addition, we believe that the growth of the investment advisers platform will result in more investment opportunities across both cash flow and specialty finance asset classes for SUNS. Meantime, we will continue to be prudent and highly disciplined in deploying our substantial available capital. Now let me turn the call back to Michael.

Thank you, Bruce. Since the 2011 inception of SUNS, our investment decisions have consistently been focused on generating long-term stockholder value while maintaining alignment with our shareholders. Importantly, we have been prudent in the face of sustained, frothy credit markets and remain disciplined, not compromising credit quality for yield. The result is a solid portfolio foundation from which to grow. We've always maintained an investment philosophy of assuming that we are late in the credit cycle, and we believe that in the current environment, it pays to be cautious. We are confident our differentiated origination platform and diversified portfolio position us well to navigate in any environment. At approximately 0.8x debt to equity, we are underlevered relative to our target range of 1.25x to 1.5x net debt to equity, we have substantial dry powder of $225 million deploy via our differentiated investment verticals. If the credit cycle does shift, we believe our history of conservatism will enable us to outperform on a relative and absolute basis, and we will be well positioned to take advantage of market dislocations. At last night's close of $17.19 per share, SUNS carries a yield of 8.2%, which represents a significant discount to the 5.8% implied yield of the S&P/LSTA Leveraged Loan 100 Index. Given the overall credit quality of SUNS' diversified portfolio, our differentiated origination engine and our disciplined investment philosophy, we believe SUNS represents an attractive investment on both a relative and absolute value basis. We thank you for the time this morning and look forward to speaking with you again next quarter. Operator, could you please open up the lines for questions?

[Operator Instructions]. Our first question comes from Mickey Schleien with Ladenburg.

Michael, I think in the call you mentioned you've seen some deceleration in revenue and EBITDA growth in the portfolio. So I'd just like to ask about Trident. I know it's a small position, but it'd be helpful to understand what issues it's been facing that caused it to file bankruptcy? And does that have anything to do with cyclicality?

Sure. Mickey, I'll take that one. Actually, Michael's comment, just to clarify for a moment, was not any trends that we're seeing in terms of the fundamentals of our portfolio, where we continue to see strong revenue on EBITDA growth in the mid- to high single digits. It's just actually as we look more broadly at some of the investments that we're looking at, opportunities we're looking at, we do see a little bit less in terms of tailwinds and growth. But our portfolio remains to be fundamentally strong. As to Trident specifically, Trident is a health care provider in the mobile diagnostics business. To your point, it is a small position for us but we treat every position as if it's our only position. And so we have been working this one. We've been an investor for a few years early on. We actually were a second lien lender a number of years ago. And in the health care sector, they're not facing anything that is systematic to either the economy or the health care sector, they just have had some headwinds in terms of what's going on at home health and some of the competitive dynamics there as well as some billing and collection issues, which we have seen from time to time in some of these health care rollouts. So it is very specific to Trident. And is not in any way an indication of what's going on either in our portfolio, the economy or the health care sector more broadly. And that's further supported by our relatively low watch list as you look at the 3%, 3.5% watch list level at SUNS.

Bruce, that's really helpful. And just one other question. In the Solar call, you mentioned that at Solar, some of the noncash flow lending businesses were looking at a broader opportunity set. And I noticed that at North Mill, the weighted average yield in the portfolio declined very meaningfully from the fourth quarter to the first quarter. Was that for the same reason? Or was there something nonrecurring in the fourth quarter North Mill?

Yes. That's a great question. Totally unrelated to our solar comments. North Mill had a couple of higher yielding investments that repaid. So that was just a one-off situation. They continue to see some very attractive opportunities, pipeline is actually strong. We have been looking at a variety of ways to grow that portfolio, either through acquisitions of either portfolios or businesses. We like factoring a fair bit and that's something that they have been focusing on diversifying their factoring business away from just its Midwest center. So the specific answer is, they had some high-paying or high-yielding assets repay, but they do have a strong pipeline.

And that pipeline's in that sort of 13% yield range?

It's actually, yes, particularly on the factoring side, those are higher yielding assets. So I would say yes, on a blended basis.

[Operator Instructions]. Our next question comes from Finian O'Shea with Wells Fargo Securities.

Just want to touch on life sciences. I know it's a core vertical for SUNS today. But has been in the past, I believe, and maybe in the future. And that seems to be a pretty good area of origination for you guys now looking platform-wide, so just kind of comments there. And then more specifically on GenMark which previously had been in SUNS name for a while, more recently, Solar and I think you just did a whole - newer larger loan platform-wide, which SUNS is in. Can you comment if this sort of indicates on interest in life sci for the SUNS vehicle?

Sure. That's a great question. I think it's fair to say, Finian, from 30,000 feet that most of life science exposure will be in SLRC as opposed to SUNS. And that's because historically, we have viewed the risk as more appropriate for SLRC where you know SUNS is our, generally speaking, our lower risk vehicle, regardless of whether it's cash flow, ABL or life science loans. But as we have expanded both the scale of the Solar platform beyond just Solar and SUNS with our private funds and our ability to take larger investment positions as well as expanding our 30% basket at both SUNS and SLRC by adopting the higher leverage capability last year, it is opened up flexibility to invest in all asset classes but specific to your question, in life sciences in larger public companies. As you know, a $250 million market cap and above investment would be a nonqualified asset, regardless of whether it's a cash flow loan or life science loan or an ABL loan. And so that has opened up a nice opportunity for life sciences where we see lower risk investments to some large public companies that otherwise we were restricted on when we had a tight nonqualified basket prior to last year. And so those are lower risk. We have some companies where market rate caps $1 billion plus, and we think that risk is very SUNS appropriate. The yields might not be as high as the 17%, 18% that our life science team has seen historically, but still very, very attractive, again, given that this team has been investing for 18 years $3 billion of investments and no losses. And so when we can find 13% to 15% first lien life science loans to large public companies, you will see us go invest with SUNS where we see that risk is very appropriate for the SUNS' investors. And GenMark is a great example of an asset like that. We have at SUNS been in GenMark, as you know, before as well as at SLRC. I think we've been in and out probably three times already and are thrilled to have the opportunity to invest there again. Our targeted yield to maturity is 10.5%. But as know, since these are short duration assets of typically two years or less, our expected IRR will be much higher than that, particularly when you add in the success fees. So you'll see a little bit of opportunity to do life sciences at SUNS as we find some of these lower risk public companies.

[Operator Instructions]. I'm not showing any further questions at this time. I would now like to turn the call back over to Michael Gross for any closing remarks.

We have no closing remarks at this time other than to thank you for your attention, and we look forward to speaking to you soon.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program, and you may all disconnect. Everyone, have a wonderful day.