Earnings Labs

SLR Investment Corp. (SLRC)

Q3 2024 Earnings Call· Thu, Nov 7, 2024

$15.66

+1.33%

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Transcript

Operator

Operator

Good day, everyone and welcome to today’s Third Quarter 2024 SLR Investment Corp. Earnings Call. [Operator Instructions] Please note this call is being recorded. And I will be standing by if you should need any assistance. It is now my pleasure to turn the conference over to Michael Gross, Chairman and Co-CEO.

Michael Gross

Analyst

Thank you very much and good morning. Welcome to SLR Investment Corp.’s earnings call for the quarter ended September 30, 2024. I am joined here today by my longtime partner of 18 years, Bruce Spohler, Co-Chief Executive Officer, our Chief Financial Officer; Shiraz Kajee and the SLR Investors Relations team. Shiraz, before we begin, would you please start by covering the webcast and forward-looking statements.

Shiraz Kajee

Analyst

Thank you, Michael. Good morning, everyone. I would like to remind everyone that today’s call and webcast are being recorded. Please note that they are the property of SLR Investment Corp. and any unauthorized broadcast in any form is strictly prohibited. This conference call is also being webcast on the Events Calendar in the Investors section on our website at www.slrinvestmentcorp.com. Audio replays of this call will be made available later today as disclosed in our November 6 earnings press release. I would also like to call your attention to the customary disclosures in our press release regarding forward-looking statements. Today’s conference call and webcast may include forward-looking statements and projections. These statements are not guarantees of our future performance or financial results and involve a number of risks and uncertainties. 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. We did not undertake 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 over to our Chairman and Co-CEO, Michael Gross.

Michael Gross

Analyst

Thank you, Shiraz and again thank you for everyone for joining our earnings call this morning. After the market closed yesterday, SLRC reported net investment income of $0.45 per share for the third quarter of 2024 consistent with the prior quarter and representing distribution coverage of approximately 110%. Given the base rates declined for the first time in four years and conditions of the sponsor finance market remains fiercely competitive in the third quarter, we are pleased with the stability of our quarterly net investment income. Additionally, as a testament to the overall credit quality of our portfolio, our net asset value remained at $18.20 per share. We believe our stability is a direct result of our conservative underwriting philosophy and multi-strategy approach to private credit investing with approximately 78% of our loan portfolio derived from specialty finance investments supported by collateral and the remainder in cash flow loans to borrowers in the recession resilient industries, as of September 30. Due to the more favorable conditions in our specialty finance markets, our investments in the third quarter were once again more heavily weighted in those asset classes, which we believe currently provide a more attractive risk-adjusted return relative to sponsor finance loans. 96% of our third quarter originations were in specialty finance, much higher than our historical mix. We believe our ability to pivot to the best risk-adjusted return across our private credit strategies is a hallmark of SLRs multi-strategy allocation approach. Increasingly, private credit investors are looking for proprietary investment strategies and less correlated portfolios across their BDC investments, which we believe is clearly visible in our results, our portfolio composition and momentum we have achieved year-to-date. Within our specialty finance businesses, we are seeing a combination of an increase in organic and strategic opportunities to expand our portfolio…

Shiraz Kajee

Analyst

Thank you, Mike. As well our Investment Corp net asset value at September 30, 2024, was $993 million or $18.20 per share, consistent with the quarter ended June 30, 2021. At quarter end, SLRC is on-balance sheet investment portfolio at a fair market value of approximately $2.1 billion and 131 portfolio companies across 34 industries, compared to a fair market value of $2.1 million and 138 portfolio companies across 37 industries at June 30. At September 30, the company had approximately $1.1 billion of debt outstanding with a net debt-to-equity ratio of 1.1x. We expect our net debt to equity ratio to remain in the middle of our target range of 0.9x to 1.25x. SLRC's funded debt consisted of 58% in revolving credit facilities and 42% of fixed rate unsecured notes at code. During the quarter, the company amended both its senior secured credit facility and SUNS SPV credit facility agreements. Extending our maturities and increasing commitments. The company's $470 million of senior unsecured fixed rate notes have a weighted average annual interest rate of 3.8%. We remain in dialogue with the fixed income community and expect to opportunistically access the investment-grade market to address near-term maturities. Moving to the P&L. For the three months ended September 30, gross investment income totaled $59.8 million versus $59 million for the three months ended June 30. Net expenses totaled $35.4 million for the three months ended September 30. This compares to $34.7 million for the prior quarter. Accordingly, the company's net investment income for the three months ended September 30, 2024, totaled $24.3 million or $0.45 per average share, consistent with the prior quarter and more than covered our $0.41 per share distribution during the period. Below the line, the company had a net realized and unrealized loss for the third quarter to $2.3 million versus a net realized and unrealized loss of $1.1 million for the second quarter of 2020. As a result, the company had a net increase in net assets resulting from operations of $22 million for the three months ended September 30 compared to a net increase of $23.2 million for the three months ended June 30. On November 6, the Board of SRC declared Q4 2024 quarterly distribution of $0.41 per share payable on December 27, 2024, to holders of record as of December 13, 2020. With that, I'll turn the call over to our co-CEO, Bruce Spohler.

Bruce Spohler

Analyst

Thank you, Shiraz. Given the current competitive sponsor finance cash flow market, the flexibility offered by our commercial finance strategies enables us to source attractive investment opportunities away from this competitive cash flow market. We take a fundamental bottom-up approach to our portfolio construction based on the relative risk-adjusted return profile across our investment verticals. At quarter end, on a fair value basis, the comprehensive investment portfolio consisted of approximately $3.2 billion of senior secured loans to over 850 borrowers. The average exposure per borrower is $3.7 million. Measured at fair value, over 98% of our portfolio consisted of senior secured loans, with just under 97% invested in first lien loans, including investments in the SSLP attributable to the company and only 0.2% was invested in second lien cash flow loans. With the remaining 1.2% of the portfolio invested in second lien asset-based loans. Our specialty finance investments account for approximately 78% of the comprehensive portfolio. With just over 22% invested in first lien cash flow loans to upper mid-market sponsor-backed companies. We believe this defensive portfolio construction positions us well and provides a differentiated risk return profile relative to sponsor finance only portfolios. At quarter end, our weighted average yield on the comprehensive portfolio was 11.8%. Our portfolio credit quality remains strong. At quarter end, the weighted average investment risk rating was just under 2 based on our 1 to 4 risk rating scale, with 1 representing the least amount of risk. Over 98% of the portfolio is rated 2 or higher at quarter end. Additionally, 99.4% of the portfolio on a cost basis and 99.6% on a fair value basis was performing with only one investment on nonaccrual. Now, let me touch on each of our 4 investment verticals. Sponsored finance or cash flow lending. In this business,…

Michael Gross

Analyst

Thank you, Bruce. In conclusion, we remain pleased with the stability achieved in our third quarter results and encouraged by the overall credit quality of our investment portfolio, which is evidenced by another quarter of NAV stability, no changes to a low level of non-accrual investments, a low level of watch list investments and minimal payment in-kind income with broad diversification. While concerns about credit quality and private credit portfolios continue to creep into the market psyche, we view the consistency of results achieved in 2024 as a testament to our multi-strategy approach to private credit investing. As we sit here today and observe the growth in our platform over the last few years that has expanded our diversified commercial finance investment capabilities and momentum across our business, we believe the company is positioned very favorably. Market expectations for the shape of the forward interest rate curve remain dynamic on the heels of this week's elections, but do continue to include declines in base rates throughout 2025. This situation may present a challenge for some private credit portfolio yields and earnings that are constructed with predominantly floating rate cash flow loans vintage concentrations. With approximately 35% of our portfolio indexed to fixed rates, investors should come to appreciate that SLRC specialty finance assets have a lower correlation to base rates and offer a more substantial, more absolute return like profile, and the company, therefore, has portfolio yields that are expected to have a lower beta to future changes in SOFR. In closing, SLRC trades at a 10.7% dividend yield as of yesterday's market close, which we believe presents an attractive investment for both income seeking and value investors and offer shareholders portfolio diversification benefits compared to cash flow-only strategies. Our investment adviser's alignment of interest with SLRC shareholders continues to be one of our significant hallmark principles. The entire investment team and the entire firm own over 8% of the company's stock and includes having a significant percentage, other annual incentive compensation reinvested in SLRC stock. The team's investment alongside fellow institutional and private wealth investors, demonstrates our confidence in the company's portfolio, stable funding and earnings outlook. We thank you all again for your time today. As we know, it's a busy time for those that have followed over the listed BDC marketplace closely. Operator, will you please open the line for questions.

Operator

Operator

Thank you. [Operator Instructions] We will take our first question from Bryce Rowe with B. Riley. Please go ahead.

Bryce Rowe

Analyst

Thanks. Good morning.

Bruce Spohler

Analyst

Good morning, Bryce.

Bryce Rowe

Analyst

I wanted to, I guess, just kind of a quick one here on business credit and the Webster acquisition, you put some equity into that subsidiary, the SLR business credit subsidiary. And kind of curious what your thoughts are around maybe increased dividend or increased earnings from that particular investment. I mean, again, it's really early days in terms of the investment, but certainly expecting some level of increased return there? Thanks.

Bruce Spohler

Analyst

Yeah. We definitely are expecting some increased return. I think in the first quarter or so, it will start a little bit slower as we integrate the business into the platform. We did buy a business, came with about 14 people as well as $125 million or so portfolio. So we're targeting a low to mid-teens ROE on that investment. So I think if you put that across the $30 million or so of equity that we dropped in, that's a good starting point, and we hope there's upside from there.

Bryce Rowe

Analyst

Okay. That's helpful, Bruce. Maybe a couple more here. As we think about the SLR senior credit, are you at a level where we're leverage within that particular portfolio? Is it where you want to be? Or would you like to operate it with potentially more leverage?

Bruce Spohler

Analyst

I think the leverage is where we want it to be. We are thematically, as Michael mentioned, rotating out of cash flow loans and the entire strategy at SSLP is cash flow investing. So you'll see it bump around a little bit as we get some repayments and opportunistically add to it. So I don't think there's much more leverage there, I think there's a little bit more upside as we optimize the size of SSLP, but we'll let a few loans go in this repricing environment.

Bryce Rowe

Analyst

Yes. Okay. And then maybe one more around the repricing environment. We've heard a lot about the potential for M&A to pick up to help maybe, I guess, remix the supply and demand within private credit as it relates to cash flow lending. Do you all sense that there could be an opportunity to maybe to reemerge within that market now that you're pivoting and just kind of trying to get a feel for how long the pivot lasts and how opportunistic new all can be with the current market environment?

Bruce Spohler

Analyst

I think the first thing that happens is, to your point, it takes the pressure off the existing portfolio because everybody starts to underwrite new opportunities and that supply dynamic shift such that it's difficult for borrowers to come in and reprice the existing portfolio. So from our perspective, we took our portfolio down from 26%, sponsor finance, 22% -- I'm sorry, 24 down to 22. Last year, we peaked at over 26%. So it will move around for us. We never see it much more than high-20s and we don't see it getting down to much lower than high to mid-teens. So we are looking for new opportunities, but the first benefit is definitely taking the pressure off the existing portfolio from a repricing perspective.

Shiraz Kajee

Analyst

I do think though -- that there's been so much money raised for just sponsor finance that --it's not going to change the yield that we're seeing dramatically at all. What it does do for us given how picky we are in cash flow lending, it gives us more opportunity to choose amongst and find things that fit our type box. But I would not sit here today and assume that spreads are going to widen dramatically just because there's more M&A supply coming.

Bryce Rowe

Analyst

Yes. Okay. All right. Appreciate your perspective.

Michael Gross

Analyst

Thanks for your questions.

Operator

Operator

Thank you. And we will take our next question from Melissa Wedel with JPMorgan. Please go ahead.

Melissa Wedel

Analyst · JPMorgan. Please go ahead.

Good morning. Thanks for taking my questions today. I was hoping you could elaborate a little bit more on the assets that were acquired in that factoring portfolio. Can you just talk a little bit about how those maybe provide some or do they diversify the rest of that existing portfolio? And then are they sort of fixed rate or floating rate assets, appreciate it?

Michael Gross

Analyst · JPMorgan. Please go ahead.

So good question, Melissa. They're all floating rate. And they're consistent with our existing platform that is already both either factoring or in an ABL structure lending against receivables. So the collateral is something that we're incredibly familiar with. What it does for us is, yes, it adds an element of diversity. We had approximately 94 different borrowers across the $124 million of funded assets. So it's a very diverse portfolio with an average investment of about $1.3 million per borrower. Yields are in the low to mid-teens and losses are de minimis because effectively, in factoring your buying or lending against high-quality receivables in this case, I think Walmart, Costco, Amazon and yet our customers are clearly not of the same credit quality. And so therefore, we get to charge higher returns, but our underlying risk really is close to investment grade. What we like about the portfolio is it is long-standing, long-tenured relationships. This is not an M&A sponsor finance portfolio that churns every couple of years of sponsors come in and out of investments. Here, this is working capital financing for our borrowers. So the average relationship in the Webster portfolio is nine years. So it's very stable assets. But the underlying collateral turns every 30, 60, 90 days. So we have the ability to unwind our investment rather quickly, if we want out. Obviously, that's not what we're seeking to do with relationships that have lasted nine years. But from a risk mitigation perspective, the ability to unwind quickly against very high-quality collateral and yet keep long duration and high returns on these assets is extremely attractive. It's also -- I would say, unique to our platform in that you need to be in this business to be able to make an acquisition like this. We acquired a business came with the team. Not all of the team that Webster had. We were able to find some synergies and bring it on platform. And it also adds diversity to the industries that we focus on. We already are very active in health care ABL we're very active in digital media ABL with our acquisition a couple of years back. And this is very, as Michael mentioned, focused on traditional factoring industries such as apparel, textile, jewelry, so it expands a region and an industry focus for the team there. So we think it's extremely attractive and we'd love to do more.

Melissa Wedel

Analyst · JPMorgan. Please go ahead.

I appreciate all that context. Speaking of doing more, leading right into my next question. Are you constrained -- are you getting constrained by the 30% cap. I mean, how much capacity do you have to do additional deals like this? Thank you.

Bruce Spohler

Analyst · JPMorgan. Please go ahead.

Just as a quick reminder, remember, the 30% catches some of our fincos because of the structure of owning the finco, we can put their assets actually on the parent company's balance sheet and it doesn't utilize the 30%. So we have a lot of flexibility. And as we see large portfolios, the BDC, as you know, benefits from the affiliation with the broader platform with over $14 billion of investable capital, we can take assets both into the BDC and alongside in our private funds as well. So we feel we bring a lot of flexibility and don't feel constrained by the 30% test.

Melissa Wedel

Analyst · JPMorgan. Please go ahead.

Okay. I appreciate that distinction. Thanks.

Bruce Spohler

Analyst · JPMorgan. Please go ahead.

Thank you.

Operator

Operator

Thank you. And we will take our next question from Sean-Paul Adams with Raymond James. Please go ahead.

Sean-Paul Adams

Analyst

Hey, guys. Good morning.

Bruce Spohler

Analyst

Good morning.

Sean-Paul Adams

Analyst

On Rug Doctor, I know it's on non-accrual for a couple of years now is also held by a number of other BDCs. But it looks like the portfolio markdowns really haven't shifted in the last couple of quarters. Has there been any change or any pathway for a resolution on that non-accrual?

Bruce Spohler

Analyst

Yes. So that's a great question. As you know, while we care about every investment, it's rather de minimis in size across the portfolio. The big thing that happened with the Rug Doctors, a couple of years back, we entered into a JV with [indiscernible] was a major player in the vacuum business, but not so much so in the rental vacuum business. And so this so actually runs this JV. And so what you're seeing is our ownership and our peers, BDC's ownership in the JV. The only reason it's on non-accrual is because we have not been collecting interest. We've been keeping it in the business and really haven't restructured our investment. We do think there'll be some resolution there with our JV partner long term. They obviously would probably prefer to own all of it than part of it. But that's really, I think, going to be the catalyst down the road is this was a likely acquirer of the remaining interest from ourselves and our pure BDCs.

Sean-Paul Adams

Analyst

Perfect. Thank you for the clarity. I appreciate it.

Operator

Operator

Thank you. And it appears that we have no further questions at this time. I will now turn the program back to our presenters for any additional or closing remarks.

Michael Gross

Analyst

No additional remarks other than to thank you for your time and attention on this particular busy season of quarter earnings. And again, as always, if you have any other follow-up questions, please feel free to follow-up with any of our team. Have a great day.

Operator

Operator

Thank you. This does conclude today's presentation. Thank you for your participation. You may disconnect at any time.