SLR Investment Corp. (NASDAQ:SLRC) Q3 2023 Earnings Call Transcript

SLR Investment Corp. (NASDAQ:SLRC) Q3 2023 Earnings Call Transcript November 8, 2023

Operator: Good day, everyone. And welcome to the Q3, 2023 SLR Investment Corporation Investment Corporation Earnings Conference. At this time, all participants are in a listen-only mode. Later, you will have the opportunity to ask questions. [Operator Instructions] Please note this call will be recorded. I will be standing by if you should you need assistance. It is my pleasure to turn conference over to Chairman and Co-Chief Executive Officer Michael Gross.

Michael Gross: Thank you, very much. And, good morning. Welcome to SLR Investment Corp.’s earnings call for the third quarter ended September, 30th, 2023. I’m joined today by Bruce Spohler, our Co-Chief Executive Officer; and our Chief Financial Officer, Shiraz Kajee. Shiraz, before we begin, would you please start by covering the webcast and forward-looking statements.

Shiraz Kajee: 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 that any unauthorized broadcast in any form are strictly prohibited. This conference call is also being webcast from the events founded 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 7th, 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 condition or results. And involve a number of risks and uncertainties as 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. Does not undertake to update any forward-looking statements unless required to do so by both. 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 over to our Chairman and Co-CEO, Michael Gross.

Michael Gross: Thank you, Shiraz. We are pleased to report that for the third quarter of 2023, SLRC generated net investment income of $0.37 per share, representing a 16% increase year-over-year, once again exceeded our distributions for the quarter. The increase in our NII per share over the past year has been driven by portfolio growth and increases in reference rates, which have flowed through to our floating rate portfolio. At September 30th, our net asset value per share was $18.06, up from $17.98 per share at June 30th, reflecting stable credit performance and the overturning of our distribution. More digging into our third quarter performance I’d like to touch on the overall investment climate. We’re living in a period of heightened market volatility resulting from geopolitical tensions and economic uncertainties.

With sadly, no near-term end in sight. Inflationary pressures from elevated energy, labor and capital costs are proving to be persistent, and interest rates are expected to stay higher for longer. Growth may slow as a result, but the U.S. economy has remained remarkably resilient despite these multiple shocks. The performance of our portfolio companies equally remains resilient, and sponsor finance, our portfolio companies largely continue to exhibit both revenue and EBITDA growth. While the rapid increase in rates impacted valuations and diminished M&A volume this year, there are attractive opportunities to finance quality borrowers with resilient cash flows or stable assets supporting borrowing basis. SLR has been an important provider of capital to the private equity community, and some private credit managers grappled with hold limitations.

Importantly, M&A volume has begun to pick up and has expected to continue expanding next year, given substantial PE dry powder and projected stable interest rates. Given a certainty associated with economy and geopolitical events, we believe that maintaining a defensive approach vs selection is critical to maintaining our long term strong performance. Across our platform, we are seeing some most attractive investment opportunities in years. And we believe that private credit asset class from Italia attractive both an absolute and relative return basis. The current market environment creates opportunities for firms like SLR with deep experience and expertise in investing throughout market cycles. SLR will be opportunistic and leveraging its diversified platform across sponsor and especially advanced investment strategies to generate attractive returns while protecting our capital.

The overhaul healthcare portfolio remains solid, with a non-accrual rate based on cost at just 0.7% and 0.3% at fair value at quarter end. The weighted average interest coverage on responsive loans is just under two times. We believe these healthy metrics are the result of our focus and sponsor finance and recession resilient industries, recurring free cash flow to healthcare and business services. As a reminder, our [indiscernible] businesses enable us to be highly selective in our sponsor finance strategy. At quarter end approximately 98% of our portfolio was comprised of firstly seeking secured loans, our long-term investment in first thing loans resulted in a portfolio, we believe it’s better equipped to withstand continued inflationary pressures and high interest rates in portfolios with second lien and unit tranche loans.

Additionally, with $36 million in our comprehensive investment portfolio, invested in specialty finance assets, which are borrowed basis and full covenant structures supporting our investments. We are defensively positioned. Our differentiated and investment pros of coupling castle loans and specialty financed loans provides us with enhanced portfolio diversification and additional downside protection in periods of tightening economic conditions. Importantly, our broad set of origination capabilities allows us greater flexibility and allocating capital to our various private credit investment strategies, the best risk reward opportunities across economic cycles. Through borrows a significant available capital, such as the SLR platform are able to fill the void left as regional banks retreat, and the syndicated loan market grapples with structural challenges from the end investor base.

Borrowers value our speed and certainty of execution and our flexibility and ability to invest $150 million to $200 million in a given upper middle market financing, which gives us greater pricing power and influence over terms with $13 billion of total investable capital across the platform inclusive and an anticipated leverage. SLR has a scale of five full financing solutions, which benefits SLRC through co-investment. As SLR has increased its capital base, we’ve continued to invest in the firm’s infrastructure and origination capabilities. Recent hires in the third quarter include an investment professionals so chief operating partner focused on growth initiatives, the Chief Business Development Officer and a former BDC equity research analyst.

We believe these human capital investments significantly enhance our strategic focus of being a right side and differentiated private credit manager with a scale to ask deep and broad opportunity set to generate alpha through security selection rather than producing index returns of a cash flow loan only approach. Additionally, our special events businesses are benefiting from the regional banking turmoil. As borrowers seek alternative financing replace existing credit lines from banks and retreated from the market. Our in-place teams of approximately 300 professionals across SLR include especially finance affiliates owned by SLRC provides us local market knowledge and relationships will lead to competitive sourcing and information advantages.

Importantly, we have ample dry powder to capitalize on the favorable investment environment. At September 30th, including available credit facility capacity at the SSLP and especially finance portfolio companies. SLRC had over $600 million available capital to take advantage of the current attract investment environment. I’ll now turn the call back over Shiraz, our CFO to take you through the third quarter financial highlights.

Shiraz Kajee: Thank you, Mike. SLR Investment Corp’s net asset value in September 30th, 2023 was $985 million or $18.06 per share, compared to $981 million or $17.98 per share at June 30th, 2023. The quarter end SLRC’s investment portfolio, fair market value of approximately $2.2 billion. In 154 portfolio companies across 43 industries, better fair market value of $2.2 billion in 136 portfolio companies across 45 industries at June 30th. September 30, the company had approximately $1.2 billion of debt outstanding, with leverage of 1.21 times net debt to equity. This point in time level of leverage doesn’t fully reflect client loan asset contributions from our balance sheet to the SSLP as we continue to ramp that vehicle.

September 30th, the SSLP portfolio consisted of $134 million of senior secured floating rate loans. To complete the SSLP ramp, we expect our leverage ratio to once again be in the middle of our target leverage range 0.9 to 1.255. SLRC’s funding profile is in a strong position to whether a rising rate environment, of existing $470 million of senior unsecured fixed rate notes, have a weighted average annual interest rate of 3.8%. We did not have the maturity until the end of 2024. Moving to the P&L for the three quarters, ended September 30th, gross investment income totaled $59.6 million was $56.3 million for the three months ended June 30th. Net expenses totaled $36.3 million for the three months ended September 30th. This compares to $33.7 million with the prior quarter.

As a reminder, at the time of the merger of SLRC Investment Corp. or SUNS into the company last year, investment advisor agreed to raise incentive fees resulting from income earned due to the accretion of purchase discount allocated to investments prior to merger. During the third quarter, the company waved approximately $175,000 of merger related incentive fees, which now totals approximately $2 million in cumulative weighted wavers by the manager related to the merger. Willingly the company’s net investment income for the three months ended September 30th, totaled $23.4 million, or $0.43 for average trend, compared to $22.7 million, or $0.42 cents per average share for the three months ended June 30th. Globalized, the company had net realized and unrealized gains for the third quarter, totaling $3.6 million versus a net realized and unrealized loss of $3.7 million for the second quarter of 2023.

As a result, the company had a net increase in net assets resulting from operations of $26.9 million dollars for three months ended September 30th, 2023, compared to a net increase of $90 million for the three months ended June 30th, 2023. As we mentioned on the previous call, the company has returned to making quarterly rather than monthly distributions. And on November 7th, the board of SLRC declared a quarterly distribution of $0.41 per share payable on December 28th, 2023 to holders as of December 14th, 2023. We estimate this change will slightly reduce our annual operating expenses, and is one change that is consistent with our objective to find solutions to maximize shareholder value. With that I’ll turn the call over to our Co-CEO Bruce Spohler.

Bruce Spohler : Thank you, Shiraz. Before we provide an overview of our portfolio, I’d like to discuss our approach to portfolio construction. Over 17 years of expanding our lending strategies as a diversified commercial finance company has provided us with a financing platform well suited for the current volatile market environment. We’re seeing the dispersion in the opportunity set across segments of the private debt markets. As a result, we believe that asset selection will be critical to achieving strong performance during this vintage. Business model provides us with flexibility and capabilities to capitalize on the most attractive lending opportunities in today’s market. Fundamental, bottom up approach to our portfolio construction, based upon the relative attractiveness and risk adjusted returns across our investment verticals.

Today, we are more active in sponsor finance. However, we expect to see increased opportunities in both ABL and life science lending as we get into next year. At that point, we will readjust our deployment accordingly. We believe having the flexibility to play offense and defense at the right moments across cycles is key to long term consistent investment performance. Now let me discuss the portfolio. At quarter end, the comprehensive portfolio consisting of approximately $3.1 billion of senior secured loans to approximately 790 borrowers, was across 110 industries with $4 million or point 0.1% average position exposure. Measured a fair value 99.2% of our portfolio consisted of senior secured loans, with approximately 98% invested in first lien bonds, including investments to our SSLP attributable to the company.

Only 0.2% was invested in second lien cash flow loans, with the remaining 1.2% invested in second lien asset-based loans, or specialty finance investments account for approximately 73% of the comprehensive portfolio with the remaining 26.05% in senior secured cash flow loans to upper mid-market sponsor own companies. We believe that this defensive approach to portfolio construction positions us well for potential economic weakness and provides a differentiated risk return profile for our shareholders. At quarter end our weighted average asset level yield was 12.3% up from 12.1% last quarter. Our portfolio credit quality remains strong at quarter end to weighted average investment risk rating was just under two, based on our one to four risk rating scale, with one representing the least amount of risk, 99.3% of the portfolio on a cost basis was performing.

Now, let me touch on each of our four investment verticals. I’ll start with our sponsor finance cash flow business. Here we rent, originate first lien senior secured loans for upper mid-market companies, and non-cyclical industries such as healthcare providers, and diversified financials. Help to mitigate the impact on our portfolio from cyclical economic factors. At quarter end, our cash flow portfolio was approximately $824 million, including loans in our SSLP attributable to the company invested across 51 borrowers. And approximately 99% of the cash flow portfolio invested in first lien loans. We believe that this portfolio is well positioned to withstand the liquidity pressures that individual borrowers may face. Additionally, we believe we have a defensively lien positioned portfolio.

Our borrowers have a weighted average EBITDA of over $130 million. We have low LTVs of approximately 41% and interest coverage ratios of just under two times. Our portfolio is comprised of businesses that perform essential services with either recurring or reoccurring revenues. And they have low capital intensity, which results in high free cash flow. Overall, our portfolio has exhibited solid credit metrics that remained relatively steady throughout this year. During the third quarter, we originated $115 million and experienced repayments of $34 million. Our third quarter investments have an average yield to expected maturity of 12.9%, leverage of approximately five times through our investment and interest coverage of just under two times.

Importantly these investments carry less leverage than the historical average for new cash flow issuance. As Michael mentioned, our sponsor finance deal flow continues to be lower overall, as valuation expectations resulted in higher base rates. But we have found pockets of opportunities to make loans and very attractive risk adjusted yields. At quarter and the weighted average yield on this cash flow portfolio was 11.8%. Now let me turn to the ABL segment. Historically, this segment has performed well during periods of market volatility when borrowers that are asset rich, but have cashflow pressures to raise capital back by their liquid assets. The opportunity set has increased for ABL, as borrowers seek working capital financing against the backdrop of increased bank regulation, the fallout from the regional banking crisis and tightening credit in the ABL segment.

Given these the economic headwinds, we are very conservative in our approach to underwriting. The increase in deal volume however it is enabling us to remain active while being extremely selective. At quarter end, our senior security ABL portfolio totaled $976 million representing 31% of the comprehensive portfolio and it was invested across 159 borrowers. Weighted average asset level yield of this portfolio was 15.3% up from 14.6% in the second quarter. The average LTV was approximately 60% but third quarter, we had $85 million of new investments and repayments of roughly the same $87 million. Now let me turn to equipment finance. At quarter end this portfolio totaled $955 million and was highly diversified across 550 borrowers. The credit profile continues to be strong.

Our weighted average asset level yield was 9.6% on the equipment portfolio. During the third quarter, we originated $122 million of new investments and had repayments of $144 million. Our investment pipeline and equipment finance has increased significantly this quarter. We have expanded our vendor financing business for non-OEM distributors and finding attractive risk and adjusted return profiles. We expect to provide — which we expect to provide portfolio and income growth for this segment in 2024. Now, let me finally turn to Life Sciences. Ripple effect of a Silicon Valley Bank failure has had a profound impact on the life science sector. With a decline in investment valuations evidenced by public market caps. Borrowers are seeking to extend the cash runway via debt financings without corresponding equity cushions provided by incremental equity investment.

This dynamic has resulted from borrowers, reluctance to issue of equity at today’s lower valuations. As a result, our team is seeing signs of distress. In the earlier riskier stage of the life science issuance market, which is where we don’t play. We are pleased to report that our $325 million portfolio remains fundamentally strong. Over 95% of the portfolio is invested in loans to borrowers that have over 12 months of cash runway. Additionally, all of our portfolio companies have revenues with at least one product in the commercialization stage, which significantly de-risked our investment. As a result, none of our life science loans are on a watch list, or have migrated lower in our risk rating system during 2023. Life science loans represent just over 10% of the portfolio and contributed just over 20% of our gross investment income in the third quarter.

During the quarter, the team committed $39 million to new investments and funded $25 million of those commitments. In addition, we had repayments of $42 million. We have just under $110 million of unfunded commitments which may be accessed by borrowers based on reaching milestones such as FDA approval, revenue levels, or liquidity milestones. At quarter end, the weighted average yield on this portfolio was 13%. This excludes any success fees and warrants which takes our yield higher. While we expect valuations in the life science market to take another quarter or two to stabilize before we see equity issuance pickup, we do continue to see several new issue opportunities that we find it extremely attractive. Given SLRCs ability to allocate capital to the best risk reward segments, we have the luxury of being highly selective in our capital deployment in the life science sector, while still generating positive originations for the company overall.

As the life science market continues to stabilize, we expect the opportunity to increase. Hopefully with less competition from lenders who were risk on during this current volatile environment. Now I’ll turn the call back to Michael.

Michael Gross: Thank you, Bruce. SLRCs portfolio reflects stable fundamentals and benefits and the flexibility to allocate capital to investments across our lending verticals that we believe offer the most attractive risk adjusted returns for our shareholders. The available capital and an opportunity for continued earnings growth in Q4 and in 2024. Well, the direction of interest rates remain volatile is important to remember that specialty finance spreads and returns are not involved with cash flow sponsor finance investments across cycles. Importantly, we would not expect yield contraction, specialty finance assets to the same extent, as sponsor financial markets return to a more normal state. Looking forward, we expect broad range nation opportunity to be driven by a combination of increased M&A activity, low maturity and regulatory/credit contraction forces, impacting regional banks to benefit the middle market lenders such as SLRC.

In addition, as the regional bank of locations continues to unfold, we are seeing increased opportunities to expand our specialty bands capabilities, to tuck in acquisitions for existing commercial finance portfolio companies, to add required portfolio teams, partner or to acquire portfolios as budget finance assets. SLRCs broad foundation of diversified commercial finance businesses have the resources and experience to acquire portfolios and service loans and opportunistic basis. If you believe that a diversified portfolio approach across sponsor and commercial finance assets, is the most effective strategy to generate income, and manage risk across economic cycles. In closing our investment advisors, alignment of interests with company’s shareholders continues to be one of our guiding principles.

The SLR team owns over 8% of company stock, including a significant percentage of annual instead of compensation invested into stock. Themes, investment alongside fellow SLRC shareholders demonstrates our competence with company’s defense portfolio, stable funding, and federal position. We thank you very much for your time today. And we’ll now open up the line for questions.

Operator: [Operator Instructions]. We’ll take our first question from Eric Zwick of Hovde Group, your line is open.

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Q&A Session

Eric Zwick: Thanks. Good morning, everyone. Wanted to start maybe if you could just provide a little bit of color into the type of investments that the characteristics of those that you are selecting to put into the SSLP at this point?

Michael Gross: Just to refresh for a minute Eric, may recall, we merged Solar and Solar Senior, which closed in April of ‘22. And so as Senior had a portfolio of low yielding, cashflow back sponsor loans, in addition to some ABL assets. And the strategy for the SSLP was to migrate the Solar Senior lower yielding cash flow assets into the SSLP. So, that’s primarily what’s been moving in there, there has been one or two assets, where we’ve originated direct cash flow loans into the SSLP, but it’s been predominantly migrating the Sun’s portfolio down there.

Eric Zwick: Thank you. That’s helpful. And then just curious, a little bit on your commentary for the life sciences. We kind of segment and you’ve mentioned that in some of the areas where you dealt with, they’re starting to see a little bit of pressure. Curious if you just add a little bit of maybe detail into, what issues are arising there. And you’re confident that those would not spread to kind of those areas of the life science that you do lead to in those companies?

Michael Gross: Sure, I think from 30,000 feet to the life science segments, it is dictated in large part by capital raising as they continue to fund the development of drugs and devices through the FDA approval process. And we’re starting to see some stresses in the early stages, because valuations have come off on the equity side, we’re finding that issuers and borrowers are waiting as long as possible, in the hopes that that equity value will recover, to fund that continued cash burn needed to move through the FDA approval process. We have always been late stage, as you may recall, our business, our team in life sciences has been doing this for over 25 years. They’ve never had a default or lost throughout their career, not downward.

But we are focused on late stage and the best evidence for that, is that the burn is lower and we have revenues, as I mentioned 100% of our company’s revenues in one product at a minimum across their portfolio of products that may be moving through the FDA. So, what that means is that there is value there, you can put a multiple on those revenues. They are moving towards cash flow, breakeven. And so the ability to raise capital still exists on the equity side. They are waiting in the hopes that they can raise it at a more attractive valuation. But they have been able to tap the equity markets, both private and public. So, that’s why as I mentioned, we have over 95% of the portfolio has cash runway over a year to fund that continued burn as they move towards cash flow breakeven.

So that’s what’s been insulating our companies from the earlier stage companies that are struggling to raise capital to fund moving through clinical trials to phase three, and commercialization with the FDA.

Eric Zwick: That’s great detail. Thank you. And last one for me. And I’ll step aside, if you could just kind of refresh me on your current interest rate sensitivity, as well as maybe your expectation of rates are going to stay here longer if we might see some changes in the near term?

Michael Gross: I don’t think we have a unique crystal ball on that, our focus is really on for our borrowers and across our portfolios, making sure that we have the liquidity as well as the free cash flow to cover interest rates today, we are stressing them to be 50 basis points to 100 basis points higher when we looked at our stress tests across the individual portfolio companies. And that’s where we’re very comfortable. I don’t think anyone is underwriting an increase much above that.

Eric Zwick: I realized the second part of that question was more speculative, but just curious. I appreciate your thoughts today. Thank you.

Michael Gross: Thank you.

Operator: We’ll take our next question from Sean-Paul Adams of Raymond James.

Sean-Paul Adams: Hey, guys, good morning. Could you just give a little bit of color about the status of the JV and the facility where they are revolving period ends and June 2024? For SSLP? Yes.

Bruce Spohler : The JV is in the process of ramping. We’ve combined $57 million of equity between the two of us at $20.5 million each so far. And the assets just to track that for you it started in the fourth quarter of last year, we had about $18 million of commitments. And had been moving assets steadily in each quarter. That was $46 million of commitments in Q1, $79, and Q2. And now we’re up to $140 million. As we’ve stated previously, we continue to expect to get in that $230 million to $250 million by year end. And the maximum should be about $300 million when we continue to complete the ramp in Q1. And the credit facility really just opened a year ago. So, we have the ability to continue to extend that forward. If the maturity is ‘27 just to give you that date.

Sean-Paul Adams: Perfect, thank you for the color.

Operator: We’ll take our next question from Ryan Lynch of KBW.

Ryan Lynch: Hey, good morning. First question I had was just on the chart that you guys have regarding that asset-based loans weighted average yield, it’s like 15.3% in the quarter. So, what I’m trying to reconcile is, that’s a very high yield on those asset-based loans. But then I look at the underlying businesses that are holding those loans besides any sort of finance that are on your balance sheet. One being like SLR Credit Solutions, that entity only generate about a 6.9% yield to SLRC over the first nine months of 2023, looks like it’s about levered one-to-one, that that entity. And so I’m just trying to understand and reconcile very high underlying asset yields on those asset-based financings. But yet, the overall entity of SLR Credit Solutions has a yield of less than half of that that is generated for SLRC. So, can you reconcile those two?