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SLR Investment Corp. (NASDAQ:SLRC) Q1 2023 Earnings Call Transcript

SLR Investment Corp. (NASDAQ:SLRC) Q1 2023 Earnings Call Transcript May 11, 2023

Operator: Good everyone and welcome to today's Q1 2023 SLR Investment Corp. Earnings Call. At this time, all participants are in listen-only mode. Later you will have the opportunity to ask questions during the question-and-answer session. [Operator Instructions] It is now my pleasure to turn the conference over to Michael Gross, Chairman, President and Co-CEO. Please go ahead.

Michael Gross: Thank you very much and good morning. Welcome to SLR Investment Corp.'s earnings call for the first - fiscal quarter ended March 31, 2023. I'm joined today by Bruce Spohler, our Co-Chief Executive Officer; and our new Chief Financial Officer, Shiraz Kajee. Shiraz, before we begin, would you please start by covering the webcast and forward-looking statements.

Shiraz Kajee: Thanks, 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 calendar in the Investor section on our website at www.slrinvestmentcorp.com. Audio replays of this call will be made available later today as disclosed in our May 10, earnings 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. 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. SLR Investment Corp. 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 over to our Chairman and Co-CEO; Michael Gross.

Michael Gross: Thank you, Shiraz. Good morning, and welcome to this SLR team. We're pleased to report that for the first quarter of 2023 SLRC earned net investment income of $0.41 per share, representing a 28% increase year-over-year and essentially covering distributions for the second quarter in a row. Improved NII performance resulted from a combination of the synergies realized from the merger with SLR Senior Investment Corp. or SUNS and higher interest income on our portfolio due to a larger portfolio size than a year ago and higher base rates. Based on current visibility, we anticipated earnings will fully cover our distributions for the foreseeable future. At March 31, our net asset value per share was $18.04 compared to $18.33 at year end, decline was primarily due to the write-down of one investment outside of the idiosyncratic circumstances for that single investment.

Our sponsor finance portfolio is performing well with both positive average revenue and EBITDA growth. Despite the continued inflationary pressures and higher interest rates our portfolio of credit quality has remained strong. We believe that this is a result of our focus on sponsor finance on recession resilient industries, with high recurring free cash flow, which is healthcare, software and business services, as well as our emphasis on specialty finance investment, with defined borrowing bases supporting our loans. At March 31, 98.6% of our comprehensive investment portfolio is comprised of first lien senior secured floating rate loans. Our longstanding investment focused on first lien loans has resulted in a portfolio better equipped to withstand continued inflationary interest expense pressures than portfolios with second lien loans or equity exposure.

Additionally, with 77% of our comprehensive investment portfolio invested in specialty finance assets, which are volume basis supporting the first lien loans and full covenants structures were defensively positioned for a volatile economic period. Our portfolio has largely been insulated from the macro challenge this year and we believe it will benefit longer term for the regional banking issues. The setbacks in the financial sector have created an acceleration of a two-decade trend of increasing market share from middle market direct lending by non-bank lenders. And banks have continued to retreat and its syndicated loan market has remained stalled, frozen of significant available capital such as SLR are able to fill the void. Borrowers value our speed and certainty of execution, 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 $12 billion of total investable capital across its platform inclusive of anticipated leverage SLR has the scale necessary to provide full financing solutions, which SLRC benefits from through co-investment. We believe the current investment environment remains as favorable as any we've seen in several years in particular, our specialty finance businesses are benefiting from the regional banking turmoil, as those banks have historically competed with their commercial finance strategies. Additionally, during uncertain economic times, borrowers increasingly turned to asset-based lending strategies for working capital and liquidity management. We believe, the structure and collateral supporting our loans provides our investors with - greater downside protection across economic cycles.

Our ABL businesses have historically outperformed during challenging market conditions when after rich companies access to traditional lending sources is constrained, and we have the flexibility to allocate more of our capital to those strategies to take advantage of their attractive risk-reward attributes. While the sponsor finance market slowed during the first quarter, which traditionally happens following the rush to close transactions before year-end, SLR was able to pick our spots in transactions with attractive terms. For Q1, the company originated $250 million of new investments across the platform. Our first quarter origination total is slightly higher than we've originated in past years during the seasonally slow first quarter. Of note, our pipeline has increased, and we expect to grow our portfolio in the coming quarters, which should result in growth of net investment income.

Importantly, we have ample dry powder to capitalize on the favorable investment environment. Our funding profile is in a very strong position to weather a rising rate environment with 42% of our $1.1 billion of funded debt comprised of senior unsecured fixed rate notes at a weighted average annual cost of just 3.8%. At March 31, our leverage was 1.12 times net debt to equity, up from a low to the COVID-19 pandemic of 0.56 times and comfort within our target level range of 0.9 to 1.25 times. Our next term debt maturity isn't until the end of 2024. We are in the fortunate position of not needing to refinance any of our term debt in the near term at current high rates. At March 31, including available credit facility capacity at a specialty finance portfolio companies and subject to borrowing base limits, we had over $800 million in available capital to take advantage of the current attractive investment environment.

During the first quarter, we and our joint venture partner continue to grow the investment portfolio of the recently formed SLR and Senior Lending Program, or SSLP. At March 31, the SSLP held $46 million of assets comprised of senior secured first lien loans across 18 different borrowers. SSLP had already committed to several transactions in Q2. And based upon a strong pipeline, we expect the SSLP to reach $250 million by year-end. Importantly, SSLP provides additional investment capacity and earnings power by generating attractive ROE once ramped. Finally, our Board of Directors has authorized an extension of our previously announced $50 million share repurchase plan to March 10, 2024. We intend to continue to utilize this program to repurchase shares at levels that are attractive to shareholders.

At this time, I'll turn the call over to our CFO, Shiraz to take you through the Q1 financial highlights.

Shiraz Kajee: Thank you, Michael. SLR Investment Corp.'s net asset value at March 31, 2023, was approximately $984 million or $18.04 per share compared to $1 billion or $18.33 per share at December 31, 2022. At quarter end, SLRC's on-balance sheet investment portfolio had a fair market value of approximately $2.1 billion and 145 portfolio companies across 45 industries compared to a fair market value of $2.1 billion and 139 portfolio companies across 45 industries at year-end. At March 31, the company had approximately $1.1 billion of debt outstanding with leverage of 1.12 times, net debt to equity. When considering the available capacity from the company's combined credit facilities, together with the available capital from the company's significant subsidiaries, SLRC had significant available capital to fund future portfolio growth while remaining within its target leverage range of 0.9 to 1.25 times net debt to equity.

Finance, Investment, Investigate
Finance, Investment, Investigate

photo by scott graham on Unsplash

Moving to the P&L, for the three months ended March 31, 2023, gross investment income totaled $53.5 million versus $54.1 million for the three months ended December 31. Net expenses totaled $31.4 million for the three months ended March 31, and this compares to $31.6 million for the three months ended December 31, 2022. As a reminder, at the time of the merger of SLR Senior Investment Corp. or SUNS into the company last year, the investment adviser agreed to waive incentive fees resulting from income fund due to the accretion of purchase discount allocated to investments acquired as part of the merger. During the quarter ended March 31, the company waived approximately $110,000 of related incentive fees. Accordingly, the company's net investment income for the three months ended March 31, 2020, totaled $22.1 million or $0.41 per average share compared to $22.5 million or $0.41 per average share for the three months ended December 31, 2022.

Below the line, the company had net realized and unrealized loss for the first quarter totaling $15.3 million versus a net realized and unrealized loss of $3.5 million for the fourth quarter of 2022. As a result, the company had a net increase in net assets resulting from operations of $6.8 million or $0.13 per average share for the three months ended March 31, 2023. This compares to a net increase of $19 million or $0.35 per weighted average share for the three months ended December 31, 2022. Finally, on May 9, the Board of SLRC declared a monthly distribution of $0.136667 per share, payable on June 1, 2023 to holders of record as of May 24, 2023. With that, I'll turn the call over to our Co-CEO, Bruce Spohler.

Bruce Spohler: Thank you, Shiraz. Let me begin by providing an overview of our portfolio. At quarter end, on a fair value basis, the comprehensive portfolio consisted of approximately $2.9 billion of senior secured loans to 780 distinct borrowers across 110 industries with an average exposure of $3.7 million. Measured at fair value 99.8% of the comprehensive portfolio consisted of senior secured loans with 98.6% invested in first lien loans, including the investment in the SSLP attributed to SLR. And only 0.2% was invested in second lien cash flow loans with the remaining 1% invested in second lien asset-based loans. Our specialty finance investments account for approximately 77% of the comprehensive portfolio, with the remaining 23% invested in senior secured loans to upper mid-market sponsor-backed companies.

We believe that this defensive portfolio composition and strategy diversification positions us well for potential economic weakness and provide a differentiated risk return profile for our shareholders. At 3/31, the weighted average asset level yield was 11.9%. At quarter end, the weighted average investment risk rating on our portfolio was just under two based on our 1 to 4 risk rating scale, with one representing the least amount of risk. During the quarter, we placed one investment of AmeriMark on nonaccrual. Due to the current ongoing reorganization process, we unfortunately cannot provide any detail on the situation at this time. Importantly, we consider the write-down of AmeriMark to be idiosyncratic to this investment and not indicative of stress elsewhere in our portfolio.

Now let me turn to our investment strategies. Sponsor finance, cash flow investing. In this segment, we originated first lien senior secured loans to upper mid-market companies in noncyclical industries with our largest exposure being in healthcare and diversified financials. As Michael mentioned, the broad middle market cash flow segment saw a seasonally low level of activity in the first quarter. However, the market turbulence and regional banking issues have reinforced the macro trend that provides a tailwind for nonbank lenders such as ourselves. We were able to make selective attractive investments during the first quarter and believe that the opportunity set will expand as the M&A market continues to pick up. In addition to the bank's retrenchment, the disruption in the BSL and CLO markets continues to benefit private debt providers with financial sponsors increasingly turning to direct lenders who have the scale and certainty to provide financing to upper mid-market companies.

As a result, we are continuing to see yields of 12% to 13% in comparison to 7% to 9% just a year ago with less leverage than the historical average for new issues. Importantly, yields continue to be priced at a premium for leveraged loans with the addition of also having more structural protections. Our pipeline has an average yield of over 12.5% and an LTV of 35%, which supports our thesis that this year should be a great vintage for sponsor finance. Given our current pipeline and lack of expected repayments, we are expecting net portfolio growth throughout the year. At quarter end, our portfolio was approximately $680 million and represented 23% of the total portfolio invested across 47 companies. We have defensively positioned this portfolio where we have an average EBITDA of $134 million, LTVs - on average, 40% and importantly, strong interest coverage of just over two times.

The performance of our cash flow portfolio of companies, remain solid with quarter-over-quarter revenue and EBITDA growth. Our portfolio is comprised of businesses that perform essential services with either recurring or reoccurring revenues, and importantly, a low capital intensity. Our industry exposure is heavily weighted towards defensive sectors such as healthcare services and insurance brokerage with the balance comprised largely in business and distribution service companies. Our portfolio has exhibited strong credit metrics that have continued to improve despite the challenging economic environment. During the quarter, we originated $115 million of new investments and experienced repayments of $82 million. Our new investments had a weighted average leverage of just under five times and a yield of 12.6%.

The weighted average yield on the entire cash flow portfolio was 11.8%, up from 11.2% in the prior quarter. With 99% of this portfolio invested in first lien loans, we believe that the investments are well positioned to withstand any pressures from rising interest payments. Now let me touch on our ABL segment. Historically, our ABL business outperformed during periods of market volatility and economic contraction, resulting in a countercyclical component to a multi private credit strategy. Borrowers which are asset rich, but have cash flows pressured by rising interest rates and slowing demand are forced to raise capital backed by their liquid collateral. The rising rate environment and general slowing of the economy has put pressure on asset-rich borrowers in more cyclical sectors, which has increased the opportunity set for our team.

In particular, slower consumer spending is a positive for this business, which has extensive experience providing collateralized working capital lines of credit. We are seeing increased deal volume that - we believe will continue throughout this year. With access to capital being limited for borrowers, we expect the rate of repayment to slow, translating into net portfolio growth. Our strong positioning in this segment has led us to expand the team with several new hires across our ABL niches. Also of note, as a result of the merger of SLRC and SUNS, our team has now been able to work closer together to provide full solutions such as providing ABL revolving lines alongside our Life Science term loans. At quarter end, our asset-based loan portfolio totaled $1 billion, representing a third of our comprehensive portfolio and was invested across 160 borrowers.

The weighted average asset level yield for the ABL portfolio was 13.6%. The average LTV is approximately 70% and is governed by strict borrowing basis and maintenance covenants. Repayments during quarter -- the first quarter in our ABL segment were elevated due to seasonal repayments at our digital finance business as that business typically benefits in the fourth quarter from increased advertising around the holiday season. In addition, we had a couple of large repayments in the first quarter and some originations that slipped into the second quarter. We expect growth in the ABL segment to accelerate during this year. Now turning to equipment finance, our equipment finance team has extensive experience in value and fixed assets and structuring loans, which allows us to provide our customers with quick creative solutions for their financing needs.

This team has seen an increase in the opportunity set resulting from the regional bank turmoil. At quarter end, the equipment finance portfolio totaled $938 million, representing 32% of our total portfolio across 500 borrowers. The weighted average asset level yield was just under 10%. During the quarter, we originated $100 million of new equipment finance loans and had repayments of $109 million. Finally, let me provide an update on our Life Science segment. Market activity has moderated as equity valuations continue to come down as the VC industry digests the recent banking failures. Our life science team is being even more selective as borrowers seek to increase the leverage as an alternative to issuing more equity in this expensive environment.

However, due to the strong - our strong presence in this market, we continue to see attractive opportunities. We're seeing a further improvement in what has already been attractive pricing, and we anticipate that volume as well as the quality of the investments will continue to improve during the course of '23. We also expect to benefit from fewer repayments as the risk of other lenders refinancing our loans has dramatically been reduced. While first quarter activity was slowed in the wake of the SVB collapse, record amounts of venture capital, coupled with improved valuations are continuing to drive our opportunity set. We expect this trend to continue throughout the year. Additionally, extremely low loan to values, which are typically 15% to 20% of cash invested have provided significant downside protection.

At quarter end, our portfolio totaled $323 million across 14 borrowers. Over 85% of the portfolio is invested in loans to borrowers that have over 12 months of cash runway. Life Science loans represent 11% of our comprehensive portfolio. We contributed just under 24% of our gross investment income for the quarter. As a reminder, this segment has never had a payment default and again, consistently has LTVs of approximately 15% to 20%. During the quarter, the team committed to $2.5 million of new investments and had repayments of approximately the same amount. We also have $120 million of unfunded commitments, which may be drawn based upon our borrowers hitting important milestones. At quarter end, the weighted average yield was approximately 12.8% on this portfolio, which excludes any success fees and warrants.

In conclusion, while the private debt market had a slow start to the year, we are seeing a pickup in activity and our specialty finance businesses specifically are benefiting from the regional banking sectors retrenchment. Given our available capital and ability to provide a full debt financing solution, we are well positioned to take advantage of this attractive investment environment. Finally, we believe that our existing portfolio should perform well through a downturn, enabling us to capitalize on any market dislocation that should arise. Now let me turn the call back to Michael.

Michael Gross: Thank you, Bruce. In closing, we believe that our conservative underwriting approach and defensively constructed portfolio comprised of first lien cash flow loans to borrowers in noncyclical industries and asset-based loans of significant collateral coverage positions us well for the continued market volatility. All of our asset classes are benefiting from the disruptions in the BSL and CLO markets as well as the REIT of regional banking issues. We currently have attractive investment pipelines in all of our businesses. In fact, we believe that our current pipeline is one of the most attractive we've ever had. Based on current visibility, we are not expecting heavy repayment activity in 2023, which would translate into portfolio growth be attractive new investments.

Our investment adviser, SLR Capital Partners, has been investing in SLR platform through addition of several key hires to our investment operations team. In total, the SLR platform, including the commercial finance companies owned by SLRC has recently hired over 30 people. Our collective expertise with a senior team that has an average 27 years of investing, gives us the necessary expertise to navigate the current economic climate. Our people, our balance sheet and our portfolio position us well to take advantage of the attractive investment climate as well as any challenges ahead. In closing, our investment adviser alignment of interest the company shareholders' continues to be one of our guiding principles. The SLR team owns over 8% of the company's common stock, including have a significant percentage of the annual incentive compensation invested in SLRC stock.

The team's investment alongside fellow SLRC shareholders demonstrates our confidence in the company's defensive portfolio, stable financing and favorable position. We thank you for your time today. Operator, would you please open up the line for questions.

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