SLR Investment Corp. (NASDAQ:SLRC) Q4 2023 Earnings Call Transcript

SLR Investment Corp. (NASDAQ:SLRC) Q4 2023 Earnings Call Transcript February 28, 2024

SLR Investment Corp.  isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day, everyone, and welcome to today’s Q4, 2023 SLR Investment Corp. Earnings Call. At this time, all participants are in a listen-only mode. Later, you will have the opportunity to ask questions during the question-and-answer session. [Operator Instructions] Please note this call is being recorded. I will be standing by if you should you need any assistance. It is my pleasure to turn conference over to Chairman and Co-CEO, Michael Gross. Please go ahead.

Michael Gross: Thank you, very much, and good morning. Welcome to SLR Investment Corp.’s earnings call for the fiscal year ended December, 31, 2023. I’m joined here 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 is strictly prohibited. This conference call is also being webcast from 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 February 27 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 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. We do 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 would like to turn the call back over to our Chairman and Co-CEO, Michael Gross.

Michael Gross: Thank you, Shiraz. We’re pleased to report that for the fourth quarter of 2023 SLRC generated net investment income of $0.44 per share, representing growth of 7% year-over-year, and a 26% increase over our net investment income immediately following our merger with SLR Senior Corp. q1 2022. Our fourth quarter NII per share equates to a 7% surplus over our distributions paid during the quarter. The increase of NII over the past two years has been driven by meaningful comprehensive portfolio growth, as well as increase in reference rates and asset yields. We believe this will be an attractive vintage to have grown our portfolio. Also [indiscernible] to our strong quarter SLRC earned $1.1 million from SLR Senior Lending Program or SSLP as we call it, representing a 10.2% annualized yield compared to earnings of $300,000 in Q3.

At yearend, investment commitments totaled $200 million, and we expect commitments to reach approximately $240 million to $250 million by the end of Q1. Once fully ramped, based on current rates, we anticipate that this vehicle will generate an annualized yield in the low double digits. On December 31, our net asset value per share was $18.09, up from $18.06 per share at September 30, reflecting stable credit and the over earning of our distribution. We continue to be pleased with the credit quality of our portfolio with no new non-accruals during the quarter. Our December 31 non-accrual rate base stop [ph] was 0.6% and 0.4% on fair value, which remained significantly below the BDC industry average. In finance, the average EBITDA and revenue growth continues to be positive for our portfolio companies.

Overall, they’ve successfully managed to transition to an environment with higher cost of capital and inflation. The weighted average interest coverage on our sponsor finance loans is 1.8 times. We believe these healthy metric is the results of our focus and sponsor finance, on recession-resilient industries, with high recurring free cash flow, such as healthcare and business services. As a reminder, our comprehensive portfolio achieved significant diversification for specialty finance investments, allowing us to be highly selective in sponsor finance. Our specialty finance allocations provide the portfolio with counter-cyclical and less correlated investment opportunities to cash flow credit. Credit quality of our specialty finance investments continues to be solid, with attractive LTVs that have meaningful collateral support.

At quarter-end, approximately 98% of our comprehensive investment portfolio is comprised of first lien senior secured loans. Our long standing focus on first lien loans has resulted in a portfolio which we believe is better equipped to withstand persistent inflationary pressures and high interest rates than portfolios with second lien loans. Additionally, with approximately 76% of our comprehensive investment portfolio, invested in specialty finance assets, we have borrowing bases and covenant structures, which we believe are defensively positioned. In 2023 SLRC had record originations of approximately $1.5 billion. The sponsor finance business in particular capitalizing on investment environment, with better pricing and lower risk profiles than the historical average.

Repayments for the year totaled over $1.3 billion, representing approximately 45% of our beginning 2023 portfolio. Although LBO volume is down in 2023, approximately 61% sponsor finance investments supported tuck-in acquisitions for new and existing portfolio companies, with remaining activity financing new LBO investment opportunities. Buyers and sellers continue to engage in price discovery with increased pressure on sponsors to transact as LPs seek return of capital before making new commitments. As a result of the slow M&A environment sponsors have held on to their performance for longer, via maturity extensions and sales continuation vehicles. While M&A activity has remained muted thus far in 2024, and competitions increased for this limited direct lending deal flow, we remain excited about the opportunity set for direct lending in 2024 from an expected acceleration in M&A activity in the second half of the year.

Our life science, ABL and equipment finance strategies continue to benefit from being uncorrelated to the broader cash flow market. The life science market continues to recover from lighter activity in 2023. Equity valuations for both private and public life science companies have been stabilized with debt opportunities continuing to improve. The ABL market remains robust with referrals from both money center banks and regional banks accelerating. In particular the continued turbulence of regional banks is providing more opportunities for private credit managers such as ourselves. Firms with significant available capital such as the SLR platform are able to fill the void left as regional banks retreat. Borrowers value our speed and certainty of execution, flexibility and our ability to invest $150 million to $200 million in a given upper middle market financing, which gives us influence over pricing and documentation.

With $13 billion of total investable capital across the platform inclusive of anticipated leverage, SLR has a scale to provide full financing solutions which benefits SLRC Corp., investment [ph]. Importantly, we have ample dry powder to capitalize on the favorable investment environment. At December 31, including available credit facility capacity at the SSLP and specialty finance portfolio companies, SRLC had over $0.5 billion of available capital to take advantage of the current attractive investment environment. I now turn over the call back to Shiraz to take you through the Q4 financial highlights.

Shiraz Kajee : Thank you, Michael. SLR Investment Corp.’s net asset value at December 31 2023 was $987 million or $18.09 per share compared to $985 million or $18.06 per share at September 30. At quarter end SLRC’s on balance sheet investment portfolio had asset value of approximately $2.2 billion in 151 portfolio companies across 43 industries compared to a fair market value of $2.2 billion and 154 portfolio companies across 43 industries at September 30. Also, at December 31, SSLP had a fair value portfolio of $187 million, mostly in senior secured loans. Of the initial $100 million joint commitment, SLRC and our JV partner have contributed combined equity in the amount of $85 million. In Q4 2023, SLRC earned income of $1.1 million from SSLP equating to a 10.2% annualized yield.

In the fourth quarter, we also upsized the SSLP credit facility by $50 million to $150 million. At December 31 SLRC had approximately $1.2 billion of debt outstanding, with leverage of 1.19 times net debt-to-equity, up from the pandemic low of 0.57 times. We expect our leverage ratio to remain in the middle of our target leverage range of 0.9 to 1.25 times. SLRCs funding profile is in a strong position to continue to weather the current interest rate environment. Just this month, we expanded the list of participants in our primary credit facility. Furthermore, our existing $470 million of senior unsecured fixed rate notes have a weighted average annual interest rate of only 3.8% and we expect to opportunistically access the investment grade debt market.

Moving to the P&L for the three months ended December 31, gross investment income totaled $59.8 million versus $59.6 million for the three months ended September 30. Net expenses totaled $35.9 million for the three months ended December 31. This compares to $36.3 million for the prior quarter. As a reminder, at the time of the merger of SLR Senior Investment Corp or SUNS into the company last year, the investment advisor agreed to waive incentive fees resulting from [indiscernible] due to the accretion of purchase discount allocated to investments acquired as part of the merger. During the fourth quarter, the company waived approximately $90,000 of incentive fees related to the merger, which now totals approximately $2 million in cumulative waivers by the manager related to the merger.

Importantly the company’s net investment income for the three months ended December 31, 2023 totaled $23.9 million, or $0.44 per average share compared to $23.4 million or $0.04 per average share for the three months ended September 30. Below the line, the company had a net realized and unrealized loss for the fourth quarter totaling $0.3 million versus a net realized and unrealized gain of $3.6 million for the third quarter of 2023. As a result, the company had a net increase in net assets resulting from operations of $23.6 million for the three months ended December 31 2023, compare to an increase of $26.9 million for the three months ended September 30. As mentioned on previous calls, the company has returned to making quarterly rather than monthly distributions, and on February 27, the Board of SLRC declared a Q1 2024 quarterly decision of $0.41 per share payable on March 28, 2024, to holders of record as of March 14, 2024.

With that, I’ll turn the call over to our Co-CEO, Bruce Spohler.

Bruce Spohler : Thank you Shiraz. Before I provide an overview of our portfolio, I’d like to touch on our approach to portfolio construction. Our commercial finance business model provides us with the flexibility and capabilities to capitalize on the most attractive lending opportunities across our four private credit investment strategies. We take a fundamental bottom-up approach to portfolio construction, based on the relative attractiveness for risk adjusted returns across our investment verticals. While we were more active in sponsor finance throughout 2023, we did see a pickup in activity in our other verticals during the fourth quarter, which we expect to continue in 2024. With our flexible mandate, and broad capabilities we are positioned to take advantage of either continued durable economic conditions, or softening of the economy.

We believe having the flexibility to play either offense or defense at the right moments across the cycle is critical to long term consistent performance. Now let me turn to the portfolio. At yearend, on a fair value basis, the comprehensive portfolio consisted of approximately $3.1 billion of senior secured loans to 790 borrowers across over 110 industries, with a $3.9 million or 0.1% position exposure. Measured at fair value 99.2% of our portfolio consisted of senior secured loans, with 97.7% invested in first lien loans, including investments through our SSLP attributable to the company, and only 0.3% was invested in second lien cash flow loans, with the remaining 1.2% of the portfolio invested in second lien asset-based loans with full borrowing basis.

Our specialty finance investments account for approximately 76% of the comprehensive portfolio, with the remaining 24% invested in senior secured cash flow loans to upper midmarket private equity owned companies. We believe that this defensive portfolio composition positions us well for potential economic weakness and provides a differentiated risk return profile for our shareholders compared to sponsor-only portfolios. At quarter end our weighted average asset level yield was 11.6 times. Our credit quality remains strong. At yearend, the weighted average investment risk rating of our portfolio was under two, based on our one to four risk rating scale, with one representing the least amount of risk. Over 97% of the portfolio is rated a two or higher and 99.4% of the portfolio on a cost basis was performing with only one nonaccrual.

Now let me turn to our four investment verticals. In our sponsor finance business, we originate first lien senior secured loans to upper mid market companies in non-cyclical industries, such as healthcare, services, business services and financial services, which we believe has helped to mitigate the impact on our portfolio from cyclical economic factors. At yearend, this portfolio was approximately $730 million, including the senior secured loans in the SSLP attributable to our company. We were invested across 50 distinct borrowers. With approximately 99% of the cash flow portfolio in first lien loans, we believe that these investments are well positioned to withstand liquidity pressures that borrowers may be facing in light of higher interest rates.

Additionally, we believe we have a defensively positioned portfolio. Our borrowers have a weighted average EBITDA of $120 million, low LTVs of approximately 40% and interest coverage ratios averaging 1.7 times. Our portfolio is comprised of businesses that perform essential services with either recurring or reoccurring revenues, and generally have low capital intensity. Overall, our portfolio has exhibited solid credit metrics that have remained steady in 2023. During the quarter we originated $107 million of cash flow loans and experienced repayments of $185 million. Our fourth quarter investments, all of which were first lien have an average yield to expected maturity of 12.6% and average leverage to our investment of 4.8 times with interest coverage of 1.7 times.

We believe these metrics support our thesis that 2023 should be a great vintage for sponsor finance investments. Importantly, this portfolio carries less leverage than the historical average for new issues. Michael mentioned sponsor finance deal flow continues to be muted due to lower M&A volume. However, there are pockets, particularly in our defensive sectors, where we do see opportunities to make loans at attractive risk adjusted returns. At quarter end the weighted average yield across the portfolio was 12%. Now let me turn to our ABL segment. In the wake of the U.S. regional banking crisis last year, the opportunity set for all of our ABL businesses improved. As lending standards tightened at commercial banks, we saw an increase in deal flow.

As a result, we were able to originate several new attractive investments. As new entrants with less experience have entered the space we’ve remained committed to our high underwriting standards, in which we focus on the quality of the underlying collateral base when determining acceptable advance rates and loan to value ratios. We believe that not adhering to this discipline may result in losses in the ABL asset class. Increase in deal volume is enabling us to remain active while being extremely selective. At yearend, the senior secured ABL portfolio totaled just under a $1 billion representing 31.5% of our comprehensive portfolio and it was invested across 160 borrowers. Weighted average asset level yield was 14.5%, and the average LTV was approximately 60%.

For the fourth quarter we had $150 million of new ABL investments and repayments of $166 million. Now let me touch on equipment finance. At yearend this portfolio totaled $1 billion representing 32% of our comprehensive portfolio and was highly diversified across 550 borrowers. Credit profile continues to be strong. The weighted average asset level yield was just over 8%. During the fourth quarter, we originated approximately $154 million of new equipment loans and had repayments of $106 million. Our investment pipeline has expanded in conjunction with the disruption caused by the regional bank failures. Finally let me touch on life sciences. At yearend, our portfolio was $350 [ph] million at fair value. Approximately 80% of the portfolio at par is invested in loans to borrowers that have over 12 months of cash runway.

Additionally, all of our portfolio companies are generating revenues with at least one product in the commercialization stage, which significantly derisks our investment exposure. Life science loans represented 11.6% of our portfolio at yearend, and contributed just under 22% of our gross income for the quarter. During the fourth quarter, the team committed to $16 million of new investments and funded $38 million of new investments, while having repayments of $6 million. We have just under $20 million of unfunded life science commitments which may be drawn by borrowers based upon reaching important milestones, such as revenue levels or liquidity levels. At yearend, the weighted average yield on this portfolio was 13%. This excludes any access fees or warrants.

While we expect valuations in the life science segment to stabilize this year, we continue to see several new lending opportunities that will meet our underwriting criteria. Given our ability to allocate our capital to the best risk reward opportunities, we have the luxury of being highly selective in our capital deployment in life sciences, while yet still generating originations and portfolio growth for the company overall. Now let me turn the call back to Michael.

Michael Gross: Thank you, Bruce. In conclusion, our portfolio reflects stable fundamentals and benefits from the flexibility to allocate capital to investments across our different lending verticals that we believe offer the most attractive risk adjusted returns for our shareholders. Based on last night’s closing price SLRC trades at an 11% yield, which we believe presents an attractive investment opportunity. We’ve available capital and an opportunity for continued earnings growth. While the current market expectations are for rates to stay higher for longer it’s important to remember that specialty finance spreads and returns are not as volatile as cash flow sponsor finance investments. As a result, we would not expect yield contraction for specialty finance assets to the same extent, as sponsor finance when interest rates begin to move lower.

Looking forward, we expect origination opportunities to be driven by a combination of increased activity, loan maturities and regulatory credit contraction forces, impacting regional banks to the benefit of direct lenders such as ourselves. In addition, we continue to seek opportunities to expand our specialty finance capabilities through tuck-in acquisitions for existing commercial finance portfolio companies, portfolio team acquisitions or acquisitions of specialty finance portfolios. SLRCs broad foundation of diversified commercial finance businesses, has the resources and experience to acquire portfolios and to service the loans on an opportunistic basis. We continue to 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 the company’s shareholders continues to be one of our guiding principles. The SLRC team owns over 8% of the company’s stock, including a significant percentage of their annual incentive compensation invested in SLRC stock. The team’s investment alongside fellow shareholders demonstrates our confidence in the company’s defensive portfolio, stable funding and favorable position. We appreciate your time today. Operator, will you please open up the line for questions.

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Q&A Session

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

Mickey Schleien: Yes, good morning, Bruce and Michael. Want to start off by asking you about other income reported for the quarter? Could you give us a sense of what underlies that amount which was relatively high in comparison to your previous quarters?

Shiraz Kajee: I think the major driver there, we had we had a chunky exit fee in our life science business this quarter. Those fees, sporadic throughout the year. And that was a major driver in Q4 versus the prior quarter.

Shiraz Kajee: And as you know, Mickey, sometimes we will get the exit fee as a success fee or warrant that comes in a detachable form subsequent to repayments. So this was actually a life science loan that paid off earlier in the year but then hit a milestone that triggered a success fee for us in the fourth quarter.

Mickey Schleien: Very nice. Congratulations on that. I wanted to also ask about the sponsor finance cash flow segment. I see that that portfolio shrank during the quarter. Can you give me a sense of to what extent the normalization of the broadly syndicated loan market and potential prepayment activity in sponsored finance drove that contraction?

Shiraz Kajee: So great question. More broadly, as you see across the year, there was growth. So I don’t want to focus too much on one quarter. But I do think it brings up a bigger issue, which is, we are beginning to see some pressure, where a lot of capital, as you know, has been raised in the cash flow market. It starts at the upper, upper market, kind of above where we play, I’ll call it the $400 million, $500 million EBITDA business competing with a broadly syndicated loan business where you start to see a fair amount of capital come in and start to put pressure in terms of borrowers asking for repricing to take their cost of capital down. It’s creeping a little bit into where we are playing in the call it $100 million to $200 million EBITDA businesses.

And we are opportunistically using that as a chance to exit, because again, we have seen very attractive opportunities to deploy. You see the originations are still strong. But we also have opportunities, as you know, in our other verticals, where we will recycle capital at higher returns. So it’s not so much a lot of sales across portfolio companies. But it’s more pricings, where certain lenders are opting to stay and we’re opting to exit. And I think that trend will continue, as we’ve seen in the early part of 2024.

Michael Gross: But I think importantly, because less than a quarter of our portfolio is in kind of that sector. The other 75% of our businesses, in specialty finance are not really driven by the technical factors of the financial markets. To your point, Mickey, as capital returns into the liquid market, I think in general, finance portfolios are at risk of being repriced or letting them go. Whereas that’s just not the case, in specialty finance. You don’t have the ebbs and flows of capital into the space to drive the pricing of returns.

Mickey Schleien: I understand. That’s helpful. My last question relates to your internal investment ratings. I see there was both migration up to ones but there was also migration down to level three and four. Any color you can provide on the downward migration?

Shiraz Kajee: Yeah, I don’t think there was much movement on four. There was a movement into three. And that was fund investment. And what I would say Mickey is, we are fortunate that our watch list is made up of names that are fundamentally performing as strong operations in terms of revenue and EBITDA growth, but maybe are facing some capital structure constraints. And so we will move it into a watch list until we resolve the capital structure. But that was literally just one specific name. I think, if we were to rate it today, rather than at 12/31, it probably would not be on watch list, which I hope will be the case going forward. But we’re comforted that our fundamentals are strong, and we’re just addressing some balance sheet issues here and there.

Mickey Schleien: Okay, that’s helpful. That’s it for me this morning. Thank you.

Michael Gross: Thank you.

Shiraz Kajee: Thank you, Mickey.

Operator: The next question comes from Erik Zwick with Hovde Group.

Michael Gross: Good morning, Erik.

Erik Zwick: Good morning, everyone. Wanted to start first, we’ve got $125 million of notes returning later this year in December. Just curious about your thoughts for the source of funding to redeem those and Shiraz, maybe you kind of alluded to that in some of your comments, indicating that you might opportunistically kind of tap the investment grade market. I just kind of curious your thoughts on finding the redemption of those notes.

Michael Gross: Yeah, so as you know, that’s our first redemption in quite some time. Very fortunate to have some good luck that we haven’t had to go to the market during this rising rate environment of the last couple of years. We have as Shiraz mentioned increased our lender universe. So we have capital such that we don’t need to refinance this in the unsecured market in December when the maturity comes up. But we are going to be opportunistic throughout this year to look to term that out.

Bruce Spohler: I think importantly, given the size of that maturity, it allows us to really pursue multiple options to be nimble, and to have the best opportunity. We’ve had a very strong following in the insurance company private marketplace and we’ve had a lot of success in doing kind of bespoke financings at the right time. So we feel very comfortable about the situation.

Shiraz Kajee: Yeah, I mean, we’ve had a lot of inbound inquiries. There’s been a fair amount of activity in the in the IG market year-to-date. So for us, it’s a matter of when not if.