SLR Investment Corp. Q3 FY2020 Earnings Call

Ladies and gentlemen, thank you for being with us. Welcome to the Q3 2020 Solar Capital Earnings Conference Call. It is now my pleasure to introduce Chairman and Co-CEO, Michael Gross.

Thank you very much, and good morning. Welcome to Solar Capital Ltd.'s earnings call for the quarter ended September 30, 2020. I'm joined here today by Bruce Spohler, our Co-CEO; and Rich Peteka, our Chief Financial Officer. Before we begin, Rich, could you please start by covering the webcast and forward-looking statements?

Sure. Thanks, Michael. I would like to remind everyone that today's call and webcast are being recorded. Please note that they are the property of Solar Capital Ltd. and that any unauthorized broadcasts, in any form, are strictly prohibited. This conference call is being webcast on our website at www.solarcapltd.com. Audio replays of this call will be made available later today as disclosed in our 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, including the impact of COVID-19 and related changes in base interest rates and significant market volatility on our business, our portfolio companies and the global economy. Additionally, past performance is not indicative of future results. Actual results may differ materially as a result of a number of factors, including those described from time to time in our filings with the SEC. Solar Capital Ltd. undertakes no duty to update any forward-looking statements unless required to do so by law. To obtain copies of our latest SEC filings, please visit our website or call us at 212-993-1670. At this time, I'd like to turn the call back to our Chairman and Co-Chief Executive Officer, Michael Gross.

Good morning, and thank you for joining us today during these hectic times. The Solar Capital team hopes to find you and your family, friends and colleagues, healthy and safe. Our thoughts remain with all of our stakeholders, including the dedicated employees across Solar Capital and the company's investment adviser, Solar Capital Partners. We would again like to express our gratitude to all the healthcare and other frontline and essential workers, and we continue to send our sincere condolences to those families who have lost loved ones. Turning to our third quarter performance. I am pleased to report that Solar Capital's portfolio remained 100% performing, and our net asset value at September 30 of $20.14 represented a modest increase over the prior period. We attribute the resiliency of our portfolio during this crisis to our long-standing investment thesis that asset-based loans in niche markets and first lien cash flow loans in upper middle market companies in defensive sectors provide meaningful downside protection during challenging economic periods. As our long-time investors know, we embarked on an initiative 8 years ago with the acquisition of Crystal Financial to broaden and diversify our origination capabilities via niche ABL strategies that are complementary to our cash flow businesses. With the majority of our comprehensive portfolio at September 30 comprised of loans originated by our specialty plans verticals, we are truly a diversified commercial finance company. And now, I'm pleased to report that we are furthering the strategic initiative through the acquisition of Kingsbridge Holdings, an existing debt portfolio company. Based in Lake Forest, Illinois, Kingsbridge is a leading independent lessor of information technology, industrial, healthcare and commercial essential-use equipment to a diverse set of investment-grade customers. During our 2-year investments in the Kingsbridge loan, we gained a deeper understanding of the business and developed a terrific relationship with its distinguished and experienced management team. With this acquisition, Solar Capital will have invested approximately $216 million, in a combination of approximately $136 million of equity and $80 million of debt to acquire 87.5% of the company in partnership with the Kingsbridge management team, which is rolling a portion of equity ownership as part of the transaction. The acquisition expands our direct origination capabilities and provides differentiated sources of growth for Solar. Pro forma for the Kingsbridge acquisition, approximately 84% of Solar's comprehensive portfolio consists of specialty finance investments, and 16% from directly originated investments in senior secured cash flow loans to sponsor-owned companies. Kingsbridge was founded in 2006 by the current management team and has underwritten over $1 billion of leases since inception. At September 30, 2020, Kingsbridge's highly diversified portfolio of leases totaled approximately $440 million, with an average funded exposure of approximately $850,000 per obligor, and it was 100% performing. Over 70% of Kingsbridge's portfolio is invested in assets leased by investment-grade borrowers. Importantly, Kingsbridge's strong track record has continued through the current health and economic crisis. The acquisition is another important step in Solar Capital's expansion of its direct lending investment strategies and provides a differentiated source of growth. The addition of Kingsbridge, with its highly experienced team and scalable infrastructure, further enhances our diversified specialty finance platform. Solar Capital now directly sources and underwrites cash flow, asset-based, life science loans and equipment financings and now lease transactions with primarily investment-grade-rated counterparties. We expect that our debt and equity investments in Kingsbridge will generate a blended cash yield of approximately 10% to 11%, consistent with our other specialty finance assets across the Solar platform. Kingsbridge will distribute substantially all of its earnings to SLRC on a quarterly basis. And we expect our investments in this company to generate approximately $20 million of gross income in 2021. Solar Capital funded its investment with available liquidity, including borrowings under Solar Capital's existing credit facility at an approximate marginal effective interest rate of 2%. Had the acquisition of Kingsbridge closed on September 30, our pro forma leverage ratio would have been 0.77x net debt to equity. Pro forma for this investment, SLRC and its significant subsidiaries still have approximately $725 million of available capital under its existing credit facilities subject to borrowing base availability to finance future portfolio growth. Yesterday, our Board of Directors declared a $0.41 per share distribution for the fourth quarter 2020. At this time, I'll turn the call over to our CFO, Rich Peteka, to take you through the third quarter financial highlights.

Thank you, Michael. Solar Capital Ltd.'s net asset value at September 30, 2020, was $851.1 million or $20.14 per share compared to $849.8 million or $20.11 per share at June 30. At September 30, 2020, Solar Capital's on-balance sheet investment portfolio had a fair market value of $1.35 billion in 105 portfolio companies across 26 industries compared to a fair market value of $1.36 billion in 108 portfolio companies across 27 industries at June 30. At September 30, the company had nothing drawn on its $545 million and $50 million revolving credit facilities and had $47 million of cash on hand. The company has unrestricted access to this undrawn capital. Therefore, the marginal cost of incremental debt from our revolving facilities is approximately 2%, which enhances operating leverage as we grow our income-producing portfolio and move towards our target leverage. As a reminder, the company has no near-term debt maturities and is investment-grade rated, which should provide us with continued access to the unsecured debt markets. Since inception, Solar Capital has taken a conservative approach to leverage and has consistently operated well below its stated target range. On September 30, the company's net debt-to-equity ratio was 0.56x. Pro forma for the Kingsbridge acquisition, our net debt-to-equity ratio at 9/30 would have been 0.77x. Solar Capital's liquidity at September 30 remains strong, with more than $900 million available to invest when including its balance sheet cash, its undrawn capital on its credit lines and the nonrecourse credit facilities of Crystal Financial and NEF Holdings, subject to their borrowing base availability. Pro forma 9/30/2020 for the Kingsbridge acquisition, Solar Capital would have had approximately $725 million of available capital. That said, Solar Capital did have only a small amount of unfunded revolver commitments outstanding at September 30, totaling approximately $16.5 million. These could have been drawn, but haven't been drawn since September 30. Moving to the P&L. For the 3 months ended September 30, 2020, gross investment income totaled $28.9 million versus $28.6 million for the 3 months ended June 30. For the quarter ended September 30, 2020, cash interest and dividends represented more than 96% of the company's third quarter 2020 gross investment income. Expenses for the quarter ended September 30 totaled $14.6 million. This compares to $14.4 million for the 3 months ended June 30. Accordingly, the company's net investment income for the 3 months ended September 30, 2020, totaled $14.3 million or $0.34 per average share compared to $14.2 million or $0.34 per average share for the 3 months ended June 30, 2020. Below the line, the company had net realized and unrealized gains for the third quarter totaling $4.4 million versus net realized and unrealized gains of $39.8 million for the second quarter 2020. Ultimately, the company had a net increase in net assets from operations of $18.6 million or $0.44 per average share for the 3 months ended September 30. This compares to a net increase of $54 million or $1.28 per average share for the 3 months ended June 30. Now Bruce Spohler will take us through, and provide us an update on our portfolio.

Thank you, Rich. First and foremost, let me just emphasize how extremely pleased we are with how well our portfolio has weathered the crisis to date. Through the third quarter, our portfolio remains 100% performing and has experienced a minimal number of amendments. Most of these have been related to audit extensions. For the third quarter, the weighted average investment risk rating of our portfolio was 1.9 based on our 1 to 4 risk rating scale, with 1 representing the least amount of risk. This supports our thesis of minimizing the risk of loss by investing in first lien assets at the top of the capital structure in both cash flow loans to noncyclical industries as well as allocating a majority of our investments to collateralized loans through our specialty finance lending verticals. At quarter end, just under 20% of our comprehensive portfolio was invested in senior secured cash flow loans, with the remaining 80% invested in our senior secured asset-based, equipment finance and life science investments. Pro forma for the acquisition of Kingsbridge, our specialty finance investments would have accounted for 84% of our comprehensive portfolio. At quarter end, our $1.5 billion comprehensive portfolio was highly diversified, encompassing over 170 borrowers across 80 industries. Our largest industry exposures are healthcare, diversified financial services, and pharmaceuticals, all having the common theme of being defensive sectors. At September 30, 99% of our total portfolio at fair value consisted of senior secured loans. This was comprised of approximately 91% first lien loans and just 8% second lien loans. Post quarter end, we were repaid on one of our remaining second lien loan investments, which accounted for 1.5% of the September 30 portfolio. Pro forma for this repayment as well as the acquisition of Kingsbridge, only 5.3% of our portfolio would have been invested in second lien loans comprised of 2.2% cash flow second lien loans and 3.1% of ABL second lien loans. We believe that our portfolio of predominantly first lien loans, which carry less risk than second lien and subordinated loans, will result in greater capital preservation during this crisis. At quarter end, our weighted average asset-level yield was 10.1% compared to 9.9% in the prior quarter. By focusing on our commercial finance verticals, we have been able to maintain asset-level yields of approximately 10% despite the 170 basis point drop in LIBOR since year-end. Approximately 77% of our portfolio is floating rate, of which 90% of these loans have a LIBOR floor with a weighted average floor of 1.1%. The 23% of our portfolio invested in fixed-rate loans are primarily in equipment financings. Including activity across our 4 business lines, originations for the third quarter totaled just over $66 million, and repayments were approximately $160 million, resulting in a net portfolio reduction of $93 million prior to the acquisition of Kingsbridge. Originations for the quarter were a combination of new transactions as well as add-on investments with existing borrowers to finance tuck-in acquisitions across our cash flow, ABL and life science segments. Now let me provide an update on each of our four investment verticals. Let me start with cash flow. 100% of our cash flow loans were performing, validating our thesis of investing in first lien loans to essential businesses, which has proven out thus far during this pandemic. Substantially, all of our cash flow companies are outperforming their COVID-revised budgets for this year as a rebound in revenues as well as cost cuts have had a positive impact on their financial performance and liquidity. None of these borrowers experienced payment defaults during the third quarter. In particular, our healthcare cash flow loans have performed extremely well. We attribute this both to the recessionary, resilient and essential-service nature of this industry as well as our underwriting edge, stemming from our experienced healthcare cash flow team as well as the access to our proprietary industry insights through our life science team as well as our healthcare asset-based lending platform at our sister BDC, Solar Senior Capital. Our predominantly first lien portfolio with significant junior capital beneath it and strong sponsor support positions us well to withstand any further restrictive measures in response to the rising COVID cases. We view many of our cash flow loan companies as providing essential services in noncyclical sectors, which will continue to be essential during any potential periods of stay-in-place mandates. Overall, we are cautiously optimistic on this portfolio despite the severe disruption caused by the pandemic. At quarter end, our cash flow portfolio was just under $300 million, equating to 16% of our total portfolio pro forma for the acquisition of Kingsbridge. It's invested across 16 issuers with an average investment of over $18 million. These companies had a weighted average EBITDA of $54 million, which highlights our focus on financing larger businesses, which we believe are better positioned to withstand a downturn. The weighted average yield of our cash flow portfolio was 8.5% compared to 8.6% at the end of Q2. And our cash flow loan segment contributed $6.8 million of gross income, representing 23% of the third quarter total. During the quarter, we originated approximately $20 million of first lien senior secured cash flow loans and experienced repayments and amortization of approximately $33.5 million. On the back of rebounding private equity activity, we're seeing an increase in our pipeline of upper mid-market cash flow investment opportunities compared to the first two quarters of this pandemic. Now let me turn to our asset-based lending strategy. Overall, our portfolio companies continue to perform according to expectations at the time of initial underwriting. As a reminder, our ABL platform, Crystal Finance, specializes in financing companies in transition who have reduced access to traditional financing options. Their asset-based loans are underwritten at a discount to net liquidation value. As a result, they have historically been very active in challenged sectors with significant working capital assets, such as the retail and consumer goods sectors. While we don't expect to foreclose on any of our borrowers, the liquidation markets have reopened following the lockdowns earlier this year, which provides Crystal with an alternative exit strategy, if necessary. At quarter end, the senior secured asset-based portfolio totaled approximately $530 million, representing 36% of our total portfolio. It's invested across 31 borrowers with an average investment of approximately $17 million. The weighted average asset-level yield of our ABL portfolio was 11%. For the third quarter, this segment contributed just under $9 million of gross income, representing 31% of our total gross income. The portfolio statistics that I just mentioned include balance sheet assets as well as a look-through to Crystal's underlying loan portfolio. During the third quarter, we funded $30 million of new asset-based investments and had repayments of just under $87 million. Our asset-based capability through Crystal has expertise in financing stressed companies over the course of 30 years together and provides us with an extremely valuable capability during the current volatile economic times. In the late third quarter and early fourth quarter, we have begun to see increased deal flow, and we expect elevated levels of demand to continue. Now let me turn to our equipment finance business. This vertical is led by a team of seasoned professionals who average 30 years of experience, including managing through multiple economic cycles. A large portion of this portfolio is invested in industries that have been deemed essential businesses, such as machinery and construction, which are our largest exposures. Those issuers are showing stability. However, NEF's best historically performing segment, transportation, has been impacted. Schools, tour and charter bus leasing have all felt pressure. While the majority of our equipment finance borrowers have been beneficiaries of PPP and other government assistance programs, the unprecedented decline in economic activity requires a long-term view and patience in working with our borrowers to help them get to the other side of this crisis. We are already seeing signs of recovery and are encouraged by both the return of the liquidation market for our equipment as well as the health of our underlying borrowers, which has been improving. It's important to remember that we provide financing on specific equipment. Financings are at low loan to values, typically 70% or so, and are well within the borrowing base in normal market conditions. In addition, a large portion of our investments come with personal guarantees and other forms of credit protection beyond the equipment. At quarter end, NEF had a portfolio of approximately $328 million. Portfolio was invested across over 100 borrowers with an average issuer exposure of approximately $3 million. As a reminder, included in this business, our equipment financings held directly on Solar's balance sheet as well as financings held in NEF Holdings, a portfolio company that for tax efficiency purposes holds certain of Nations Equipment's assets. Better-than-expected performance for the third quarter led us to mark up our investment in equipment finance by 1% from the prior quarter. The equipment financing asset class represents 22% of our total portfolio. 100% of our equipment financings are in first lien positions. At quarter end, the asset-level yield was 10.3%. Additionally, 99% of this portfolio is fixed rate and is not impacted by the drop in LIBOR over the last several quarters. For the third quarter, our equipment finance segment contributed $4.5 million to gross income, representing just over 15% of our total gross income. During the quarter, we invested just under $12 million and had repayments of approximately $37 million. Our equipment finance team is focused on managing the existing portfolio and helping its borrowers through this challenging time. However, as we sit here today, our pipeline has also increased, and NEF continues to work with our broader platform's origination team to offer equipment financing solutions to private equity sponsors and their portfolio companies. Finally, let me provide an update on life sciences. Overall, our life science portfolio has largely been insulated from short-term market and economic dislocations, given the long-dated equity investment periods as well as product development cycles. The impact of COVID-19 on our portfolio remains de minimis. As a reminder, we have never realized a loss in our life science portfolio. Currently, 100% of these companies have more than 12 months of cash runway. At quarter end, our portfolio totaled $323 million, consisted of 17 borrowers with an average investment of just under $20 million. Life science loans represented 21.5% of our total portfolio and contributed $8.7 million to our gross investment income, equaling 30% of our total gross income. The weighted average yield of our life science portfolio was approximately 9.7%, excluding any success fees or warrants. During the quarter, the life science team originated approximately $5 million of investments and had repayments of just $1.5 million. Our pipeline for life science investments, including demand from larger, more mature companies, has increased going into this fourth quarter as financing needs have become clearer for these businesses. In conclusion, we believe that Solar's portfolio is extremely well positioned to weather this crisis. As we continue to navigate this challenging environment, we remain in close contact with our portfolio companies, the management teams and their sponsors to support them as well as work closely with our extensive network of relationships to source new investment opportunities. Solar's commercial finance platform, and significant dry powder, enables us to provide structured solutions for both cash flow and asset-based loans for capital-constrained companies. Solar will be able to participate in these financings while maintaining significant diversification across our portfolios. Now let me turn it back to Michael.

Thank you, Bruce. In closing, and before we open up to questions, we feel confident in our portfolio's ability to weather the current crisis as well as in our ability to grow our portfolio and subsequently net investment income over the coming quarters. The acquisition of Kingsbridge has further positioned Solar Capital as a diversified commercial finance platform that provides solutions across the capital structure to middle market businesses and now investment-grade companies. Our origination engines are broad and provide us the opportunity to source loans in specialty niches focused on collateral, loan-to-value lending that are less competitive than traditional cash flow lending. In addition, the specialty finance strategies are less correlated to liquid credit markets and have a differentiated risk-return profile that is complementary to our cash flow lending. They afford us greater flexibility to stick to our investment discipline. With significant dry powder, a strong portfolio and low leverage, Solar is well positioned to originate attractive new investments and grow net investment income. Our patience and willingness to remain underinvested allows us to be opportunistic. Given the magnitude of the economic disruption and expected uneven recovery, we believe that the improved investment opportunity set will persist as companies continue to require financing solutions for liquidity, working capital, and growth initiatives. In conclusion, the team is confident in Solar Capital's defensively positioned portfolio, stable funding sources, strong liquidity, and the potential to make new attractive differentiated investments. Later on this morning, at 11:30, we'll be hosting an earnings call for the third quarter results of Solar Senior Capital, or SUNS, as we call it. Our ability to provide traditional middle market senior secured financing through this vehicle continues to enhance our origination team's ability to meet our clients' capital needs, and we continue to see benefits from this value proposition in Solar Capital's deal flow. We thank you for your time this morning. Operator, would you please open up the line for questions?

And our first question comes from the line of Casey Alexander with Compass Point.

I have a couple of questions. First, I believe the portfolio for Kingsbridge is $444 million. Does adding it to the Solar platform facilitate greater access to capital, potentially allowing that portfolio to exceed what Kingsbridge could achieve on its own? How large could it grow as it scales? Additionally, could you provide the average weighted yield impact on the overall Solar Capital portfolio from Kingsbridge?

So Casey, yes, similar to our other commercial finance platforms, Kingsbridge was owned by either private equity or hedge fund, short-term-duration equity capital. So it's a combination of access to our investment-grade capital as well as having permanent capital underneath the vehicle, which gives the business the ability to grow. Having said that, as you know, we typically have been acquiring our commercial finance platforms based upon targeted ROEs. We know that it's not always a healthy time to be growing a credit business, one has to look at the cycle. But there is an opportunity for growth. We view it, though, as a nice, steady state, as we mentioned, sort of 10% to 11% return business.

And I think, Casey, the nice thing is that given the nature of the clients in investment grade, you can grow your return on equity here and expand without needing to invest significant additional capital into the business. Regarding your second question, it doesn't really affect our weighted average portfolio because, as we mentioned, we expect this to yield, on a blended basis, close to 10%, which is approximately what our overall portfolio is yielding today.

Okay. Well, that's what I thought. I just wanted to verify that. One other question. You talk about a more robust pipeline. I don't want to compare it to the pipeline in the pandemic, which we know didn't exist. But how would you compare it to, say, the pipeline a year ago at this time? And what's different about the pipeline as compared to a year ago? What are you more willing to do? What are you less willing to do than you would have been a year ago? And do you think it is executable to continue to expand that leverage ratio? I know it's a lot, but...

Sure. The short answer is that it’s about the quality of the pipeline. There was a strong pipeline prior to COVID. However, there was a significant slowdown in the first couple of quarters after COVID. Although it has improved from the early COVID days, there is still a way to go to reach pre-COVID levels. Two important points to highlight: we have diversified strategies that are somewhat uncorrelated, which has been enhanced by the addition of Kingsbridge, allowing us to lend to investment-grade borrowers. This diversification also supports our sourcing, as we’ve seen an increase in asset-based lending (ABL) to companies facing stressed cash flow during the COVID crisis, affecting many businesses this year due to uncertainty and episodic shutdowns. Our ideal situation is when all areas, including acquisitions, are performing well simultaneously, as we are currently experiencing with Kingsbridge. Life science lending has been steadily building throughout COVID, though there was a slight slowdown in Q2 and Q3. Conversely, we have not seen a high level of repayments in life science, which has helped maintain our portfolio size and duration, and we value these assets. ABL activity has increased due to stress in sectors, particularly retail. In cash flow lending, we are witnessing high-quality opportunities rather than just more opportunities, allowing us to assess performance through COVID as a way to stress test these businesses. Many companies are utilizing this moment to pursue add-on acquisitions at lower purchase multiples than before COVID, possibly because their existing lenders are at capacity or face portfolio constraints. We believe we are entering an environment where we can achieve our target leverage range despite prepayment challenges, leading to longer duration and more new investment opportunities across different sectors.

All right. Well, congrats on the acquisition, and we look forward to you getting to those leverage targets.

And our next question comes from the line of Chris Kotowski with Oppenheimer.

I was wondering if the Kingsbridge acquisition falls under your 30% bucket. Is it only the equity that counts, or do both the debt and equity components apply to your 30% bucket?

The good news is the company is a qualified asset because a significant portion, over 80%, consists of operating leases. Therefore, both the debt and the equity are regarded as qualified investments.

And our next question comes from the line of Ryan Lynch with KBW.

You guys did provide some pretty good commentary on your pipeline, thinking both in the quantity and the quality of deal flow. I was just curious specifically on your ABL or Crystal Financial business. Why that had picked up thus far in the third quarter? If I look at what you guys did in that a year ago, it was about $140 billion, you guys did only $30 million this quarter. I always thought that, that business, from an origination standpoint, was kind of countercyclical in the fact that during downturn, when there was more stress, most potential borrowers would need greater access to that ABL type of lending. So I'm surprised we haven't seen that pick up thus far. Even though I know you said the pipeline is growing, why haven't we seen that thus far?

The short answer is twofold. Some larger businesses that experienced a pause in their cash flows due to shutdowns across the country were able to access capital from banks on a receivable inventory lending basis at a much lower cost than we and Crystal's competitors could offer. This allowed those companies with immediate liquidity needs to tap into the bank market temporarily, despite having had temporary cash flow interruptions. As this period of stress extends, we typically observe an increase in activity, especially as banks become more cautious and cash flow shortfalls deepen. This is starting to reflect in Crystal's pipeline, which is why we've mentioned that it is building. Additionally, it takes time for these businesses, even those undergoing transitions, to navigate through the stress and decide to close deals. A typical deal with Crystal may remain in the pipeline for three to four months before the borrower ultimately states that they need to secure funding, despite the high cost of capital. Therefore, it’s expected to see this flow fluctuate, as we have only been in this situation for about six or seven months.

That's helpful, Bruce. I have one follow-up regarding Kingsbridge. Did you provide what the interest rate would be on your debt in that business? Also, of the $20 million in gross income you expect to generate in 2021, do you have any estimate of the breakdown between the interest income and dividends that you will receive?

We are funding the investment with cash on hand, which is approximately $50 million and carries no interest cost. The remaining balance will be financed through a revolver, with a marginal borrowing cost just under 2%. Regarding earnings, the $80 million of debt has a yield of about 8.25%. The remainder will come from qualified dividends from our stock investment.

Congrats on the acquisition.

And our next question comes from the line of Matt Tjaden with Raymond James.

Just a quick one from me, if I can. On the acquisition outlook, does Kingsbridge kind of whet your appetite for acquisitions in the near to mid-term? Is there anything you're seeing currently that's interesting?

We are always searching for opportunities. Our team is focused on lending to and acquiring these types of companies. While we don't have any immediate plans for a significant acquisition, we are definitely interested in pursuing the right businesses when we find them.

And I would just add that similar to what we saw coming out of the recession in '08, what really led our portfolio out then was, to Michael's point, not only acquisitions in commercial finance but lending into commercial finance businesses. As you can see with Kingsbridge, that gave us great R&D and actually an opportunity to buy the business. In other cases, we bought competitors of companies we've lent into. So I would say our pipeline there is incredibly active in terms of lending to other lenders, which is understandable, given that as you move away from the liquid credit markets and into smaller niche strategies, such as lending to other finance companies, there is a real need for capital and a shortage of lenders willing to provide capital with that kind of expertise to underwrite other people's loans. So long-winded way of saying the pipeline has been building there. And that is generally the leading indicator for future acquisitions.

Congrats on the acquisition.

Our next question comes from Mickey Schleien with Ladenburg.

I don't want to beat a dead horse, but I do have some follow-up questions on Kingsbridge. Michael and Bruce, could you help us understand or describe the level of correlation, if any, between Kingsbridge's leasing business and your existing equipment leases in terms of credit risk?

Sure. I would say that the simple way to think about it, Mickey, is NEF with the team that has led that business and earlier in their careers led GE's leasing business, equipment finance business for many, many years, it really is an underwrite of liquidation of collateral first and credit quality of the borrower second. But as we've talked about, we also very often, because those are small entrepreneurial-owned companies, find other credit support behind just the liquidation value of the equipment in the form of personal guarantees and other assets for collateral on a personal basis. As you think about Kingsbridge, it is more an investment-grade underwrite of the borrower, the obligor, with over 70% of the obligors being investment-grade rated. And then the liquidation value of the equipment is important, but it's a secondary part of the underwriting.

That's really helpful, Bruce. It somewhat addresses my next question. I was going to inquire about any significant synergies between Kingsbridge and the leasing platform, but it seems like they are focused on different types of customers. I have another question, which is a math question, and it might just be my fatigue after a couple of long days, but you've indicated that Kingsbridge will generate $20 million of income for Solar on your $216 million investment, translating to a return of 9.3%, while you've projected a return of 10% to 11%. So, what am I overlooking there?

10% to 11%, it would be on the equity.

Okay. It makes sense. And if we look in the rearview mirror, Michael and Bruce, sponsored finance investments have been pretty resilient even during the pandemic over the last several years, and I understand you've been cautious on them, obviously, for many years. With that performance in hindsight, have you changed your view on potentially growing this segment going forward, given that my understanding and from what we're hearing is that although spreads are probably back to pre-COVID levels, attachment points in terms of leverage and the number of covenants you can get are still fairly attractive?

It really depends on the sector and each specific transaction. We've identified increased opportunities, particularly in defensive sectors like healthcare. This sector is especially appealing due to our expertise in life sciences and healthcare cash flow, alongside our Gemino team's experience at Solar Senior. We believe we have valuable insights, and our best track record has been in healthcare when examining our cash flow strategy. Thus, we are increasing our focus there while maintaining our strategy in defensive sectors. I completely agree that pricing hasn't returned to pre-COVID levels, which affects our decision-making. The primary factor influencing the number of opportunities we've decided to pass on recently has been the underlying credit quality. We encounter businesses with significant EBITDA adjustments, which presents a considerable risk for lenders and investors. There are covenants in place, but these need to be in sectors where lenders can enforce them, like healthcare, which isn't broadly applicable. This is crucial for our entry into deals. It's still early to determine how portfolios will fare nine months from now, and many of us are anticipating a lengthy economic recovery, despite any short-term fluctuations. We remain cautious but are attracted to certain sectors. Concerns arise when covenants are merely nominal and when EBITDA adjustments are substantial. Therefore, we are narrowing down our opportunities and seeking to take significant positions in the assets we value. Our strategy remains consistent, yet we are beginning to see improved prospects in cash flow and would like to expand that area.

And Bruce, the fourth quarter typically sees stronger volume for that business as people aim to finalize deals before the year ends. Can you share any expectations on how this might affect your cash flow sponsor finance business this year?

The reason I'm pausing, Mickey, is, as you know, in M&A, just looking at our own transaction with Kingsbridge, it never closes until it's closed. So it's hard to pick a Q4 versus a Q1 or a Q3 versus a Q4. But the activity is definitely picking up, and we are optimistic, but most of it is add-on. You're not seeing a lot of new platforms. And the difference in that statement implies that the investment might be a little bit smaller because you're doing add-ons to existing investments. But we're definitely seeing increased activity, and if it's not going to materialize in Q4, we feel it will over the next couple of quarters.

Fair enough. My last question is about the dividend. Last year, there was a small return of capital in your distributions. Based on GAAP, and understanding the differences between tax and GAAP, it seems there will be a return of capital this year as well. I don't have Kingsbridge pushing you to cover the dividend, and we can discuss that offline if needed. Aside from Kingsbridge, what is the plan for eventually covering the dividend? Is the Board thinking about adjusting the dividend to align with current market realities?

So the path is to utilize the $700 million liquidity that we have available to us at LIBOR plus 2%, which is 2% today, basically, and continue to grow the portfolio and take advantage of opportunities that we're seeing. So I think we don't intend to realign our dividend because we think we have the ability in the near term to grow into our dividend.

And meanwhile, Michael, you're okay returning capital if that's needed?

Yes. I mean it's not a lot. So yes, we are.

And again, I think when we do the math, and we're happy to talk offline, it doesn't take much to get there. And we're blessed by, yes, we're seeing increased opportunities in cash flow. But we are seeing increased opportunities in ABL and life science and now Kingsbridge. So we think we have multiple paths to get there. And importantly, the repayment headwinds other than in second lien assets, which we're happy to get repaid on in our cash flow segment, we see multiple ways to get there.

You're implying that repayment headwinds are pretty low right now given the state of the economy? I understand.

Yes.

Congrats on the acquisition. We've been looking forward to that sort of news, and hopefully. more to come.

Our next question comes from Finian O'Shea with Wells Fargo.

Just a couple of quick questions. For Kingsbridge, what did you pay on a price-to-book basis?

So this is not really a business that you look at a multiple book value basis. It's more of an ROE return basis. And so we bought at about 10% to 11% ROE. If you think about it, a huge portion of their debt is nonrecourse, not just nonrecourse to SLRC, but nonrecourse to Kingsbridge itself because as we talked about earlier, is the business of taking your leases, package together and then getting effectively off-balance sheet financing at the investment-grade rate of your counterparty. And so it's not really a business that one looks at as a multiple book.

Okay. Makes sense. And then, Bruce, I think you gave a bit of color on NEF. Could you touch on the dividend? I believe the NEF dividend was turned off. Any input or color on that?

Yes, it was de minimis last quarter, so it wasn't a material adjustment, just a couple of hundred thousand dollars. And we've been, as you know, running that low, a, because, Finian, a lot of the NEF assets are on Solar's balance sheet. So the income from the NEF business is actually coming directly through the investments on balance sheet, whereas the subsidiary also contains the cost and the team of running the business. So it is loaded by that expense factor. We, as I mentioned, continue to feel that this is the one business that obviously has got some cyclicality to it. Having said that, it is outperforming our expectations quarter-over-quarter, in terms of the underlying performance of its borrowers. So we're being conservative in keeping that down in terms of the distribution up. But we expect as we get into next year, we will start to see income, not only from the assets on balance sheet, but on a combined basis, together with the dividend.

That's helpful. I have a final question about the fee structure for Solar. Compared to other major BDCs, your fees appear to be among the highest. Considering your managed assets, it looks like there is a roughly equal split between proprietary credit and financial companies. Is it more costly for the adviser to manage financial companies like NEF, or are there other factors contributing to the higher fees that shareholders are paying? Any insight would be appreciated.

Well, first of all, as you know, with all these finance companies, whether it's NEF, Crystal, and now Kingsbridge, we don't get paid on the assets. So we're getting paid on the equity. This means we are actually managing much greater pools of assets and charging fees only on the equity component of that investment, unlike typical BDCs that take all their fees on assets. These are complex businesses to manage. We are truly managing these companies rather than simply buying loans and adding them to our books. Therefore, we believe it's fair.

I'm showing no further questions. I'll now turn the call back over to Chairman and Co-CEO, Michael Gross, for any closing remarks.

We have no further comments other than to thank everybody for their extensive participation this morning, especially given everything that's going on, a, in our sector; and more importantly, with our country. Take care everybody, and be healthy.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may now disconnect.