SLR Investment Corp. Q2 FY2021 Earnings Call

Good day and thank you for standing by. Welcome to the Q2 2021 SLR Investment Corp. Earnings Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Michael Gross, Chairman and CEO. Please go ahead.

Thank you very much and good morning. Welcome to SLR Investment Corp.’s earnings call for the second fiscal quarter ended June 30, 2021. I’m joined today by Bruce Spohler, our Co-Chief Executive Officer; and Richard Peteka, our Chief Financial Officer. Rich, before we begin, would you please start by covering the webcast and forward-looking statements?

Of course. 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 SLR Investment Corp. and that any unauthorized broadcast in any form is strictly prohibited. This conference call is being webcast from the Investors tab on our website at www.slrinvestmentcorp.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 impacts from COVID-19. 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 to our Chairman and Co-CEO, Michael Gross.

Thank you, Rich. Good morning and thank you for joining us. For the second quarter of 2021, SLRC earned net investment income of $0.37 per share, consistent with the first quarter of 2021. Net asset value per share for the quarter ended June 30th was $20.29, representing a modest increase over the prior quarter. We attribute the resiliency of our portfolio to our conservative underwriting, our focus on first-lien secured loans to large upper middle-market businesses, and our cash flow segments, as well as our specialty finance investment verticals which offer attractive structural protections and yields. At June 30th, over 99% of our comprehensive investment portfolio was invested in senior secured loans, and 82% of the portfolio's fair value was allocated to specialty finance investments. Against the backdrop of the continued economic rebound, the U.S. middle market has reflected a more favorable economic climate, punctuated by a resurgence in sponsor activity and a robust pickup in M&A activity. We expect record levels of deal activity in the second half of 2021, supported by substantial amounts of private equity dry powder and potential future changes to the U.S. tax structure. We are seeing a significant increase in investment commitments post-quarter end. We remain modestly leveraged at 0.73 times net debt-to-equity as of June 30th. Looking ahead, we expect to deploy much of our $740 million of low-cost available capital towards new investments across our lending strategies. In our cash flow lending business, we are noticing an increase in the size of companies seeking direct financing due to financial sponsors' desire for speed and certainty of execution. The scale of SLRC’s investment advisor allows us to hold up to $200 million of a given investment, enabling us to participate in these upper middle-market financings, which we believe are better positioned to protect capital in the event of future economic disruptions. Our specialty finance teams are also experiencing increased deal flow as more companies look to pledge collateral to obtain working capital for growth initiatives. The breadth of our investment strategy means that we only need to see modest growth from each vertical to drive meaningful portfolio and earnings growth. Given our sizable third-quarter pipeline, we expect portfolio growth in the third quarter to bring SLRC’s net leverage within our target range of 0.9 times to 1.25 times. At this time, I’ll turn the call back over to our CFO, Rich Peteka, to go over the second-quarter highlights.

Thank you, Michael. SLR Investment Corp.’s net asset value at June 30, 2021, was $857.4 million or $20.29 per share, compared to $856.2 million or $20.26 per share at March 31, 2021. At June 30, 2021, SLRC’s on-balance sheet investment portfolio had a fair market value of $1.50 billion across 101 portfolio companies in 27 industries. This compares to a fair market value of $1.57 billion across 105 portfolio companies in 27 industries at March 31, 2021. At June 30th, the company has $670 million of debt outstanding, with leverage of 0.73 times net debt-to-equity. When considering available capacity from the company’s credit facilities, together with available capital from non-recourse credit facilities that SLR Credit Solutions, SLR Equipment Financing and Kingsbridge, SLR Investment Corp. has over $740 million to fund future earnings growth. Moving to the P&L, for the three months ending June 30, 2021, gross investment income totaled $35.6 million versus $35.9 million for the three months ended March 31st. Expenses totaled $20.1 million for the three months ended June 30th, compared to $20.4 million for the three months ended March 31, 2021. Accordingly, the company’s net investment income for the three months ended June 30, 2021, totaled $15.5 million or $0.37 per average share, compared to $15.5 million or $0.37 per average share for the three months ended March 31, 2021. Below the line, the company had net realized and unrealized gains for the second fiscal quarter, totaling $3.0 million versus net realized and unrealized gains of $6 million for the first quarter of 2021. Ultimately, the company had a net increase in assets resulting from operations of $18.6 million or $0.44 per average share for the three months ended June 30, 2021. This compares to a net increase of $21.5 million or $0.51 per average share for the three months ended March 31, 2021. Finally, our Board of Directors declared a Q3 2021 distribution of $0.41 per share, payable on October 5, 2021, to shareholders of record on September 23, 2020. And with that, I’ll turn the floor over to our Co-CEO, Bruce Spohler.

Thank you, Rich. SLRC’s strong portfolio performance supports our underwriting thesis of investing at the top of the capital structure in first-lien cash flow loans to upper middle-market borrowers in non-cyclical industries, as well as allocating a significant portion of our exposure to collateralized loans to our specialty finance verticals. At quarter end, our portfolio was just under $2 billion and remained highly diversified, encompassing 600 borrowers across 75 industries. Our largest industry exposures were healthcare, diversified financials, life sciences and retail asset-based loans. The average investment per issuer was approximately $3 million or 0.2%. Over 99% of the portfolio consisted of senior secured loans. Of those, 95% were first-lien and only 4.3% were second-lien. Of those second-lien loans, 2.4% were cash flow and 2% were asset-based loans. At quarter end, our weighted average asset level yield was 9.8%, consistent with the prior quarter. By focusing on our niche commercial finance verticals, we’ve been able to maintain asset level yields close to 10%, despite decreases in LIBOR, as well as spread compression. Notably, we’ve been able to maintain these yields, while actively reducing our exposure to second-lien cash flow loans. At June 30th, the weighted average investment risk rating was just under 2 based on our 1-to-4 risk rating scale, with 1 representing the least amount of risk. Total originations for the second quarter were $173 million and repayments were just over $300 million, resulting in a net portfolio of approximately $2 billion. In addition, we had $82 million of unfunded investment commitments outstanding at quarter end, which we expect to be drawn down in future quarters. Now, let me provide an update on each of our investment verticals. SLR sponsored cash flow finance, at quarter end, our cash flow portfolio was approximately $340 million or 18% of our total portfolio. We invested across 18 borrowers with an average investment of approximately $20 million. The average EBITDA of our SLR cash flow portfolio was $80 million, consistent with our focus on upper mid-market larger borrowers. During the second quarter, we made $63 million in new cash flow commitments, of which $48 million was funded into new and existing investments. We experienced repayments of $40 million. As Michael mentioned, we have been able to take advantage of the broader scale of the SLR platform to underwrite larger hold positions in first-lien cash flow loans to upper mid-market sponsor-owned companies. Given the sponsor community's preference for partnering with just a few lenders on each transaction, each large hold size, SLRC would not be able to participate in these financings without the broader capacity of the SLR platform. We are increasingly committed to delay draw acquisition lines of credit that are used by borrowers to fund future acquisitions. These transactions offer a prudent opportunity for SLRC to grow its investment and establish credits with existing financial covenants. At quarter end, we had $50 million of unfunded cash flow commitments, which we expect to be drawn down in future quarters. We’re also seeing robust new deal activity in our cash flow protocol and expect to meaningfully grow this segment during this third quarter. Our asset level yield for cash flow loans was 8.4%, slightly below the prior quarter. Now, let me turn to asset-based lending, SLR Credit Solutions. At quarter end, the portfolio for asset-based lending was $390 million, representing approximately 20% of our total portfolio. The weighted average asset level yield was 10.3%, compared to 10.5% in the prior quarter. During the quarter, we funded approximately $27 million of new loans and had repayments of $100 million. Looking forward, the pipeline in asset-based lending is robust. For example, retailers, and the core competency of this team are actively exploring alternative financing solutions at an active rate following the challenging 2020. For the quarter, Credit Solutions paid SLRC a cash dividend of $5.5 million. Now let me turn to Corporate Leasing, our Kingsbridge platform. We are now nine months into our investment in Kingsbridge and are extremely pleased with the results. The credit quality of the portfolio remains strong and originations during the second quarter were steady. At quarter end, the highly diversified portfolio of leases totaled approximately $590 million, with an average funded exposure of $1.3 million per obligor. The portfolio was 100% performing, with a large majority of the Kingsbridge portfolio invested in assets that are leased by investment-grade borrowers. For the quarter, Kingsbridge paid a dividend to SLRC of $3.5 million, which is an increase from $2.75 million in the prior quarter. This equated to a 10.2% annualized yield on cost. When we include the interest on our $80 million loan into Kingsbridge, gross income from Kingsbridge for the second quarter was just over $5 million. Now, let me turn to Equipment Finance. As a reminder, including our Equipment Finance business, our financing held both directly on our balance sheet, as well as in our subsidiary SLR Equipment Finance. For the second quarter, the strategy invested $24 million and had repayments of $31 million. At quarter end, the portfolio totaled approximately $314 million. It was invested across 104 borrowers with an average exposure of $3 million. The Equipment Finance asset class represents 16% of our total portfolio; 100% of their investments are first-lien loans, and for the second quarter, the yield on this portfolio was just under 10%. For the second quarter, investment income from this portfolio totaled $4 million. The rebound in economic activity that started last year and has continued this year has been supportive of the performance of our Equipment Finance portfolio. We are seeing equipment valuations return to their pre-COVID levels, and the credit quality of the borrowers is improving. Our team is currently focused on growing the portfolio. Now, let me provide an update on our life science business. At quarter end, this portfolio totaled just over $270 million, consisting of 15 borrowers with an average investment of $18 million. In total, this portfolio represents 14% of our comprehensive portfolio. During the second quarter, the team committed to $11 million in new investments, of which $6 million has been funded. Repayments and amortization totaled $65 million, which included the repayment of one investment of $50 million, which generated over 13% unlevered asset-level IRR. During the pandemic, our life science portfolio experienced lighter churn that is typical, as repayments started occurring at a more normal cadence this year, realization fees and other income associated with these loans will become more recurring and consistently benefiting our earnings. At quarter end, SLRC had $22 million of unfunded life science commitments, which are available to borrowers upon reaching certain milestones. These may be drawn to continue to fund SLRC’s life science portfolio growth. The weighted average yield on this portfolio was just over 10%, which excludes any success fees and warrants. In conclusion, SLRC’s portfolio activity represents a continuation of the investment themes that have been driving our portfolio over the last few years, focusing new origination activity on first-lien cash flow loans to portfolio companies in defensive industries. Increasing our investments in specialty finance assets, we’re able to get tighter structures and more attractive risk-adjusted returns and growing alongside our portfolio companies by committing to acquisition lines, which may fund over the next few quarters. Across all of our asset classes, including cash flow, we are seeing a larger volume of quality investment opportunities than we have seen in a number of quarters. This uptick is reflective of the solid economic rebound and increased middle market sponsor activity. The current environment is attractive and provides a great opportunity for us to grow our portfolio throughout the remainder of this year. Given our sizable third quarter pipeline, we expect this growth to bring our net leverage within our target range of 0.9 to 1.25. Now let me turn the call back to Michael.

Thank you, Bruce. In closing, we are optimistic about our earnings growth potential and the opportunity set across each of our investment verticals. With the economic recovery in full swing and SLRC’s portfolio on solid footing, we’re focusing our available capital into attractive investment opportunities. The breadth of our investment strategy will spend cash flow, ABL, life science lending in addition to Equipment Financing and Corporate Leasing, means that modest activity in each vertical can aggregate meaningful overall portfolio growth. We also believe that we’re still in the early innings with substantial runway as financial sponsors deploy record amounts of dry powder and more larger businesses prefer to lend to direct financing over syndicated debt markets. These industry tailwinds combined with the scale of our investment advisor should benefit SLRC investors through greater access to upper middle market cash flow investment opportunities, which as of last year, have proven to be better positioned to protect capital than most smaller companies. Now that we’re including incentive fee catch-up, every incremental dollar of income is highly accretive to shareholder returns. We have access to ample low-cost capital with which to fund portfolio growth. As we continue to grow the portfolio, we believe net investment income will ultimately return to fully covering the dividend. In July, our advisor announced that they have completed initial closings of over $480 million in equity commitments for its private healthcare lending fund, capitalizing on our strength and deep experience in the healthcare lending industry across cash flow, ABL and life science investment strategies. With anticipated leverage, this fund adds over $1 billion of investable capital to our platform. Our pipeline of healthcare investments is strong. Due to industry diversification targets, our platform has originated more healthcare opportunities than SLRC can handle on its balance sheet. The addition of the private healthcare fund enables the SLR platform to continue providing full capital solutions of over $200 million, which benefits SLRC to increase diversification within its healthcare portfolio and a steady stream of new investments into which we can invest. At 11 o’clock this morning, we’ll be hosting an earnings call for the second quarter results of SLR Senior Investment Corp. or SUNS. Our ability to provide traditional middle market senior secured financing for this vehicle continues to enhance our origination team’s ability to meet our clients’ capital needs and we continue to see benefits of this value proposition in our deal flow. We thank you for your time. Operator, could you please open the line for questions?

The first question comes from the line of Bryce Rowe with Hovde.

Thanks. Good morning. Appreciate you taking the question here. Bruce and Michael just wanted to try to frame up the projected third quarter activity. It sounds like a good portion of it will come from the sponsor finance business, but curious how we should think about the mix of third quarter activity in terms of the sponsor finance, ABL and possibly the life sciences vertical?

Yeah. I think we expected to be more heavily weighted this quarter towards both cash flow and ABL. Life sciences are active, but as you know, it’s a smaller strategy. So I just think magnitude-wise, it will be driven more by cash flow and ABL in terms of the current pipeline. But activity level is there across actually all of the strategies.

That's helpful. I wanted to follow up on the comments about the ABL strategy. You mentioned that there's a strong pipeline, although the overall portfolio was down this quarter. You also pointed out a dividend of $5.5 million on the equity investment in that area. Considering the robust pipeline and its potential to convert into fundings, how should we evaluate the $5.5 million dividend coming into the BDC compared to the previous amount of $6 million?

That’s a great question. As you know, this vertical tends to be a little bit variable quarter-to-quarter, over the course of a year it’s been pretty consistent, but quarter-to-quarter can vary based upon the short duration of the assets, what you’re booking when you’re generating prepayments. So we try to smooth this out. I think this is a good level to assume for the moment based upon what we’re seeing.

Okay. And then maybe one more for me, on the cash flow side of things, you’ve noted larger companies that you’re lending to average investment of $20 million. Do you expect hold sizes to kind of go up within that vertical kind of given the increased scale within the platform and maybe the private equity sponsors being more active and looking at more M&A opportunities?

Yes, historically, the hold size was small because we had shifted our focus away from cash flow due to concerns about the market prior to COVID. Coming out of COVID, it's worth noting that our cash flow strategy is a niche for us. We are not a broad cash flow lender supported by sponsors. We concentrate on industries that are stable and generate high free cash flow, avoiding capital-intensive sectors like healthcare, financial services, software, and business services, which make up 90% of our portfolio. We do not operate in every sector of cash flow, and those we do have performed exceptionally well, demonstrating resilience during COVID. This increased our investment activity both in private equity and in credit. As a result, we are seeing larger hold sizes because we want to increase our exposure, leveraging our platform's greater scale. This applies not just to SLR but also makes our platform attractive to borrowers seeking $150 million to $200 million holds. Therefore, we anticipate that hold sizes will rise, boosting our exposure in the sectors that have consistently shown resilience and where we have been investing for years.

Okay. That’s it for me. Appreciate your time.

Thank you.

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

Good morning. I have one question today. Over the past few years, you have done an impressive job of expanding your lending business across various verticals, which has helped diversify your asset base and proved beneficial during COVID. Additionally, you have raised more funds outside of the BDC, enabling you to increase your commitment size and relevance while maintaining diversification at SLRC. However, this growth in your platform has not translated into significant portfolio growth at SLRC. There has only been about 3% total net portfolio growth in the two years leading up to COVID, and since then, there has been no organic quarterly growth, aside from the Kingsbridge acquisition. Essentially, there has been no net growth in your portfolio post-COVID. I understand you mentioned a robust pipeline for the third quarter and your plans to reach your targeted leverage range. My question is whether your platform can achieve consistent organic net portfolio growth moving forward. I assume the answer is yes. If so, what would need to change compared to the past data we've seen?

So I think you hit the nail on the head and to some extent answered your own question. We have grown by adding verticals in and of themselves, bring capital to the table that we have invested in these verticals. Importantly, as you appreciate Ryan, having followed us for many years, many of these verticals are very stable, less transactional, and so we don’t face that headwind some of the asset classes, such as cash flow that are very transactional, short-duration assets driven by M&A exits. Once the business tends to perform, you get repaid on your loan. So Kingsbridge is a great example. As you know, we’ve been a lender for a number of years, brought that platform on late last year, deploying over $200 million of capital. We view that as permanent deployment that we will then grow as a business grows. Now, it’s not a high grower, but it’s a steady consistent grower. It’s already proven. And importantly, those are long-duration assets that are less transactional; the average duration there is five years. And so that’s kind of a permanent piece of deployment here that is less facing those headwinds of constant churn as we try to grow the portfolio to your question. So I think as we look at it, we have a number of verticals through which to grow. As Michael mentioned, we are seeing growth in all of them coming out of COVID right now given the economic climate, and that’s obviously nirvana. We don’t count on all of them growing at the same time. We view ourselves as allocators of capital to the segments that offer the best risk-adjusted returns. But I think on one hand, we feel like they have incredibly strong stable foundations, and yet, we’re telling you we’re also seeing growth right now across the portfolios. Again, there is a time to grow, and there is a time to get repaid in lending, as you know, based on where you are in the credit cycle, but we feel that we are incredibly well-positioned for prudent growth.

Yeah. The other color on growth is, which we don’t factor in and you can’t model in is, we are active acquirers, but that’s a line of business for us. And we have a team that is dedicated to finding new opportunities, and that’s kind of a step function. I mean, we have an active pipeline today, can’t predict if, when something happens, but in all likelihood, given our experience and our desire, we’ll be adding other platforms to Bruce’s point, as different layers of kind of permanent funded capital that’ll generate attractive returns.

Okay. Where would you like to see cash flow originations that SLRC holds reach? They have been relatively small in recent quarters, and I understand you were trying to move away from certain areas and some sub-debt before COVID. Now it seems you want to focus on growing in that area. What do you envision those quarterly origination numbers and cash flow lending for SLRC could achieve on a quarterly or annual basis, considering that quarterly figures can fluctuate?

Look, again, to your point, it can be lumpy; it’s hard to predict repays. Our average hold will go up, because the facilities that we’re doing are going up. If we do $100 million in our facility, the hold size for SLRC is probably around $20 million; if we do 20 more facilities, close to $50 million. We don’t put any constraints or budgets in place on the cash flow originating team. With the same pool of dry powder, we’ll take whatever opportunity we see that makes sense. So it’s really a hard question to answer, because we have all these different verticals. We don’t sit here and provide budgets and guidelines to each vertical; it’s more like show us what the opportunity is, and we’ll invest in the best risk-adjusted opportunities we can see.

And I think one of the points that’s worth noting, Ryan, is our team is agnostic. They’re out sourcing from the sponsor community loans. They may go to a particular issuer that’s owned by a sponsor, where we think the best solution is an asset-based solution. Increasingly, we’re finding PE firms that are in healthcare migrating into earlier stage life science businesses that historically were dominated by venture capital firms. So for us, we don’t look at it, as Michael mentioned, in terms of how do we grow the capital book versus the ABL book versus the life science book. They’re all doing one thing. We lend to middle-market U.S. corporates. And then what we do is our origination team is well-versed across these strategies. The underwriting expertise is definitely specialized within those verticals. But the sourcing network is broad-based, and our head of originations is out there with his team offering all of our products. And it may be owned by a sponsor, it may be owned by venture capitalists or it may be owned by an entrepreneur. But we don’t segment our business that way. We are just looking at the best risk-adjusted return for a given borrower. So it’s a different strategy. It obviously has helped us on the risk mitigation side by having multiple ways to underwrite risks for U.S. corporate borrowers.

Yeah. Yeah. I totally understand that kind of one approach, the reason I was focusing on the cash flows that seems like an area that was de-emphasized in the past and now you guys are starting to emphasize that more given where we got in the economics cycle. So… appreciate the discussion today. That’s all for me.

Thank you.

The next question comes from the line of Robert Dodd with Raymond James.

Hi, everyone. I want to focus on the outlook for the pipeline. It seems like cash flow and asset-backed assets are strong, particularly your healthcare fund, which appears to be a significant part of that robust activity moving forward. On the asset-backed side, healthcare used to be larger but is now shrinking, and it seems you are pointing to retail as a potential area for growth in asset-backed assets soon. Has there been any market shift away from asset-backed healthcare in favor of cash flow healthcare? Is there a dynamic trend happening right now that explains the need to raise a fund for healthcare?

No. Actually, just to clarify. We are active in healthcare asset-backed lending, including receivables-backed financing at SUNS, our sister BDC related to our healthcare ABL segment, and Equipment Finance in the healthcare sector through Kingsbridge. However, the asset-based group at SLRC really considers healthcare as just one sector; they primarily focus on sourcing for the rest of the platform. Their main emphasis has always been on retail, due to the liquidity of finished goods inventory, which is key to their underwriting approach centered around liquidation value and liquidity of assets needed for repayment. This is not typically the case, but it is their underwriting principle. Retail has returned to their foundational roots from over 20 years ago when they started, and while it is not the only focus, it remains a core segment of their business. They have been increasingly active coming out of COVID, especially with the challenges posed by lockdowns and online competition as retailers adapt to a less brick-and-mortar environment. Their activity in this area has been quite consistent.

Thank you. Regarding Equipment and Kingsbridge, you mentioned that origination is steady or looking to grow, but you didn't describe it as robust, which is not a term you frequently use. Could you provide some insight on that? We are aware of the supply chain issues affecting equipment; buying a car right now is quite challenging. Are the moderate expectations for these two segments in the near-term related to supply chain issues? Please go ahead.

Yeah. No. That’s a good question. So just to clarify, the Equipment Finance segment is really mission critical equipment for small borrowers and Corporate Leasing, Kingsbridge is equipment for larger investment grade borrowers. Both segments have, to your point, been affected by supply chain disruption. So they’re getting orders, but again, our fundings don’t occur until the equipment is delivered, and those have been pushed off in some cases till next year. So it’s good pipeline, winning business, but not funding it, because the supply chain has delayed those deliveries. Stepping back from that, what is hopefully a timing issue and we will correct itself over time here. Stepping back, both of those segments are not sponsor-driven, M&A-driven acquisitions. This is clearly internal borrowing, sitting down and thinking out what is their CapEx need and do they want to buy or lease. And those are smaller transactions and are lead itself to kind of a steady drip of growth, rather than huge volumes quarter-to-quarter. So that’s why our comments are tempered in terms of their growth, not that they’re not growing, but the nature of the asset class is different from the M&A-driven asset classes such as cash flow and ABL.

Understood. So regarding those two areas, perhaps we can remove the strong wording. How would you differentiate between the current orders and their delivery? Although deliveries might be limited in the short term due to supply chain issues, how would you describe the pipeline outlook and the level of interest coming in, even if the equipment isn't readily available?

Strong, I would say strong; people are looking to deploy capital coming out of COVID and obviously need equipment to fund their growth at the business level, so it’s strong. But the only other thing I would just say real quick on those two segments is, these are monthly amortization payment asset classes. So you always have a steady slow, but steady headwind of amortization of those loans. So, unlike cash flow where there’s very little amortization until the deal is repaid, here you always have a steady drip of growth and a steady drip of repayments; that’s the nature of Corporate Leasing.

Understood. Thank you.

Thank you.

The next question comes from the line of Mickey Schleien with Landenburg.

Good morning, Michael and Bruce. Hope you’re well?

Good morning.

Good morning. I want to follow up on the cash flow lending segment. I appreciate your enthusiasm about the pipeline, but it seems that the terms are generally at least as tight as or even tighter than pre-COVID levels. Can you explain if there’s something about the solar platform that offers you more attractive opportunities in cash flow lending now compared to what was available in the very dislocated market six or nine months ago?

So, I let Bruce comment on the kind of the terms again the current market, but just to step back, Mickey. So we as a team sat down last year around this time, and said, yeah, we see spreads winding out and terms a little better. But the big thing that we’re still missing in capital loans back then was there was no call protection. And so, we were faced with really asymmetrical risk-reward. If we were right and the market did pick up and did well, then those loans that were put on at attractive spreads would be called out the minute the markets tightened, which is what happened. Loans that were done last summer, at quote-unquote, wider spreads were taken out in the first and second quarters of this past year, because spreads tightened. So we were faced with the choice of, yeah, we could put some money to work, make money for six months, if we were right. But if we were wrong and the market did not recover, and COVID continued to be as bad as it was, then we would have really regretted making those loans. So we chose not to be aggressive in the face of being able to make money for six months versus potentially losing money. That’s changed. We can see light at the end of the tunnel. We’ve seen it for a few months now. And so that’s why, from our perspective, our activity has picked up dramatically. Yeah, terms are still not ideal, but we are getting covenants in the things we’re doing. We’re still incredibly picky. We’re not looking to put out $1 billion a quarter. We are focused on industries and sponsors that are willing to accept having some structure in the transaction. So they tend to be more complicated situations, more complicated industries, companies that are kind of evolutionary, meaning that they’re acquisitive and are growing, and where the owners want lender partners who will grow with them and be flexible.

Yeah. I think just to add to that for a moment, Mickey. I guess maybe the best analogy is, look at our life science business. As we are only really funding the late-stage life sciences companies that are either through Phase 3 and in commercialization or close to it. There’s a whole other business in life science lending earlier stage, preclinical, Phase 1, there’s drug royalties, there’s a lot of ways to play, life science investing. But our niche is the late stage where we feel it is less risky and we still can get an attractive return for our capital. I think as we approach cash flow is very similar, to Michael’s point, we play within a niche within cash flow. We are not broad-based cash flow lenders. We’re not going to play the economic recovery. We’re not going to go into capital-intensive businesses. We have four industries: business services, healthcare, financial services, and recurring software. That is 90% of SLRC’s cash flow portfolio. So we’re very niche within cash flow. And not surprisingly, given our conservative underwriting posture, these are sectors that are high free cash flowing and are very resilient through cycles, and were resilient last year. So you think about it, given the resiliency of those sectors, it’s part of why our portfolio performed so well last year is that they are now attracting equity, because people see these as great businesses that now we’re poised for growth, a lot of tuck-in acquisitions, both in healthcare, as well as we’re seeing in insurance brokerage, for example. And so, they’re attracting new equity capital, which wants credit capital alongside that to fund it. And so that’s really what is driving our ability to grow cash flow right now is a combination of the industries have proven themselves to be very resilient. They’re attracting a lot of private equity, and they’re looking for lenders with expertise.

I appreciate that, Bruce. So if I’m understanding correctly, just to make sure we’re on the same page, terms in terms of leverage and spreads may be tied to pre-COVID levels, but it’s the documents and the covenants that are better today than they were, let’s say, a year or two ago.

Well…

And that is what’s attracting you within the niches that you operate in?

I would say the fundamentals of the businesses are more proven and attracting more capital, which drives activity. To your point, we’ve always had some covenants in these sectors. These are just very active sectors coming out of COVID. And on the margin, you get a little bit better price, maybe or maybe not. But our strategy is to underwrite the risk and the fundamentals and then charge what we can as much as we can. But we get to barbell that with our specialty finance verticals in SLRC that are higher yielding and blend out to that 10%. So whether a capital loan is at 7% or 7.25% or 7.5%, sure, 7.5% is better, but it’s not going to drive our portfolio yield on balance because of the weightings of our portfolios to especially finance alongside the cash flow. But, yes, the terms are better, but the fundamentals are strong and the activity is high.

It’s also important to keep in mind that because our liabilities are so much funded today by our fixed-rate, investment-grade paper, our incremental borrowing for new loans are coming from our bank facility, given where LIBOR is today and what our unused fee is. Our net cost on additional funding is 1.75%. And so when we’re putting on these loans at decent spreads, it’s significantly accretive to earnings for us.

Understand. That’s it for me this morning. Thank you for your time. I appreciate it.

Thanks, Mickey.

Thanks, Mickey.

The next question comes from the line of Finian O'Shea with Wells Fargo Securities.

Hi, everyone. Good morning. Just to follow-on with the dialogue just then with Mickey. Michael, I think, you just outlined that issuers are looking for lending partners that are willing to grow with them and be flexible. Isn’t that really sort of the opposite of you guys? I don’t say that in a negative way. Obviously, we want you to be credit disciplined, principle disciplined. But tying this all together with the whole sustainability of the growth of your lending book? It feels like you’re only willing to engage in the market for a pretty short window of the credit cycle, which is right now we’re on the rebound post-COVID; presumably if things continue in six months, you’re not going to like the market. So how do you sort of contend with or do you view yourself as someone sponsors view as a lending partner that’s always there, given that, for example, you’re not over the past year when perhaps they needed you most?

Yeah. So that’s a great question. But just to get a little bit more granular. We are always there for sponsors in our sectors that we lend into. So if we’re in healthcare, Finian, we’re dealing with the top tier healthcare private equity firms. We are there through thick and thin with them. And we get our diversification by investing across their portfolio companies, rather than by being with 50 different sponsors. We’ll be with 10 phenomenal healthcare sponsors that never lose money for the equity, which is probably a good place to be as a lender. So we are incredibly consistent, but we’re consistent within our core competencies. We’re not, to your point, going to try to be the one-off lender on a business that is, again, perhaps, is playing the recovery. We stay away from that; we stay away from capital-intensive businesses. We don’t do retail other than on an asset-based lending basis. So we spend time with sponsors who are active in the sectors that we’re comfortable with, and they tend to be very resilient through the cycle. So we’re not in and out to your question. It’s more about what is the level of activity in those core sectors. And then, obviously, we have the benefit of having other segments beyond cash flow to drive portfolio growth.

Okay. That’s very helpful. And just a small follow-up on the pipeline; you seemed pretty optimistic about the pipeline, which would tell us that it’s probably very real and right in front of you presumably. Can you give us any color on what the spread or yield looks like on your pipeline right in front of you?

Yeah. It’s consistent with the existing portfolio. We haven’t really, I mean, compression feels like it’s kind of floored for the moment; every time I say that, we see more over the last few years, but at the moment, it’s pretty consistent with what we’re seeing across our existing portfolio.

Okay. Great. Thanks so much.

Thanks, Finian.

The next question comes from the line of Bryce Rowe with Hovde.

Thanks. Just one quick follow-up here a lot of discussion about the left side of the balance sheet, just wanted to ask about the right side. You guys have a pretty good chunk of your liability structure tied up in fixed-rate unsecured notes as you, as you noted, Michael, you’ve got some coming due next year. Just curious kind of what the appetite is to maintain that level or percentage of unsecured notes and would you be willing to maybe take the revolver higher and reduce the level of unsecured from where it is now?

I think we’d like to take the level of revolver higher given that we’re growing. We’d also like to refinance fixed-rate notes at more attractive terms and bring down our cost of capital that way as well. So you should expect that our cost of capital hopefully comes down between usage of the revolver and terming out some of the notes that come due next year.

Great. Thanks, Bruce. Appreciate it.

Thank you.

I will now turn the call back over to Michael Gross, Chairman and Co-CEO for closing remarks.

No closing remarks at this time, but thank you for your time and we look forward to speaking to those of you who are also engaged in SUNS in six minutes. Thanks. Bye-bye.

This concludes today’s conference call. Thank you for participating. You may now disconnect.