SLR Investment Corp. Q4 FY2021 Earnings Call

Thank you for standing by and welcome to the Q4 2021 SLR Investment Corp. Earnings Call. At this time, all participants are in a listen-only mode. After the speaker’s presentation, there will be a question-and-answer session.

Thank you, operator, and good morning. Welcome to SLR Investment Corp.’s earnings call for the fiscal year ended December 31, 2021. I’m joined here today by Bruce Spohler, our Co-Chief Executive Officer; and Richard Peteka, our Chief Financial Officer. Rich, before we begin, would you please start off 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, and 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. Comments on today’s call include forward-looking statements reflecting our current views with respect to, among other things, the timing and likelihood of the merger closing, the expected synergies and savings associated with the merger, the ability to realize anticipated benefits of the merger, our future operating results and financial performance, and the payment of dividends going forward. Please specifically note that the amount and timing of past dividends and distributions are not a guarantee of any future dividends or distributions, or the amount thereof, the payment timing and amount of which will be determined by SLR Investment Corp.’s Board of Directors. At this time, I’d like to turn the call back to our Chairman and Co-CEO, Michael Gross.

Thank you very much, Rich. Good morning and thank you for joining us. The fourth quarter of 2021 culminated in a record of originations for SLRC having originated $1.1 billion of investments, which translated into net portfolio growth for the year. Against the backdrop of the continued economic rebound and record levels of private equity and leveraged finance activity, our pipeline has been robust. During the quarter, we originated $340 million of new investments following strong third-quarter originations. This is one of our most active quarters in recent years. We’ve been able to remain highly selective while generating portfolio growth. Net asset value per share for the fiscal year ended December 31 was $19.93. For the fourth quarter of 2021, SLRC earned net investment income of $0.35 per share. Overall, portfolio credit quality remains strong, with only one investment on non-accrual. Due to our focus on the upper middle market companies in defensive sectors, the effects of rising inflation and supply chain disruptions in our portfolio had been muted. Thus far, we have seen no impact on our portfolio companies from the economic consequences resulting from the Russian invasion of Ukraine, as their operations are largely tied to the US economy. We are, however, closely monitoring the economic impacts of this evolving crisis. At December 31, over 99% of our comprehensive investment portfolio, which takes into account the loan portfolios of SLRC subsidiaries, was invested in senior secured loans, with 79% of the portfolio’s fair value allocated to specialty finance investments. Our most recent commercial finance acquisition, Kingsbridge, is performing above expectations. Our other specialty finance subsidiaries continue to grow their portfolios following trough utilization levels resulting from government stimulus and other COVID-induced challenges. At December 31, SLRC’s leverage was 0.97 times net debt-to-equity compared to 0.56 times net debt-to-equity at September 30, 2020, when our leverage hit its lowest point during the pandemic. The increase represents progress in rebuilding our portfolio from its pandemic low. During the fourth quarter, we amended our senior secured credit facility. The amendment includes a reduction in the credit facilities pricing grid of 25 basis points to LIBOR plus 175 basis points to 200 basis points. The credit facility was expanded from $620 million to $700 million and was extended by two years until December 2026. Additionally, the amendment enhanced our flexibility. In January of 2022, we issued $135 million of 3.3% senior unsecured notes due January 2027 in a private placement. Through this $135 million issuance, together with the $50 million of senior unsecured notes issued in Q3 2021, we have lowered the company’s long-term average unsecured financing rate. The $185 million of senior unsecured notes due 2027 have a weighted average interest rate of 3.2%, a significant reduction from the 4.5% weighted average interest rate on the $150 million of senior unsecured notes that are due this May. Looking forward, we expect to deploy our low-cost available capital towards investments across our lending strategies. The breadth of our investment strategies means that we only need to see modest growth from our verticals to drive meaningful portfolio growth and earnings growth. In addition, we have an active pipeline of tuck-in and new specialty finance platform acquisition opportunities. As we announced in December, SLRC has entered into an agreement to merge with SUNS, also managed by SLR Capital Partners, with SLRC as the surviving company, subject to shareholder approval and customary closing conditions. The Board of Directors of both SLRC and SUNS, on the recommendation of special committees consisting only of the independent directors, have unanimously approved the acquisition. We’ve been in transaction with SUNS, which makes strategic sense for the company and will create long-term value and growth opportunities for SLRC shareholders for a number of reasons, a few of which I’ll highlight now. The greater scale of the combined company should provide several benefits. As of December 31, the combined company would have approximately $2.1 billion of total assets and $1.1 billion of net assets with a larger market capitalization that is expected to provide greater trading liquidity, garner additional institutional investor interest and research coverage, and enhance the company’s access to equity and debt markets. Additionally, the greater scale will increase portfolio diversification, as well as expand the opportunity set for additional commercial finance opportunities to include large investments and asset purchases. Upon closing, SLR Capital Partners, the investment advisor of SLRC, has voluntarily agreed to a permanent 25 basis point reduction of the annual base manager fee from 1.75% to 1.5% of gross assets. The contractual step down on the base management fee to 1% on gross assets above 1 to 1 leverage will remain in place. The business combination is expected to be accretive to net investment income per share. Based on SLRC’s and SUNS’ balance sheet at December 31, 2021, the pro forma leverage for the combined entity would have been approximately 0.9 times, translating into only a slight reduction in SLRC’s leverage. Over time, we expect that the combination of expected cost savings, reduced base manager fees, and interest savings resulting from more efficient debt financing should drive net investment income growth. Importantly, it is anticipated that the larger scale and capital base should allow the combined company to grow net investment income faster than either SLRC or SUNS would be able to achieve on a standalone basis and to potentially generate higher net investment income per share. At this time, I’ll turn the call over back to our CFO, Richard Peteka, to take you through the fourth quarter financial highlights.

Thank you, Michael. SLR Investment Corp.’s net asset value at December 31, 2021 was $842.3 million or $19.93 per share, compared to $853.5 million or $20.20 per share at September 30, 2021. At December 31, 2021, SLRC’s on-balance sheet investment portfolio had a fair market value of $1.67 billion in 106 portfolio companies across 34 industries compared to a fair market value of $1.62 billion in 106 portfolio companies across 33 industries at September 30, 2021. At December 31, the company had $818.5 million of debt outstanding, with leverage of 0.97 times net debt-to-equity. When considering available capital capacity from the company’s credit facilities, together with available capital from the non-recourse credit facilities at SLR Credit Solutions, SLR Equipment Finance, and Kingsbridge, SLR Investment Corp. had significant available capital to fund future portfolio growth. Moving to the P&L. For the three months ended December 31, 2021, gross investment income totaled $35.7 million versus $32.2 million for the three months ended September 30, 2021. Expenses totaled $20.8 million for the three months ended December 31, 2021, and this compares to $17.2 million for the three months ended September 30. Included in this quarter’s expenses were $0.9 million of one-time costs associated with the merger with SLR Senior Investment Corp. Importantly, due to SLRC’s incentive fee catch-up, these expenses were effectively incurred by the manager and not by our shareholders. Accordingly, the company’s net investment income for the three months ended December 31, 2021 totaled $14.9 million or $0.35 per average share, compared to $15.0 million or $0.36 per average share for the three months ended September 30. Below the line, the company had net realized and unrealized losses for the fourth fiscal quarter totaling $8.8 million versus net realized and unrealized losses of $1.6 million for the third quarter of 2021. Ultimately, the company had a net increase in net assets resulting from operations of $6.1 million or $0.14 per average share for the three months ended December 31, 2021. This compares to a net increase of $13.4 million or $0.32 per average year for the three months ended September 30. Finally, our Board of Directors declared a Q1 2022 distribution of $0.41 per share, payable on April 1, 2022 to shareholders of record on March 18, 2022. Following the closing of the proposed merger with SLRC Senior Investment Corp., SLRC’s Board of Directors intends to begin declaring monthly distributions instead of quarterly. And with that, I’ll turn the call 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 mid-market financial sponsors in non-cyclical industries, and allocating a significant portion of our exposure to collateralized loans to more specialty finance verticals. At year-end, our comprehensive portfolio was just over $2 billion and remained highly diversified, encompassing over 600 distinct borrowers across 75 industries. Our largest industry exposures continue to be healthcare services, diversified financials, life sciences, and recurring software. At year-end, over 99% of the portfolio consisted of senior secured loans, 94% was invested in first lien assets and only 5% was invested in second lien. Of the second lien loans, roughly half were cash flow or 2.4% of the portfolio, and roughly 2.8% were asset-based second lien loans with full borrowing basis. At year-end, our weighted average asset level yield was 10%. By focusing on our commercial finance verticals, we’ve been able to maintain blended asset level yields around 10% despite a decrease in LIBOR and recent spread compression. Notably, we’ve been able to maintain these yields while actively reducing our exposure to second lien cash flow investments. At year-end, the weighted average investment risk rating was under two based on our 1 to 4 risk rating scale, with one representing the least amount of risk. Total originations for the fourth quarter were $340 million, and repayments were just over $260 million. In addition, we had approximately $150 million of unfunded commitments outstanding at year-end, which we expect to fund in future quarters. Now let me provide an update on each of our investment verticals. SLR sponsored finance; our sponsored cash flow portfolio was $440 million or approximately 21% of the comprehensive portfolio, and has invested across 24 borrowers. The average EBITDA of our cash flow investments was approximately $85 million, which is consistent with our focus on larger upper mid-market borrowers. During the fourth quarter, a compelling set of cash flow opportunities across healthcare, software, and financial services industries drove our originations. We originated $56 million in the fourth quarter of new and existing investments. As Michael mentioned, we’ve been able to take advantage of the broader scale of the SLR platform to underwrite larger investment positions in first lien cash flow loans to upper mid-market sponsor-owned companies. Given the sponsor communities’ preference for partnering with just a couple of lenders, each with large investment sizes, SLRC would not be able to participate in these financings without the capacity of the broader SLR platform to co-invest alongside SLRC. Recent commitments have grown to over $200 million on a given investment, which demonstrates the benefit of our platform’s ability to speak for larger transactions. We’ve also increased our commitments to the late draw term loans, which are issued by the borrowers to fund future acquisitions. These transactions offer a prudent opportunity for SLRC to grow its investments and establish credits with existing financial covenant packages. At year-end, the weighted average yield of our cash flow portfolio was just over 8%. Now, let me turn to our asset-based lending vertical, credit solutions. At year-end, this portfolio was $440 million, or approximately 21% of our total portfolio across 23 distinct borrowers. The weighted average asset level yield of this portfolio was 11.5%. In the fourth quarter, we originated $105 million of new asset-based investments and had repayments of just under $70 million. Credit solutions’ ability to assess and monitor collateral makes it an attractive financing partner during periods of economic stress when banks tend to pull back. Therefore, this business provides counter-cyclicality to a broader platform. We’re also seeing greater demand from commercial finance businesses for working capital as well as growth capital in lending strategy that our team has significant expertise in. For the quarter, SLR Credit Solutions paid a cash dividend of $5.5 million, consistent with the prior quarter. Now let me turn to our leasing business Kingsbridge. We’re now over a year into the investment in Kingsbridge and are thrilled with our results. Credit quality of the portfolio remains strong, and origination during 2021 was steady. At year-end, the highly diversified portfolio of leases across three equipment sectors, which include technology, industrial sectors, and healthcare, totaled just over $575 million, with an average funded exposure of just over a million and a quarter per obligor. This lease portfolio was 100% performing at year-end, with the majority of Kingsbridge assets being leased by investment grade borrowers. For the fourth quarter, Kingsbridge paid a dividend of $3.5 million to SLRC, consistent with the prior quarter and equating to 10.2% annualized yield on costs. Including the interest on our loan investment in Kingsbridge of $80 million, gross income generated for the fourth quarter was $5.2 million. We expect to see Kingsbridge portfolio expand during 2021, as a result of their sizable pipeline. Now let me turn to equipment finance. As a reminder, included in our equipment finance segment are financings held directly on our balance sheet as well as those held in our subsidiary SLR Equipment Finance for tax efficiency purposes. In the fourth quarter, equipment finance invested just under $60 million and had repayments of just over $40 million. At year-end, the portfolio totaled $336 million and was invested across 83 different borrowers with an average exposure of $4 million. This asset class represented 16% of our total comprehensive portfolio. Reminder, 100% of these investments are first lien. The weighted average asset level yield was 9.5%. During the fourth quarter, our comprehensive investment income across equipment finance was just under $4 million. The rebound in economic activity that started in the second half of last year and continued throughout into this year has been supportive of the performance of our equipment finance portfolio. We are seeing equipment valuations return to pre-COVID levels and an improvement in the underlying credit quality of the borrowers. Our team expects to grow this portfolio this year. Life Sciences, at year-end, our portfolio totaled just over $270 million and consisted of 15 borrowers. All of our borrowers in this asset class are currently exceeding expectations relative to the time of underwriting. Life Science loans represent 13% of the comprehensive portfolio, yet contribute 21% of our gross investment income during that quarter. The Life Science team committed over $120 million during the fourth quarter, of which $66 million was new originations; repayments and amortizations totaled $31 million. During the pandemic, our Life Science portfolio experienced lighter churn that is typical for this asset class. As we see repayments start to reoccur at a more normal cadence, realization fees and other income associated with loans will become more recurring and more consistently benefit from quarterly earnings. At year-end, SLRC had $104 million in unfunded Life Science commitments that are available for the borrowers upon reaching certain milestones. We expect these to be drawn in future quarters to fund continued growth of our Life Science portfolio. In addition, the Life Science team has a robust pipeline of new opportunities, which we also expect to fuel growth this year. The weighted average yield of this portfolio is just under 11% at cost. This excludes any success fees and warrants. In conclusion, SLRC’s portfolio activity in the fourth quarter represents a continuation of our investment themes, focusing new origination activity on first lien cash flow loans that are operating in defensive sectors, increasing our investments in specialty finance assets where we are able to secure tighter structures and more attractive risk-adjusted returns, and also growing our investments alongside existing portfolio companies by committing to delayed draw facilities, which fund acquisitions over future quarters. Across our strategies, we’re seeing a number of attractive investment opportunities. This is reflective of the solid economic rebound and increased middle market sponsor activity. The current market environment provides a great opportunity for us to continue to grow our portfolio this year. At this time, I’ll turn the call back to Michael.

Thank you, Bruce. In closing, the fourth quarter culminated in a strong year of origination for SLRC. In particular, our sponsor finance team capitalized on a strong opportunity set in our core industries. We are optimistic about earnings growth potential and the opportunity set across each of our investment verticals. With the economic recovery in full swing and our portfolio on solid footing, we are focused on deploying our capital into attractive investment opportunities. Across our investment strategies, which span cash flow, ABL, Life Sciences, and additional equipment financing and corporate leasing, we’re seeing steady origination activity which would translate into continued portfolio growth in the coming quarters. We believe that we are still in the early innings with substantial runway as financial sponsors deploy record amounts of dry powder, and more of the larger businesses we prefer to lend to choose direct financing over syndicated debt markets. These industry tailwinds combined with a scale of SLRC’s investment advisor should benefit SLRC investors by providing greater access to upper middle market cash flow investment opportunities, which as last year have proven are better positioned to protect capital than most smaller companies. Additionally, we are reaping the benefits of scale advantage in our cash flow, Life Science, and ABL verticals. As I mentioned in my opening comments, Bruce and I, as Co-CEOs and our independent directors believe that the proposed merger of SLRC and SUNS will increase our ability to deliver shareholder value through capital preservation and increased net investment income per share. We believe that now is the opportune time to merge the two companies given the benefits of greater scale, expected synergies, and ease of integration resulting from the overlap in their investment focus and the advisors’ knowledge of both portfolios. Both companies have healthy balance sheets today, and their portfolios are in excellent shape with strong credit quality, which we believe bodes well for this merger. Additional details about the merger can be found by going to www.proxyvote.com and typing in the control number that was provided in the proxy materials mailed to our shareholders. Once on the site, you can also submit your vote. We encourage you to support the merger by voting for the issuance of common stock. We appreciate your support. At 11 o’clock this morning, we’ll be hosting an earnings call for the fourth quarter 2021 results of SLR Senior Investment Corp or SUNS. Our ability to provide traditional middle market senior secured financing through this vehicle continues to enhance our origination team’s ability to meet our borrowers' capital needs, and we continue to see benefits of this value proposition in our deal flow. We appreciate your time. Operator, would you please open the line for questions?

First questions from Bryce Rowe with Hovde.

Great, thanks. Good morning. Michael and Bruce, just nice to see the balance sheet leverage continuing to build here and it sounds like pipelines are strong for potential continued balance sheet leverage increases. Any thoughts on how to think about the built-in balance sheet leverage, certainly not looking for specifics from a quarterly basis, but as you think about the build over, let’s say, the next year or two, how do you see it kind of playing out?

Yeah, I think there are a couple of moving parts as always, if you can imagine here. First of all, as we talked about, with the merger, given SLR being potentially larger than SUNS, it really doesn’t impact the leverage materially. The pro forma at year-end at 0.97 for SLR would go down close to 0.9, but nothing meaningful in terms of impact on the leverage there. So I think our goal would be to target the upper end of our range, which as a reminder, SLR’s range, the leverage is 0.9 to 1 in a quarter. We’d be targeting middle to upper end of that by the end of the year. And obviously, we don’t have visibility on repayment activity, but just on unfunded commitments that we’ve made, we can firmly see if those end up getting drawn this year, the path to getting towards that upper end.

That's useful information. Additionally, I have another question regarding the income statement and the dividends from the specialty finance sectors. As you mentioned, several of these sectors experienced reduced volumes during COVID, but we are beginning to see the portfolios recover. I am interested in your thoughts on the potential for rebuilding dividends in those specialty finance areas. What indicators do you think would need to be present to support an increase in those dividend streams? Thank you.

I believe it’s important to consider the equipment financing businesses, including both leasing and equipment finance. By year's end, we anticipate some growth in those portfolios and consequently in the underlying dividend streams. While we aim to smooth out earnings due to their variability on a quarterly basis, we assess them over a 12-month period. There is a substantial backlog in these sectors. Conversely, the credit solutions business presents more challenges due to its short-duration asset class, which leads to less consistency in repayments. Therefore, it may be less likely to see immediate growth, although there are still opportunities to expand those portfolios. It's worth mentioning that the equipment finance and corporate leasing businesses are experiencing a strong pipeline, but commitments have not yet been funded due to supply chain delays in delivering equipment to borrowers. As those delays resolve, we expect to see additional growth. Those involved would tell you it’s the strongest pipeline they’ve ever encountered. Furthermore, we are pleased that they are exceeding our initial expectations at the time of purchase. Thus, I believe there’s potential for upside, and we will revisit this as we approach the year's end.

Okay, great. I’ll step back. I appreciate the answers.

Thank you for your time.

Your next question comes from Mickey Schleien with Ladenburg.

Yes. Good morning, Bruce and Michael. I want to ask how you feel about your borrowers’ revenue and margin trends, given the tight labor markets and rising input costs, and how do you feel about their ability to service their debt with the potential rate increases that the Fed is talking about?

Yeah, that’s a great question. I think, look, the pressure is definitely there. We’re not seeing it coming into the P&Ls of our borrowers in a big way yet, but we are expecting to this year. I think, as you can appreciate, if you look across our segments, we’re blessed that our ABL businesses, yes, they look to the P&L for liquidity and cash flow to service the debt, but our underwriting thesis is based on the underlying liquidation value of its assets. Our Life Science businesses used to have no free cash flow and funds themselves off of additional equity constantly coming in from the VCs and owners. The casual business is where we feel that pressure and expect it this year, and I think the best thing one can do is try to mitigate it: a, by being in defensive, high free cash flowing sectors where you are seeing three to one interest coverage; maybe that’ll come back to more traditional norms of two to one interest coverage, but still provide substantial cushion, particularly when you think about the fact that, A, we’re in defensive sectors; B, we are dollar one first lien, so we’re going to be the last guys harmed from that margin pressure that we do expect. And then, importantly, we have floating rate investments that provide us with a bit of a hedge there, too. So we are starting to see it come in, particularly in some of the service businesses, in terms of staffing charges and the ability to attract personnel and pay up for that personnel that goes for margin pressure; early days. But again, we really don’t see that in most of our segments; we’re not in manufacturing, where you have other raw material input inflation that would impact your margins.

Yeah. Importantly, as you know, today, only 20% of our cash portfolio is in cash flow and it is concentrated in those industries that really aren’t affected. I think that’s a question that I think a lot of private equity owners who own levered equity, or high-yield bond buyers who own unsecured debt, I think that’s a much greater worry for them than someone who’s a senior secured lender like ourselves.

Yeah, I appreciate that, Michael. Just one follow-up question from me, I noticed the valuation of PPT management was down quarter to quarter. I do know that it’s moved up and down in the past, but that borrowers in the physical therapy segment, which generally has strong secular trends, so could you just give us some background on what’s going on there and what drove down its valuation?

Sure. Yeah, I think that’s a great follow-up question to your prior question. That is a business that is, to your point, physical therapy. It has a unique and dominant footprint in the Tri-state New York metropolitan area, so very attractive from a strategic perspective, which was part of our initial underwriting thesis. We have been invested, as you know, being a longtime supporter of ours, in ATI and other physical therapy businesses around the country. And this is definitely a business that we see being impacted by increased costs on the staffing side, reflecting some pressure on margins. So we tried to reflect that in our mark here. Revenues have held up nicely. It has been strong during COVID. Obviously, physical therapy is a business that one needs after certain elective surgeries and activity injuries, etc.; you need to rehab from. During COVID lockdowns, a lot of that was deferred. It picked back up in ‘21, which is why, to your point, you saw the marked recovery, as the business recovered. And then Omicron hit; again, we saw some pullback late last year, that seems to be coming back. So revenues held up nicely, but we’re definitely watching that in terms of margin pressure from staffing costs. But again, I think the fallback is, as a first lien floating rate investor rather than a junior capital or equity investor, is that there’s real strategic value for these assets across the market, particularly given their presence in the New York metropolitan area where there are not only several hospitals that do elective surgeries that would lead themselves to physical therapy, post-surgery for recovery, but also dense population trips and falls and other needs. So we’re very focused on the demand drivers here, but I do think we’re going to see some margin pressures we have recently.

Bruce, just a follow-up on the presentation, is the sponsor there? I’m assuming it’s sponsored. Do you think they would be more inclined to pursue acquisitions and a roll-up, or would they prefer to sell to someone else?

I think it’s too soon to know, but they’ve done both. Our perspective is we like where we sit in the capital structure, we like the strategic value, and we’re comfortable whether they sell it or make more acquisitions. Either way, we’d like where we’re positioned, so too soon to know. I think there will be some developments over the next couple of years here because they have been invested for a few years.

Appreciate that. That’s it for me this morning. Thank you for your time.

Thank you, Mickey.

Thanks. Your next question comes from Melissa Wedel with JP Morgan.

Good morning. Thank you for taking my questions today. First, I wanted to discuss the yield trends you’re experiencing quarter-over-quarter in cash flow and equipment finance specifically. I’d like to clarify what’s going on, especially considering the notable decline in the yield quarter-over-quarter. Is this decrease due to spread compression, or is there another factor at play?

Yeah, cash flow, I don’t think there’s been a significant change, although we have put out a number of new investments in cash flow in ‘21. And as you know, the reality is that the good cash flow loans get repaid rather quickly, which accelerates our return. So we underwrite a yield to expected that is higher than the yield to maturity, but we’re reporting yields on a yield to maturity basis, not a yield to expected basis. So to step back for a moment, leaving the reporting and accounting aside, we haven’t seen much compression, obviously, we have over the last few years. But in ‘21, we really haven’t seen much compression because the cash flow deals that came to market, by and large, and where we invested our focus on are our core industry groups and healthcare, business services, recurring software, financial services, and tends to be with sponsors who have, rather than just looking for financial help to drive the returns, really organic acquisition growth stories, and spreads have held up very nicely there. So we really haven’t seen much recent pressure aside from the compression that we saw over the last few years, but that seems to have abated in ‘21. And on the equipment finance side, we definitely just as a strategy are looking to expand our footprint. We’re finding that there are some lower-yielding assets that bring pretty attractive risk-adjusted returns, so we’re expanding the footprint of our equipment finance business to include some lower-yielding, lower-risk assets to help us scale that portfolio, which, on a net basis, because, as you know, equipment finance is a cyclical sector as apart from our corporate leasing, which is investment-grade borrowers, but the equipment finance is to small borrowers against mission-critical equipment there. It is the one part of our platform that has a little bit of cyclicality, and we’ve been mitigating that by, yes, doing a little bit lower risk, lower-yield larger borrower investments.

Okay, so that’s really helpful. It seems like your outlook, considering the strategy, particularly in equipment finance, may indicate some yield stability based on recent levels.

Yes.

Okay. Okay. I was also hoping to get an update on American Teleconferencing Services. It looks like there might have been a bit of a markdown on that one during the quarter. I was hoping to get an update. Thanks.

That’s a great question. Currently, we have one investment on non-accrual, which is also the only non-accrual at SUNS. Both portfolios are slightly affected by this asset. However, the positive aspect is that we took control of the business in the middle of last year, as we approached the third quarter. In challenging investments, understanding what you own as a lender is crucial; you have limited access to management and board insights. Taking control puts us in a strong position, as we are detail-oriented and focused on information. We believe we have marked the asset for recovery, and we have a strong management team in place that is already making significant improvements. Initially, we thought the lender group might need to inject some liquidity and working capital, but they have successfully strengthened the business's liquidity. In 2022, we will focus on planning the recovery strategy. The business has several divisions; some may be best sold while others can be grown. Although it’s not ideal to have an investment on non-accrual, we have a track record of taking control of assets, placing management teams, and being patient to optimize recovery, which is our plan for this situation.

Next question is from Paul Johnson with KBW.

Yeah, good morning, guys. Thanks for taking my questions. Good morning. So my first question is just on your guidance on ROE. It’s been running around 7% or thereabouts for the last year or two. Understanding we obviously have the base fee reduction coming up after the merger, as well as some other potential cost savings there. But also maybe a potentially lower overall yield just with the combination of the two books. So I’m just wondering, trying to get your thoughts on where you think your ROE could eventually get to following the merger?

Yeah, I would just one clarification, great question. The book at SLR Senior, to your point, does have some lower yielding cash flow assets, but it also has some high yielding ABL specialty finance businesses. So coincidentally, the yield is pretty close to the SLR yield of 10%, on a blended basis. They are similar to SLR; SUNS’ balances that or barbells it by having lower yielding cash flow, it’s just their cash flow assets are sub 7% whereas SLRs are 8%. So on a blended basis, we think that there is no dilution in terms of the yield across the combined portfolio post-merger, and I think the target, you know, should be thought of as something over 80%.

Okay, great. That’s good to hear. Thanks for that. Lastly, I’m curious about your thoughts on how you see inflation or the possibility of rising rates and a higher forward LIBOR curve affecting your various verticals, particularly in equipment finance or leasing and asset-backed sectors. Do you anticipate any pressure on asset values in those areas, and how do you expect that to impact demand for those types of funding?

Yeah, look, great question. As you know, across the majority of our verticals, we’re floating rate. We are first lien across all verticals, so that’s a great hedge there. Equipment finance does have fixed-rate assets, but also, we have a fair amount of fixed-rate borrowings, including the asset, the liabilities we just put on in Q1 and Q3 of last year. So we’ve always been very heavy; once they were probably over 60% fixed-rate in terms of reliability structure. But I also think from an inflation perspective, we are seeing values recover from the depths of COVID. And we’re seeing borrowers both in equipment financing and corporate leasing extending their leases with us, which is giving us a nice pop on earnings, as we extend those leases because they’re struggling to get new equipment to replace the equipment they’re already leasing from us. So we feel like we’re pretty well hedged there.

Okay, appreciate that. It’s very helpful. That’s all for me today.

Thank you.

Your next question is from Robert Dodd with Raymond James.

Hi, everyone. Michael, you mentioned an active portfolio of acquisition opportunities. Would you say that the potential in that pipeline is higher than usual, or is it just at your typical level of assessment? Considering Kingsbridge, which was a very successful acquisition with a great return on invested capital, is that the kind of return we might expect from future acquisitions? Can you provide any additional insights?

In general, our pipeline is definitely more active now than it was in the fourth quarter. It’s certainly picked up. We typically target a return on equity for specialty finance acquisitions between 10% and 13%, depending on the situation. This could take the form of a new platform acquisition like Kingsbridge or an add-on acquisition, as we’ve done with the business credit division of SUNS. We’re excited about merging the two entities because it enhances our acquiring capabilities. Having two separate companies imposed constraints, mainly regarding size. For instance, SUNS has a market cap of $220 million to $230 million, which restricted its ability to pursue add-on acquisitions because those targets were often too large. Now, as a combined entity with over $2 billion in assets and more than a billion dollars in net asset value, we possess a much stronger balance sheet to acquire from. This forms part of the strategic reasoning behind the merger. Regarding the broader commercial finance M&A pipeline, aside from our specific interests—which we are quite keen about given our various platforms—I would say it’s a very active marketplace right now. Many companies are coming to market. Additionally, one of our lending verticals is our lender finance business, where we’ve historically lent to social finance companies, which may lead to acquisitions. That’s how Kingsbridge came about. We currently have $80 million in loans outstanding to the private equity sponsor for over two years. This past year, we’ve significantly expanded our team, adding two senior individuals focused on sourcing not only potential acquisitions but also loans. Overall, our pipeline in the lending business is quite robust.

Got it. Got it. Thank you. I mean, put air quotes around this, have there been any holes in your path? I mean, as you’ve expanded these verticals, I mean, there’s potential, especially when you bring everything under one larger umbrella like for them to intensively be sourcing synergies and things like that. Are there any holes that you found in terms of sourcing opportunities that your existing portfolio companies see, but that you don’t have an offering in?

So that’s a great question. I would say we keep learning more and more about these niche commercial finance businesses and marketplaces as we go. So, as we talked about over at SLR Senior, we have a business that is focused on working capital financing, both in terms of ABL, revolving lines of credit, but also in terms of factoring. Well, last year, they did an add-on acquisition of a factoring business in digital media, which is an industry extension from a core competency they already had. So what I mean by this example, Robert, is that there are a number of these very fragmented businesses. There are regional expansions, there are industry-focused expansions that give us a lot of whitespace for the existing platforms that, is it a new business or an expansion; it’s something we’re not doing today, but we’re building on a core competency to leverage off of. And then I think, to Michael’s point, we often will use as we have to get into life sciences, to get into Kingsbridge, to get into so many things, especially finance, we use our lender finance R&D laboratory to lend into these asset classes prior to finding something that we might want to own control of. And I think one of the areas that we continue to sniff around and make some investments may be in the fourth quarter, is ways to look at lower-risk differentiated niche real estate opportunities, from a lending perspective, where we can try to mitigate a lot of the inherent cyclicality in the asset class and maybe look at shorter duration assets that give us comfort. So, that is an area that we continue to focus on ways that might be consistent with, A, our D&A and, B, our risk-adjusted return profile. Got it?

Thank you. I have one last question about the dividend. After the merger, the plan is to switch from quarterly to monthly payments. Can you provide any insight on why this decision was made? I understand it was a Board decision, and we have some Board members on the call. Additionally, considering the math, $0.41 doesn't divide evenly by three. While it doesn't have to be a round number, any comments you could share on that would be appreciated.

I was going to say, I guess we’ll just have to increase it. All kidding aside, I think it was something that just for simplicity purposes … although Rich would not call it simplifying, it is like getting a different handout every month. But I think, a number of our investors just like the consistency of a payment schedule on a monthly basis. So we thought it might be a good time to adopt it.

And then the current intent is to take the $0.41 and divide it by three.

Okay, fair enough. Thank you.

Thank you.

Thank you, and your next question comes from Casey Alexander with Compass Point.

Well, that’s the risk of coming in a minute 56. I was going to ask about lender finance and pipeline for acquisitions, and I was going to ask about the dividend. So my questions have been answered, thanks.

Perfect. We knew you were going to ask that, so we read your mind.

Thank you. And I'm not showing any further questions in the queue, sir.

Well, we appreciate all your support and, again, for those of you who own shares, we appreciate you voting so we can close our merger, and we’ll talk to whoever is going to be on our SUNS' call in three minutes. Thank you. Bye-bye.

And this concludes today’s conference call. Thank you for participating, and you may now disconnect.