SLR Investment Corp. Q1 FY2024 Earnings Call

Good day, everyone, and welcome to today's SLR Investment Corp. First Quarter 2024 Earnings Call. It is now my pleasure to turn the call over to Chairman and Co-CEO, Michael Gross. Please go ahead.

Thank you very much, and good morning. Welcome to SLR Investment Corp.'s earnings call for the fiscal quarter ended March 31, 2024. I'm joined today by my long-term partner of over 17 years, Bruce Spohler, Co-Chief Executive Officer, and our Chief Financial Officer, Shiraz Kajee; and the Solar Investor Relations team. Shiraz, could you please start by covering the webcast and forward-looking statements.

Thank you, Michael. Good morning, everyone. I would like to remind everyone that today's call and webcast are being recorded. Please note that they are the property of SLR Investment Corp., and any unauthorized broadcast in any form is strictly prohibited. This conference call is also being webcast on the Events County in the Investors section of our website at www.slrinvestmentcorp.com. Audio replays of this call will be made available later today, as disclosed in our May 8 earnings press release. I would also like to call your attention to the customary disclosures in our press release regarding forward-looking statements. Today's conference call and webcast may include forward-looking statements and projections. These statements are not guarantees of our future performance or financial results and involve a number of risks and uncertainties. Past performance is not indicative of future results. Actual results may differ materially as a result of various factors, including those described from time to time in our filings with the SEC. We do not undertake to update any forward-looking statements unless required to do so by law. To obtain copies of our latest SEC filings, please visit our website or call us at 212-993-1670. At this time, I'd like to turn the call back over to our Chairman and Co-CEO, Michael Gross.

Thank you, Shiraz, and again, thank you to everyone for joining our earnings call this morning. After the market closed yesterday, SLRC reported net investment income of $0.44 per share in the first quarter of 2024, representing year-over-year growth of 7.7%. First quarter results marked the sixth consecutive quarter of net investment income per share meeting or exceeding the quarterly dividend and contributed to an increase in net asset value per share to $18.19 as of March 31, 2024, from $18.09 per share at December 31, marking a sequential increase of 0.6%. Despite a continuation of slow M&A activity in the first quarter, with further strengthening in bank participation in the BSL market and recovery in CLO issuance, we continue to find attractive investment opportunities across our complementary private credit strategies of sponsor finance and specialty finance. In the first quarter, we originated new investments of approximately $261 million and received repayments of approximately $314 million, which resulted in a slight decline in the comprehensive investment portfolio to $3.1 billion. SLR is one of a handful of private credit managers that have been in existence since before the great financial crisis, and we have the experience and strong track record of navigating various market environments and credit cycles over our 20-year history. The cyclicality of the sponsor finance markets, which can be governed by the ebbs and flows of the markets, is a condition that is not new to us. In fact, it is this condition that led us to diversify our investments away from strictly cash flow lending more than a decade ago to asset-based lending in 2012. Since then, SLRC has added several commercial finance teams to expand our investment strategies, resulting in a more diverse private credit investment model. Our multi-strategy approach to private credit investing was showcased in the first quarter as lending-friendly conditions existed in 2023 in Sponsor Finance. Originations of $220 million from SLRC specialty finance investment verticals of asset-based lending, life sciences lending, and equipment finance represented approximately 88% of total originations in the quarter. Said another way, only 20% of our first quarter originations were sponsor finance, a significant reversal of last year's trend where sponsor finance originations comprised close to half of total originations in the first quarter of 2023. While we expect the 2020 vintage for sponsor finance investments to be very strong for both us and the private credit industry more broadly, our flexible investment mandate allows us to shift to areas of less competition currently existing in the sponsor finance market. Management teams and sponsors are increasingly exploring ways to raise new capital to support owning assets over a longer time frame to execute their business plans. This has resulted in an increasing opportunity for asset-based loans and liquidity solutions as middle market companies grapple with lower free cash flow and tighter working capital. ABL originations were more than $50 million in the quarter. Post-quarter end, we have closed some attractive new ABL investments and have a strong pipeline of ABL investment opportunities. We've also started to see some green shoots in the life science market following a period of muted transaction activity in 2023. In the first quarter, we originated $24 million via both new deals and DDTL draws based on borrowers hitting certain performance milestones. This activity exceeded originations for the first half of 2023. Equity valuations for both private and public life science companies have begun to stabilize, with credit investment opportunities improving. In equipment finance, the transition from banks to non-banks continues to evolve rapidly, and our team's deep industry expertise across a wide range of equipment solutions allows us to be a solution provider for both large and small companies. We continue to be pleased with the construction, quality, and performance of our portfolio. At quarter end, approximately 98% of our comprehensive investment portfolio was comprised of first lien senior secured loans. SLR's long-standing focus on first lien loans has resulted in a portfolio which we believe is more conservatively positioned and better equipped to withstand persistent inflationary pressures and high interest rates than portfolios with second lien and broader cyclical exposure. As of March 31, our investments in non-accrual represented 0.8% and 0.6% of the investment portfolio on a cost and fair value basis, respectively. We believe our low rate of non-accruals relative to the BDC sector is a result of our multi-strategy approach to our specialty finance strategies, which accounted for 75% of our comprehensive portfolio at March 31, enabling us to be more selective in our sponsor finance investments. In sponsor finance, the average EBITDA and revenue growth continues to be positive for our portfolio companies. Overall, they have successfully managed the transition to an environment with a higher cost of capital and inflation. The weighted average interest coverage on our sponsor finance loans has held steady at approximately 1.7x. Additionally, importantly, only 1.8% of our first quarter gross income is in the form of capitalized PIK income from cash flow borrowers resulting from amendments. We believe these healthy metrics are the result of our focus on sponsor finance in recession-resilient industries with high recurring free cash flow, such as healthcare, business services, and financial services. The credit quality of our specialty finance investments continues to be solid with attractive LTVs that have meaningful collateral support and borrowing base structures. With the refinancing market open only to the best credits, sponsors are now focused on the remainder of their portfolios in a higher for longer rate environment. While we are optimistic that M&A will increase in the back half of the year, current activity remains centered on DTL draws and amended extensions, which we are addressing very prudently. As of March 31, including available credit capacity at SSLP and our specialty finance portfolio companies, we have approximately $800 million of available capital to deploy. From our perspective, we believe SLRC is in a favorable position to take advantage of continued durable economic conditions or a softening economy. I'll turn the call now back over to Shiraz to take you through the first quarter financial highlights.

Thank you, Michael. SLR Investment Corp's net asset value at March 31, 2024, was $992 million, or $18.19 per share, compared to $987 million, or $18.09 per share at December 31. At quarter end, SLRC's on-balance sheet investment portfolio had a fair market value of approximately $2.1 billion and 145 portfolio companies across 41 industries compared to a fair market value of $0.2 billion in 151 portfolio companies across 43 industries at December 31. At March 31, the company had approximately $1.2 billion of debt outstanding with leverage of 1.16x net debt to equity. We expect our leverage ratio to remain in the middle of our target leverage range of 0.9 to 1.25x. SLRC's funding profile is in a strong position to continue to weather the current interest rate environment. Our existing $470 million of senior unsecured fixed notes have a weighted average annual interest rate of only 3.8%. We expect to opportunistically access the investment-grade debt market and are always in dialogue with investors in the fixed-income community. Moving to the P&L. For the three months ended March 31, gross investment income totaled $58.1 million versus $59.8 million for the three months ended December 31. Net expenses totaled $34.2 million for the three months ended March 31. This compares to $35.9 million for the prior quarter. Accordingly, the company's net investment income for the three months ended March 31, 2024, totaled $23.9 million or $0.44 per average share, the same as the prior quarter. Total line, the company had net realized and unrealized gains for the first quarter totaling $4 million versus a net realized and unrealized loss of $0.3 million for the fourth quarter of 2023. As a result, the company had a net increase in net assets resulting from operations of $27.9 million for the three months ended March 31 compared to a net increase of $23.6 million for the three months ended December 31, 2023. On May 8, the Board of Directors declared a Q2 2024 distribution of $0.41 per share payable on June 27, 2024, to holders of record as of June 13, 2024. With that, I'll turn the call over to our Co-CEO, Bruce Spohler.

Thank you, Shiraz. We believe that SLRC's commercial finance investment model provides us with the flexibility and capabilities to capitalize on the most attractive lending opportunities across our four private credit investment strategies. This diversity provides us with the flexibility to determine where we want to invest today and importantly, the ability to say no. We take a fundamental bottom-up approach to our portfolio construction based on the relative attractiveness or risk-adjusted returns across our investment verticals. At quarter end, on a fair value basis, the comprehensive portfolio consisted of $3.1 billion of senior secured loans to approximately 800 distinct borrowers across 110 industries with $3.8 million as our average position. Measured at fair value, 99.3% of the portfolio consisted of senior secured loans, with 97.8% invested in first lien loans, including investments in the SSLP attributable to the company. Only 0.3% was invested in second lien cash flow loans, with the remaining portfolio invested in second lien asset-based loans aggregating 1.2%. Our specialty finance investments account for approximately 75% of our comprehensive portfolio, with the remaining 25% invested in senior secured cash flow loans to upper mid-market sponsor-backed companies. We believe that this defensive portfolio construction positions us well for potential economic weakness and provides a differentiated risk-return profile for our shareholders compared to cash flow-only portfolios. At quarter end, our weighted average asset-level yield was 11.8%, up from 11.6% in the prior quarter. Our portfolio credit quality remains strong. At March 31, the weighted average investment risk rating of our portfolio was just under 2 based on our 1 to 4 risk rating scale, with 1 representing the least risk. Consistent with last quarter, over 97% of the portfolio is rated at 2 or higher, and 99.2% of the portfolio on a cost basis and 99.4% on fair value were performing, with only 2 investments on non-accrual. Now let me turn to our four investment strategies. In our Sponsor Finance business, we originated first lien senior secured loans to upper mid-market companies in non-cyclical industries, such as healthcare, business services, and financial services, which has helped us mitigate the impact from cyclical economic factors. At quarter end, our Sponsor Finance cash flow portfolio was approximately $750 million, which includes loans in the SSLP attributable to the company. This was invested across 48 distinct borrowers. With approximately 99% of this cash flow portfolio invested in first lien loans, we believe our investments are well positioned to withstand liquidity pressures that borrowers may face in today's environment. Additionally, we believe we have a defensively positioned portfolio. Our cash flow borrowers have a weighted average EBITDA of approximately $125 million, carry low LTVs of approximately 40%, and interest coverage of approximately 1.7x, consistent with last quarter. Our portfolio is comprised of businesses that perform essential services with either recurring or reoccurring revenues and have low capital intensity. Overall, our portfolio has exhibited solid credit metrics that have remained steady throughout this year. During the quarter, we originated $33 million of cash flow loans and experienced repayments of $16 million. Our first quarter investments, all of which were first lien, have an average yield to expected maturity of 12.2% and leverage through our investment of 3.8x. Importantly, this leverage level is less than the historical average for new issues. As Michael mentioned, Sponsor Finance deal flow continues to be muted due to lower M&A volume. However, there are pockets in our defensive industries to invest on an attractive risk-adjusted basis. At quarter end, the weighted average cash flow yield was just under 12%. Now let me turn to our ABL segment. In the wake of the U.S. regional banking crisis last spring, the opportunity set for all of our ABL businesses has increased. As lending standards tightened at commercial banks, we saw an increase in ABL flow. As a result, we were able to originate several attractive new investments. As new entrants with less experience have entered the space, we've remained committed to our high underwriting standards, focusing on the quality of the underlying collateral when determining acceptable loan-to-value lending ratios. The increase in our deal volume is enabling us to remain attractive and active while being extremely selective. At quarter end, our ABL portfolio totaled $930 million, representing 30% of our total portfolio and was invested in 166 different borrowers. The weighted average asset-level yield was 15.7%, compared to 14.5% in the prior quarter. For the first quarter, we had $53 million of new investments and repayments of $103 million across our ABL strategies. Now let me touch on Equipment Finance. At quarter end, this portfolio totaled $1 billion, representing one-third of our total portfolio and was highly diversified across 550 borrowers. The credit profile of this portfolio continues to be solid. The weighted average asset-level yield was approximately 8%. During this quarter, we originated approximately $150 million of new investments and had repayments of approximately $143 million. Our investment pipeline has expanded in conjunction with the disruption caused by last year's regional bank failures. Finally, let me touch on Life Sciences. At quarter end, this portfolio totaled $338 million. Over 80% of our portfolio at par is invested in loans to borrowers that have over 12 months of cash runway. Additionally, all of our life science companies are generating revenue with at least one product in the commercialization stage. This significantly derisks our underlying investment. Life Science loans represented 11% of the portfolio and contributed over 22% of our gross investment income for the quarter. During the first quarter, the team funded $24 million of new investments and had repayments of $52 million. At quarter end, the weighted average yield was approximately 13% on our life science loans, excluding the addition of potential success fees and warrants. While we expect valuations in the life sciences market to stabilize this year, we continue to see several new opportunities that we believe will meet our underwriting criteria. Given SLRC's ability to allocate capital to the best risk-reward opportunities, we have the luxury of being highly selective in our capital deployment towards life sciences while still generating positive originations for the company overall. Lastly, I want to touch on the company's investment in SSLP. SSLP was a strategic initiative which we put in place at the end of 2022 following the merger with SLR Senior Investment Corp. This was to rotate some lower-yielding cash flow loans from Sun's portfolio. Six quarters after launching the initiative, we are pleased with the ramp of the portfolio and the income it has delivered thus far. In the first quarter, SLRC earned $1.6 million from the SSLP program, representing a 13.6% annualized yield. This compares to earnings of $1.1 million last quarter, which was an annualized yield of 10.3%. As of quarter end, investment commitments at the SSLP totaled $238 million. Post-quarter end, we have invested an additional $6 million in the SSLP, bringing our total commitments to $244 million. Now let me turn the call back to Mike.

Thank you, Bruce. In conclusion, we are pleased with the results achieved at SLRC in the first quarter of 2024. The continued momentum we are seeing across the lending verticals and the credit quality and diversity of our investment portfolio remains strong. Asset quality remains a top priority for investors today, with tight risk premiums priced across risk assets. From our perspective, we have started to see the dispersion in credit quality metrics within the private credit marketplace and believe our history of conservatism and predominantly first lien investment portfolio with significant diversification has begun to differentiate our performance. As of March 31, non-accrual investments represented 0.8% and 0.6% of the investment portfolio on a cost and fair value basis, respectively. We believe our low rate of non-accruals is a result of a multi-strategy approach, with our specialty finance strategies which accounted for 75% of our comprehensive portfolio at March 31, allowing us to be more selective in our sponsor finance business. Furthermore, only 1.8% of our gross investment income is in the form of capitalized PIK on restructured cash flow loans, which we believe is also significantly below peers. Looking forward, we expect origination opportunities to be driven by a combination of an increase in M&A activity, refinancings, and regulatory forces impacting regional banks to the benefit of direct lenders such as SLRC. In addition, our specialty finance teams continue to seek tuck-in acquisition opportunities and have the resources and experience to acquire portfolios. We continue to believe that a diversified portfolio approach across sponsor and commercial-enhanced assets is the most effective way to generate income and manage risk across economic cycles. While current market expectations are for rates to stay higher for longer, it is essential to remember that specialty finance spreads and returns are not as volatile as cash flow sponsor finance investments. As a result, we do not expect yield contraction for specialty finance assets to the same extent as sponsor finance when base rates move lower. In closing, SLRC trades at a 10.5% dividend yield as of yesterday's market close, which we believe presents an attractive investment for both income-seeking and value investors and offers shareholders diversification benefits compared to sponsor finance-only strategies. Our investment buyers align interests with SLRC shareholders, which continues to be one of our hallmark principles. The SLR team owns over 8% of the company's stock and has a significant percentage of their annual incentive compensation reinvested in SLRC stock. The team's investment alongside fellow institutional and private wealth investors demonstrates our confidence in the company's portfolio, stable funding, and earnings outlook. We thank you all again for your time today. We especially appreciate your attendance, given that it’s a particularly busy day for those who have closely followed the listed BDC marketplace. Operator, would you please open up the line for questions.

And we will take our first question from Eric Zwick with Hovde Group.

I wanted to start by getting your view of competition in both the ABL and equipment finance markets. I know you mentioned in your prepared comments that there are a couple of new entrants that you've seen in the ABL market. I was wondering if you could elaborate on what type of companies those are that are entering the market and how you see that might impact pricing and underwriting terms.

Yes, I think the most important takeaway is that the magnitude of participants departing far exceeds any new entrants. Historically, regional banks were very active in these markets, but they have been pulling back or seeking ways to joint venture in their business model such that we become their balance sheet while they retain relationships and deposits. So we're not overly concerned about new entrants. The competition is tough to enter these businesses, particularly on ABL, due to the significant infrastructure investment required. As you know, we have 18 offices around the country and a major investment in systems and personnel. We have 300 people across our $13 billion AUM platform, many of whom are dedicated to our ABL strategies for monitoring underlying collateral and borrowing bases. While there is still competition, we believe the environment has become less competitive overall. Given where we are in the economic cycle, borrowers tend to borrow more on an ABL basis at this stage of the cycle since many are finding the cash flow market closed to them if they are not in recession-resilient sectors.

That's very helpful. I appreciate that, and it's good to hear you frame it as there have been many more exits than new entrants. We've heard reports from several companies that there has been a fair amount of spread compression in the sponsor finance market. Is it safe to say you're not seeing this to the same extent in the specialty finance lending verticals?

Yes, as Michael mentioned, our overall yield increased from 11.6% to 11.8% quarter-over-quarter. This is driven by increased returns on the ABL asset classes. There is a cap to this increase; however, the key point is that we don't see the same compression as you mentioned. Our specialty finance strategies are more absolute return cost-of-capital strategies and have not widened out as drastically as cash flow did over the last two years, which increased from 6% and 7% to 12% and 13%. We have not experienced this compression to the same extent; our correlation analyses suggest that specialty finance businesses, in contrast to cash flow businesses, are not meaningfully correlated to movements in base rates. As you know, even with elevated base rates, we are seeing pricing compression due to the amount of capital entering the cash flow market relative to the available deals.

We will pause for a moment to allow any further questions. We'll take our next question from Melissa Wedel with JPMorgan.

Just one for you today. I was hoping you might elaborate a little bit on your comment about having the willingness and availability of capital to pursue additional tuck-ins. Obviously, you guys have diversified your strategy and origination approach over the years. When looking at that portfolio in totality, where are you seeing the potential for additional tuck-ins? Would it be within the same verticals that you have existing now, or are there other opportunities out there?

Yes, it would be within the same verticals, predominantly across the asset-based strategies. Anything we would do as an adjacent vertical would more likely be an organic approach to that side of the market. The tuck-in opportunities are definitely coming from our existing ABL strategies.

This allows us to take advantage of the significant investment we've made in infrastructure at those companies. As you know, we have close to 300 people, many of whom are spread through the ABL strategy. This positions us well to acquire portfolios and service them without needing to add much more overhead to those entities.

It appears there are no further questions at this time. I will turn the call back over to Michael Gross for any closing comments.

No closing comments other than thank you for your attendance this morning. We realize it is a very busy time. If you have any follow-up questions, please feel free to reach out to any of us. Thank you.

Thank you. This does conclude today's program. Thank you for your participation. You may disconnect at any time.