SLR Investment Corp. Q3 FY2024 Earnings Call

Good day, everyone and welcome to today’s Third Quarter 2024 SLR Investment Corp. Earnings Call. Please note this call is being recorded. And I will be standing by if you should need any assistance. It is now my pleasure to turn the conference over to Michael Gross, Chairman and Co-CEO.

Thank you very much and good morning. Welcome to SLR Investment Corp.’s earnings call for the quarter ended September 30, 2024. I am joined here today by my longtime partner of 18 years, Bruce Spohler, Co-Chief Executive Officer, our Chief Financial Officer Shiraz Kajee and the SLR Investors Relations team. Shiraz, before we begin, would 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 Calendar in the Investors section on our website at www.slrinvestmentcorp.com. Audio replays of this call will be made available later today as disclosed in our November 6 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 a number of factors, including those described from time-to-time in our filings with the SEC. We did 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 for everyone for joining our earnings call this morning. After the market closed yesterday, SLRC reported net investment income of $0.45 per share for the third quarter of 2024 consistent with the prior quarter and representing distribution coverage of approximately 110%. Given that base rates declined for the first time in four years and conditions in the sponsor finance market remain fiercely competitive in the third quarter, we are pleased with the stability of our quarterly net investment income. Additionally, as a testament to the overall credit quality of our portfolio, our net asset value remained at $18.20 per share. We believe our stability is a direct result of our conservative underwriting philosophy and multi-strategy approach to private credit investing with approximately 78% of our loan portfolio derived from specialty finance investments supported by collateral and the remainder in cash flow loans to borrowers in recession-resilient industries, as of September 30. Due to the more favorable conditions in our specialty finance markets, our investments in the third quarter were once again more heavily weighted in those asset classes, which we believe currently provide a more attractive risk-adjusted return relative to sponsor finance loans. 96% of our third quarter originations were in specialty finance, much higher than our historical mix. We believe our ability to pivot to the best risk-adjusted return across our private credit strategies is a hallmark of SLR’s multi-strategy allocation approach. Increasingly, private credit investors are looking for proprietary investment strategies and less correlated portfolios across their BDC investments, which we believe is clearly visible in our results, our portfolio composition and momentum we have achieved year-to-date. Within our specialty finance businesses, we are seeing a combination of an increase in organic and strategic opportunities to expand our portfolio and product offering. Across our ABL strategies, our ongoing bank consolidation and risk reduction are driving commercial banks to exit non-core business lines and consider strategic partnerships, resulting in an increase in investment pipelines for our ABL teams. At the end of the third quarter, SLRC's portfolio company, SLR Business Credit, capitalizes on this dynamic by acquiring an asset-based factoring portfolio and operations from Webster Bank’s Commercial Services division in an asset purchase that included a seasoned portfolio and a small team of professionals. The $124 million factoring portfolio is diversified with loans to long-standing customers. The team of 14 professionals, which is based in New York specializes in providing financing solutions to middle-market companies with a focus on apparel, textile jewelry, and transportation businesses. The low to mid-teens returns and cumulative loan loss rate experience in this factoring business make the asset class an attractive addition to our ABL portfolio. Additionally, the acquisition of the team enhances our suite of ABL financing capabilities, expands our expertise in lending to new industry verticals, and deepens our extensive geographic coverage. This transaction represents SLR Business Credit's fourth tuck-in acquisition under our ownership. Importantly, it is indicative of the opportunities that we are seeing from regional banks retreating in certain direct lending asset classes. We have a strong pipeline of potential additional acquisitions that our team is currently evaluating. Given that our ABL businesses have not experienced a degree of increased competition at Sponsor Finance, we are able to remain highly selective in cash flow lending. We achieved this by focusing on recession-resilient industries and not feeling beholden to recommitting to loans and refinancing that no longer meet our underwriting thresholds. All that said, with the election uncertainty behind us, we believe that the supply/demand dynamic in the Sponsor Finance market has the potential to improve from accelerating merger and acquisition activity and new capital formation. Our flexible approach enables us to allocate capital to new Sponsor Finance investments when market conditions improve. As an example, in 2023, our origination mix was heavily weighted towards cash flow loans. SLRC's comprehensive portfolio had originations of $397 million and repayments of $328 million in the third quarter, resulting in net portfolio growth of $68 million. 96% of originations were from SLRC specialty finance verticals. Said another way, only 4% of our third quarter originations were in Sponsor Finance, a continued reversal from last year when originations were concentrated in Sponsor Finance. We remain pleased with the composition, quality performance of our portfolio. At quarter end, approximately 97% of our comprehensive investment portfolio was comprised of first lien senior secured loans. Our 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 compared to portfolios with second lien and broader circa exposure. As of September 30, we only had one investment on nonaccrual, representing 0.6% and 0.4% of the investment portfolio on a cost and fair value basis, respectively. We believe our low rate of non-accruals is a result of our multi-strategy approach and is well below the peer BDC average. At September 30, including available credit facility capacity at SSLP and our specialty finance portfolio companies, SLRC had over $750 million of available capital to deploy. From our seats, we believe SLRC is in a favorable position to take advantage of either durable economic conditions or a softening of the economy. I'll now turn the call back over to Shiraz, our CFO, to take you through the Q3 financial highlights.

Thank you, Mike. As well our Investment Corp net asset value at September 30, 2024, was $993 million or $18.20 per share, consistent with the quarter ended June 30, 2021. At quarter end, SLRC's on-balance sheet investment portfolio had a fair market value of approximately $2.1 billion and 131 portfolio companies across 34 industries, compared to a fair market value of $2.1 million and 138 portfolio companies across 37 industries at June 30. At September 30, the company had approximately $1.1 billion of debt outstanding with a net debt-to-equity ratio of 1.1x. We expect our net debt to equity ratio to remain in the middle of our target range of 0.9x to 1.25x. SLRC's funded debt consisted of 58% in revolving credit facilities and 42% of fixed rate unsecured notes at code. During the quarter, the company amended both its senior secured credit facility and SUNS SPV credit facility agreements. Extending our maturities and increasing commitments. The company's $470 million of senior unsecured fixed rate notes have a weighted average annual interest rate of 3.8%. We remain in dialogue with the fixed income community and expect to opportunistically access the investment-grade market to address near-term maturities. Moving to the P&L. For the three months ended September 30, gross investment income totaled $59.8 million versus $59 million for the three months ended June 30. Net expenses totaled $35.4 million for the three months ended September 30. This compares to $34.7 million for the prior quarter. Accordingly, the company's net investment income for the three months ended September 30, 2024, totaled $24.3 million or $0.45 per average share, consistent with the prior quarter and more than covered our $0.41 per share distribution during the period. Below the line, the company had a net realized and unrealized loss for the third quarter of $2.3 million versus a net realized and unrealized loss of $1.1 million for the second quarter. As a result, the company had a net increase in net assets resulting from operations of $22 million for the three months ended September 30 compared to a net increase of $23.2 million for the three months ended June 30. On November 6, the Board of SRC declared Q4 2024 quarterly distribution of $0.41 per share payable on December 27, 2024, to holders of record as of December 13.

Thank you, Shiraz. Given the current competitive sponsor finance cash flow market, the flexibility offered by our commercial finance strategies enables us to source attractive investment opportunities away from this competitive cash flow market. We take a fundamental bottom-up approach to our portfolio construction based on the relative risk-adjusted return profile across our investment verticals. At quarter end, on a fair value basis, the comprehensive investment portfolio consisted of approximately $3.2 billion of senior secured loans to over 850 borrowers. The average exposure per borrower is $3.7 million. Measured at fair value, over 98% of our portfolio consisted of senior secured loans, with just under 97% invested in first lien loans, including investments in the SSLP attributable to the company and only 0.2% was invested in second lien cash flow loans. With the remaining 1.2% of the portfolio invested in second lien asset-based loans. Our specialty finance investments account for approximately 78% of the comprehensive portfolio. With just over 22% invested in first lien cash flow loans to upper mid-market sponsor-backed companies. We believe this defensive portfolio construction positions us well and provides a differentiated risk return profile relative to sponsor finance only portfolios. At quarter end, our weighted average yield on the comprehensive portfolio was 11.8%. Our portfolio credit quality remains strong. At quarter end, 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. Over 98% of the portfolio is rated 2 or higher at quarter end. Additionally, 99.4% of the portfolio on a cost basis and 99.6% on a fair value basis was performing with only one investment on non-accrual. Now, let me touch on each of our 4 investment verticals. Sponsored finance or cash flow lending. In this business, we originated first lien senior secured loans to upper mid-market companies in non-cyclical industries, such as health care, business services, and financial services. This has helped to mitigate the impact on the portfolio from cyclical economic factors. At quarter end, our sponsor finance cash flow portfolio was $714 million, including senior loans in our SSLP, representing 22.4% of the comprehensive portfolio. It was invested across 45 borrowers with approximately 99% of the portfolio invested in first lien loans. Our borrowers have a weighted average EBITDA of approximately $132 million, EBITDA of $65 million and carry low LTVs of just over 42%. Sponsor Finance, the average EBITDA and revenue growth continues to be positive across our portfolio companies. Overall, our borrowers have successfully managed the transition to an environment with higher cost of capital, as well as inflationary premiums. The weighted average interest coverage for our sponsor cash flow loans has been stable at approximately 1.8 times. Additionally, only 1.7% of our third quarter gross income is in the form of capitalized PIK interest from cash flow borrowers, resulting from amendments. We believe these healthy credit metrics are the result of the diversity of our investment portfolio across private credit strategies. And our focus in sponsor finance on recession-resilient industries with high recurring free cash flow. While M&A has picked up in the second half of this year, activity levels are still well below the historic norm. This has caused much of the private debt activity to remain centered on repricings and dividend recaps. With the resulting spread compression and weaker structural protections, we are remaining highly selective in our cash flow investments. However, we are optimistic that the sponsor finance conditions will improve next year as sponsors seek to return capital to their LPs through exits. During the quarter, we made investments of $14.5 million in sponsor first lien loans and experienced repayments of just under $39 million. Michael mentioned sponsor finance deal flow continues to be muted due to the lower M&A volume. However, there are pockets of opportunities in our defensive sectors to invest at attractive risk-adjusted returns. At quarter end, the weighted average yield on our cash flow portfolio was 11.1%. Now let me turn to our specialty finance segments. Across the board, the credit quality of these loans continues to be solid with attractive LTVs supported by meaningful collateral. I'll first discuss our ABL portfolio. At quarter end, this portfolio totaled $1.1 billion, representing 35% of our total portfolio. It was invested in 262 different borrowers. The weighted average asset level yield was 14.4%. We continue to see an increase in the opportunity set for ABL resulting in a strong pipeline heading into year-end. Money center and regional domestic banks have been pulling back from the ABL market, creating an attractive opportunity for our team. Additionally, banks' ability to pledge asset-based loans or factoring loans as collateral for borrowing with the Fed has been reduced. SLR is positioned to collaborate with banks who are shifting their ABL strategies in reaction to these challenges. Our recent acquisition of the loan portfolio and servicing platform from Webster Commercial Services is an example of this type of opportunity. We're currently involved in other strategic discussions regarding either purchasing portfolios, joint ventures, or referral programs. Additionally, we'll continue to see opportunities to provide ABL structured facilities to traditional cash flow borrowers who are facing liquidity pressures. Borrowers who have traditionally accessed the cash flow market are now more receptive to SLR’s ABL solutions to provide working capital financing. These ABL facilities far about working capital assets from our borrower into a borrowing base that supports an incremental ABL facility ahead of their cash flow facility and provides additional liquidity for our borrowers. For the third quarter, we had $244 million of new ABL investments, including the Webster acquisition and repayments of $107 million. Turning to equipment finance. At quarter end, this portfolio totaled $1.1 billion, representing a third of our comprehensive portfolio with facilities across 540 borrowers. Credit profile of this portfolio continues to be stable. Weighted average asset level yield was 9.4%. During the third quarter, we originated $138 million of new assets with the majority of this coming from our business that provides leases to investment-grade borrowers for their mission-critical equipment. We had repayments of approximately $104 million. Our investment pipeline has expanded in conjunction with the disruption caused by last year's regional bank failures as well as the expansion of our vendor finance program. Now let me turn to Life Sciences. At quarter end, this portfolio totaled $267 million. Approximately 90% of the portfolio is comprised of investments in borrowers that have over 12 months of cash runway. Additionally, all of our portfolio companies have revenues with at least one product in the commercialization stage, which significantly derisks our life science investment. These investments represented 8.4% of the total portfolio for the third quarter and contributed over 25% of our gross investment income. The life science industry continues to be somewhat challenged, with 28% of the deals to date being invested in down or flat rounds, which is the highest level in recent history. Many small cap and private biotech values have remained significantly lower than their pre-Silicon Valley Bank collapsed highs and over $300 billion of VC dry powder has remained mostly on the sidelines waiting for valuations to reach a better equilibrium, particularly in later stage development companies where we invest. While SLR's portfolio has held up well, in part due to our focus on late-stage post-commercialization life science companies, there has been an increase in defaults in life science portfolios due to weaker lender protections that prevailed in the market prior to the collapse of Silicon Valley Bank. A forward-looking rate environment should result in a more normalized life science lending activity, but it will also slow the process and we anticipate current conditions to persist for at least another couple of quarters. Venture debt financing in healthcare-related IT service companies has been active. But due to the lack of IP protection and other collateral that we require, SLR has remained on the sidelines. In addition to sourcing new opportunities in late-stage drug development and device companies, we remain focused on supporting and in some cases expanding our existing portfolio of borrower relationships. By keeping healthy life science credits longer and increasing our credit facilities to finance their growth, we have been able to maintain meaningful exposure to this asset class during a challenging time for the life science industry broadly while maintaining a comfortable level of diversity. During the third quarter, the team funded $1 million of new facilities and had $78 million of repayments. At quarter end, the weighted average yield on our life science portfolio was 12.6%, including potential success fees, however, excluding any potential warrant gains. With early signs of improvement in the life science market, we've seen a modest uptick in private and public equity valuations as well as in our investment pipeline. Given our ability to allocate capital to the best risk-reward opportunities across our various private credit asset classes, we have the luxury of being highly selective as we look to deploy capital in life sciences, while still generating positive originations across the entire platform. Lastly, let me touch on our SSLP. During the quarter, SLRC earned $1.9 million from SSLP, representing a 15.7% annualized yield, consistent with the prior quarter. At quarter end, it had a fair value of $204 million, including unfunded commitments, investment at SSLP totaled approximately $219 million.

Thank you, Bruce. In conclusion, we remain pleased with the stability achieved in our third quarter results and encouraged by the overall credit quality of our investment portfolio, which is evidenced by another quarter of NAV stability, no changes to a low level of non-accrual investments, a low level of watch list investments and minimal payment-in-kind income with broad diversification. While concerns about credit quality and private credit portfolios continue to creep into the market psyche, we view the consistency of results achieved in 2024 as a testament to our multi-strategy approach to private credit investing. As we sit here today and observe the growth in our platform over the last few years that has expanded our diversified commercial finance investment capabilities and momentum across our business, we believe the company is positioned very favorably. Market expectations for the shape of the forward interest rate curve remain dynamic on the heels of this week's elections, but do continue to include declines in base rates throughout 2025. This situation may present a challenge for some private credit portfolio yields and earnings that are constructed with predominantly floating rate cash flow loans vintage concentrations. With approximately 35% of our portfolio indexed to fixed rates, investors should come to appreciate that SLRC specialty finance assets have a lower correlation to base rates and offer a more substantial, more absolute return-like profile, and the company, therefore, has portfolio yields that are expected to have a lower beta to future changes in SOFR. In closing, SLRC trades at a 10.7% dividend yield as of yesterday's market close, which we believe presents an attractive investment for both income-seeking and value investors and offer shareholders portfolio diversification benefits compared to cash flow-only strategies. Our investment adviser's alignment of interest with SLRC shareholders continues to be one of our significant hallmark principles. The entire investment team and the entire firm own over 8% of the company's stock and includes having a significant percentage, other 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. As we know, it's a busy time for those that have followed the listed BDC marketplace closely. Operator, will you please open the line for questions.

Thank you. We will take our first question from Bryce Rowe with B. Riley. Please go ahead.

Thanks. Good morning.

Good morning, Bryce.

I wanted to, I guess, just kind of a quick one here on business credit and the Webster acquisition, you put some equity into that subsidiary, the SLR business credit subsidiary. And kind of curious what your thoughts are around maybe increased dividend or increased earnings from that particular investment. I mean, again, it's really early days in terms of the investment, but certainly expecting some level of increased return there? Thanks.

Yeah. We definitely are expecting some increased return. I think in the first quarter or so, it will start a little bit slower as we integrate the business into the platform. We did buy a business that came with about 14 people as well as a $125 million or so portfolio. So we're targeting a low to mid-teens ROE on that investment. So I think if you put that across the $30 million or so of equity that we dropped in, that's a good starting point, and we hope there's upside from there.

Okay. That's helpful, Bruce. Maybe a couple more here. As we think about the SLR senior credit, are you at a level where we're leverage within that particular portfolio? Is it where you want to be? Or would you like to operate it with potentially more leverage?

I think the leverage is where we want it to be. We are thematically, as Michael mentioned, rotating out of cash flow loans and the entire strategy at SSLP is cash flow investing. So you'll see it bump around a little bit as we get some repayments and opportunistically add to it. So I don't think there's much more leverage there, I think there's a little bit more upside as we optimize the size of SSLP, but we'll let a few loans go in this repricing environment.

Yes. Okay. And then maybe one more around the repricing environment. We've heard a lot about the potential for M&A to pick up to help maybe, I guess, remix the supply and demand within private credit as it relates to cash flow lending. Do you all sense that there could be an opportunity to maybe to reemerge within that market now that you're pivoting and just kind of trying to get a feel for how long the pivot lasts and how opportunistic you all can be with the current market environment?

I think the first thing that happens is, to your point, it takes the pressure off the existing portfolio because everyone starts to underwrite new opportunities, which shifts the supply dynamic and makes it difficult for borrowers to come in and reprice the existing portfolio. From our perspective, we reduced our portfolio from 26% in sponsor finance to 22%. Last year, we peaked at over 26%. So it will fluctuate for us. We never see it much more than the high-20s, and we don't expect it to drop below the high to mid-teens. Therefore, we are looking for new opportunities, but the initial benefit is certainly alleviating the pressure on the existing portfolio from a repricing perspective.

I do think though that there's been so much money raised for just sponsor finance that it's not going to change the yield that we're seeing dramatically at all. What it does do for us, given how picky we are in cash flow lending, it gives us more opportunity to choose amongst and find things that fit our type box. But I would not sit here today and assume that spreads are going to widen dramatically just because there's more M&A supply coming.

Yes. Okay. All right. Appreciate your perspective.

Thanks for your questions.

Thank you. And we will take our next question from Melissa Wedel with JPMorgan. Please go ahead.

Good morning. Thanks for taking my questions today. I was hoping you could elaborate a little bit more on the assets that were acquired in that factoring portfolio. Can you just talk a little bit about how those maybe provide some or do they diversify the rest of that existing portfolio? And then are they sort of fixed rate or floating rate assets, appreciate it?

Thank you for the question, Melissa. All the assets are floating rate and align with our current platform, which is based on either factoring or an ABL structure that lends against receivables. We are very familiar with the collateral involved. This adds a layer of diversity, as we have around 94 different borrowers across the $124 million of funded assets, resulting in a diverse portfolio with an average investment of about $1.3 million per borrower. The yields are in the low to mid-teens, and losses are minimal because, in factoring, we're lending against high-quality receivables from companies like Walmart, Costco, and Amazon, even though our customers may have different credit qualities. This allows us to charge higher returns while maintaining an underlying risk level close to investment grade. We appreciate the long-standing relationships in our portfolio, as this is not a sponsor finance portfolio that changes frequently. The average relationship in the Webster portfolio lasts nine years, ensuring stability. The collateral refreshes every 30, 60, or 90 days, giving us the option to quickly unwind our investment if desired. Although we plan to maintain these long-term relationships, the ability to exit quickly against high-quality collateral, while achieving long duration and high returns, is quite appealing. This acquisition is also unique as it requires industry expertise. We acquired a business that brought in a team, and while not all members from Webster were retained, we found synergies to integrate it into our platform. This addition broadens our industry focus, as we're actively involved in healthcare ABL and digital media ABL, alongside this new focus on traditional factoring industries like apparel, textiles, and jewelry. We find this acquisition extremely attractive and look forward to pursuing more opportunities.

I appreciate all that context. Speaking of doing more, I'd like to ask about the 30% cap. Are you facing any constraints because of it? How much capacity do you have to pursue additional deals like this? Thank you.

Just as a quick reminder, remember, the 30% catches some of our fincos because of the structure of owning the finco, we can put their assets actually on the parent company's balance sheet and it doesn't utilize the 30%. So we have a lot of flexibility. And as we see large portfolios, the BDC, as you know, benefits from the affiliation with the broader platform with over $14 billion of investable capital, we can take assets both into the BDC and alongside in our private funds as well. So we feel we bring a lot of flexibility and don't feel constrained by the 30% test.

Okay. I appreciate that distinction. Thanks.

Thank you.

Thank you. And we will take our next question from Sean-Paul Adams with Raymond James. Please go ahead.

Hey, guys. Good morning.

Good morning.

On Rug Doctor, I know it's on non-accrual for a couple of years now is also held by a number of other BDCs. But it looks like the portfolio markdowns really haven't shifted in the last couple of quarters. Has there been any change or any pathway for a resolution on that non-accrual?

Yes, that's a great question. While we value every investment, its size in the portfolio is relatively small. The significant development with Rug Doctor occurred a few years ago when we formed a joint venture with a major vacuum business player, which lacked presence in the rental vacuum sector. This venture is managed by that partner. What you're witnessing is our and our peers' ownership stakes in the joint venture. The reason it's on non-accrual is that we haven't been collecting interest, and we've maintained our investment without restructuring it. We believe there will eventually be a resolution with our joint venture partner; they would likely prefer to own the entire operation rather than just a portion. Ultimately, the key factor moving forward will be this potential buyer looking to acquire the remaining interests from us and our peer BDCs.

Perfect. Thank you for the clarity. I appreciate it.

Thank you. And it appears that we have no further questions at this time. I will now turn the program back to our presenters for any additional or closing remarks.

No additional remarks other than to thank you for your time and attention on this particular busy season of quarter earnings. And again, as always, if you have any other follow-up questions, please feel free to follow up with any of our team. Have a great day.

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