SLR Investment Corp

NASDAQ:SLRC

Earnings Call Analysis

SLR Q2 2024: Record Net Investment Income and Strategic Portfolio Growth

SLR Investment Corp. announced a record net investment income of $0.45 per share, a 1% increase from the previous quarter and the highest in five years, covering dividends by 110%. The net asset value (NAV) grew to $18.20 per share. The company emphasized a deliberate, post-COVID portfolio rebuilding, focusing on high-yield asset classes like asset-based lending (ABL), life sciences lending, and equipment finance. Originations were $356 million, with 87% in these sectors. The portfolio's credit quality remains strong, with 98% in senior secured loans. SLRC anticipates benefiting from economic headwinds and maintains a strong dividend yield of 11.1%.

Strong Performance Amid Competing Conditions

In the second quarter of 2024, SLR Investment Corp. (SLRC) reported a net investment income of $0.45 per share, reflecting a 1% increase from the previous quarter. This achievement represents the highest level of net investment income per share in five years and indicates a solid coverage of approximately 110% against its distribution of $0.41. This performance marks a successful return following a period of conservative portfolio adjustments during the COVID-19 pandemic.

Resilient Net Asset Value

As of June 30, 2024, SLRC's net asset value (NAV) remained stable at $18.20 per share, up slightly from $18.19 in the first quarter. The portfolio demonstrated resilience amidst fluctuating private credit conditions and a re-emergence of the syndicated loan market. The investments reflect a multi-strategy senior secured portfolio nurtured to withstand the prevailing high interest rates and economic uncertainties.

Diversified Investment Strategy and Growth

SLRC's comprehensive portfolio saw $356 million in new originations and $292 million in repayments, achieving a net growth of $62 million in the second quarter. Notably, only 13% of these originations came from sponsor finance, marking a continued shift from a year earlier when sponsor finance dominated originations. Most new investments were in asset-based lending, life sciences lending, and equipment finance, reflecting a strategic pivot to sectors with more favorable risk-adjusted returns.

Emerging Opportunities in Asset-Based Lending

The quarter saw $130 million in asset-based lending originations, a potential countercyclical strategy benefiting from economic tightening. This segment now holds a significant portion of the portfolio, accounting for approximately 31% of total holdings, underpinned by a rigorous focus on loan quality and collateral evaluation. This approach can provide higher recovery values, particularly against the backdrop of rising competition in ABS-like strategies.

Solid Credit Quality Metrics

Focus on quality and diversification has kept SLRC's credit profile robust. As per the latest assessment, over 99% of the portfolio maintains a risk rating of 2 or higher on a scale where 1 is the lowest risk. Also, only 0.8% of gross income derives from capitalized PIK on restructured assets, demonstrating prudent risk management. The weighted average loan-to-value ratio remains healthy, underscoring SLRC's defensive position.

Market Conditions and Future Outlook

Given the economic uncertainty, SLRC's leadership expressed cautious optimism, referencing a potential increase in mergers and acquisitions activity in the latter half of the year. The current competitive landscape in sponsor finance is muted due to lower M&A volume but remains open to attractive investment opportunities, particularly in defensive sectors. As they prepare for potential changes in interest rates, the company maintains a readiness to adapt its strategy further.

Dividend Stability and Shareholder Alignment

SLRC announced a quarterly distribution of $0.41 per share for Q3 2024, marking a commitment to returning value to shareholders. The company highlights its attractive dividend yield of approximately 11.1%, aimed at income-seeking investors, and points out that management's ownership of over 8% of SLRC further aligns their interests with those of shareholders, underscoring their confidence in the long-term stability and earnings outlook of the firm.

Earnings Call Transcript 2024-Q2

[Operator]

Good day, everyone, and welcome to today's Q2 2024 SLR Investment Corp. Earnings Call. [Operator Instructions] Please note that this call is being recorded [Operator Instructions].

It is now my pleasure to turn the conference over to Michael Gross, Chairman and Co-CEO.

[Michael Gross, executive]

Thank you very much, and good morning. Welcome to SLR Investment Corp.'s earnings call for the fiscal quarter ended June 30, 2024. I'm joined today by my long-term partner of 18 years, Bruce Spohler, Co-Chief Executive Officer; and 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?

[Shiraz Kajee, executive]

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 that any unauthorized broadcast in any form is strictly prohibited. This conference call is also being webcast through 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 August 7 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 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 [phone].

At this time, I would like to turn the call back over to our Chairman and Co-CEO, Michael Gross.

[Michael Gross, executive]

Thank you, Shiraz, and thank you to everyone for joining our earnings call today. After the market closed yesterday, SLRC reported net investment income of $0.45 per share in the second quarter 2024, representing a 1% increase over the prior quarter and distribution coverage of approximately 110%.

Our net investment income per share in the second quarter reached the highest level in 5 years, reflecting our deliberate approach to -- in rebuilding the investment portfolio after a period conservatism following -- during the onset of COVID.

Our NAV per share increased $0.01 sequentially to $18.20 as of June 30, 2024. We believe the recent stability of our NAV reflects our multi-strategy senior secured portfolio, which is substantially constructed in 2023 and 2024, and underwritten to withstand higher interest rates and a softening of the economy.

While private credit conditions in the second quarter continued to be impacted by a revival of the syndicated loan market, we were able to source attractive investment opportunities across our platform. The combination of increased competition from the BSL and CLO markets, together with muted M&A activity, has caused pricing and turns for deals in the sponsor finance market to become more borrower-friendly. In many indices, this has reduced the illiquidity premium for some BDC portfolios.

Due to the more favorable conditions in our specialty finance markets, our investments in the second quarter were once again more heavily weighted to those asset classes which we believe currently provide a more attractive risk-adjusted return relative to sponsor finance loans. Our ability to pivot to the best risk/reward opportunities within various private credit strategies is a hallmark of SLR's strategy allocation approach. We believe private credit investors are increasingly looking for diverse and proprietary investment strategies within BDCs.

SLRC's comprehensive portfolio had originations of $356 million and repayments of $292 million in the second quarter, resulting in net portfolio growth of $62 million. 87% of originations were from SLR's asset-based lending, life sciences lending and equipment finance verticals. Said another way, only 13% of our second quarter originations were in sponsor finance, a continued reversal from last year, when most of our originations were concentrated in sponsor finance.

Management teams and sponsors are exploring ways to raise new capital to support owning assets over a longer time frame in order to execute their business plan. Additionally, more sponsors have been increasing their focus on asset-rich industries which portfolio companies can more effectively leverage current assets and ABL structures to finance their working and growth capital requirements.

This has created an opportunity for asset-based lending and resulted in $130 million of ABL originations in the second quarter. Post quarter end, we've identified several attractive ABL investment opportunities and expect the countercyclical attribute of this financing instrument to benefit from potential economic headwinds.

We are 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 of second lien and broader cyclical exposure.

As of June 30, our investments on nonaccrual represented just 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 in which our specialty finance strategies enable 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 of companies. Overall, they have successfully managed the transition to an environment with higher cost of capital as well as inflationary premiums. The weighted average interest coverage in our sponsor finance loans has steadily -- has held steady at approximately 1.7x. Additionally, only 0.8% and of second quarter gross income is in the form of capitalized PIK from cash flow borrowers resulting from amendments. We believe these healthy metrics are the result of the diversity of our investment portfolio across private credit strategies and our focus in sponsor finance and recession-resilient industries with high recurring free cash flow.

The credit quality of our specialty finance investments continues to be solid with attractive LTVs which have meaningful collateral support and borrowing base structures. This collateral support should lead to higher recovery values relative to sponsor finance, cash flow backed loans.

While we are optimistic that M&A will increase in the back half of the year, current sponsor finance activity remains centered on DDTL draws and amend and extend transactions, which we have addressed -- which we are addressing cautiously.

At June 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 seat, we think 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 Q2 financial highlights.

[Shiraz Kajee, executive]

Thank you, Michael. SLR Investment Corp.'s net asset value at June 30, 2024, was $993 million or $18.20 per share compared to $992 million or $18.19 per share at March 31. The quarter-end SLRCs on-balance sheet investment portfolio had a fair market value of approximately $2.1 billion in 138 portfolio companies across 37 industries, compared to a fair market value of $2.1 billion in 145 portfolio companies across 41 industries at March 31.

At June 30, the company had approximately $1.2 billion of debt outstanding with a net debt-to-equity ratio of 1.16x. We expect our net debt to equity ratio to remain in the middle of our target 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 rate notes have a weighted average annual interest rate of only 3.8%.

We remain in dialogue with the fixed income community and expect to opportunistically access the investment-grade market. The recent decline in risk-free rates subsequent to quarter end has been constructive to reduce the all-in cost of any future debt issuance.

Moving to the P&L. For the 3 months ended June 30, gross investment income totaled $59 million versus $58.1 million for the 3 months ended March 31. Net expenses totaled $34.7 million for the 3 months ended June 30. This compares to $34.2 million for the prior quarter.

Accordingly, the company's net investment income for the 3 months ended June 30, 2024, totaled $23 million or $0.45 per average share $0.01 higher than 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 second quarter totaling $1.1 million versus a net realized and unrealized gain of $4.4 million for the first quarter of 2024. As a result, the company had a net increase in net assets resulting from operations of $23.2 million for the 3 months ended June 30 compared to a net increase of $27.9 million for the 3 months ended March 31.

On August 7, Board of SLRC declared a Q3 2024 quarterly distribution of $0.41 per share payable on September 27, 2024, to holders of record as of September 13, 2024.

With that, I'll turn the call over to our co-CEO, Bruce Spohler.

[Bruce Spohler, executive]

Thank you, Shiraz. In the current competitive sponsor finance cash flow market, the flexibility offered by our commercial finance strategy enables us to source attractive investment opportunities away from this competitive market. We take a fundamental bottoms-up approach to portfolio construction based upon the relative risk-adjusted return profile 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 800 different borrowers. Measured at fair value, 99.2% of our portfolio consisted of senior secured loans with 97.7% in first lien loans, including investments in our SSLP attributable to the parent company. And only 0.3% was invested in second lien cash flow loans, with the remaining 1.2% invested in second lien asset-based loans.

Our specialty finance investments account for approximately 75% of the portfolio with just over 24% of the portfolio invested in senior secured cash flow loans to upper mid-market sponsor-backed companies. We believe this defensive portfolio construction positions us well for potential economic weakness and provides a differentiated risk/return profile relative to a sponsor finance-only portfolio. At quarter end, our weighted average asset-level yield was 11.7% compared to 11.8% prior quarter.

Our credit quality remained strong. At quarter end, the weighted average investment risk rating of the portfolio was just under 2, based on our 1 to 4 risk rating scale, with 1 representing the least amount of risk. Over 99% of the portfolio is rated 2 or higher at quarter end. Moreover, 99.4% of the portfolio on a cost basis and 99.6% on a fair value basis was performing, with only 1 investment on nonaccrual.

Now let me touch on each of our four investment verticals. I'll begin with sponsor finance. In this business, we originated first-lien senior secured loans to upper mid-market companies in noncyclical industries, such as health care, business services and financial services. This has helped to mitigate the impact on our portfolio from cyclical economic factors.

At June 30, our sponsor finance portfolio was approximately $760 million, including loans in the SSLP, 24% of the comprehensive portfolio. It was invested across 47 different borrowers. With approximately 99% of this cash flow portfolio invested in first lien loans, we believe that we are well positioned to withstand any pressures that our borrowers may face.

Importantly, we have a defensively positioned portfolio. Our borrowers have a weighted average EBITDA of approximately $130 million, carry low loan-to-values of just over 37% and interest coverage of 1.7x consistent with the prior quarter.

Overall, the sponsor finance portfolio has continue to exhibit solid credit metrics. During the quarter, we made investments of approximately $45 million and experienced repayments of $33 million. 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 at attractive risk-adjusted yields. At quarter end, the weighted average cash flow yield was 11.7%, down slightly from the prior quarter.

Now let me turn to asset-based lending. We continue to see an increase in the opportunity set for ABL asset classes as a result of ongoing credit tightening and rationalization of business lines at U.S. regional banks. We were able to originate several investments during the second quarter. However, we've remained committed to our disciplined underwriting standards, on which we focus on the quality and liquidity and of the underlying collateral base when determining our acceptable loan-to-value ratios.

Additionally, it's important to note that recent headlines around increased interest in asset-based financing or asset-based securitization does not impact the competitive landscape for our asset-based loans. Within the more ABS-like strategies, originators underwrite pools of assets, such as student loans, credit card loans or residential mortgages, and securitize them.

In our ABL businesses, we focus on individual corporate borrowers and conduct extensive due diligence on their underlying collateral. We then actively monitored their borrowing base throughout the life of our loan. These asset classes require unique skill sets and target very different issuers. Thus, an increase in ABS competition does not have a material impact on our asset-based lending businesses.

At quarter end, our ABL portfolio totaled $960 million, representing approximately 31% of the total portfolio. It was invested across 163 borrowers. The weighted average asset-level yield was 15.2% compared to 15.7% in the prior quarter. And our average loan-to-value was 67%. For the second quarter, we had $130 million of new asset-based lending investments and repayments of $100 million.

Now let me touch on equipment finance. At quarter end, the portfolio totaled approximately $1 billion, representing 1/3 of our total portfolio. It is highly diversified across over 580 borrowers. The credit profile of the portfolio continues to be stable. The weighted average asset-level yield, 8.1%.

During Q2, we originated approximately $178 million of new assets with the majority coming from our business that provides leases to investment-grade borrowers for their mission-critical equipment. We have repayments of approximately $160 million. Our investment pipeline has expanded in conjunction with the disruption caused by last year's regional bank failures as well as the continued expansion of our vendor finance program.

Now finally, let me turn to life sciences. At quarter end, our life science portfolio totaled $345 million. Approximately 86% of the portfolio at par is invested in loans to borrowers that have over 12 months of cash runway. Additionally, all of our portfolio companies have revenues with at least 1 product in the commercialization stage, which significantly derisks our investment. Life science loans represented just over 11% of the portfolio and contributed 21% of our gross investment income for the quarter.

During Q2, the team funded $3 million of follow-on investments and had no repayments. At quarter end, the weighted average yield on this portfolio was 13%, excluding potential success fees and warrants. With early signs of an improvement in life sciences, we have seen a modest [ uptick ] of our valuations and pipeline.

While valuations remain challenging, we believe a decline in interest rates will inspire greater investment activity. Given our ability to allocate capital to the best risk-adjusted reward sectors, we have the luxury of being highly selective in our capital deployment in life sciences while still generating positive total originations across the entire company.

Lastly, let me touch on the SSLP. During the second quarter, we earned $1.9 million from the SSLP, representing a 15.7% annualized yield compared to earnings of $1.6 million in the first quarter at a yield of 13.6%. At quarter end, we had a portfolio of just over [ $220 million ]. Including unfunded commitments, we now have close to $240 million of investments.

Now let me turn the call back to Michael.

[Michael Gross, executive]

Thank you, Bruce. In conclusion, we are pleased with our second quarter results as well as the credit quality of our portfolio. The growth of our platform in the last few years has enhanced our diversified commercial finance investment capabilities. We believe SLRC's recent performance, portfolio credit quality and diversified proprietary sourcing engines create a differentiated and attractive risk/return profile for our shareholders.

We've started to see significant dispersion in credit quality metrics within the private credit marketplace and believe our deliberate and tactical approach to rebuild the portfolio into predominantly first lien investments with significant diversification to begin to differentiate our performance.

This is seen in our credit quality metrics from our low rate of accrual and our multi-strategy portfolio construction approach, in which our specialty finance strategies -- and enable us to be more selective in our sponsor finance business and mostly pass on deals that don't meet our risk-adjusted return profile. Furthermore, only 0.8% of our gross income is in the form of capitalized PIK on restructured cash flow assets, which we believe is also significantly below the peer group.

Recent economic data has increased the perceived risks of a hard landing for the U.S. economy and heightened fears of recession. With the November election and ongoing negative geopolitical developments, markets are experiencing elevated volatility and greater uncertainty. These factors, along with comments made by members of the FOMC in the third quarter 2024, has started to change the forward curve's expectation.

While that condition may present a challenge for some private credit portfolio yields that are constructed with floating rate assets, 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 an 11.1% dividend yield as of yesterday's market close, which we believe presents an attractive investment for both income seeking investors and offer shareholders portfolio diversification benefits compared to sponsor finance-only strategies.

Our investment advisers' alignment of interest with SLRC shareholders continue to be one of our significant hallmark principles. The SLR team owns over 8% of the company's stock and includes having a significant percentage of their annual incentive compensation invested 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.

Thank you all again for your time today. As we know, it's an especially busy day for those that follow the listed marketplace closely. Operator, will you please open up the line for questions.

[Operator]

[Operator Instructions] Our first question will come from Melissa Wedel with JPMorgan.

[Melissa Wedel, analyst]

You touched on parts of it, really, and it's about the earnings power of the portfolio. We definitely take note that, in the face of potentially lower interest rates, a good sizable portion of the SLRC portfolio is fixed rate. So there would be a little bit less pressure there relative to some peers.

But 2/3 of the portfolio is fixed rate. And when we look at the cushion of sort of outearning the dividend level, it's about $0.04 right now per share just based on 2Q levels. As you look at the forward curve moving forward, how -- where do you see incremental upside to sort of NII, or protecting that sort of dividend coverage level, especially as you get into sort of '25 and beyond?

[Bruce Spohler, executive]

Sure. Great question, Melissa. A couple of thoughts. First of all, as you know, only 24% of the portfolio is currently invested in cash flow assets. And some of those are held in the SLP.

First off, on the cash flow portfolio, while you know that portfolio is sensitive to changes in base rates, the SSLP portion of that portfolio was constructed back in 2022 with the merger of SUNS and SLRC and had lower-yielding assets at the time. So as those have been repaying, we've been putting higher-yielding assets. So even as spreads come down, we don't expect much compression in that part of our cash flow portfolio.

But again, only 24% of the comprehensive portfolio is exposed to cash flow assets, and the other 76% is exposed to our specialty finance verticals, which are much more absolute return assets. It didn't widen out nearly as much as the cash flow market did over the last 2 years because at that point -- at some point, those interest rates for those corporate borrowers would just become too expensive for them to carry. But they also don't compress nearly to the extent of the cash flow market. They tend to vacillate within 200 to 300 basis points.

You see life sciences were yielding 14%, that's before warrants and success fees. The track record is closer to 15%, 16% when you include those. So that may compress a little bit, but it also didn't expand much over the last couple of years. So we feel that we will be insulated on the downside because of our exposure to the commercial finance businesses that are less interest rate-sensitive, as well as the fact that we are not fully invested across all of the FinCos.

We have rebuilt these portfolios as well as rebuilding on-balance sheet with the leverage currently at about 1.16, but there is room to grow across the portfolio. So we feel very good about the stability of our earnings.

[Operator]

[Operator Instructions] Our next question will come from Sean-Paul Adams with Raymond James.

[Sean-Paul Adams, analyst]

I hopped on the call a little bit late, so I apologize if this question has already been asked. But just the competitive environment in the life sciences division, do you guys think that, that's going to change materially if activity picks up?

[Bruce Spohler, executive]

So that is a terrific question. We have found -- as you may recall, our team has been doing this for over 25 years, going back to starting the business at GE Capital before they joined our platform 10 years or so ago. And they have seen competitors come and go. It's obviously a very attractive-return business, the team having, as I said, mid-teens returns with no defaults, no losses in their entire history.

But it's -- beauty is in the eye of the beholder. You really need to get in there and peel the onion and understand that it is a high barrier to entry business in terms of the expertise needed in the sector, understanding the FDA approval process, understanding CMS reimbursement process, having relationships with number of the venture capital firms as well as the management teams.

And so people come in and unfortunately tend to experience losses rather quickly. This is not a business that it takes a few years to figure out whether you're good or not. And so we've seen a number of people come in, and fortunately, they exit rather quickly. So we're not expecting any significant change in competition.

I think what we're really looking for is that natural cycle to reverse itself with the amount of VC capital that's been raised, being deployed, coming through the FDA approval process, getting to the late stage, where we deploy our debt capital and support them in their equity investment.

And also, having the confidence to invest means seeing the valuations stabilize in the sector, and that begins to attract more capital. A lot of the investing was paused as the FDA slowed down and turned all of their attention to approvals for therapies and treatments for COVID. That has changed. And so that those wheels are turning again, and we think this is just a part of the cycle, and look to actively be more deploying capital as we get into later this year and to next year.

[Sean-Paul Adams, analyst]

That's phenomenal color. I really appreciate it.

[Operator]

[Operator Instructions] And with no further questions, I'd like to turn the conference back to Michael Gross for closing comments.

[Michael Gross, executive]

No further comments, other than to thank all of you for your participation today, recognizing it is an extremely busy day. For those of you who listen to this on a recording, please feel free to follow up with any questions that you may have. Thank you.

[Operator]

And that will conclude today's teleconference. Ladies and gentlemen, you may now disconnect.