DBRS Assigns Long-Term Issuer Rating of BBB to Solar Senior Capital Ltd., Trend Stable

DBRS, Inc. (DBRS Morningstar) has assigned a Long-Term Issuer Rating and a Long-Term Senior Debt rating of BBB to Solar Senior Capital Ltd. (SUNS or the Company). The trend on all ratings is Stable. DBRS Morningstar also assigned an Intrinsic Assessment (IA) of BBB to SUNS and a Support Assessment of SA3, resulting in SUNS’ final ratings to be positioned in line with its IA.

KEY RATING CONSIDERATIONS
The ratings and Stable trend reflect the Company’s sound franchise lending to U.S. upper middle market companies and the benefits gained from its access to the Solar Capital Partners, LLC (SCP or the Adviser) platform. SUNS’ primarily first lien senior secured investment portfolio that has resulted in better-than-peer credit performance and consistent earnings performance are also considered in the ratings. The ratings also take into account the Company’s disciplined use of balance sheet leverage with net debt-to-equity historically maintained comfortably below the industry peer average. DBRS Morningstar expects that the Company will gradually increase its leverage over time to its target range of 1.25x to 1.50x, while maintaining its disciplined investment strategy.

While the Company has multiple bank facilities to fund originations across its cash flow and asset-based lending businesses, the funding profile is considered narrow and a constraint on the ratings. Further, as a business development company (BDC), the Company’s inability to retain its organic capital to support balance sheet growth is also a ratings constraint. The Stable trend reflects that while U.S. economic growth is slowing and global uncertainties continue to pose potential challenges, performance of the U.S. middle market is expected to remain acceptable.

RATING DRIVERS
Diversification of SUNS’ funding profile that results in greater unencumbrance of the balance sheet could have positive implications for the ratings. Furthermore, continued strong earnings generation, low levels of nonaccruals and disciplined balance sheet leverage could benefit the ratings.

An increase in the Company’s risk appetite or a deficiency in risk management that results in asset performance to weaken materially from historically strong performance could result in negative pressure on the ratings. A sustained and notable increase in leverage that exceeds the current leverage targets would likely have negative implications for the ratings.

RATING RATIONALE
SUNS’ franchise is viewed as sound. It benefits from SUNS’ relationship with SCP. The Company also benefits from access to SCP’s well-established and seasoned management team, origination platform, investing expertise, and underwriting and investment monitoring capabilities. At September 30, 2019, the Adviser had over $6.0 billion of investable capital across its BDCs, private credit funds and separately managed accounts. With 14 offices across the U.S., SCP and its affiliates have a strong national direct origination platform that emphasizes a regional focus on sourcing transactions from top private equity sponsors, regional banks, and financial intermediaries, which provides SCP with access to a broad flow of deals.

SUNS has received co-investment exemptive relief from the SEC so it may invest alongside other SCP private credit funds, BDCs and separately managed accounts, allowing SCP greater flexibility to negotiate terms of co-investments. DBRS Morningstar views this exemptive relief as a positive, as it allows SCP to participate in the larger deals that are common in the upper middle market space. The co-exemptive relief also allows SUNS to lower concentrations in the portfolio, as investment hold sizes can be better managed through allocation across the SCP platform. As of 3Q19, SUNS’ investment portfolio totaled $469.2 million at fair value (FV) with debt investments across 45 portfolio companies.

SUNS has four investment strategies, including traditional cash flow lending to upper middle market companies. The other three investment strategies are unique to peers and utilize the non-qualified asset basket. As of September 30, 2019, SUNS’ non-qualified assets totaled 17.2% of total assets still comfortably under the 30% limit per BDC regulations.

SUNS’ investment in Gemino Healthcare Finance LLC (Gemino) accounts for 7.4% of its investment portfolio at fair value ($34.9 million) and has a cost of basis of $31.4 million as of September 30, 2019. Gemino is a first lien asset-based lender to small and mid-sized healthcare companies with $115.9 million of loans to 32 unique issuers. Year to date, Gemino had dividend income of $2.6 million to SUNS generating a yield of approximately 9.9%.

SUNS’ investment in North Mill Holdco LLC (North Mill) accounts for 13.7% of its investment portfolio at fair value ($64.5 million) and has a cost of basis of $67.0 million as of September 30, 2019. North Mill is a first lien asset-based lender to small and mid-sized businesses with $175.9 million of loans to 148 unique issuers. Year to date, North Mill had dividend income of $4.2 million to SUNS generating a yield of approximately 8.7%.

In 3Q19, SUNS began to report its Life Sciences portfolio as a separate unit. The Life Sciences portfolio is modest but is expected to grow over time given SCP’s established presence in the market. At September 30, 2019, this portfolio accounts for just 4% of its comprehensive investment portfolio at fair value, or $25 million.

Credit performance at SUNS has been strong and better than the peer average demonstrating SCP’s disciplined and conservative investment strategy combined with underwriting that has been tested through several business and economic cycles. The Company’s comprehensive portfolio is primarily first lien senior secured loans across a wide range of industries and generally avoids cyclical industries. The comprehensive portfolio totaled approximately $650 million at September 30, 2019, including the underlying loan portfolios at Gemino and North Mill. At September 30, 2019, SUNS had no investments on non-accrual status.

SUNS’ earnings generation has been consistent with the Company reporting an annual profit each year since inception in 2011. Revenues are predominately from interest income and largely recurring in nature, with dividend income a larger component of revenue than at peers. While DBRS Morningstar generally views dividend income as potentially a more volatile source of income, DBRS Morningstar notes that most of SUNS’ dividend income comes from Gemino and North Mill, which are essentially pass-through entities that upstream their earnings quarterly to SUNS and thus are a more reliable source of income. Through 9M19, annualized net investment income as a percentage of the average investment portfolio at cost during the year continues to be solid at 4.86%, and has averaged 5.1% since 2013, which is consistent with the ratings per DBRS Morningstar methodology. DBRS Morningstar expects the Company’s net investment income generation to continue to strengthen as SUNS invests available capital into its four core investment strategies and gradually increases leverage towards its target range.

Balance sheet leverage (debt-to-equity) is well-managed and is currently in line with the DBRS industry peer average. At September 30, 2019, the Company’s debt-to-equity was 0.80x, which is below management’s target range of 1.25x to 1.50x. DBRS Morningstar sees SUNS as having a strong cushion to the regulatory limit of 2.0x. As of 3Q19, the Company’s cushion was estimated at $151.6 million implying that SUNS would need to take a loss of 32% on its investment portfolio to breach the regulatory limit. SUNS’ largest single name exposure was just 10.5% of the ACR cushion.

SUNS is reliant on bank facilities for financing. As such, DBRS Morningstar considers the funding profile as narrow and a ratings constraint. However, the bank facilities are considered adequately diversified to fund both the cash flow lending as well as the asset-based lending businesses. Liquidity is managed appropriately. SUNS had approximately $270.2 million of cash, cash equivalents and unfunded bank revolver commitments, which are subject to borrowing base limitations, on its revolving bank facilities, as of September 30, 2019. Moreover, SUNS has the ability to increase a revolving bank credit facility under an accordion feature by an additional $375.0 million. DBRS Morningstar notes that refinancing risk is low, with the earliest revolving bank facility maturity not until June 2023.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal methodology is Global Methodology for Rating Non-Bank Financial Institutions (September 2019), which can be found on our website under Methodologies & Criteria.

The primary sources of information used for this rating include Company Documents and S&P Global Market Intelligence. DBRS Morningstar considers the information available to it for the purposes of providing this rating was of satisfactory quality.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

For more information on this credit or on this industry, visit www.dbrs.com.

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