DBRS Morningstar Confirms BBB LT Issuer Rating of SLR Senior Investment Corp. Following Merger Announcement

DBRS, Inc. (DBRS Morningstar) confirmed the BBB Long-Term Issuer Rating and Long-Term Senior Debt rating of SLR Senior Investment Corp. (SUNS or the Company). The trend on the ratings is Stable. SUNS’ Intrinsic Assessment (IA) is BBB and its Support Assessment is SA3 resulting in SUNS’ final rating being equalized with its IA. The rating action follows SUNS announcement that it has agreed to a merger with SLR Investment Corp. (SLRC). The merger is subject to shareholder approval, as well as customary closing conditions. The transaction is expected to close in 1H22.

KEY RATING CONSIDERATIONS
The rating actions consider the benefits of the merger for SUNS’ franchise given the larger scale of the combined company, as well as the broader diversity of the investment portfolio. Importantly for the ratings, SLR Capital Partners LLC (SLR Capital Partners) will continue to be the Advisor to SUNS and that all senior executive management will remain in their current roles. With the continuation of the Advisor and management team, we expect SUNS to maintain its conservative underwriting and strong credit culture that has underpinned the robust loan performance of SUNS’ investment portfolio during the Coronavirus Disease (COVID-19) pandemic. Post-merger balance sheet fundamentals are also expected to remain supportive of the ratings. The merger is expected to be accretive to net investment income of the combined company with more diversified revenues and the benefit of cost synergies. With continuation of the Advisor post-merger and an existing investment portfolio overlap of 29% between SUNS and SLRC as of September 30, 2021, we see only modest integration risk in the merger.

The Stable trend incorporates SUNS’ sound performance since the onset of the pandemic. The Stable trend also reflects our view that the U.S. economic recovery will likely continue, supporting continuing private credit investment opportunities. While the robust M&A market remains constructive for middle market and upper middle market loan originations, further COVID-19 outbreaks or new variants as well as supply chain disruptions amid an increasingly tight labor market and rising inflationary pressure could pose some downside risks to growth going into 2022. In such an environment, we expect that SUNS financial performance will remain solid in such an environment and that the performance of the investment portfolio will remain acceptable.

RATING DRIVERS
Sound earnings performance supported by strong performance of the investment portfolio while maintaining disciplined deployment of leverage and appropriate liquidity would result in an upgrade of the ratings. Conversely, a sustained and meaningful deterioration in the buffer to debt facility covenants or regulatory requirements could result in a ratings downgrade. Weak performance in the investment portfolio that erodes net asset value (NAV) and dividend coverage would result in a downgrade of the ratings.

RATING RATIONALE
On December 1, 2021, SUNS announced that it had entered into a merger agreement with SLRC. SLRC will be the surviving company in which shareholders of SUNS will receive shares of SLRC that will be neutral from a net asset value (NAV) perspective. The Board of Directors of both companies have approved the agreement consistent with their special committees which were comprised only of the independent directors.

Under the terms of the proposed merger, SUNS shareholders will receive an amount of SLRC shares with a net asset value (NAV) equal to the NAV of SUNS shares held at the time of closing. The exchange ratio will be determined 48-hours prior to the closing. Upon closing of the merger, SLR Capital Partners has agreed to a 25 basis points (bps) reduction in the base management fee resulting in a base management fee of 1.50% on gross assets up to 200% of SLRC’s total net assets as of the immediately preceding quarter end. The base management fee payable to SLR Capital Partners by SLRC of 1.00% on gross assets that exceed 200% of SLRC’s total net assets as of the immediately preceding quarter end will remain in place. The combined company will trade on the NASDAQ under the ticker “SLRC”.

We expect SUNS’ franchise to benefit from the greater scale of the combined company, allowing for larger hold positions on balance sheet while maintaining diversification, which is critical in a competitive private credit market. The merger also brings together both SLRC’s and SUNS’ niche commercial finance platforms into one entity that will allow for greater cross-collaboration and additional synergies, while providing a more diverse set of investment verticals. Overall, the investment portfolio will become more diversified with the combined company having over $2.0 billion of assets invested in more than 125 portfolio companies as of September 30, 2021. This is compared to SUNS’ portfolio of 51 investments and $389 million of fair value at September 30, 2021. With the combined company, 65% of investments are senior secured while 35% is comprised of equity investments, of which 98% is invested in commercial finance companies, which lend and/or lease on a senior secured first lien basis.

SUNS earnings will benefit from the merger, which is expected to be accretive to net investment income of the combined company through an anticipated $1.4 million of cost and operational synergies via the elimination of duplicative expenses such as regulatory filings and audit fees, and interest expense savings resulting from more efficient debt financing. SUNS earnings generation will also benefit from the broader revenue diversity due to the larger investment portfolio, which should more than offset the higher base management fee (1.50%) of SLRC than SUNS’ current 1.00% fee on gross assets.

Importantly for the rating, we see no material impact to the historically strong credit performance of SUNS. Historically, SLRC had focused on riskier investments across the capital structure of middle market companies. However, over the recent years SLRC has largely pivoted to an investment strategy similar to the first lien, senior secured loans to sponsored-backed companies of SUNS. Given the alignment in investing strategy and underwriting, the combined company will not have to rotate out of a portfolio of “legacy assets”, which we view favorably as such activities can be a distraction to management and a drag on a BDC’s performance. Credit performance has been sound across both platforms and is expected to continue to benefit from the conservative underwriting and investing strategy of SLR Capital Partners. On a combined basis, investments on non-accrual at September 30, 2021, was 2.2% of the investment portfolio at cost (1.5% at fair value) across one overlapping portfolio company.

Balance sheet fundamentals post-merger are expected to remain supportive of the rating. At September 30, 2021, pro-forma net leverage for the combined company was 0.74x, below management’s target range of 0.90x to 1.25x, which is consistent with DBRS Morningstar methodology for the rating level. Meanwhile, on a pro-forma basis, funding as of September 30, 2021, was 66.4% unsecured. We note that the combined company will have an appropriately laddered debt maturity profile with a manageable $171 million of debt maturing in 2022.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

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

The principal methodology is the Global Methodology for Rating Non-Bank Financial Institutions (September 2, 2021):
https://www.dbrsmorningstar.com/research/383936/global-methodology-for-rating-non-bank-financial-institutions.
Other applicable methodologies include the DBRS Morningstar Criteria – Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021): https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

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.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

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

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