SLRC

Business Context and Reporting Period

Company: Solar Capital Ltd. (SLR Investment Corp.)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2011
Business Overview: Solar Capital is a closed-end, externally managed business development company (BDC) and regulated investment company (RIC). It invests primarily in middle-market companies through senior secured loans, mezzanine debt, and equity securities. As of March 31, 2011, the portfolio consisted of 35 companies with a weighted average yield of approximately 13.9%.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue: Total investment income decreased 9% to $32.3 million from $35.3 million. This decline was driven by lower prepayment premiums and accelerated fee amortization ($1.5 million in Q1 2011 vs. $6.9 million in Q1 2010), partially offset by higher interest income from increased invested balances.
• Expenses: Total operating expenses decreased 7% to $13.1 million. Interest and credit facility expenses dropped 31% due to lower average debt balances and the repayment of 8.75% senior unsecured notes in December 2010. Management fees increased 14% due to higher average gross assets.
• Portfolio Performance: Net realized and unrealized gains totaled $29.9 million, down from $40.9 million in Q1 2010. The current period gain was driven by credit improvement in the portfolio, whereas the prior period benefited from asset valuations recovering from recession lows.
• Foreign Currency: The company recorded a net loss of $4.6 million on foreign currency forwards and exchange, compared to a gain of $0.8 million in Q1 2010, reflecting the weakening of the U.S. dollar.

Guidance, Outlook, and Risks

• Dividend Policy: On May 2, 2011, the Board declared a quarterly dividend of $0.60 per share, payable July 5, 2011. The company intends to maintain its status as a RIC by distributing at least 90% of taxable income.
• Liquidity: The company maintains $55.0 million of unused borrowing capacity under its credit facilities. Liquidity is supported by cash flows from operations, investment sales, and access to a $355 million senior secured revolving credit facility and a $100 million facility.
• Market Risks:
  • Interest Rate Risk: The company has floating-rate debt and portfolio loans. To mitigate rising rates, it purchased a LIBOR cap at 1.00% on $100 million of notional amount through January 2014.
  • Foreign Exchange Risk: Significant exposure exists in Euro, British Pounds, Canadian Dollars, and Australian Dollars. The company uses forward contracts to hedge these exposures.
• Valuation: Approximately 63.9% of total assets are classified as Level 3 fair value measurements, relying on unobservable inputs and management assumptions.

Investor Verification Checklist

• Debt Covenants: Verify continued compliance with financial covenants (minimum shareholders' equity and debt-to-total assets ratios) under the $355 million and $100 million credit facilities.
• Level 3 Valuations: Review the methodology and assumptions used for the $867.1 million in Level 3 assets, as these rely heavily on management estimates.
• Non-Accrual Status: Confirm the status of the portfolio; as of March 31, 2011, there were no non-accrual investments, an improvement from one non-accrual asset ($6.6 million) at year-end 2010.
• Related Party Transactions: Monitor fees paid to Solar Capital Partners (Investment Adviser) and Solar Capital Management (Administrator), which totaled $9.8 million in Q1 2011.
• Foreign Currency Hedging: Assess the effectiveness of forward contracts given the $4.6 million net loss in the quarter due to currency fluctuations.