Fitch Ratings has affirmed SLR Investment Corporation's (SLRC) Long-Term Issuer Default Rating (IDR), secured debt rating and unsecured debt rating at 'BBB-'.

The Rating Outlook is Stable.

Today's rating actions have been taken as part of a broader review of business development companies (BDCs), which included 18 publicly rated firms. For more information on the peer review, please refer to 'Fitch Ratings Completes 2023 BDC Peer Review,' available at www.fitchratings.com.

Key Rating Drivers

The rating affirmation reflects SLRC's first-lien portfolio profile, relatively solid credit track record since the financial crisis, appropriate asset coverage cushion, sound liquidity, and a demonstrated willingness to moderate portfolio growth in a highly competitive underwriting environment.

Rating constraints include weaker-than-peer dividend coverage metrics in recent years; higher relative exposure to non-qualifying assets, which were 24.2% of total assets at Dec. 31, 2022, consisting of equity investments in its asset-based lending, equipment finance, and a life science portfolio; and lack of affiliation with a broader investment platform, which could be a headwind should bank financing become more constrained for the sector.

Rating constraints for the BDC sector more broadly include the market impact on leverage, given the need to fair-value the portfolio each quarter, dependence on access to the capital markets to fund portfolio growth and a limited ability to retain capital due to dividend distribution requirements. Additionally, Fitch believes BDCs will experience weaker asset quality metrics in 2023 amid macroeconomic headwinds and higher debt service burdens and slower growth prospects at portfolio companies.

In addition to senior secured cash flow loans, SLRC provides asset-based loans and equipment financing and leasing solutions through its equity holdings in SLR Credit Solutions (Crystal), SLR Equipment Finance (NEF), Kingsbridge Holdings, LLC (Kingsbridge), SLR Healthcare ABL (SLR Healthcare), and SLR Business Credit. SLRC's portfolio is more concentrated than peers given these equity investments accounted for approximately 36.5% of the portfolio at fair value at Dec. 31, 2022, which was meaningfully above the rated peer average. If these investments were consolidated on SLRC's balance sheet, the overall portfolio would be 99.8% senior secured loans.

Non-accrual investments accounted for 0.5% of the debt portfolio at value and 3.1% at cost at YE22, both of which were higher than a year ago. SLRC's net realized losses as a percentage of the average portfolio at value averaged 0.9% from 2019-2022, which exceeded the rated BDC average during this period. Fitch believes higher interest rates and a more challenging economic backdrop will lead to increased amendment activity and higher payment-in-kind (PIK) income in coming quarters, which could translate to additional losses.

SLRC's net investment income (NII) amounted to 4.0% of the average portfolio at cost in 2022. This was up from 3.7% a year prior but remained below the rated peer average, given the focus on lower-yielding first lien investments. Fitch believes SLRC's NII should benefit further from rising interest rates in 2023, given the floating-rate nature of the majority of its investments and its meaningful fixed-rate funding component, although the potential for credit deterioration in the portfolio will be a headwind.

At Dec. 31, 2022, SLRC's leverage (par debt-to-equity) was 1.09x, or 1.08x net of cash, which remained below peers and was consistent with management's targeted range of 0.9x-1.25x, on a net basis. The reported leverage ratio implied an asset coverage cushion of 21.7% at Dec. 31, 2022, which was within Fitch's 'bbb' benchmark range of 11%-33%. Fitch expects the firm will continue to maintain the covenant cushion at an appropriate level to account for potential valuation volatility in the portfolio and/or future credit losses.

Unsecured debt amounted to 49.9% of SLRC's outstanding debt at YE22, which was in line with the rated BDC average and within Fitch's 'bbb' category quantitative benchmark range of 35%-50% for BDCs. Assuming SLRC utilized secured borrowings to repay $75 million of unsecured notes that came due in January 2023, Fitch estimates the firm's unsecured debt decreased to approximately 43% of total debt, pro forma. Given that SLRC's next debt maturity is not until in December 2024, Fitch believes SLRC's funding flexibility should continue to remain sound with unsecured debt in the 'bbb' category range, at a minimum.

GAAP NII coverage of dividends declared was 90.2% in 2022, which was up from 87.9% in 2021, but remained below SLRC's average of 92% from 2019-2022. Cash NII coverage, adjusted for PIK income net of collections, was 77.6% in 2022. Dividend coverage is expected to improve as the company utilizes available liquidity to originate new investments, NII grows with rising interest rates in 2023, and given the permanent 0.25% reduction in the base management fee following the completed merger with SLR Senior Investment Corp. in April 2022. Fitch would view the firm underearning its dividend for a sustained period of time negatively.

The Stable Outlook reflects Fitch's expectation that SLRC will improve dividend coverage, operate with an asset coverage cushion consistent with the risk profile of the portfolio and to account for potential valuation volatility and credit deterioration, while maintaining solid asset quality and sufficient liquidity.

Rating Sensitivities

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Failure to improve NII dividend coverage to 100%, a decline in the company's asset coverage cushion below 11%, a sustained increase in non-accrual levels, meaningful realized losses, and/or an inability to continue accessing the unsecured debt markets resulting in unsecured debt falling below 35% of total debt would be negative for ratings. Additionally, a more rapid-than-expected increase in leverage and, longer term, an increase in leverage above 1.25x or a material change in the firm's risk profile represented by a material decline in first-lien positions or a shift in focus toward subordinated debt and/or pure equity investments without a commensurate decline in leverage could also yield negative rating momentum.

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Strong and differentiated asset quality performance of recent vintages, which would be evaluated in conjunction with the stability and consistency of the firm's operating performance, asset quality, valuation and underlying portfolio metrics that include leverage and interest coverage could yield positive rating momentum. Additionally, a sustained improvement in dividend coverage, the maintenance of unsecured debt of at least 40% of total debt, a strong liquidity profile and consistent core operating performance would also be viewed positively. Although not envisioned, a reduction in the leverage target not accompanied by an offsetting increase in the portfolio risk profile could also contribute to positive rating momentum.

DEBT AND OTHER INSTRUMENT RATINGS: KEY RATING DRIVERS

The equalization of the secured and unsecured debt ratings with the Long-Term IDR reflects solid collateral coverage for all classes of debt given the firm's focus on senior secured investments, the high level of unsecured funding in the capital structure, and because the firm is subject to a 150% asset coverage limitation.

DEBT AND OTHER INSTRUMENT RATINGS: RATING SENSITIVITIES

The secured and unsecured debt ratings are primarily linked to the Long-Term IDR and are expected to move in tandem. However, a material reduction in unsecured debt as a proportion of total debt could result in the unsecured debt rating being notched down from the IDR.

Best/Worst Case Rating Scenario

International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.

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