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spk01: Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Saratoga Investment Corporation's Fiscal Third Quarter 2021 Financial Results Conference Call. Please note that today's call is being recorded. During today's presentation, all parties will be in a listen-only mode. Following management's prepared remarks, we will open the line for questions. At this time, I would like to turn the call over to Saratoga Investment Corporation Chief Financial Outcompliance Officer, Mr. Henry Steenkamp. Sir, please go ahead.
spk07: Thank you. I would like to welcome everyone to Saratoga Investment Corps' Fiscal Third Quarter 2021 Earnings Conference Call. Today's conference call includes forward-looking statements and projections. We ask you to refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these forward-looking statements and projections. We do not undertake to update our forward-looking statements unless required to do so by law. Today, we will be referencing a presentation during our call. You can find our fiscal third quarter 2021 shareholder presentation in the events and presentation section of our Investor Relations website. A link to our IR page is in the earnings press release distributed last night. A replay of this conference call will also be available from 1 p.m. today through January 14th. Please refer to our earnings press release for details. I would now like to turn the call over to our Chairman and Chief Executive Officer, Christian Oberbeck, who will be making a few introductory remarks.
spk05: Thank you, Henry, and welcome, everyone. Another volatile and challenging quarter across our businesses and the world, we continue to see improvement in market conditions and improved visibility on the immediate prospects of our portfolio companies. We continue to believe that Saratoga and our portfolio companies are positioned well at this point in time to weather potential future economic challenges. We look forward to presenting our most recent results and reviewing the solid structure of our capitalization and continued improvement in liquidity on today's call. While no business can anticipate with clarity how long the displacement in the market and global economy will last, we have confidence that our historically conservative approach to investing, strong capital structure, solid levels of liquidity, organization, and management experience will enable us to effectively navigate this challenging current and uncertain future environment. To briefly recap the past quarter on slide two. First, we continue to strengthen our financial foundations quarter by maintaining a high level investment credit quality with nearly 93% of our loan investments retaining our highest credit rating after incorporating the impact of changes to market spreads, EBITDA multiples, and or revised portfolio company performance related to COVID-19. This is up from 90% in Q1. Importantly, more than two-thirds of the reduction in the valuation of the overall portfolio in the first quarter has been reversed since May 31, 2020, generating a return on equity of 11% on a trailing 12-month basis in Q3, net of the nine-month COVID-19 impact to the portfolio. This significantly exceeds the BDC industry average of negative 3.6%, and registering a gross unlevered IRR of 16.6% on total realizations of $523 million. Second, our assets under management increased to $547 million this quarter, an 8% increase from $508 million as of last quarter, and up 13% from $486 million as of year end. Despite the unprecedented uncertainty and turmoil in the markets, we originated a healthy $51 million of new investments, offset by $18 million of repayments. Importantly, our new originations included three new portfolio company investments. Our capital structure, portfolio performance, and recently improved liquidity have enabled us to remain open for business, an important differentiator in today's market. Third, as we continue to look ahead to the persistent challenges presented by the COVID-19 pandemic to the economy and particularly to small businesses, liquidity and NAV preservation are paramount, both for our portfolio companies and ourselves. Our current capital structure at quarter end was strong, with $300 million of mark-to-market equity supporting $108 million of long-term covenant-free non-SBIC debt and $176 million of SBIC debt. Our available liquidity enables us to grow our AUM by 42% currently. We had $30 million of committed undrawn lending commitments as of quarter end and $19 million of discretionary funding commitments. Our quarter end regulatory leverage of 377% substantially exceeds our 150% requirement. Finally, Reflecting on our improved liquidity and overall portfolio resiliency, the Board of Directors decided to increase our quarterly dividend by one cent to 42 cents per share for the quarter ended November 30th, 2020. We will continue to reassess the amount of our dividends on at least a quarterly basis as we gain better visibility on the long-term economy and fundamental business performance. As discussed on previous calls, we have historically managed our compliance obligations conservatively, such that we have had no ordinary income obligations going into this fiscal year and therefore substantial spillover flexibility and consequent liquidity. Payment of this increased dividend further preserves our spillover liquidity position. This quarter saw continued solid performance within our key performance indicators as compared to the quarters ended November 30th, 2019 and August 31st, 2020. and considering the current economic environment. Our adjusted NII is $5.5 million this quarter, unchanged versus $5.5 million last quarter, and down 10 percent versus $6.1 million last year. Our adjusted NII per share is 50 cents this quarter, up from 49 cents last quarter, and down from 61 cents last year. Latest 12 months return on equity is 11 percent, currently the second highest in the BDC industry. And our NAV per share is $26.84, up 6% from $25.30 last year and up 1% from $26.68 last quarter. This is the 11th quarterly increase in the past 13 quarters and the highest year-over-year growth in the BDC industry, with only one other BDC having grown NAV per share over the last 12 months. Henry will provide more detail later. As in the past, we remain committed to further advancing the overall long-term size and quality of our asset base. As you can see on slide three, our assets under management have steadily risen since we took over the BDC, and the quality of our credits remains high. AUM increased to $547 million at fair value in Q3, an 8% increase since last quarter. With that, I would now like to turn the call back over to Henry to review our financial results, as well as the composition and performance of our portfolio.
spk07: Thank you, Chris. Slide four highlights our key performance metrics for the quarter ended November 30, 2020. When adjusting for the incentive fee accrual related to net capital gains in the second incentive fee calculation, Adjusted NII of $5.5 million was unchanged from last quarter and down 10% from $6.1 million as compared to last year's Q3. Adjusted NII per share was 50 cents, down 11 cents from 61 cents per share last year, and up 1% from 49 cents per share last quarter. The decrease in adjusted NII from last year primarily reflects the not recurrence of the $1 million income tax benefit recognized last year and the impact of lower LIBOR rates on the overall mostly variable rate portfolio. The decrease was partially offset by a higher level of investments with AUM up 12.3% from last year and lower interest expense following a repayment of the $74.5 million SAB baby bonds last year. Compared to Q2, slightly higher interest income generated from the increase AUM this quarter was mostly offset by lower other income and higher operating expenses. Of note is that this quarter does not include the full impact of the increased AUM, as all of this quarter's originations occurred in the second half of the quarter, with the repayments mostly in the first month of the quarter. Once all available cash is deployed, the impact of that cash will be fully accretive to NII. In addition to the above, the decrease in adjusted NII per share from last year was due to the higher number of shares outstanding this year. Weighted average common shares outstanding increased by 11.3 percent from 10 million shares last year Q3 to 11.2 million shares for both Q2 and Q3 this year. Adjusted NII yield was 7.4 percent. This yield is down 230 basis points from 9.7 percent last year and down 20 basis points from 7.6% last quarter, reflecting primarily the impact of our growing NAV, the reduced LIBOR over this period, and the effect of our currently undeployed capital. For this third quarter, we experienced a net gain on investments of $1.9 million, or 17 cents per weighted average share, resulting in a total increase in net assets resulting from operations of $6.4 million, or 57 cents per share, The $1.9 million net gain on investments was comprised of $6 million in net unrealized depreciation on investments offset by $3.8 million of federal income tax paid on our realized gains on investments and $.2 million of net deferred tax benefit on unrealized depreciation in our block and subsidiaries. The $6 million unrealized depreciation reflects a 1.2% increase in the total value of the portfolio primarily related to improvements in market spreads, EBITDA multiples, and or revised portfolio company performance. Therefore, more than two-thirds of the reduction in the value of the overall portfolio in the first quarter has been reversed since May this year. Thinking about the total impact since COVID-19 began this year, and as outlined in the MD&A in our Form 10Q that was filed last night, the cumulative nine-month impact is now as follows. There are two investments with year-to-date unrealized depreciation of more than $3 million and only five with reductions of more than $1 million. The two largest reductions are C2 Education Services with $3.0 million and Nolan Group with $3.5 million. Return on equity remains an important performance indicator for us, which includes both realized and unrealized gains. Our return on equity was 11.0% for the last 12 months, which places us second in the industry for this period and well above the industry average of negative 3.6%. Total expenses, excluding interest and debt financing expenses, base management fees, and incentive management fees, increased from $1.5 million for the third quarter and second quarter this year to $1.6 million this quarter. This represents 1.1% of average total assets for all three quarters. We have also again added the KPI slide starting from slides 26 through 29 in the appendix at the end of the presentation that shows our income statement and balance sheet metrics for the past 13 quarters and the upward trends we have maintained. A particular note is the consistent NAV per share growth on slide 26 and slide 29 that highlights how our net interest margin run rate has almost quadrupled since Saratoga took over management of the BDC and has continued to increase in Q3. Moving on to slide five, NAV was $299.9 million as of this quarter end, a $1.7 million increase from last quarter and a $17.7 million increase from the same quarter last year. NAV per share was $26.84 as of quarter end, up from $26.68 as of last quarter and up from $25.30 as of 12 months ago. For the three months ended November 30, 2020, $4.5 million of net investment income and $6.0 million of net unrealized depreciation were earned, offset by $3.9 million federal tax paid on net capital gains realized in fiscal 2020, $0.2 million deferred tax benefit on unrealized depreciation and Saratoga blockage subsidiaries, and $4.7 million of dividends declared. In addition, $0.8 million of stock dividend distributions were made through the company's DRIP plan, and 50,000 shares were purchased for $0.9 million per swing to the share repurchase plan, all in this quarter. Our net asset value has steadily increased since 2011 and is up 6% over the past year alone. Very importantly, this growth has been accretive, as demonstrated by the increase in NAV per share. No other BDC has grown NAV per share like we have over the past 12 months. And in fact, only one other has grown it at all, and that at only 0.9%. We continue to benefit from our history of consistent realized and unrealized gains. On slide six, you will see a simple reconciliation of the major changes in NII and NAV per share on a sequential quarterly basis. Starting at the top, NII per share increased 1 cent from 49 cents per share last quarter to 50 cents per share in Q3. A 1 cent decrease in non-CLO net interest income and 1 cent increase in operating expenses was more than offset by a 3 cent increase in CLO interest income. Moving on to the lower half of the slide, this reconciles the 16 cents NAV per share increase for the quarter. The 40 cents of NII and 54 cents of net unrealized depreciation on investments were partially offset by the $0.35 tax impact of net capital gains realized in fiscal 2020, $0.02 net change in deferred taxes on net realized gains in Saratoga Investments block risk subsidiaries, and $0.41 dividend paid in Q3. Slide 7 outlines the dry powder available to us as of November 30, 2020, which totaled $227.9 million. This was spread between our available cash, undrawn SBA debentures, and undrawn Maddison facilities. This quarter-end level of available liquidity allows us to grow our assets by an additional 42% without the need for external financing, with $54 million of it being cash, and that's fully accretive to NII when deployed, and $149 million in SBA debentures with an all-in cost of less than 2%, also very accretive. We remain pleased with our liquidity position, especially taking into account the overall conservative nature of our balance sheet and the fact that all our debt is long-term in nature and mostly fixed rate. Now we'd like to move on to slides 8 through 11 and review the composition and yield of our investment portfolio. Slide 8 shows that our composition and weighted average current yields have changed slightly as compared to the past. We now have $547 million of AUM at fair value invested in 42 portfolio companies and one CLO fund. Our first lien percentage represents 75% of our total investment, of which 9% of that is in first lien lost out positions. On slide 9, you can see how the yield on our core BBCA assets, excluding our CLO, as well as our total assets yield has dropped below 10%, yet remains healthy. This quarter, our overall yield decreased slightly by 20 basis points to 9.4%, and our core asset yield by the same margin to 9.7% as compared to Q2. But with LIBOR already below floors, this was purely because of the increase in our fair value. This is demonstrated by our core asset yield based on cost remaining unchanged at 9.5%. As a reminder, 100 basis points is our lowest floor. So we did not expect to see further decreases in LIBOR really impact interest income. Our CLO yield is 11.8% and our CLO is current and performing. Turning to slide 10, our investments remain highly diversified by type as well as in terms of geography. During the third fiscal quarter, we made investments of $51.3 million in three new portfolio companies and five follow-ons and had 18% in two exits plus amortizations, resulting in an net increase in investments of $53 million for the quarter. On slide 11, you can see the industry breadth in diversity that our portfolio represents. Our investments are spread over 32 distinct industries with a large focus on education software, IT services, and education and healthcare services. In addition, our total investment in the CLO is reflected as structured finance securities, Of our total investment portfolio, 5.7% consists of equity interests, which remain an important part of our overall investment strategy. For the past nine fiscal years, including Q3, we had a combined $59.6 million of net realized gains from the sale of equity interests or sale of redemption of other investments. Over two-thirds of these gains were fully accretive to NAV due to the unused capital loss carry-forwards they were carried over from when Saratoga took over management of the BDC. This consistent performance highlights our portfolio credit quality, has helped grow our NAV, and is reflected in our healthy long-term ROE. In fact, our six-year ROE average is now almost 13%, with not one year below 9%, and compares very favorably to an industry average over the same period of 5%. That concludes my financial and portfolio review. I will now turn the call over to Michael Grisheth. our Chief Investment Officer, for an overview of the investment market.
spk02: Thank you, Henry. I'll take a couple of minutes to describe the current state of the market as we see it, and then comment on our current portfolio performance and investment strategy in light of the continued impact of COVID-19 and the unique economic environment. Market conditions continue to be affected by COVID-19, but to a far lesser extent than earlier in the crisis. We are seeing rebounding transaction volumes, tightening credit yields, and a general lessening of risk aversion in the market. Earlier in the crisis, deals were mostly limited to existing portfolio companies either pursuing growth initiatives or seeking liquidity. This started a change in our Q2, and this trend we saw in Q2 of more originations with new platform companies continued into Q3. Quality deals are helping widen leverage and tighten pricing, albeit not quite to pre-COVID levels. That said, Q4 was quite robust, and there appears to be a positive outlook for 2021. Lenders in our market are for the most part staying disciplined with covenants and requiring deals to have healthy equity capitalizations. In uncertain economic times such as these, our underwriting bar remains higher than usual. Nonetheless, we are actively seeking and finding opportunities to deploy capital. We believe that compelling risk-adjusted returns can be achieved by deploying capital in support of those highly select businesses that have demonstrated strength and durability in the midst of this difficult environment. We have invested in 10 new platform investments since the onset of the pandemic, including five in this past calendar quarter alone. We also remain actively engaged with our portfolio companies. We have found that our portfolio companies have generally taken the right steps to help mitigate both the near and long-term effect of COVID-19 on their businesses. Now, as we've mentioned before, many of them were also able to avail themselves of the Paycheck Protection Program or PPP loan relief. All of our loans in our portfolio are paying according to their payment terms, including now Roscoe since this quarter. We have opted to keep it on non-accrual for now as it still has past due interest owing. Taco Mac and My Alarm Center are the other two investments that remain on non-accrual. There have been no new non-accruals during calendar 2020. We also recognize an additional $6 million in unrealized appreciation this quarter, which brings our recovery of the Q1 fair value reduction, primarily related to COVID-19, to almost 70 percent. As an overall portfolio, the fair value of non-legacy assets originated by Saratoga has approximately recovered to its cost basis. We believe this strong performance reflects certain attributes of our portfolio that we expect will help us as we navigate through this economic environment. And we remain confident thus far in the overall durability of our portfolio. Seventy-five percent of our portfolio is in first lien debt and generally supported by strong enterprise values in industries that have historically performed well in stress situations. We have no direct energy exposure. In addition, the majority of our portfolios comprise the businesses that produce a high degree of recurring revenue and have historically demonstrated strong revenue retention. However, there are still plenty of uncertainties and therefore potential future adverse effects of COVID-19 on market conditions and the overall economy. including but not limited to the related declines in market multiples, increases in underlying market credit spreads, and company-specific negative impacts on operating performance could lead to unrealized and potentially realized depreciation being recognized in our portfolio in the future. Now, despite this lack of clarity, we continue to believe that our well-constructed capital structure and liquidity will help us to navigate the challenges presented by COVID-19. We believe sticking to our strategy has and will continue to serve us best, especially in the market we currently face. Our approach has always been to focus on the quality of our underwriting, and as you can see on slide 13, this approach has resulted in our portfolio performance being at the top of the BDC space with respect to net realized gains as a percentage of portfolio at cost. We are close to the top of the list of only eight BDCs that had a positive number over the past three years. Furthermore, a strong underwriting culture remains paramount at Saratoga. We approach each investment working directly with management and ownership to thoroughly assess the long-term strength of the company and its business model. We endeavor to peer as deeply as possible into a business in order to understand accurately its underlying strengths and characteristics. We always have sought durable businesses and invested capital with the objective of producing the best risk-adjusted accretive returns for our shareholders over the long term. Our internal credit quality rating reflects the impact of COVID and shows nearly 93% of our portfolio at our highest credit rating as of quarter end, up slightly as compared to last quarter. Now, looking at leverage on slide 14, you can see that industry debt multiples are trending downward from calendar Q1 to Q3. We expect that trend to have continued in Q4. Total leverage for our overall portfolio was 4.03 times, decreasing from last quarter, reflecting strengthened portfolio company capitalization and the lower leverage of certain new deals. As we frequently highlight, rather than just considering leverage, our focus remains on investing in credits with attractive risk-return profiles and exceptionally strong business models where we are confident that the enterprise value of the businesses will sustainably exceed the last dollar of our investment. In addition, this slide illustrates our strengthening ability to generate new investments over the long term, even in the midst of difficult market dynamics. During the calendar year 2020, we added 11 new portfolio companies and made 26 follow-on investments, including eight follow-ons that supported portfolio companies' liquidity during COVID-19. easily the year in which we have executed both the most new portfolio company investments and most deal closings, reflecting ongoing emphasis on broadening our origination capabilities. Moving on to slide 15, our team's skill set, experience, and relationships continue to mature, and our significant focus on business development has led to new strategic relationships that have become sources for new deals. We recently hired an additional senior resource to continue to grow this important function and demonstrate our focus on this strategic priority. The number of new business opportunities has been greatly impacted by COVID-19, although we are beginning to see more active deal pipeline. But what is especially pleasing is that a quarter of our term sheets issued over the past 12 months and four of our 11 new portfolio company investments are from newly formed relationships. reflecting notable progress as we expand our business development efforts. There are a number of factors that give us measured confidence that, despite a decline in deal activity, we can continue to grow our AUM steadily in this environment as well as over the long term. First, we continue to grow our reach into the marketplace, as is evidenced by several investments we have recently made with newly formed relationships. Second, We have developed numerous deep long-term relationships with active and established firms that look to us as their preferred source of financing. Third, we continue to see plenty of investment opportunities in industry segments that are experiencing long-term secular growth trends and within which we have intentionally developed expertise. As you can see on slide 16, our overall portfolio credit quality remains solid. On the chart to the right, you can see the total gross unlevered IRR on our 502 million of combined weighted SBIC and BDC unrealized investments is 12.5 percent since Saratoga took over management. More than two-thirds of the Q1 markdowns have bounced back since then, and what remains is across a wide variety of companies. We do not believe that the remaining unrealized depreciation changes our view of their fundamental long-term performance. The three largest depreciations are in our Nolan Group, C2 Education, and Arbiter Sports investments, all three of which are more dependent on in-person human interaction. Our investment approaches yielded exceptional realized returns. The gross unlevered IRR on realized investments made by the Saratoga Investment Management Team is 16.6%. on approximately $523 million of realizations. Moving on to slide 17, you can see our first SBIC license is fully funded with $222.3 million invested at cost as of quarter end. Our second SBIC license has already been funded with $69 million of equity, of which $98 million of equity in SBA debentures have been deployed. There is still 0.7 million of cash and 112 million of debentures currently available against that equity. In looking back at Q3, and really the whole year, the way the portfolio has proven itself to be well-constructed and resilient against the impact of COVID-19 really came to the fore in the past nine months, demonstrating the strength of our team, platform, and portfolio, and our overall underwriting and due diligence procedures. Credit quality is always our primary focus. And while the world has changed significantly this year, we remain intensely focused on preserving asset value and remain confident in our team and the future for Saratoga. This concludes my review of the market, and I'd like to turn the call back over to our CEO, Chris.
spk05: Thank you, Mike. As outlined on slide 18, following Saratoga Investment's recent capital raises and the current performance of its portfolio, the Board of Directors has decided to declare a 42 cent per share dividend for the quarter ended November 30th, 2020. This reflects a one cent increase from last quarter. The Board of Directors will continue to reassess this on at least a quarterly basis, considering both company and economic factors. Moving to slide 19, our total return for the last 12 months which includes both capital appreciation and dividends, has generated total returns of negative 12 percent in line with the BDC index of negative 12 percent. The latest 12-months total return was impacted by COVID-19, which has caused volatility, severe market dislocations, and liquidity constraints in many markets, particularly impacting the smaller BDCs, with average latest 12-month returns for BDCs with NAV below 300 million closer to negative 16 percent. Our longer-term performance is outlined on our next slide, 20. Our three- and five-year returns place us in the top 15 and top two, respectively, of all BDCs for both time horizons. Over the past three years, our 17 percent return outperformed the 4 percent return of the index, and over the past five years, our 123 percent return greatly exceeded the index's 33 percent return. On slide 21, you can further see our outperformance placed in the context of the broader industry and specific to certain key performance metrics. We remain above the industry average across diverse key categories, including interest yield on the portfolio, latest 12 months return on equity, and latest 12 months NAV per share growth. We continue to focus on our latest 12 months return on equity and NAV per share outperformance, which are which are top two and first, respectively, and reflects the growing value our shareholders are receiving. Not only are we one of the few BDCs to have grown NAV, we have done it accretively by also growing NAV per share, one of only two BDCs to have done that in the past year. Moving on to slide 22, all of our initiatives discussed on this call are designed to make Saratoga Investment a highly competitive BDC that is attractive to the capital markets community. We believe that our differentiated characteristics outlined on this slide will help drive the size and quality of our investor base, including adding more institutions. Our differentiating characteristics include maintaining one of the highest levels of management ownership in the industry at 15 percent, access to low cost and long-term liquidity with which to support our portfolio and make accretive investments, Receipt of our second SBIC license providing sub-2% cost liquidity, a BBB investment grade rating, and active public and private baby bond issuances. Solid historic earnings per share and NII yield. Strong and industry-leading historic return on equity accompanied by growing NAV and NAV per share, putting us at the top of the industry for both. High quality expansion of assets under management and attractive risk profile In addition, our historically high credit quality portfolio contains minimal exposure to conventionally cyclical industries, including the oil and gas industry. We remain confident that our experienced management team, historically strong underwriting standards, and tested investment strategy will serve us well in battling through the substantial challenges in the current and future environment, and that our balance sheet, capital structure, and liquidity will benefit Saratoga shareholders in the near and long term. In closing, I would again like to thank all of our shareholders for their ongoing support. And I would like to now open the call for questions.
spk01: Thank you. And ladies and gentlemen, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Our first question comes from the line of Casey Alexander with Compass Point. Your line is open.
spk06: Hi, good morning. Can you hear me? Yes.
spk02: Can you hear me fine, Casey? Good morning.
spk06: All right, terrific. Mike, a couple questions for you. There was a $20 million quarter-over-quarter increase in control investments. Can you give us some idea what changed at Netreo that caused it to become a control investment, or was it an investment decision that you made? And give us some sort of feel of what kind of company it is.
spk07: Yeah, Casey, so I'll just quickly first jump in just on the classification. So Netreo has always been a control investment because we actually have quite a substantial ownership on that. Mike can talk through that in more detail. The change that you're probably seeing in dollars in the control category is the additional $20 million that a loan, unsecured loan that we invested in our CLO warehouse, potentially in advance of our refinancing of our CLO. So that's the change in dollars. Mike, do you want to expand just a little on our equity ownership there in Natrio?
spk02: Yeah, happy to. Good morning, Casey. The Natrio investment is one where we have a significant equity ownership. There's no change that occurred in the quarter as it relates to that. It's a business that we feel very good about and feel like it's got a lot of confidence that we can grow the enterprise value over time. The market that it operates in is one that is ripe for expansion, and we feel the company is really well positioned in the products that it's offering.
spk06: All right, great. Thank you for that clarification. Secondly, there was an increase in unsecured term loans, and those term loans are at a yield that is pretty far below the weighted average yield of the entire portfolio. Did you guys grab an investment in a broadly syndicated loan during the quarter, or what caused that change?
spk07: No, Casey, that's actually exactly that $20 million CLO warehouse loan. So because it's an unsecured loan, any loan that you put into your CLO warehouse loan, it falls into that category. And so that's exactly, to my earlier point, that's the reason that category increased as well. So it's an additional investment in our CLO warehouse ahead of the refi.
spk06: So does that give you the flexibility to buy some new paper prepping for the refinance of the CLO? Is that what that's for?
spk05: Okay, so this is Chris. Yes, that's what we used it for.
spk06: Okay, great. Thank you. Mike, also, could you expand some C2 education? You mentioned that there was a mark down there, and that seems to be a vertical that has done well during the pandemic, although I see it's a a tutoring and college prep business. Could you give us a little more color as to what's going on there, what led to the markdown, and what the prospects are for C2?
spk02: Happy to. And, of course, I've got to limit my remarks as I typically remind folks. These are obviously private companies, so we can't get into all the nitty-gritty. But this is a business that provides tutoring services services to high school students that are looking to get into top colleges. It's not just SAT prep, but it's also tutoring around the application process and things of that nature and helping them with AP exams and so forth. But their model has historically been predicated upon in-person meetings with tutors, direct in-person meetings that part of their business has naturally been challenged. The business has, I think, reacted very well, and they've introduced much more remote sessions, and that's worked very well. The biggest challenge that they're facing now is really attracting new customers because the parents that are engaging their kids to do that typically want to have a one-on-one in-person interaction before they sign on to that. They are, we think, holding up quite well under the circumstances, and this is a business that we feel really good about. We've been in it for quite some time. We're in a really good spot in the balance sheet. It's one of the key players in the industry. Its outcomes, which is what we always look at when we look at education deals, are very strong. So we have good sponsorship support as well. So we feel... good in the long term, but certainly it's a business that's been challenged. We have not really materially changed our valuation in recent quarters. We certainly devalued it with the onset of the pandemic, recognizing that it would be a business that would face some headwinds. And the valuation that you see now reflects continuing experience that the company's having in that respect.
spk06: Okay, great. Thank you. Lastly, Chris, I guess I'll ask this of you. Noting that the significant capital gains tax Can you explain for us again, will there be a capital gains distribution, or is there some manner of deferring that capital gains distribution to shareholders?
spk05: Yeah, that's a good question, Casey. I think as you recall historically, From when we took over the BDC, we had some capital loss carry-forwards, a significant amount. And over time, those were used to shelter the significant capital gains that we've had and build our NAV and NAV per share. In this past set of realizations last year, primarily coming from Easy Ice, we utilized a portion of the final remaining amount of those capital loss carry forwards, and then we incurred what would be a capital gain. Under the tax rules for RICs, there's a choice. You can distribute that, or at the BDC level, you can pay a 21% capital gain and retain them. As our historical practice has been to retain our capital gains, we have done so with this payment. And so what it does is allows an increase in the net asset value of the company, you know, without incurring any of the costs of, you know, selling additional equity, for example. And a further benefit, because of the way RICs are structured, is that if that were distributed, those shareholders who pay state taxes, those people, you know, not fortunate to live in the five states that don't pay state taxes, you know, they do not incur that state tax. So by retaining it, there's only a federal tax paid at the BDC level. And so to answer your final part of your question, that will be retained and there will not be a capital gain distribution.
spk06: Okay, great. Thank you. That's all of my questions, and I appreciate your taking my questions this morning.
spk05: Thank you, Casey.
spk01: Thank you. Our next question is from Nickish Land with Aladdinburg. Your line is open.
spk04: Good morning, everyone. I hope everyone's doing well. I want to ask about liquidity at the borrowers. You know, it's been we're getting close actually to a year of the onset of the pandemic. Obviously, at the beginning of that time frame, there was a lot of liquidity provided through PPP and by private equity sponsors. I'd like to understand how you're generally viewing liquidity amongst your borrowers now that we've been through several quarters of the pandemic and we're still in a stage where the pandemic is increasing rather than decreasing. And do you think they have enough liquidity to make it through to the end?
spk02: Good morning, Mickey. I'll take that question. You're right. The majority of our portfolio companies took advantage of the PPP program and that was quite helpful as they were managing liquidity through the early stages of the pandemic. We're actually quite pleased and we're monitoring this very carefully. It's something that we switched to as job one when things started in March is managing and making sure that we're on top of the liquidity position of each and every one of our portfolio companies. But as things have settled in general, except for the handful of deals that you see that have material write-downs, and we've discussed them, the other portfolio companies are actually, the performance of the other portfolio companies has stabilized significantly. And by and large, we feel very good about their liquidity position. Even those businesses where we have a significant write-down. We have worked with management and the ownerships to make sure that we understand their liquidity needs, and we feel good about the position that they're in in that respect. We've got sponsorships that's very good, or the company has put themselves in a position where they've reduced their costs and managed to keep their profitability that's appropriate for the environment that they're dealing with right now.
spk04: Mike, in terms of those, let's call them problem deals, are those all sponsored transactions?
spk02: The three that we referenced are all sponsored transactions. Of course, we invest in non-sponsored transactions as well, but my comments on the portfolio overall apply to both.
spk04: Okay. And Amongst those sponsors are these three investments, deals that they believe will ultimately survive the pandemic, and do you think they're willing to write more equity checks to keep those businesses afloat until later this year when the backdrop improves?
spk02: Well, I think the important thing, and I want to make sure that we make this message clear because we've referenced those three businesses earlier, And they constitute the largest portion of our remaining devaluation in the portfolio due to COVID. Each one of those businesses, we feel very good about their long-term prospects. In Nolan's case and in Arbiter's case, they're each the absolute leader in their market niche and both supported by very good sponsorships. and their liquidity position is strong. In C2's case, also sponsored, they're not the absolute leader in their space. It's a space that has some other competitors, but it's one of the leading companies in its space. And in each one of these businesses, and this is really important because it's how we think about underwriting on the front end, the value proposition that they're making for their customers has fundamentally not changed. So we don't feel like if the world returns to any sense of normalcy that these companies won't recover. We think that they'll be right back to where they had been before. Now, there's never certainty around that, but that's our expectation, and we think that they're all adequately capitalized to ride the storm, if you will.
spk04: Excuse me. That's very helpful, Mike. Thank you for that. Turning to the CLO, I have a couple of questions. I noticed that the CLO equities estimated yield increased quarter to quarter, and I realize it's at the end of its reinvestment period. Was there anything we should understand in terms of the dynamics of that investment that caused the estimated yield to go up?
spk07: It's really primarily a reflection of the performance of the CLO this past three months. The past quarter, Mickey, CLO had a really strong performance, and as you could see, it was actually up quarter over quarter in valuation and actually would have been up in valuation even more if not for the fact that we did change one of our assumptions. We increased our prepayment rate from 10% to 20%, reflecting the information we're getting from the desks and the prepayment trends over the past quarter or so. which offset some of the increase in value. But the full impact of the strong performance came through in the actual cash flows and thus in the effective interest rate.
spk04: Okay. And, Henry, at a high level, it looks like you're – do you expect the CLO to be upsized upon refinancing? And what sort of timing are we looking at in terms of the refinancing?
spk05: Mickey, maybe I'll step in for that one. We do have a warehouse attached to our CLO, and as we discussed earlier, we have funded into that, and so we do have assets in the warehouse. And so we already have some assets that could allow us to upsize, and we also have additional leverage, which we have not fully utilized in the warehouse. And so we're prepared to upsize should the market environment you know, be conducive to that in our judgment. In terms of the refinancing, you know, as you've seen over the years, you know, generally speaking, this is the time zone in which we would, you know, seek to, you know, refinance. And so we are in the process of engaging with the market. As you can also appreciate, you know, over the last, you know, six months, the market has evolved very dramatically. So, you know, Six months ago, basically, it was closed, and then now it's much more robust than it has been.
spk04: I definitely agree with that, Chris. And given sort of market terms available right now in CLO, can you give us a sense of what level of estimated yield we might see on that CLO once it's refinanced and what level of fee income the manager or the BDC can earn from the upsized CLO?
spk05: Well, Mickey, I think it's a little preliminary for us to actually know that, let alone communicate that. So we're still in the marketplace right now, so it's just a little early. I think our next conversation we would probably have it done by then, hopefully.
spk04: Okay. And one just sort of last housekeeping question maybe for Henry. What is the level of the undistributed ordinary taxable income per share?
spk07: I don't have an exact amount for you, Mickey, but I guess a way to think about it is we sort of went into the year with no spillover, so basically break even. And then, of course, we've declared now this is the third dividend we've declared since then and obviously had three quarters and has over-earned by, you know, between six and eight cents each quarter the dividend thus far. So I think hopefully that gives you sort of a parameter and sort of how to think about what the current amount is.
spk04: But, Henry, there was also one quarter where you didn't pay a dividend. So I'm assuming the undistributed taxable income is fairly meaningful right now.
spk07: Well, exactly as you said, yeah. I mean, there's the one quarter, and then there's probably $0.68 for the other quarter. So that's more or less what the amount is. Now, having said that, you know, There is obviously still unknowns. The CLO refinancing, CLO is consolidated for tax purposes. So that could also obviously impact that as that progresses over the next couple of months.
spk04: Right. And, Henry, can you just remind us then under RIC rules, when are you required to either distribute that or, you know, consider other options for that spillover?
spk07: Sure. So we went into the year with no spillover. That means this full year's taxable income through February 2021, so the end of this coming February, only has to be distributed eight and a half months after this February. So only, I think it's middle November of this year. So there's still quite a period until the February spillover amount would have to be distributed. And all of the dividends post-February would obviously count towards that as well.
spk04: Right, right. Okay, that's it for me this morning. Thank you, and congratulations on your performance.
spk01: Thank you.
spk07: Thank you.
spk01: Thank you. Our next question is from Sarkis Sherbeckian with B. Reilly Securities. Please go ahead.
spk03: Hi, good morning, and thanks for taking my question here. Just wondering what sectors or industries are you guys currently seeing the most opportunities to recycle capital? I suppose especially in light of increased prepayments and the rate environment. Thank you.
spk02: Good morning. I'll take that. I think the way we think about it is more the flip side of that, which is where are we not seeing opportunities or where are we avoiding investing capital? And certainly there are generally the obvious ones in the COVID environment. So we're avoiding doing anything new in the hospitality space and the travel and leisure space, certainly restaurants, those types of industries that are most greatly affected in COVID. And those happen to be those industries that require a good deal of human interaction and especially group interaction. Those are areas where we've avoided, I think, By and large, any of the businesses that are holding up well, and there certainly are significant subsets of the economy that have held up really well, some have even flourished in this marketplace, we see lots of activity, increasing activity there. If anything, what's happened in the marketplace for those businesses that have performed well in this environment, there's even greater interest. You start to see valuation multiples expand and kind of a fair amount of aggressiveness toward lending to those business models that have proven themselves. One example there would be businesses that are delivering their product through a SaaS platform, so a software as a service platform. That happens to be an industry sector or a business model type that we have particular expertise in, and we're seeing quite a bit of activity in that space, for example. But I would point out, and this is one of the things that we're super excited about as we build out our business development group and further penetrate the lower end of the middle market. Two of the last three new portfolio companies in this last quarter that we invested in, two of them were in businesses that weren't in the software space. They're businesses that are One is a dental practice management company. Another one is a heating and air conditioning business for residential customers. And those are businesses that are holding up exceedingly well, but it's very much case specific.
spk03: Got it. Thanks for that, Kohler. And can you maybe make some comments regarding kind of the interest rate environment and what you're seeing on spreads given the bulk of the portfolios floating?
spk02: Well, as Henry pointed out, the good news on spreads is that all of our assets are at their floors. So we've got, if there's any further erosion in LIBOR, we won't experience it in our portfolio. But what we have witnessed is that the marketplace is getting very aggressive on spreads. And I would say that for Strong credits, spreads have returned to kind of pre-COVID levels. And there's certainly a distinction people are drawing between businesses, you know, in kind of the sectors that I already described. But for those businesses that are performing, people are being quite aggressive in lending to those businesses, and we're kind of back to pre-COVID levels by and large.
spk03: Thank you. That's all for me. Thank you.
spk07: Great.
spk03: Thank you, Sark.
spk01: Thank you. And this concludes our Q&A session for today. I will turn the call back to Christian Overbeck for his final remarks.
spk05: Well, we'd like to thank everyone for joining us today, and we look forward to speaking with you next quarter.
spk01: Thank you for your participation in today's conference. You may now disconnect.
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