Logan Ridge Finance Corp (LRFC) 2014 Q4 法說會逐字稿

At this time I would like to welcome everyone to Capitala Financial Corporation's conference call for the quarter ended December 31, 2014.

(Operator Instructions)

Today's call is being recorded and a replay will be available approximately three hours after the conclusion of the call on the Company's website at www.capitalagroup.com under the Investor Relations section.

The host for today's call are Capitala Finance Corporation's Chairman and Chief Executive Officer, Joe Alala; Chief Operating Officer, Treasurer and Secretary, Jack McGlinn; and Chief Financial Officer, Steve Arnall.

Capitala Finance Corporation issued a press release on March 4, 2015 with details of the Company's quarterly financial and operating results. A copy of the press release is available on the Company's website.

Please note that this call contains forward-looking statements that provide information other than historical information, including statements regarding the Company's goals, beliefs, strategies, future operating results and cash flows. Although the Company believes these statements are reasonable, actual results could differ materially from those projected in the forward-looking statements. These statements are based on various underlying assumptions and are subject to numerous uncertainties and risks, including those disclosed under the section titled Risk Factors and Forward-Looking Statements in the Company's Annual Report on Form 10-K. Capitala undertakes no obligation to update or revise any forward-looking statements.

At this time I would like to turn the meeting over to Joe Alala. Sir, you have the floor.

Thank you, operator. Good morning, everyone. Thank you for joining us. To begin, just to recap our fourth-quarter activity. We had growth originations of $67 million. We had net originations of $51.6 million. Our net investment income was $0.39 per share. We did have capital gains at $0.17 per share, so we did cover our distribution with both NII and realized gains. Again reminder, our goal is to be able to cover our distributions, our core distributions through NII, which we forecast to be able to do that in the foreseeable future.

The weighted yield on our debt portfolio is 12.5%. We break that up into both the lower middle market and the traditional middle market. Our lower middle market yield was 13.3% with a mix of 45% senior secured and 55% subordinated debt, with the great majority of that second-lien debt. Then our traditional middle market activity, the yield was 10.2% with 23% of that being senior secured paper and 77% of that being subordinated debt.

The 12.5% is down slightly from prior quarter, which was 12.8%. Two things we continue to point out when we deliver these statistics is, our average funded debt to EBITDA at the portfolio Company level has still remained around 4 times, which has been consistent from IPO through the last fourth quarter. One thing that has grown over that time, even though the we've kept the yield has come down slightly, the mix is more senior and the funded debt is more or less the same, the EBITDA at IPO was $8 million, on average. At the end of the fourth quarter, our average EBITDA was $31 million, at the portfolio Company level.

We also have been successful at rotating out of some of these equity positions. Our equity portfolio is down to 23.2% based on fair value at the end of the fourth quarter. That would not include Boot Barn, which we'll talk about in a second, that we monetize in a subsequent activity. The net asset value of approximately $241 million, $18.56 per share. We paid monthly distributions totaling $0.47 per share for the quarter.

For the year, we ended up adding five new investment professionals to take our team to 25 total, which is a very sizeable team for assets of our size. We also, in fourth quarter, closed our senior secured credit facility, a $150 million accordion-up facility, with $50 million in the fourth quarter.

At the end of the quarter, and continuing today, we do have a strong, robust pipeline of both lower middle market and traditional middle market activity. We continue to focus on covering our core distributions through core NII.

Subsequent activity that's happened since the end of the fourth quarter. We did monetize 30% of our position in Boot Barn. We sold basically $4 million, which translated into a $3.3 million gain. The return on that investment at that portion that we have monetized is a 78% IRR. It represents a 6.1x cash-on-cash multiple. The rest of the shares are in the lockup and those expire during the second quarter, so we would be able to monetize more at that time.

With the realized gains of both Boot Barn and Chef'n, we declared a special dividend for the remainder of the year of $0.50 per share. Those will payable monthly, beginning the next pay period. This represents approximately a 32% premium to our core dividends.

We also increased the revolver capacity at the end of the fourth quarter to $80 million, so we increased it from $50 million to $80 million. We also, the Board adopted a $12 million share buyback plan. We've had a lot of great activity subsequent to the end of the fourth quarter.

At this point, I would like to turn the meeting over to Steve Arnall for some additional comments on our operating and financial performance. Steve?

Thank, Joe. Good morning, everyone. As previously mentioned, on March 4 we filed a press release with our fourth-quarter and full-year 2014 earnings. In addition, we also posted a fourth-quarter 2014 investor update to our website, provided additional details about the Company, the investment portfolio and other financial related trends. We hope you find that helpful.

I'd like to take a few minutes to highlight a few items within our earnings release, which again can be found on the Investor Relations section of our website. During the fourth-quarter 2014 total investment income was $13.5 million, a $1.4 million increase over same period last year. Total interest and fee income was $4.3 million higher in the fourth quarter of 2014 compared to 2013, both partially offset by $3.1 million less in dividend income.

Total expenses for the fourth-quarter 2014 were $8.4 million compared to $6.0 million in the same period last year. The increase of $2.4 million is attributable to: One, an increase in interest and financing fees of $2.6 million. Two, an increase of $0.8 million in management fees net of the waiver. Three, an increase of $0.5 million related to administration and other operating expenses. Four, a decrease of $1.5 million related to the incentive fee not being earned in the fourth quarter of 2014.

Net investment income totaled $5.1 million or $0.39 per share for the fourth-quarter 2014 compared to $6.1 million or $0.47 per share for the same period last year. The decrease in net investment income relates primarily to a $2.4 million increase in operating expenses, as previously discussed, partially offset by a $1.4 million increase in total investment income.

Management remains focused on covering distributions with core net investment income and is confident that the distribution rate is sustainable. Recent equity exits and subsequent rotation into debt investments coupled with continued investment activity in the lower and traditional middle market will position us to accomplish our objective.

Net realized gains were $2.2 million or $0.17 per share for the fourth quarter of 2014 compared to a net loss of $48,000 for the same period last year. During the quarter we realized gains related to Chef'n Corporation, $2.7 million, and Naples Lumber & Supply Company, $1.4 million, was partially offset by a $1.9 million loss from the exit of the equity investment in Impressa Aerospace Holdings.

The net change in unrealized depreciation was a decline of $18.5 million or $1.42 per share for the fourth quarter of 2014 compared to an increase of $0.7 million or $0.06 per share for the same period last year.

The depreciation during the fourth quarter of 2014 was related to declines in the fair value of energy-related investments coupled with general declines in EBITDA levels for several lower middle market portfolio companies. Jack will discuss this further during the portfolio update section of this call.

Our net decrease in net assets resulting from operations during the fourth-quarter 2014 totaled $11.2 million or $0.86 per share down from an increase of $6.8 million or $0.52 per share last year. Total net assets of $240.8 million at December 31, 2014 equate to $18.56 per share compared to $19.89 at the end of September and $20.71 at December 31, 2013.

From a liquidity standpoint we have cash and cash equivalents of $55.1 million at December 31, 2014 compared to $101.6 million at the end of last year. SBA debentures outstanding at December 31, 2014 totaled $192.2 million with an annual weighted-average interest rate of 3.51%. In addition, the Company has $113.4 million of notes outstanding bearing a fixed-interest rate of 7.125%.

Lastly, the Company has a $50 million available under its senior secured revolving credit facility. The credit facility is priced at LIBOR plus 300 basis points and matures in October of 2018. It should be noted that the availability under this credit agreement increased to $80 million as previously disclosed on January 8 of this year.

At this point I'd like to turn the call over to Jack for a few comments on our investment portfolio and trends we're seeing in the overall investing market.

Thanks, Steve. During the quarter we originated $67 million of new investments and received repayments of $15.4 million for net deployments of $51.6 million. For further clarity, Capitala will provide investment info going forward by lower middle market deals, companies below $30 million of EBITDA, and middle market activity, companies greater than $30 million of EBITDA. Please see the break out in the earnings announcement for further details.

During the fourth quarter we originated one, new, lower middle market subordinated loan totaling $20 million at a 12.5% cash rate while also completing five add-on investments for $3.7 million. The weighted-average interest rate for the new investments in the fourth quarter was 11.9%.

We also originated $43.3 million in six new middle market investments. $18 million of these new investments were senior secured loans, which helped support the borrowing base for our new senior secured credit facility.

The weighted average yield on the new middle market senior secured loans and second-lien loans was 7.6% and 11.3% respectively. The overall debt portfolio yield is 12.5% versus 12.8% at the end of the third quarter, and 13.7% at the end of 2013. At the same time, overall leverage at the portfolio level stayed flat at around 4x.

While the deal market remains competitive, the majority of the decrease in our yield is related to moving up the balance sheet to more senior securities and/or increased investments in larger middle market companies. We feel this is a prudent tradeoff as we move further into the cycle.

As Steve mentioned, unrealized depreciation declined by $18.4 million for the quarter. Approximately a third of that decline was related to our energy investments. With the recent declines in oil prices we have been very closely involved with our investments in the energy space. At year end, Capitala had five investments within the energy sector representing approximately 12.3% of the total investment portfolio at fair market value.

The year-end fair values of our energy investments were approximately 89.5% of cost, as compared to 96.9% of cost at the end of the third quarter. At year end, all of our energy investments were current on interest payments, and we continue to have frequent dialogue with our sponsors, management teams, announced outside consultants regarding situation.

Most other declines in the portfolio are related to the increase in yield spreads and EBITDA decreases in a few lower middle market companies where we have a large ownership stake.

In regards to non-accruals, we have one $3.4 million cost-basis debt investment on non-accrual status. This investment has a fair-market value that we've written down to zero. In addition, we have one portfolio debt investment on PIK non-accrual. This investment has a cost basis of $13.1 million and a fair-market value of $10.6 million. Our internal weighted average risk rating remained relatively flat at 1.83 versus 1.80 at the end of the third quarter.

As of the end of the fourth quarter, the Capitala portfolio consists of 52 companies with a fair market value of $480.3 million and a cost basis of $441.2 million. Senior-debt investments represent 30.5% of the portfolio, senior-subordinated debt 46.3% and equity-warrant value of 23.2% down from almost 36% at IPO. On a cost basis equity investments comprise just 14.2% of the portfolio.

As Joe mentioned we are very pleased with the ongoing efforts to monetize a good portion of our equity holdings and rotate those proceeds into interest bearing debt investments.

Subsequent events involving the portfolio include $35 million invested in two new lower middle market investments yielding a combined 13.1% weighted rate and a $2.6 million investments in add-on debt fundings. There is also a $12 million repayment on the lower middle market loan that had 12% rate.

We are pleased to announce that through a secondary offering, we were able to monetize about a third of our Boot Barn holdings generating a $3.3 million realized gain on a $4 million payment. Capitala has sold 179,000 shares and continues to hold 420,000 shares that are subject to a lockup agreement that expires during the second quarter of 2015.

Briefly, in regards to market conditions. While it continues to be a competitive market, we are finding much more deal activity now versus the first quarter of 2014. We continue to see a robust pipeline of directly originated deals from our proprietary, multi-office origination platform, and we believe that we have seen some stabilization in rates. With that I will turn it back over to Joe.

Thanks, Jack. Thanks, Steve. Now, we'll ask the operator to turn it over to Q & A.

(Operator Instructions)

Our first question comes from the line of Terry Ma from Barclays.

Hi, guys. Can you just maybe talk about the overall EBITDA and revenue growth trends you're seeing in portfolio, given a couple of your lower middle market companies are seeing lower EBITDA levels?

I would say it's hard to classify, over 50 companies it's really mixed. We have -- it's a normal mix. Some are outperforming, some are underperforming. Obviously, the energy investments are readjusting their forecasts. They are also readjusting their cost structures, too. Otherwise, its been, I would say, relatively stable. I think the middle of the pack has been flat. We don't see a lot of revenue or EBITDA growth there, but steady performance.

Got it. Can you just give us some color in how you're thinking about monetizing the rest of Boot Barn after the lockup?

Yes, the lockup expires second quarter, but as we continue to rotate out of these equity positions, we think a lot of that activity will happen between now and when the lockup expires. At that time, we'll revisit. The overall strategy of rotating out of these equity positions is happening. It's continuing to happening. We think enough of that activity will happen before the lockout expires that we'll have to revisit it at that time.

Okay, got it. Can you maybe just give us some color on the thinking for paying the additional dividend of $0.50 over the rest of this year as opposed to holding on to some of it?

I think, and Steve will add his comments here, but I think our process of rotating out of these equity investments is going to continue to happen at the pace that we are forecasting. Our forecast is that will happen. We'll get this closer to 10%, probably, in the fairly near future, and with that we'll have more decisions. We can either reinvest into higher yielding platform-generated deals or we could pay future special distributions. We will revisit at the time, but we think a lot of activity will occur over the next this quarter or next quarter, so revisit those decisions with our Board.

Got it. That's it for me, thanks.

Thank you. Our next question is from the line of Mickey Schleien from Ladenburg.

Good morning, gentlemen.

Good morning.

I wanted to ask you about the energy investments. We're generally hearing that a lot of oil production and consumptions hedged for most of this year, but those hedges will roll off next year on average. I'd like to understand how you think that will affect your investments in that sector? How the borrowers are preparing themselves for that?

Yes, Mickey, this is Jack. We've, obviously, going to spend a lot of time talking to our companies here. We have five companies that are impacted by the prices, some more than others. There's some more focused in natural gas, and they're not as impacted by the oil prices and what's going on there.

We do have a large investment that is impacted. The management team has been through the cycle before. They lived through 2008/2009 downturn. They've been aggressively restructuring their cost base, actively involved with their customers and working through. Some of it is just getting the right scale to work through this. Actually, sometimes during the downturns, as their working capital needs reduce, the cash flow increases. We're fortunate to have experienced operators in this space and know how to manage through this. We're working with them in that regard.

Obviously, I don't think anybody has been able to really gauge how long this is going to last, but there seems to be some stabilization in rates. Again, a lot of our companies operate in the lower cost fields. We feel pretty good based on the circumstances where those companies are. We think we've, again, reduced the fair values to where they should be. We'll continue to monitor it, but we think they're on top of things.

All right, different question. In your prepared remarks, you talked about going higher up in the capital stack as we continue in the credit cycle. I'd like you, perhaps, can you remind us, of the almost 100 portfolio companies you've invested in to date, how many of those were placed on non-accrual at some point? What's been the average recovery rate on those?

Well, you stumped me on that one.

Well, we can do that offline, if you'd like?

I can sit down and look back through. Before we went public, we didn't have the non-accrual monitor on things. When I work with our operations team, we don't talk in terms of non-accruals. We talk in terms of which companies need more support than others. To go back through the all and 100 investments, I'd have to spend some time on that.

Right. My question is really trying to get an idea of how you manage through previous downturns given your comments that we seem to be well into the credit cycle, but we can talk more about that later. Target leverage, its climbed. Your leverage is now, with SBA debentures, almost 1.3, which is pretty high in the BDC space. It's obviously well under the limit, if you exclude SBA debentures. How are you thinking about target leverage on a go-forward basis?

This is Steve. I think our regulatory leverage is how we're looking at it. We're at 0.47. We've got the ability with our undrawn credit facility to draw maybe up to $70 million to $100 million and stay within the 1 to 1 ratio. We probably will get know where near that. We've said before, our target may be 0.7 as a topping out point, until we see the equity percentage decline. At that point, maybe we'll go above that. We're very sensitive to the leverage and understand that we're on the high end of that relative to our peers, but we've still got capacity. We'll be very thoughtful as we proceed forward.

Steve, a 0.7 would take you to about 1.5 total debt to equity; correct?

That's about right, yes.

As you monetize the equity investments, on which you've done very well, is there a possibility you'll use some of that to reduce leverage?

Possibly, but that's not -- we haven't made any decisions in that regard, right now.

Okay.

Mickey, this is Joe. Reminder, most of our leverage is the SBIC leverage is 6.5 year life, really can't repay it other than schedule repayments. Then, we have the bonds at $113 million, so most of that debt is fixed and doesn't have the option to really repay in the foreseeable future.

I understand. In terms of the new credit facility, how much flexibility is there in terms of the assets you can put in there? Is it really geared toward first lien? Can you put second lien in there? What are the advanced rates you can get on those?

The advanced rates vary from 50% up to 70% First lien, obviously, get the highest advance rates, and as you move down the food chain, if you will, the advance rates decline, so it's very flexible. I think the borrowing base needs to be, I think, 30% firsts lien and/or cash and then down below from there.

Okay, one last question. Can you give us a sense of how much your current spillover taxable income is? I saw in the K the numbers from way back in August, I was just curious where we stand now?

We really don't have any spillover income right now. Our tax year ends August 31, so we're a little unique in that regard. As we looked at our year end, tax year end of 8/31, we really didn't have any. That's going to change this year as we start seeing some of these monetizations, these equity positions. That whole dynamic is going to be a lot different. That will be something that we communicate with you going forward.

Okay, thanks for your time this morning.

Thank you.

Thank you. Our next question comes from the line of Vernon Plack from BB&T Capital Markets.

Thanks. Jack, could you give us a little more color on On-Site Fuel Services? I know that you marked that down about $2.5 million during the quarter and you added another $1 million after quarter. I'm just trying to get some thoughts there in terms of what you're thinking on On-Site?

That one sounds like it might be oil and gas related, but it's not, so just wanted to clarify that first. That has been a lot of work over the last year. We've had a change in management there, and at the same time had a change in the whole IT infrastructure. Those two things have lead to a slowdown in the financial performance of the business. It has needed financial and management support from Capitala over the last year. That is continuing, as we speak. We have a new management team in place, new systems in place, and we are working very hard to get both revenue and profitability improved there, but it has required some further investment.

We own a pretty large stake in that business, with co-investment partners we control the Board of Directors. We are very actively engaged in making decisions to drive that Company to better performance. The very recent trends have been improving.

Okay.

Actually, I should mention, buy part of the financial support -- we had -- one significant customer that went bankrupt over the last couple months. Part of our funding was, basically, as that came out of the borrowing base for the Company, we had to put money into support that. That was an isolated incident, and we'll continue to work through it.

Do you think you'll be -- knowing what you know today, do you think you'll be putting more money into On-Site?

Yes, there's a good possibility of that, not necessarily related to operating performance but just as far as -- it is -- we do buy fuel. So actually, the Company does benefit from the lower fuel prices, but there are a lot of fuel purchases. We may have to put some money in to help support just their buying patterns.

Okay, and one other company, is it SSCR, that also took a write down of about $2 million? I'm just curious in terms of what's going on there? It looks like you put $2 million in, then fair value didn't change a whole lot, so can you help me out there?

Yes. It's somewhat similar, not as many management issues there. That's the main product that they produce is sun screen, so if you go back two years, two summers ago, it was a horrible year for all of the sun screen producers. They had a bad year, bad summer two years ago, lots of returns from the retail outlets as the summer was not great. Product wasn't used all that much. That trickled in, then, to last summer, which wasn't all that bad from a buying perspective, but there was a lot of product on the market. It was heavily discounted, couponed, and again, just a local of product out there. Financially, it was not a good year.

We've been, also, very active in that one in cutting costs, trying to work back into a more profitable situation. Similarly, it's taken some funding to get that one restructured and moving in the right direction. That is, obviously, another one that we spent a lot of time on.

Sure. One final one, just in terms of the amount of capital that you're willing to put in any investment? I know that during the fourth quarter you made the two around $20 million. Is that what you're thinking in terms of the max, around that range, around $20 million, right now?

No, I think our max would be more in the $25 million range, with some room to go above that.

Okay, all right, thank you very much.

Thank you. Our next question comes from the line of Christopher Nolan from MLV & Company.

Hi. Could you give a little detail in terms of any plans to use non-qualifying bucket?

Right now, we've got really nothing in there. I think, in the future, we'll be more thoughtful there. Really, I can't announce some of the things we're working on right now that might fall into what you're asking. I would just say be patient and look for some releases in the next coming weeks, and we'll cover it that way. I can't cover that right now, Chris.

Understood. I guess, then, turning to the energy investments again. Is the write downs really due to weakening EBITDA or just some more cautious approach in terms of lower energy prices?

No, reduced EBITDA, which obviously comes from the top line. It's going to be reduced revenue. Again, I'm referring to our largest investment in the energy space. They know that revenue is going to be significantly reduced. Margin are going to be reduced, and their EBITDA is going to be significantly reduced. From a debt perspective, and this is from the management, they don't think it's going to impact how they service the debt all that much, but their performance is certainly going to be off. We do have an equity holding in that business, so that certainly decreases our valuation on the equity.

Given you guys tend to invest in some of these companies all along the capital stack and some of the more subordinated pieces are more subject to asset-quality issues, do you anticipate a portion of these investments to be restructured in some way?

I would think -- there will probably be some restructuring that goes on. For the most part, when we do energy investments or really any investments in cyclical sectors, we're very conscience of what the balance sheet looks like and the amount of amortizing senior debt in front of us. We go into these situations with a pretty well structured balance sheet that can withstand a cycle, maybe not a three-year or great-recession-type cycle, but we do make sure the balance sheet can handle a downturn. I don't contemplate any major restructurings with large debt discounts and such, but there will be some covenant changes and things.

Got it. Thanks for taking my questions.

Thank you.

Thank you. Our next question is from the line of Greg Mason from KBW.

Great, good morning, guys. Just hitting on some of the last topics, but trying to drill it down a little bit more. On the $16 million of portfolio depreciation net in the quarter, you gave us three buckets: energy related, higher yield spreads and EBITDA declines. Energy is what it is. Yield spreads should just be temporary. Could you help us understand maybe what percentage of that $16 million of depreciation is the actual EBITDA decline that could be more concerning over the long term?

Sure, so we've already talked about two of the bigger pieces in the EBITDA decline and that would be the On-Site and the SSCR.

Yes.

That's actually the bulk of it right there. We had one other, Print Direction is a company that we own, I think, roughly 70% of. They had an EBITDA decline. That's customer related, over a couple customers. We don't see any cyclical downturn in their market. I think it's just they go through cycles of having customers roll off, and then they bring in new customers and fill back in. We think that's more of a temporary decline in EBITDA. But when you own 70% of it, it's going to have a larger impact on our decrease in valuation for the period. I think those three pieces in that declining EBITDA bucket -- that's, again, so PDI and Print Direction and On-Site, we have large ownership percentages, so any decrease in EBITDA has a pretty large impact on things. SSCR, we also have a good sized equity position, so that gets impacted.

We also had our one non-accrual, Precision Manufacturing. That's been on our watch list. Its been on and off non-accrual, and that company has hit some headwinds. I think we reported before that they had some backlog issues. They got pushed back. Then, it seemed to be strengthening. Then, they got pushed back again, so we have taken that, we think prudently, down to zero fair market value. That was the fourth big piece to that.

That's great color, I appreciate it. On the traditional versus the lower middle market, you've built up the traditional a bit. With EBITDAs of $95 million in that business, it seems definitely much more of a liquid portfolio versus the real alpha you guys generate in the lower middle market. How big do you want that traditional middle market to become? Or what percentage of your overall portfolio do you want the traditional middle market to be?

I don't think we really look at it as percentage, right now. We try to move around to find the best risk-adjusted returns. I think what we're seeing now is, in our lower middle market, we're doing a lot more non-sponsored deal and senior-secured deals. We're getting some very attractive rates and very low leverage points.

The equity-sponsor activity in the lower middle market, we continue to find that's very competitive, higher EBITDA out of the gate requests from these equity sponsors, and very compressed yields that they're offering their potential debt providers. We are actually finding more attractive -- we're finding attractive opportunities in both spaces, but we'll go around and find where the best opportunities that provide the highest risk adjusted returns. What's really great about our capital structure is that, since we have the fully deployed SBIC leverage or almost fully deployed, we can put those lower middle market credits in the SBIC subsidiaries. Then, with our new revolver in place, we can finance these traditional larger middle market opportunities with that type revolver financing.

We really have a nice balance sheet that can play in both the lower middle market and the traditional middle market space. Right now, we're just moving around to try to find the best risk-adjusted returns and continuing to focus on that leverage at the portfolio level in larger EBITDA companies, because we think we're further along in the cycle.

Got it. You mentioned $35 million of lower middle market deals post quart end. Any traditional middle markets post quarter end?

Those are all lower middle market deals, not non-sponsor.

Okay. So, you haven't closed any traditional middle markets here in the first quarter?

Correct.

Got it. One last question, as we look through the schedule of investments, there's, call it eight or nine investments, that look like they have source and then the name of the company or Source Capital is the sponsor. That seems to be a pretty large percentage of your deals with that one private equity sponsor Source capital, so could you just talk about that relationship a bit given there are eight or nine investments with them?

I guess what you don't see is there's a history going back 8, 10 years of investing with that group. We've had some very successful investments with them. We've also had some ones that we've had to work very closely with to get through operational issues or management issues or performance issues, so we have a good history of working with them. There's a range just like any other portfolio investments with a group where you have out performers and underperformers and the middle of the pack ones. The good thing is there that we have a long track record of working very closely with them in the decision-making process and understanding the relationship of Capitala as a lender and they as the equity provider and the relative rights there as well as common objectives and really the long term focus on getting the company where we want it to be. It's a great question. There is some privacy on their side as well as on the portfolio company side. We do have a very strong relationship there, and we'll continue to have a good relationship with them.

Great. Thanks, guys.

Thank you. Our next question comes from the line of Hannah Kim from JMP Securities.

Hi, good morning. Thanks for taking my questions. I'm calling in for Chris York this morning. Just wanted to start off talking about sub debt in your portfolio. I see that as a percentage of the total portfolio, sub-debt investments has been trending upwards. I understand that you're looking at deals on the deals-by-deal basis, but just going forward, how should we think about that? Do you have a target allocation amount to your sub-debt investments in the portfolio?

Yes, this goes back to we're trying to find the best risk-adjusted returns. Right now, we're finding in the lower middle market, we're finding senior debt that's paying us 13%, 14%. We're pursuing those activities.

We're sort of moving around. We do, with our revolver in place, have to have more in that traditional middle market definition, senior loans, to really have an optimal revolver advance rate. We do have to do that. That's the reality of our revolver.

I think what we're finding now is we're continuing to do more senior credits. We're getting great pricing. If that changes, we would probably go more to the traditional mezzanine. This late in the cycle, I think where really you'll see our trend is much more senior related. Because we do, we think we're further in the cycle.

The thing we're constantly doing and continuing to do is lower our equity percentage investments and getting that down. At IPO, again, it was 36%. It was 23% end of the fourth quarter. It's probably under 20% now that we monetized some of Boot Barn, and we're still rotating out of several larger equity positions, as we speak.

Okay, great. That's great color. My next question is related to Market E and Source Recycling. I see that they have been removed from your non-accrual list this quarter. Marks for Source Recycling went up, but marks for Market E remained relatively flat. I was wondering if you can provide any additional color on these two investments?

Sure, Market E had been a deal that we were the largest investor in, had control provisions in the Board. We had been looking for a buyer for that business for several quarters. We were able to come to an agreement with a buyer in the first quarter. The reason it still shows up on our portfolio but not on non-accrual, the buyer bought the assets of the business. The entity Market E still exists, and there is a lot of contingent note and upside also involved in the sale of that. It's still on the portfolio list, but it has been taken over by a new party that's funding the growth of that business.

Again, we had been in that for about seven years or so and really weren't at the stage where we wanted to invest in kind of a new growth phase that the company was about to take on. That's what the new buyer is doing. That's a little bit behind of what the structure of the transaction was and why it's still on our portfolio. That adequate answer?

Yes, got it. Thanks, that makes sense. Last question is the new PIK non-accrual Sparus Holding. I was wondering if you can provide some additional color on this one? I see that during the quarter, you probably restructure the deal and added some sub-debt investments?

That's correct. That company has also gone through some reorganization. They sold off a division and brought in a new CEO to reorganize the business. That reorganization plan has required some more capital, so we funded that. We've also marked down the investment, in total. I think with a decrease in some of the value in our debt, we didn't think it was appropriate to continue to recognizing the PIK on that debt investment. We continue to monitor that investment and work with the new CEO. It's a company we've been in for a long term, and it also has its ups and downs as a lot of utility services. Its got a good base of operations. It just got a little heavy on the cost side and management is working to address that.

I think you'd also mentioned the Source Recycling. That is a company that also went through a transaction late last year that helped support the overall operations. There's been some changes there, but the performance in a new combined company has been much stronger, even though pricing in the recycling industry is still off with the economy. We don't see any downturn there, but as things improve the operations there will begin to improve. So, we see a better outlook for that portfolio company.

Okay, great. Thank you. That is all for me today.

Thank you.

(Operator Instructions)

That is all the questions we have in the queue at this time. I'd like to turn the call back over to the speakers for closing remarks.

Thank you. We want to thank everybody for their time today. We also want to remind everyone, we did upload an investor update on our website that goes into a lot of detail on the yields, the security, what we're seeing lower middle market, traditional middle market. We go into a lot of detail on this presentation. We invite you to look at it. This is something we will continue to update quarterly going forward.

Thank you for your time. Our phones are always open for any future questions or comments. Thank you.

Ladies and gentlemen, thank you again for your participation in today's conference. This now concludes the program, and you may all disconnect your telephone lines. Everyone have a great day.