MidCap Financial Investment Corp (MFIC) 2016 Q4 法說會逐字稿

Good morning, and welcome to Apollo Investment Corporation earnings conference call for the period ended March 31, 2016.

(Operator Instructions)

I will now turn the call over to Elizabeth Besen, Investor Relations Manager for Apollo Investment Corporation.

Thank you, operator, and thank you, everyone, for joining us today. With me are Jim Zelter, Chief Executive Officer, Ted Goldthorpe, President and Chief Investment Officer, and Greg Hunt, Chief Financial Officer.

I would like to advise everyone that today's call and webcast are being recorded. Please note that they are the property of Apollo Investment Corporation, and that any unauthorized broadcast in any form is strictly prohibited. Information about the audio replay of this call is available in our earnings press release.

I would also like to call your attention to the customary Safe Harbor disclosure in our press release regarding forward-looking information. Today's conference call and webcast may include forward-looking statements. Forward-looking statements involve risks and uncertainties, including, but not limited to, statements as to our future results, our business prospects, and the prospects of our portfolio companies. You should refer to our registration statement and shareholder reports for risks that apply to our business and that may adversely affect any forward-looking statements we make. We do not undertake to update our forward-looking statements or projections unless required by law.

To obtain copies of our SEC filings, please visit our website at www.apolloIC.com. I would also like to remind everyone that we've posted a supplemental financial information package on our website, which contains information about the portfolio, as well as the Company's financial performance.

At this time, I would like to turn the call over to Jim Zelter.

Thank you, Elizabeth. This morning, we reported results for the quarter and the year ended March 31, 2016 and filed our Form 10-K. I'll begin my remarks with some comments about market conditions, followed by a brief overview of our results. I will then discuss some additional recent business highlights. Next, Ted will review our investment activity for the quarter, including an update on some of our energy investments. Then, Greg will go through some of our financial results in greater detail. We will then open the call to questions.

Beginning with market conditions, negative sentiment from the December quarter continued during the first half of the March quarter, as volatility persisted in the high yield and leveraged loan markets. The credit markets were negatively impacted by the new concerns about overall global growth, and further declines in the price of oil. That volatility pushed investors to the sidelines and forced most investors to build liquidity by selling higher quality credit names, which put downward pressure on secondary prices and caused the primary market to slow considerably.

That said, beginning in mid-February, the credit markets began a sharp recovery, essentially erasing the early quarter losses. Yields were volatile and higher [intra] quarter, but were little changed quarter over quarter end. The recovery was attributable to moderate new issue activity and fund flows, especially for mutual funds turning positive in March. These factors allowed prices to recover, and the new issued clearing spreads tightened on quality names. Similar to the syndicated markets, middle-market activity was muted during the quarter, as volatility hampered new business across the board.

Moving to our results. For the quarter and fiscal year, we reported net investment income of $0.20 and $0.83 per share, respectively. Net asset value declined $0.28, or 3.7%, to $7.28 per share during the quarter, largely driven by losses on our oil and gas investments, as well as credit-driven markdowns on a handful of legacy investments. Oil and gas, legacy and commodities accounted for $0.22 of our $0.28 decline. There was also a $0.02 per share accretive impact to NAV from stock buybacks partially offsetting that decline.

Regarding our oil and gas exposure, we continue to closely monitor our investments and work with our portfolio companies. We continue to focus on reducing our exposure at attractive values, when possible, and on maximizing recovery for shareholders. We will continue to be proactive with respect to potential restructurings, or future funding requirements in our portfolio. In many instances, as Ted will mention, we are the lead lender and in a position to drive outcomes that will maximize long-term value. Ted will provide more detail on some of our oil and gas investments in his remarks.

Moving on to stock buybacks, we continued to execute on our share repurchase program during the quarter, although we repurchased less stock in the March quarter than in the prior quarter. In addition to stock price, we consider other factors when we allocate capital to our buyback program. These other factors include our leverage, our liquidity, and the ability of attractive investment opportunities. As always, we continue to evaluate the most prudent use of capital for our shareholders. At this time, we intend to continue to have a balanced approach by both repurchasing stock, as well as making select new investments. Greg will provide more detail in his remarks regarding our share repurchase activity.

Moving to other business highlights, we are pleased to report that Apollo Investment recently received co-investment exemptive relief from the SEC. This relief provides Apollo Investment the ability to participate in negotiated joint transactions with other funds managed by Apollo. We believe this ability will provide BDC shareholders with access to a broader array of investment opportunities. We will be able to participate in larger transactions, which means Apollo Investment, along with other Apollo funds, will more frequently be a lead lender and in a position to drive outcomes. We look forward to providing you with updates on our co-investment activity going forward.

Next, in March, we announced that our investment advisor in consultation with our Board, agreed to reduce fees for FY17. The base management fee has been reduced to 1.5%, and the calculation of the incentive fee will include a performance adjustment that could lower the incentive fee to as low as 15% ongoing. Greg will provide greater detail on this calculation in his remarks.

Additionally, AGM has embarked on a program to purchase up to $50 million of Apollo Investment common stock in open market transactions. AGM currently owns 8.6 million shares, or 3.8% of outstanding shares. We believe these modifications to the fee structure, combined with the investment being made by Apollo, our parent, significantly improve the alignment of interest between the manager and our shareholders. Moving to our dividend, the Board approved a $0.20 dividend for shareholders of record as of June 21, 2016.

I will now turn the call over to Ted.

Thank you, Jim. I will begin with our investment activity for the quarter, and I will provide an update on several of our core oil and gas positions.

Amid the market volatility that Jim mentioned, our origination activity was relatively modest, as we invested $179 million in four new portfolio companies and 12 existing companies. We continue to focus on secure debt opportunities, which accounted for 76% of investments made during the period. The weighted average yield on investments made during the quarter was 11.2%. During the period, we exited $265 million of investments, of which 72% were proactive sales and the remaining balances, repayments and revolver paydowns. The yield on debt investments sold was 10.5%, and the yield on debt repayments was 9.6%.

During the quarter, we exited our investments in Hunt Companies, [Fiji Letsco], amongst others. Partial sales for the quarter included our investments in Magnetation, Deep Gulf, Asurion, among others. Repayments for the quarter totaled $75 million, which included the full repayment of GenCorp and the partial repayment of our investments in Golden Bear and Merx Aviation.

Moving to specific investment activity, beginning with corporate originations, we invested $29 million in the first lien debt of LabVantage Solutions. LabVantage Solutions offers web-based laboratory information management solutions. We also invested $20 million in the second lien of Sterling Holdings to support an acquisition. Sterling is a leading technology-enabled provider of comprehensive employment and background screening services. We also invested $10 million in the second lien debt of GCA Services Group, an existing portfolio company. Regarding both Sterling and GCA, our scale enabled us to commit larger amounts to these transactions and generate up front fees.

Moving to our specialty verticals and beginning with renewable energy. We invested $35 million during the period, including $20 million in Solarplicity. Renewable energy accounted for 8.7% of the overall portfolio at the end of the quarter, up from 7.7% last quarter. As intended, Solarplicity has constructed its portfolio on an unlevered basis, resulting in our current exposure. With requisite portfolio scale, the company was able to secure financing, which we used to decrease our exposure over time.

Moving to aircraft, we increased our investment in Merx Aviation by $28 million during the quarter. In addition, Merx Aviation paid a $2.4 million dividend during the quarter, but an increase in our investment primarily related to the purchase of some aircraft. At the end of March, Merx represented 17% of the portfolio, up from 15.2% last quarter. Although Merx Aviation is our largest portfolio company, our investment is very well diversified. At the end of March, Merx owned 75 aircraft, consisting of 12 aircraft types on lease to 35 different carriers in 18 countries. The weighted average life of the portfolio is 7.5 years, and the weighted average lease maturity is 4.5 years. Since inception in 2012, Merx has acquired 87 aircraft for its own fleet. We expect Merx to continually optimize its portfolio, and opportunistically [sell off] aircraft, as well as seek new investment opportunities.

As the energy exposure continues to be an important topic of interest, I will now discuss some of our investments in the sector. We continue to work closely with the management teams at each of our portfolio companies. As we said before, our portfolio is diversified by borrower and geography, and our investments are generally structured with strong legal documents, which provide us with some significant protections. We believe our marks reflect the underlying fundamentals of each borrower and the stress in the industry. We continue to focus on reducing oil and gas exposure and maximizing recoveries.

Oil and gas represented 11.9% of our portfolio or $347 million at the end of March, down from 12.9% or $395 million at the end of December on a fair value basis. The decline was due to the partial sale of our investment in Deep Gulf to a third party, as well as fair value adjustments. At the end of March, our portfolio had seven core borrowers, and I'll now provide updates on some of these investments.

Beginning with Deep Gulf, an E&P company with assets located in the Gulf of Mexico, as I mentioned, during the quarter, we sold half our $50 million first lien investment to a third party at a price consistent with our marks. We are pleased with this monetization, particularly given the challenging market environment. The company has no liquidity issues for the foreseeable future.

Miller Energy successfully emerged from bankruptcy in late March. As part of the restructuring, our second lien term loan was replaced with $25 million of second lien debt, in addition to new equity in the company. We also provided a $10 million delayed draw first lien loan. We, along with another investor, control the vast majority of the equity of the company, and the reorganization substantially reduced the company's debt and provided it with a streamlined cost structure and appropriate capital structure. The company continues to reduce G&A, conserve cash and defer projects. Our preconditioned second lien is no longer on non-accrual status.

On Pelican Energy, an entity financing participation in certain wells at Chesapeake Energy, this company's assets are more tied to gas, which represent 75% of production. We have a $28 million first lien investment marked at 65% of cost. The decline in value during the quarter is the result of lower oil and gas prices, combined with production rolling off. Pelican may [pick] interest going forward to preserve liquidity, and given the tighter liquidity and lower net asset value, the risk rating on this investment was lowered to 5 and placed on non-accrual.

Moving to Osage Exploration, an E&P company with assets in Oklahoma, at the end of March, we had a $25 million first lien investment marked at 22% of cost. As mentioned on the last quarter's call, the company filed a negotiated bankruptcy in February. The company completed an auction process in mid-April, and our valuation is consistent with the net proceeds that we expect to receive from this process.

Moving to Spotted Hawk, an E&P company with core Bakken assets, we have $84 million first lien investment marked at 76% of cost. The risk rate on this investment was downgraded from a [3%] to a [4%], and the investment was placed on non-accrual in the quarter. Despite being the core of a good basin, having good drilling results and taking steps to preserve cash, the company's liquidity remains constrained. We believe the company may go through a restructuring in the near term.

And lastly, moving to Venoco, an E&P company with assets located in Southern California, the company filed a prearranged bankruptcy in mid-March after entering into a restructuring support agreement. The reorganization plan contemplates that the secure creditors will take a majority interest in the company in exchange for debt forgiveness. We provided a $35 million delay draw debt that will likely remain unfunded, given the company's cash position. At the end of the quarter, we had a $41 million first lien marked at 80% of cost and a $48 million second lien marked at 43% of cost. The risk rating of the first lien remained at [3%], and the second lien was downgraded from a [4%] to a [5%] and placed on non-accrual status. We expect the company to emerge from bankruptcy in the late summer or early fall.

To summarize, four of our oil and gas positions are on non-accrual status at the end of March. Since then, as mentioned, the auction process for Osage has been completed. In addition, Miller recently emerged from bankruptcy and is no longer on non-accrual, and was successfully sold at half of our investment in Deep Gulf to a third party during the quarter.

We believe our remaining core positions Canacol, Deep Gulf and Extraction are performing in line. Extraction continues to raise junior capital and raised $93 million of equity in April. Canacol, whose assets are primarily gas related, is benefiting from higher cash flows from newer gas contracts with local power plants. In addition, our $25 million unfunded commitment to Canacol expired in April. We do not currently anticipate any additional capital requirements or restructurings for any of these companies.

Outside of energy, we also placed our unsecured debt investment in Delta Education in non-accrual status. As a reminder, Delta is a for-profit education company, an industry that is experiencing significant headwinds.

At the end of March, we had eight investments on non-accrual status across six different portfolio companies. Investments in non-accrual represented 4.2% of the fair value of the portfolio and 8.4% on a cost basis, compared to 2.5% and 6%, respectively, at the end of December.

The portfolio's weighted average risk rating on a cost basis remained at [2.4%] on a fair value basis, remained at [2.2%], consistent with the end of December. The current weighted average net leverage of our investments was 5.4 times, down from 5.5 times, and the current weighted average interest coverage remains at 2.7 times.

With that, I will turn the call over to Greg, who will discuss the financial performance for the quarter.

Thank you, Ted.

Total investment income for the quarter was $85.3 million, down 9.5% quarter over quarter and down 16.4% year over year. The decline quarter over quarter was primarily attributable to a lower asset base and increase in investments on non-accrual, partially offset by higher fee income. Fee and prepayment income was $4.5 million in the quarter compared to $1.1 million in the December quarter, and $7.8 million in the year-ago quarter.

Dividend income for the quarter was $11.4 million, down $6.9 million quarter over quarter, due in part to the repayment of our investment in Golden Hill, the conversion of our investment in Solarplicity from preferred to secured debt, as well as lower dividend income from our Dynamic Product Tankers and Merx Aviation investments. As we indicated in the past, our quarterly dividend run rate should approximate $10 million to $11 million.

Expenses for the March quarter totaled $40.7 million compared to $46.2 million last quarter, and $50 million for the same period a year ago. The sequential decrease was due to lower incentive fees associated with the decreased level of investment income, lower management fees associated with the decrease in the average portfolio, a decrease in interest expense, primarily associated with the maturity of our $200 million of convertible notes, which was repaid with funds from our credit facility and lower G&A.

The repayment of the convertible notes helped reduce our weighted average interest rate to 4.4%, compared to 4.7% at the end of the December quarter. As Jim mentioned, the investment advisor has agreed to waive a portion of its management and incentive fee so that during the FY17, the management fee has been reduced to 1.5% and the incentive fee has a minimum rate of 15%, to the extent the company experiences cumulative net realized and unrealized losses during the period. Please refer to the Related Party section within our 10-K.

Net investment income was $44.6 million, or $0.20 per share for the quarter. This compares to $48.1 million or $0.21 per share for the December quarter, and $52.1 million or $0.22 per share for the year-ago quarter.

For the quarter, the net loss on the portfolio totaled $68 million or $0.30 per share, compared to a net loss of $74 million or $0.32 a share for the December quarter and a net loss of $64 million or $0.27 per share for the year-ago quarter. The net loss of $68 million includes $75 million of realized losses, of which $68 million had previously been reported as unrealized loss.

As Jim mentioned, the primary contributors to the NAV decline were associated with our energy and certain legacy investments. And included valuation adjustments to our Miller Energy, Venoco and Spotted Hawk investments, and certain legacy names such as Garden Fresh, Delta and SquareTwo. In total, our quarterly operating results decreased net assets by $23 million or $0.10 per share, compared to a decrease of $26 million or $0.11 per share for the December quarter and a decrease of $12 million or $0.05 per share for the year-ago quarter.

At the end of March, our portfolio had a fair value of $2.9 billion, and consisted of 89 companies across 25 industries. The weighted average yield on the portfolio at cost was 11%, down 40 basis points quarter over quarter. The decrease in the overall yield was primarily due to the placement of higher yielding investments on non accrual.

On the liability side of our balance sheet, we had $1.3 billion of debt outstanding at the end of the quarter. As I mentioned in January, we repaid $200 million of 5.75% convertible notes upon their maturity. We used borrowings under our revolving credit facility to repay these notes. The repayment of this higher cost debt benefited earnings during the period.

The Company's net leverage, which includes the impact of cash and unsettled transactions stood at 0.76 times at the end of March, unchanged from December. [Heading in to] quarter end, we were aware of a few near-term repayments. For example, it was recently announced that Generation Brands was being purchased by a middle market sponsor. At the end of March, our investment in Generation Brands had an aggregate fair value of [$67 million].

During the March quarter, we also repurchased 2 million shares or $10 million of our common equity. Since commencing our repurchase program in August, we have purchased 10.6 million shares or 4.5% of our shares outstanding for a total cost of $62.4 million. And it leaves us $38 million remaining for future purchases under the current Board authorization.

This concludes our remarks. Operator, please open the call to questions.

(Operator Instructions)

Our first question comes from the line of Rick Shane of JPMorgan.

Guys, good morning, and thanks for taking my questions. I think the interesting thing here is the tick-up in leverage at the end of the quarter. And, Greg, you may have addressed this actually in terms of the Generation Brands exit, but the leverage is pretty high at this point.

And I do wonder, given that, if you're going to continue to buy back shares. And I'm also wondering just from a fiduciary perspective right now, given stock is trading at about a 27% discount to NAV, does it make sense to accelerate the sales of assets within the portfolio, take the leverage down, and actually start to turn this into a little bit of cash?

Yes. I think, Rick, you hit right on the point. We came into the end of the quarter. We have a very good visibility as to the activity coming into the first quarter and therefore, our leverage was somewhat higher than normal, and we would expect that to come down in this quarter.

Greg, and given the volatility on the marks and look, you guys have a unique -- not unique to BDCs, but BDCs having new quality, which is that the fair value marks mean that your leverage can move around, despite repayments or investment activity in a way that a lot of financial institutions don't experience that. Given the environment we're in right now, does it make sense to run at a lower leverage? And what do you think the right leverage is in this environment?

I think as we've been working with our Board and looking at the composition of our portfolio, I would say that probably the mid 6%s is probably a goal that we are -- we'll move to in the next few quarters.

Great. Greg, thank you for the question. Thank you, everybody.

Thank you.

Our next question comes from the line of Jonathan Bock of Wells Fargo.

Good afternoon, or excuse me, good morning, and thank you for taking my questions. Starting first, Jim, as we look at the BDC space, we actually saw one BDC in particular take a proactive move and reduce the dividend. As it relates to the fact that the returns that are being offered in the market, senior secured, mezzanine or otherwise, are certainly lower than what you've experienced in the past. And so we don't want to reach for income or for yield and possibly put a bad asset on the books.

And I've seen consistency of around an 11% yields coming off both your secured and unsecured portfolio. And when I think about that plus the prospects for just getting a bit more difficult to date, I'm curious if you would still peg the forward returns of around 11% as on investment yields as sustainable going forward? Because even with those yields today, we're just at the dividend.

Yes, let me tie that question -- make sure that the question before was answered in clarity. So as Greg mentioned, we came into the quarter a little bit higher leverage, but we had a very visible forward view on pre-payments and sales that would occur. So we feel comfortable we are at a lower level of leverage than we ended the quarter, so let's put that out there.

To your question, it really gets to the yield issue and the earnings power. Certainly, we take a long-term view of our dividend and when we reset it several years ago and the market was focused on the ability to have your NII and have your NII cover your dividend, we had been focused on that and did so well for quite some time.

Certainly in the last handful of quarters, there's been NAV volatility and as we have really focused on trying to get NAV stability, there's going to be an impact over time with how we want to deal with forward investments. We don't want to reach in an effort to have NAV stability, we don't want to have to reach. So certainly we're very aware of that.

Now to your specific question, with the yields in our portfolio at 11%, we've been able to do so. But certainly we are making sure that we, as our goal of having NAV stability comes more into focus for going forward, I think that we're not going to reach to make that dividend. And as a result, some assets may be booked at lower yields, which again, we don't want to look at it quarter to quarter, we want to look at it over a longer period of time.

So certainly I think that your question stems from very good insight in how these businesses are managed, and we respect that a little bit quieter on the front end this past quarter. We do think that the exemptive order that we've just achieved, just received, excuse me, is quite unique in the industry. And now the onus is on us collectively to be able to show evidence of us being able to exercise that for the benefit of our shareholders.

But certainly you're right. As I said before, we were always very focused on our dividend in terms of the NII, which is what the industry was focused on. But we realized in a more volatile NAV environment, we might need to have a second look at that and we don't want to reach if that's what the yields that are being demanded from our shareholders.

And look, we -- may I say, we always appreciate, taking a proactive look is absolutely the right thing to do and people should be applauded for it. So in light of that, maybe an additional question. So clearly the BDC space in general trades off as a result of [hawkish] comments.

And, Greg, I know we've got about $150 million of CLO equity ish structured product stuff on the balance sheet that can -- whose return can be hampered to the extent the LIBOR curve or short end LIBOR rises. So how do we think about distributable income and cash coming off that portfolio and modeled CLO equity returns, as well as modeled, I'd say, earnings power of the business as the short end of the curve increases and pinches our spreads a little bit? Because we're still well under the floor on your revolver, I believe, as well as owning a little bit of CLO equity that levered at 10 times a 50-basis point moving your cost of funds is a big deal?

I know you asked the question to Greg, Jonathan. But let me say one thing first. There's structured credit and then there's CLO equity.

We have a portion in structured credit, which Greg will go through. Our broadly syndicated CLO equity is actually a very small portion, but let me have Greg go into that. So I would differentiate, obviously we think we're a market leader in terms of how we mark these products, but certainly Greg can talk about the impact to earnings from what we own today.

Yes. So, Jonathan, I think you're very well aware that when we look at our CLO equity, we have about $100 million. So it's a middle market CLO equity that primarily makes it up. Those have been marked.

Obviously the volatility in the marketplace on -- we've looked at certain of the variables have widened in that, and then they are all marked by our third-party valuation firm. With regard to the earnings off of those, I would say to you that where you level yields so that we're very comfortable with the earnings power, as you see quarter over quarter.

And so that, I think, we're comfortable with where we are with that, and including that within our $10 million to $11 million worth of dividend income for the quarter. The remainder are really the rate cap trades, which I think we've taken you through, which are very senior loans, although they are the equity positions the first look, again, those performance -- underlying portfolios are performing very well given the underlying credits.

Got it. And I would assume the credit length notes are fairly -- I would say fairly similar to the point where there's leverage, but still at the end of the day, you modeled the forward curve. The forward curve likely had that incorporated.

Then two more, and I greatly appreciate it. Jim, the fee waiver, greatly appreciated certainly as a lot of folks are going to see, just a step that folks should certainly take notice of and respect.

And the question was, I know we also -- there's an offer of a Scion management fee that goes and reduces the all-in fees paid by Apollo. Scion being a non-traded BDC that's managed by the general Apollo franchise. And I'm curious if the Scion fee contribution to the lower fee of Apollo, excuse me, for the very poorly worded sentence, if that still continues post the base fee reduction, as well as the incentive fee reduction as well?

No. For just for clarity, and it's really well laid out in our public documents, and Greg can answer as well. But we really wanted to wipe the slate clean of some of the historic [waivers] that he had done on equity deals, we wanted to wipe the slate clean on the Scion. So in an effort to do so, we think we put together an interesting structure.

Our Board embraced it. So the answer to your question is, the previous waivers were all put to the side. The Board was reset to this new [1.5%], and then the various incentives based on our overall performance.

Okay. And then the last question just relates to Venoco. So clearly, see the first lien at 80% and the second lien at 58%, Ted. As we look at just the general reports across the space, can you tell us your confidence level in receiving a 58% recovery on that asset, in light of the fact there may be other points to say that recovery on that loan may be something less? Is there something that perhaps we're missing or the market is missing that allows a second lien mark at that level to date?

Yes. So what I would say is, we're just confirming the second lien mark. I think second lien was actually marked a little lower than what you just pointed out. So I would say on Venoco, I would say they have a very large asset that is a big contributor to value that may or may not happen.

So the valuation of Venoco specifically, vis-a-vis everything else we do, is probably more variable, I would say. Because the future prospects for the Company have more upside and more downside depending on one large asset that's subject to regulatory approval. And so that's why when you see a first lien, I'm assuming the question is, if the first lien is marked at 80%, why is the second lien marked so high?

And the answer is, if you look at the future outcomes for the business, there's a whole bunch of scenarios where there's value through to second liens and there's also scenarios where the second lien is impaired. It's a little bit of a one-off vis-a-vis everything else, because there's just so much future value that's dependent on approvals of future lease rights. So that's why the numbers might look a little strange to you.

Yes, got it. And then just --.

It's a good question, though.

The only other one, and just because we're closer to the line on the dividend, but also appreciate it if you guys work it out, there's always upside opportunity. So if we think about Garden Fresh going from $36 million to $25 million or an 83% mark to something in the 50%s, what's driving that decline? And how do we feel about that name and that's ability to remain on accrual status? Thank you for taking my questions.

Yes, that name is definitely at risk. It's a highly levered restaurant company that was originated 10 years ago, and we are at the bottom of the capital structure. So small changes in the company's performance leads to changes in valuations, because, again, it's a mezzanine piece of paper.

So I would say, we can't assure you it's going to remain on accrual status going forward. And also we think that there's definite risk to getting back our principle on this investment. It's a long-term -- again, we've had it for a long time, the company is doing okay. But again, when you're at the bottom of the capital structure in the mezz tranche, your valuations are very, very sensitive to small changes in the company's performance.

Got it. Guys, thank you.

Thanks, Jonathan.

Our next question comes from the line of Ryan Lynch of KBW.

Good morning. The first question is just on the fee reduction. It definitely simplifies your guys' fee structure, and I think it gives you guys all credit for some of the previous fee waivers you guys have been previously have been waiving in some of the previous years. But this fee reduction, it's only been put in place for one year.

So my question is, this creates a little bit of uncertainty because this fee waiver, I guess the fee reduction down to 1.5%, it's only temporary. So why not make this fee reduction permanent or extend the fee waiver just to give the market some more clarity about future earnings past March of 2017?

We've had this question in the past. I think our Board views that these, because the contacts are one-year rolling contracts, that's how they have chosen to deal with it. Certainly, we're very aware of how the market would react if we were to reverse the trend that we've been taking so far.

So again, I think that we are -- some folks have also pointed out that why don't you make these things permanent. I think we're comfortable that the trend that we have shown over the last several years, we've continued to lean into doing what's right by shareholders with regard to this theme, and I think that any reversal of that theme we would be punished if we did so. So I understand the question, but that's how our Board has chosen to deal with these types of issues on the [4DIAC] vehicles.

That makes sense, and it's good to hear where your guys' thoughts are as far at that going forward, while it's only technically a one-year waiver. And then just one on Merx Aviation, that's been growing pretty consistently over the last several quarters. It now sits at about 17% of your portfolio.

So what is your outlook on growth in that business? Is it at 17% of your portfolio, is it hitting an upper limit, or do you guys see that investment expanding going forward?

Let me give you the overview, then I'll pass it along to Ted for details. But I think you've characterized it properly. We always said mid to high teens. I think we feel really comfortable with the portfolio. We like what we've done in a diversified manner.

But as also, as we've been prudent about the rest of our portfolio and it has shrunk, the result of Merx has kicked it up a little bit. But I think you characterize it properly in terms of the overall high side of where we are right now.

Okay. And then just one last one. I don't know if you guys mentioned this, but other income had a pretty big jump in this quarter. Can you just give any drivers of what drove that increase?

I think as Ted mentioned, there were -- when you looked at certain of our investments, you see a Sterling, they were larger facilities that we were able to take down and then syndicate out and we earned fees on those.

Okay. That's all the questions for me. Thanks, guys.

Our next question comes from the line of Leslie Vandegrift of Raymond James.

Good morning. Most of my questions have already been answered this morning. But I've just got a quick one on the purchase program by Apollo Global.

I know that we're probably going to shift focus away from the repurchase program for a little while, at least while you guys are talking about leverage coming down this quarter. But what's the timeline for the use of that $50 million program?

Well, I think that we operated those two programs in concert as required by the securities regulators, and we did so in this quarter. And I think that we want to be a prudent purchaser of our stock. So I think that that program, like as you said, I think we're trying to balance from the Company's perspective doing the appropriate balance sheet management with regard to purchasing stock.

But I think that Apollo certainly does -- would like to increase its exposure and will do so. I don't want to put a strict timeline on it, but I think there was certainly an expectation that we would in time exercise that ability to purchase the stock as laid out per the program. So I think we'll have obviously certainly more information in the next quarter.

Okay. And then my last question then would just be on new -- your new right to co-invest with other Apollo Global and other Apollo managed funds. Have you seen much come through this quarter in the pipeline then that interests you already? Is this something that we're going to see slowly ramp over the next few, or something we're going to see really hit this quarter?

Yes, I think we just got approval for it and as part of the approval process, there's a lot of controls and procedures we had to put in place and get approval from our Board as well. So I don't think you're going to see a very large impact in the June quarter, but I think you'll see a very large impact on a go-forward basis.

We've reorganized our whole business to have an integrated front end that includes a finance company we bought a couple years ago that has grown materially and is very, very well run. So this allows us now to with banks pulling back in the letter of finance markets, as opposed to AINV only being able to commit $50 million, $75 million to a transaction, now as a Firm, we can commit to much larger transactions while keeping concentrations lower than AINV.

So this has been a lot of work by our general counsel over a long period of time ad I think it's a big, big, big advantage for us on a go-forward basis. But I don't think you're going to see a lot of material impacts in the June quarter.

Okay. Perfect. Thank you, guys.

Our next question comes from the line of Doug Mayweather of SunTrust.

Hello, good morning. Just a couple of questions on some investments.

First, SquareTwo has been marked down for a while now. I think you may have even taken an additional mark. I know that their larger publicly traded competitors have also hit some turbulence, which implies some softness in the industry.

I guess what are the general -- but it looks like it's still on accrual. So does it look like, your last update, does it look like there's any sign of conditions turning around? What are your expectations for that investment, and so forth?

Yes. So they've publicly announced an exchange offer, which you can look at publicly, whereby the bonds will be converted into a new package of securities. So this will delever the balance sheet and give the company, and clean up at least the liability side of the company.

I would say we really haven't seen a big pickup on the actual day-to-day business side of the company. I think these guys have a very, very good mouse trap. But again, just given some of the CPB headwinds, I think they continue to -- I don't think you've seen a material change, good or bad, in their business prospects since we last updated people last quarter.

Okay, thanks. My -- shifting over to the energy side, the energy transportation side. There's been obviously a lot of movement in the, both the product markets and the oil markets, especially with regards to the big oil-producing powers like Iran and Saudi Arabia and the US. How has that affected your tanker business?

Has that boosted it? Is it more challenging now? How are those investments going?

They continue to perform very, very well. So remember, most of our portfolio is contracted. So we don't -- we're not impacted by day-to-day changes in day rates and other things.

And our contracts that we have are well below where current market rates are, but our counter parties are people like Shell and British Petroleum, very, very high quality. And obviously, the benefit of low oil prices has been increased demands. And so obviously there's been more demand for these tankers to ship oil around the world.

And the way -- and more and more of the product has been refined now in the Middle East, which requires longer shipping distances. So we continue to see very good performance in the underlying portfolio. Again, I don't think -- that this portfolio is not going to grow. If anything, it will shrink over time, and we'll continue to be apprised of performance. But yes, most of it's contracted. Again, if day rates go up materially because of all of these factors, we don't really benefit that much from it.

Okay. Thanks. That's all my questions.

Our next question comes from the line of Christopher Testa of National Securities.

Good morning, guys. Thanks for taking my questions. Just with the convertible note maturing and being retired, are you looking to replace that with another issue of fixed rate debt, or are you more comfortable having the revolver as a boost to earnings?

I think currently, we're comfortable with both the utilization of our revolver, which is probably about 50% utilized, and then our mix of unsecured debt at the time. It was about 50/50, we're more comfortable with that ratio.

Okay. And just thoughts on energy going forward, obviously this has been a thorn in your side as many other BDCs as well. As these either are restructured or the performing ones are repaid, are you looking to shy away from more cyclical industries going forward, or do you see this as a core part of your strategy regardless?

I think this is how I would answer the question. I would say we don't expect our oil and gas exposure to increase materially over the next couple quarters. We think that the portfolio will continue to decrease as things get monetized and everything else.

I will say that we've had to restructure some of these companies. Roll forward three to four months, and effectively the whole portfolio will either be restructured or in very good shape. So I think from that perspective, the worst is behind us.

Now that we have equity upside in a number of different companies. So to the extent that oil prices recover, which you've seen in the June quarter, to the extent it continues, obviously there may be some benefit for our shareholders out of this portfolio. But I don't think we're exiting the energy business per se, but I think you'll see this portfolio shrink rather than grow over the next couple quarters unless there's a material increase in oil prices, which reduce fair value.

Okay. Got it. And just with the attachment point, it's been hovering around 5.5 times, is this something where you're comfortable being? I know that you have steadily increased senior secured exposure. Should we expect this to tick down or should this remain stubbornly high, given where the marks are on the non-accruals? Just any color there is appreciated.

I would say in the December quarter and March quarter, as you've heard from all other BDCs, activity levels are really, really, really -- some of the lowest activity levels we've seen since 2009. But we've seen that pick up very materially, but I would say terms and spreads they're still very wide today, vis a vis where they were -- I'm talking in the middle market, vis a vis where they were call it 12 months ago.

So I think the attachment point will be reasonably stable, if not lower over time on new originations. And if our existing portfolio of companies, if you strip out the energy names, EBITDA and leverage, leverage has been going down and EBITDA has been going up. So I wouldn't expect to see a material uptick in total leverage on the overall portfolio.

Got it. And just with the exemptive relief you were granted, do you see this assisting your pricing going forward, given that there's not as many BDCs, the smaller ones that operate in the lower part of the middle market and now you're able to move more upmarket? Do you see this having a beneficial impact on your pricing? And if so, how much benefit do you expect to receive from this?

I think it would be preliminary to say we have a view on specific pricing. Certainly we believe we will be able to originate a broader, higher quality product set, hopefully with better structure and better economics to us. But I think it would be premature to put an actual number on that at this point.

Let us get a couple of quarters behind us and show you some evidence of that. Then we can give you more specifics in due course.

Okay, great. Thanks for taking my questions.

No problem.

Our next question comes from the line of Derek Hewett of Bank of America, Merrill Lynch.

Good morning, and thank you for taking my question. With the stock trading at about roughly a 25% discount to NAV and the exemptive relief now presumably reduces the need for liquidity to service clients going forward, what is preventing you from accelerating buybacks at this point? Or if not now, given that you're going to do some selective deleveraging in the back half of this year?

I'm not sure -- I understand the question about buybacks, but I'm not sure what the exemptive order, what's the comment about that?

Not needing as much liquidity to service new clients going forward because you can co-invest with across the entire Apollo platform.

I think that we've shown a willingness to buy back stock as much as most of our peers. And so we feel good that we've announced the program and have shown steady progress on it.

As we alluded to earlier in the phone call, I think it's just a -- we're trying to be thoughtful about the overall leverage in the marketplace at a time like right now, and we choose to operate at a little bit lower leverage. So I think we are intrigued and excited and expect to have some more buybacks going forth in the coming quarters.

You're making a good point, which is for us to buy back stock is obviously very accretive and for AGM to buy stock is very good for shareholders. So if you look at our new origination activity, it's been evidenced that we're being much, much more discerning around new originations and new portfolio companies, vis a vis buying back our stock.

So as Jim said, there's a huge trade-off between leverage and liquidity and you have to be mindful of that. But given where our stock is trading, I think we're still focused on executing a buyback program.

Okay, great. Thank you very much.

Our final question comes from the line of Kyle Joseph of Jefferies.

Morning, guys. Thanks for taking my questions. Most of them have been asked and answered.

But I just wanted to get a sense of yields in the markets you guys are seeing. I know you guys had yield compression, but I think that was mostly a result of some non-accrual additions. And I know deal flow is light, but give us your outlook for the core portfolio yield going forward.

I would say you have to really break it down by vertical. So I would say in response to our origination business, or our direct origination business, spreads are definitely wider. But as you know, if you break on a book by vertical, some of the yields in the other asset classes are higher.

So I would say market yields are wider. Middle market yields are definitely wider, which is very good for our business, but again that's typically on the lower end of the yields of our overall portfolio.

So when we face -- they're spread in light of everything else, I think you'll see that part of our business, I think you'll see yields either increase or at least remain stable. But obviously as energy and other parts of our business shrink, they're typically higher yielding verticals.

Got it. Thanks for answering my question.

And that was our final question. I would now like to turn the call back over to Jim Zelter for any additional or closing remarks.

Well, as usual, thank you for your focus and your questions on our Company. We look forward to talking to you in the future or in the interim as appropriate. Thank you.

Thank you, ladies and gentlemen. This does conclude today's conference call. You may now disconnect.