MidCap Financial Investment Corp (MFIC) 2017 Q1 法說會逐字稿

Good morning and welcome to Apollo Investment Corporation's earnings conference call for the period ended June 30, 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. Speaking on today's call are Jim Zelter, Chief Executive Officer, Howard Widra, President, Tanner Powell, Chief Investment Officer of AIM, and Greg Hunt, Chief Financial Officer.

I'd 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'd 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'd 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'd like to turn the call over to Jim Zelter.

Thank you, Elizabeth. Before we begin this morning, I'd like to briefly discuss the management change that was announced in June. Howard Widra, who has worked with Apollo and its affiliates for the last several years as Co-Head of Direct Origination and now Head of Direct Origination was appointed President of AINV. Howard is an industry veteran and Co-Founder of MidCap Financial, a company acquired by an entity managed by Apollo Global Management in 2013. Since that time, we have worked closely with Howard who came into this role through a thorough understanding of Apollo investment Corp.

Howard has a strong credit track record and brings a breadth of direct lending experience to the role. For those of you who are not familiar with MidCap, the company was founded in 2008 and is a middle-market focused specially finance firm with nearly $7 billion of assets under management that provides senior debt solutions to businesses across a variety of industries. We are excited to have Howard join the AINV team, and look forward to him and his team furthering the Company's strategic initiatives.

We have taken this opportunity with the management change and the recent receipt of coinvestment relief from the SEC to redefine AINV's strategy in a direction which we believe is designed to provide shareholders with a more consistent return and a stable NAV. On today's call, I will discuss our go-forward strategy as well as our dividend policy and some additional business highlights. Howard will then discuss our plans to execute this strategy in greater detail. Tanner will then cover our investment activity for the quarter, and provide an update on credit quality. And finally, Greg will go through our financial results before we open the call to questions.

The AINV Board and our management team are focused on driving long-term shareholder value. Over the last several years, our strategy sought to capture incremental yield by prioritizing complexity over underlying liquidity which resulted in NAV volatility. Going forward, we intend to reposition our portfolio in such a way that we believe is designed to have a lower risk profile, less volatility, and should provide more stable return for shareholders.

We intend to achieve this by repositioning a portion of the portfolio into traditional corporate loans, primarily floating rate, directly sourced from the Apollo platform while adding additional product offerings via MidCap. We expect to also transition the portfolio away from some of our existing specialty verticals, and we will endeavor to continue to proactively work through some of our more challenging investments which continued to impact results.

About a year ago, we developed a unified direct origination effort between AINV and MidCap's origination teams. We believe that our platform has one of the largest and most diverse origination teams in the competitive marketplace. This origination platform expanded the funnel of opportunities available to AINV, and as a result we are now seeing more opportunities which allow us to be even more selective in credit quality.

With a coordinated calling effort under combined leadership, seamless underwriting, and portfolio management process, we believe the collective Apollo platform should have one of the broadest product offerings for middle-market companies. We have already made great progress as a unified origination platform penetrating the sponsor world, and we have seen robust and increased deal flow.

Our ability to invest and directly source loans has also been greatly enhanced by the recent receipt of coinvestment exemptive relief from the SEC, which is also expected to drive more deal flow. This relief provides AINV the ability to participate in negotiated joint transactions with MidCap and other funds managed by Apollo, among other things.

In summary, we believe our strategy is designed to achieve a more stable return for shareholders, inclusive of credit losses. As we have seen over the past several years, the investing environment remains attractive given the secular changes in credit extension by the banks. With the successful execution of this plan and relatively stable market conditions, we believe the portfolio should generate more sustainable ROEs, although returns in the short term may be volatile as we position the portfolio.

Moving on to our dividend policy, which is based on a few key fundamentals. We believe our target dividend payout ratio payout should be a function of our desired portfolio construction. We believe it is important to strike the right balance between generating investment income and preserving NAV.

We believe the dividend level should reflect the current market environment, which as you know, has experienced yield compression over the last several years and should be aligned with the earnings power of the existing portfolio. Consequently, our decision to adjust the dividend was based on the input of all these factors with a view toward the ultimate portfolio construction, the ability to resolve assets on nonaccrual today, and operating within a prudent leverage range. Accordingly, the Board approved a $0.15 dividend to shareholders of record as of September 21, 2016.

As credit investors, some amount of loss is expected. However, we believe that the strategy that we are outlining today is designed to reduce future losses, resulting in a more consistent and stable return for shareholders over the longer term.

I will now turn the call over to Howard.

Thanks, Jim. In the short time I have been President of AINV, I have had the opportunity to speak to several of you, and I look forward to an ongoing dialogue with all of you.

We have completed a comprehensive review of the business, which included a detail assessment of our performance and the assets in the portfolio. Our visit review underscored the benefits of investing in directly sourced transactions, which historically have had lower loss experience, lower attachment points and greater all-in returns. Going forward, our investment strategy is expected to continue to focus on corporate loans sourced from Apollo's broad and deep platform.

With a unified direct origination platform, we expect to focus even more on loans with lower loss given default characteristics, primarily floating rate, with a substantial portion in first-lien loans. We are emphasizing portfolio diversification, and avoiding outsized single name or industry concentrations. We are rightsizing our portfolio segmentation by reducing several of our existing specialty verticals, as well as lowering commodity dependent and highly cyclical credit exposures.

A key element of our portfolio construction is building a credit portfolio with a relatively low level of correlation to any single risk factor. As credit investors, some losses over a cycle are expected. However, with the unified direct origination platform combined with exemptive relief to coinvest, we can be even more selective and we believe that our strategy is designed to produce results that should be more consistent and predictable.

We intend to reallocate a portion of the portfolio in a steady and measured manner into traditional corporate loans sourced by Apollo's integrated direct origination team, while adding additional specialties in life sciences, asset based lending and lender finance via MidCap. Access to these additional products should not only help diversify the portfolio, but it should also provide returns that are less correlated with the liquid credit markets.

Given the illiquid nature of many of our investments, you should expect that the repositioning will take some time. In certain cases, we may seek to accelerate the disposition of assets which are not core to our strategy. As mentioned last quarter, we received coinvestment exemptive relief from the SEC, which provides AINV the ability to participate in negotiated joint transactions with other funds and entities managed by Apollo, including MidCap. We believe this relief is critical to our future success, since it allows us to compete for investments along with the broader Apollo platform. And in so doing, should improve our competitive positioning by allowing us to compete more on the basis of size and certainty of execution rather than just price.

We believe the scale of AINV, MidCap and other Apollo managed capital on a combined basis makes us one of the largest market participants uniquely positioned to take on large commitments. We have already made what we believe to be good progress in the past few months repositioning the portfolio, with the resolution of certain legacy positions and lowering our oil and gas exposure to less than 10% post quarter end. In the coming months and quarters, you should see further progress in this repositioning with the continued reduction of positions higher on the risk spectrum that have more volatile returns.

As we continue to exit investments, we expect to put more capital work in assets where MidCap has had an excellent track record. MidCap is focused on the direct origination of asset based loans, leverage loans, real estate loans, life sciences loans and lender financed loans. While MidCap is largely a complementary platform to AINV, there are opportunities where mandates do overlap, particularly in asset based, life sciences and lender financed.

We expect to diversify our portfolio by ramping each of these areas over the next 2 to 3 years. By the end of FY19, we currently believe that these three asset categories should represent approximately 15% to 25% of the portfolio with yields of around 10% to 10.5%. We are already seeing a strong pipeline of coinvestment opportunities with MidCap. In fact, three coinvestment deals have either closed or been approved since the end of the quarter. We look forward to reporting our continued process with respect to repositioning the portfolio over the coming quarters.

With that, I'll now turn the call over to Tanner who will discuss investment activity and credit quality.

Thanks, Howard.

As mentioned on our last call, we ended the March quarter slightly above our target leverage ratio due to anticipated sales and repayment activity. During the period, we exited $339 million of investments, of which 57% were repayments and revolver paydowns and the balance was proactive sales.

We invested $123 million in 5 new portfolio companies and 12 existing companies. Accordingly, net investment activity was negative $217 million in the quarter.

The weighted average yield on investments made during the quarter was 10.8%. The yield on debt investments sold was 11.9%, and the yield on debt repayments was 9.9%. Repayments for the quarter totaled $193 million, which included the full repayment of GTCR Valor Companies, Novolex, Osage, Pabst and Transfirst. Sales for the quarter totaled $146 million, which included Aveta, Deep Gulf, and Generation Brands amongst others.

We used the strength in the broader CLO market to exit our remaining two broadly syndicated CLO positions in the quarter, Jamestown and Highbridge. Our structured product asset class primarily consists of middle market CLOs and regulatory capital trades. We have no exposure to broadly syndicated CLOs.

Regarding aircraft, we continue to be very pleased with our investment in Merx Aviation, as the underlying portfolio continues to perform well. At the end of June, Merx represented 18.6% of the portfolio, a function of the lower overall portfolio size. Our aircraft portfolio continues to be well diversified by aircraft type, lessee, and geography. Over the last 12 months, Merx has returned approximately $42 million of capital to AINV.

I'll now give a brief update on our energy exposure. At the end of June, oil and gas represented 11.6% of our portfolio or $304 million, down from 11.9% or $347 million at the end of March on a fair value basis. The decline was primarily due to the exit of our investments in Deep Gulf, Osage, and Renaissance Umiat.

Subsequent to quarter end, Extraction repaid our loan at [101%] as the company issued high yield bonds. Pro forma for the exit of Extraction, oil and gas is now approximately $250 million, representing less than 10% of the total portfolio. Over the last 12 months, we have considerably reduced our exposure to the sector, and have received approximately $156 million in proceeds from the sale and repayment of our oil and gas investments.

At the end of June, the portfolio included six companies. We continued to closely monitor our investments in this space, and will continue to seek to reduce our existing exposure when possible and will be patient with our more challenged names. Three oil and gas positions remain on nonaccrual, Pelican, Spotted Hawk and our second lien investment in [Zeneca]. In each of these cases, we're working closely with the respective management teams.

Moving to overall portfolio credit quality, six investments and three companies were placed on nonaccrual status during the quarter. These investments are all challenged, so we continue to look for ways to improve value and maximize our recovery. Both Garden Fresh and Delta Education were undergoing sales processes in the quarter, and in June both processes faced significant challenges which adversely impacted our positions. Additionally, SquareTwo continues to be impacted by the regulatory environment, as industry supply of charge-off receivables remains at depressed levels. During the quarter, the company completed a recapitalization that will provide an improved capital structure and interest savings to better operate during the difficult market conditions.

In aggregate at the end of June, we had 13 investments on nonaccrual status across 7 different portfolio companies. Investments on nonaccrual status represented 4.5% of fair value of the portfolio and 11.8% on a cost basis. Compared to 4.2% and 8.4% respectively at the end of March. The portfolio's weighted average risk rating on a cost basis remained at 2.4%, and on a fair value basis remained at 2.2%. The current weighted average net leverage of our investments was 5.4 times, unchanged quarter over quarter. And the current weighted average interest coverage improved to 2.8 times, up from 2.7 times.

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

Thank you, Tanner.

Total investment income for the quarter was $76.5 million, down 10.4% quarter over quarter. The decline was primarily attributable to a lower asset base and an increase in investments on nonaccrual. Fee and prepayment income was $6.9 million in the quarter, compared to $4.5 million in the March quarter. Dividend income for the quarter was $8.9 million, down $2.5 million quarter over quarter, primarily due to a lower dividend from Merx aviation as we retained earnings, as well as a lower yield on two of our middle-market CLO equity investments.

Expenses for the quarter on a comparative basis totaled $37.7 million, versus $40.7 million last quarter. The June comparative expenses excluded approximately $2.7 million of nonrecurring expenses related to a strategic transaction that was considered but did not incur. The manager also bore a similar level of direct expenses associated with the strategic transaction.

Management fees were lower, given the reduced base management fee rate and a decrease in the average portfolio. Incentive fees were lower, given the decreased level of investment income and the performance adjustment in our fee structure. Given the net losses experienced during the quarter, the incentive fee was 15%. Furthermore, interest expense decreased during the quarter due to a lower average debt balance.

Net investment income was $38.8 million or $0.17 per share for the quarter, excluding the previously mentioned nonrecurring expenses which were $0.01 per share. This compares to $44.6 million or $0.20 per share for the March quarter.

For the quarter, the net loss on the portfolio totaled $78 million or $0.35 per share, compared to a net loss of $68 million or $0.30 per share for the March quarter. Approximately $63 million of the net loss for the quarter related to three legacy investments, Garden Fresh, SquareTwo, and Delta Education. The net loss of $78 million included $12.6 million of realized losses, which approximately $11.3 million of those realized losses were previously recognized as unrealized depreciation.

In total, excluding the nonrecurring expenses, our quarterly operating results decreased net assets by $39.4 million or $0.18 per share, compared to a decrease of $23.4 million or $0.10 per share in the March quarter. Net asset value per share declined $0.38 or 5.2% to $6.90 per share during the quarter, largely driven by the credit driven markdowns on several of our legacy investments. There was a $0.01 per share accretive impact to NAV from our stock repurchases.

Turning to the portfolio composition. At the end of June, our portfolio had a fair value of $2.6 billion and consisted of 81 companies across 25 industries. First-lien debt represented 40% of the portfolio, second-lien debt represented 25%, unsecured debt represented 9%, structured products represented 12% and preferred and common equity represented 14%. The weighted average yield on our debt portfolio at cost was 11%, unchanged quarter over quarter.

On the liability side of the balance sheet, we had $1.1 billion of debt outstanding at the end of the quarter. The Company's net leverage ratio, which includes the impact of cash and unsettled transactions, stood at 0.66 times at the end of June, compared to 0.75 times at the end of March. The Company's debt to equity ratio was 0.71 times at the end of June, down from 0.8 at the end of March.

Regarding stock buybacks, we continued to see the stock market discount to NAV as an attractive opportunity to accretively repurchase stock. During the period, we repurchased 1.1 million shares for approximately $6 million. Since the inception of the program a year ago, we have purchased 12 million shares or approximately 5% of our outstanding shares, for a total investment of $69 million and we have $31 million remaining under our current Board authorization. At this time, we expect to continue to actively repurchase our common stock. In addition, Apollo Global Management continues to execute its share repurchase program. As a reminder, AGM initiated a program to repurchase up to $50 million of AINV stock in the open market, of which $5 million has been utilized to date. AGM owns approximately 8.9 million shares or 4% of the outstanding shares of the Company.

Let me conclude by saying that the Board and the management team considered many factors in the decision to reduce the dividend including our desired portfolio construction, a prudent target leverage ratio, and the current market environment. We believe it was a successful execution of the repositioning strategy that we have outlined today. We will be well positioned to provide shareholders with a more consistent return and stable NAV.

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

(Operator Instructions)

Your first question comes from Jonathan Bock of Wells Fargo Securities.

Good morning and thank you for taking my questions. And, Jim in {pima] it is very appreciated that you focused on stability both in NAV and cash flow stream going forward. That is very valuable to investors.

One question we wanted to try to understand a bit is now at the new underlying required yield as you lowered the dividend on an absolute basis, what type of yields one needs to originate at in order to maintain the dividend yield and perhaps grow it over time if it's appropriate. Can you give us a sense on what you would expect to be your target our ROA requirement in order to meet the new dividend obligation that the Board set forth?

Sure. Thanks, Jonathan. It's around 10% is the asset yield on the ultimate portfolio as we gravitate the portfolio from where it is today to that, of which a good portion of the portfolio is already in place as a part of that.

Got it, appreciate that. So clearly, certainly achievable. And then the question folks will ask is that I understand Apollo has such a wide variety of avenues to originate credit and through different buckets. So, Howard, could you give us a sense of MidCap's core asset base what the average yields were? But then also you talk about these specialty verticals where there is overlap, and clearly you outlined ABL or life sciences is at 10% returns.

Just trying to get an understanding of now that you will be partnering more, where MidCap's core really is, and where Apollo AINV's core is and then the areas that you work together. I think you already outlined, but just trying to understand the differences between the two vehicles so we can understand where they will partner and where they will not.

Right. So MidCap does all senior debt, and its yields can range anywhere from 6% to 10% or even 6% to 12%. To the extent that the products that MidCap offers ex real estate are in the yield range that I just talked about before, 10%.

That is where the overlap is. With the only other overlap being the assets being of enough size that it would make sense for AINV from a scale perspective to invest. It is a subset of what MidCap does, and that subset falls in the categories that we described: lender finance, asset based lending, and life sciences. But in all cases, (multiple speakers).

Got it. How if you think about just the dollar amounts that have originated in those types of three categories, how would you describe the just general relative size? So rates are going to get bigger now that you can speak for larger hold sizes and do more together, but how much has already been done in that portfolio over a normal course of 2 to 3 years in each of those categories?

Two things. It is a growing platform with growing market share because of its ability to invest together, so you're right. The past does not necessarily prologue that set. The numbers are pretty high.

It's just bifurcating it out to ones that would have historically been an AINV participated deal and one that had not. I don't have that exact numbers, but MidCap originates multiple billion dollars of investments every year.

Got it, and great that the two can partner together. Turning to new investments very quickly. Just looking for an update on the AIC SPV holdings. So certainly a divert investment vehicle with common equity interest.

Can you outline the investment itself? And I just believe once you saw the opportunity, because when folks see common equity it's always generally it raises a small bit of questions in terms of where we are in the credit cycle. But then again there's always Merx et cetera, there's some unique exceptions to the rule.

Jonathan, that is our investment SquareTwo. We restructured that and put a combination of debt and preferred into an SPV.

Okay, great. And then also looking at the energy opportunities. So for the investments that you did or choosing to dispose of, so are we -- now that you have sold down the 10%, are we to take under advisement that is the comfortable level you'll be operating at going forward. Or would you expect that to fall further over time if nothing changes?

Clearly it things get better, great, there's more opportunities to sell. But the static, is that where you're going to choose to keep it on a go-forward basis for the next four quarters?

Yes. Hey, Jonathan. I think our intention is to continue to work through our exposure there and we would like to get that percentage down lower.

As Howard alluded to, we are going to be very discriminating in when and how we reposition. And clearly in cases such as extraction, it was a function of the performance of the underlying company. But all things being equal, and you're right to point out depending on market environment, this may change. But it is our intention to try to manage that exposure down.

Got it. And then last question just as it relates to Merx and aircraft finance, I know we'll certainly get more as we dive into the queue a bit more. But how would you go and categorize the outlook for aircraft finance in today's environment, and the opportunity to perhaps grow what is already a very strong and respected business? Those are all my questions.

Sure. Thanks, Jonathan.

We continue to classify our Merx team as best in class, and the opportunity set ebbs and flows. And we continue to think that irrespective of market environment, they've demonstrated an ability to source attractive risk reward assets. We are cognizant of where our percentage is at the moment at 18.6%, as I alluded to. That had more to do with the decline of the overall portfolio than any underlying or any additional investment at Merx.

And so I think the takeaway is, we really like the exposure. We are cognizant of how big it is, and we're going to evaluate opportunities as they arise. Certainly all things being equal, as that portfolio managers down, we certainly see opportunities to reinvest should repayments be more robust than expected.

I had a comment. I would say that, and Tanner is right, we feel like our team is best in class and I think that we feel we got in early, vis a vis, a lot of our competitors. So we're not in a rush to put new asset to work right now. We're very patient just to let our portfolio do what it is doing day in and day out, and over time as the cycle changes -- I know there' been a lot concern about the new VC market.

As you know, our portfolio is a bit more of leases and air cap that have a bit more mature in their life. So we're pretty comfortable to -- we don't feel we need to be an aggressive investor right now. And is Tanner said, it's increased because of other challenges in our portfolio, but we were cognizant of the overall size, as well.

Got it. We appreciate the focus, understand the realignment and appreciate you taking my questions. Thank you.

No problem.

Your next question comes from Cal Joseph of Jefferies.

Morning. Thanks for taking my questions. Greg, I just wanted to get your thoughts a little bit on dividend and other income in the quarter.

Obviously, other income is pretty volatile, dividend income dropped. It this a good new run rate level that we're at right now?

Yes, I think what we have indicated previously is a we had said a 10% to 11%, I think at 9% to 10% is probably given where we are with some of our equity positions. So I think that is a good run rate, yes.

All right. Thank you.

And then also I wanted to talk about a little bit of the delevering in the quarter. Was it somewhat back weighted? Because if I just take in the average -- or if I calculate your cost of funds in the quarter, it looked like it ticked up a little bit.

Is that related to some timing of the delevering in the quarter? And then just your outlook for cost of funds going forward. Do you have and more tailwinds for margins there?

So you are absolutely right that we had a number of our repayments towards the end of the quarter, so therefore, we had more leverage on average during the quarter than we ended the quarter with. And we do have -- we will be paying down a secured piece of indebtedness that has about $28 million or so in the quarter that has a cost of about 5 7/8%. So that will get some minor impact on our cost of capital for the next -- but that's later in the quarter, so it will affect us going forward.

Great. That's all my questions. Thanks for the color.

You next question comes from Terry Mall of Barclays.

Hey, good morning. Just wanted to touch on Merx a little bit more. Can you remind us how that investment is structured, and how you would manage it down over time? And also longer term, what is the right size as a percentage of your portfolio?

Sure. So as we mentioned, 18.6% I think per our earlier comments, we like the risk reward there. So our current outlook is perhaps a little bit lower, but we are comfortable with the current percentage.

In terms of the structure of our investments, we have an equity investment in Merx that we characterize as partially debt security and partially in equity which you see on our balance sheet. But the nature of the investments within the vehicle are such that many, an in fact, just about all have underlying leverage on them and we are the equity, we own the underlying claims. And so the leverage resides in the on a trade basis in the underlying investments.

Got it. And what is the typical lease term for the planes? And also how do the lease rates right now compare to a couple years ago?

It's a very good question. And as Jim alluded to, we're less focused on the new lease market and new leases can be 10 to 12 years. On average, we are buying planes with [hardy] 4 to 7 years old. So do the math, 5 to 6 years remaining on lease term.

But we have invoked a strategy that is asset agnostic, and in fact we endeavor to be diversified by aircraft type. And more importantly, have our lease maturities not concentrated in any one year so we do not have planes coming back into any one specific market. So there are numerous factors that we look to in ensuring diversification in the total Merx portfolio.

Got it. And are lease rates generally lower or higher than a couple years ago?

I would answer that question by saying across different asset types it really depends, and so it defies a clean statement. Again, when we look at value we are taking into account lease rate, but also underwriting to a residual and the underlying credit risk associated with that lease rate. So it is one of many factors we consider.

Got it. Can you give some additional color on the opportunity you're seeing right now in the ABL and life sciences space?

Sure. In the ABL space as a general matter, there is more and more opportunities for non-bank lenders that is the regulatory scrutiny for banks expands. So there is an increasing amount of strongly collateralized adequate credit assets that are being moved out of banks for reasons that I think the banks would prefer not to happen, so that is a continually expanding market in terms of opportunity.

Yet there is fairly meaningful barriers to entry because you need to have a platform that can manage collateral and fund people every day and things like that, and so there is really good secular tailwind in that area. So that is one.

The life sciences business is steady. There are a few competitors in the market that have been there for a long time, Hercules in DDC space and then a few private companies of which MidCap is one. That effectively have been in the market for a long time and remains there.

The competitive market has been pretty steady. There's always a good set of opportunities. It is sometimes a function of alternative source of capital for those companies, so partnerships in pharma and IPO markets sometimes can piece against that capital and so that can ebb and flow. But has generally been pretty steady and has been steady for an extended period of time.

Okay, great. Thank you.

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

Hello, good morning. Thank you for the really good color at the beginning of the call. I have got one question on the shift that you guys were talking about to the more secure credit assets there, the timeline here we're talking about.

I know you said the target you were heading for was a 10% yield. Are we looking at the three-year of life there moving over, or as organically repayments come in? Or are we going to see more of looking to sell off some of these assets subordinated, even some second lien to move to that 10% overall yield more rapidly?

I think it's a combination of everything. But our strategy does not exclude second lien going forward; originated second lien through the middle market. So there are excessive assets that we would not want to move off the balance sheet long term for our strategy anyway.

But I think the answer is, we have an ultimate goal, a picture of the portfolio that if you do the math, produces the yields we want and long-term dividend and growth that everybody wants and vast ability. And certain assets don't match that, and those are the ones we will look to exit but only at an attractive price versus where we think they're ultimately worth.

So that goes back to what your initial point was. Over three years, we would expect the whole portfolio in a normal case to run off.

That is generally average three-year life. So we will accelerate that, and when we have opportunities for ones that don't fit and we'll replace those with a new origination as that comes. So the sooner we can do, the better, but only if it meets the long-term goals of maximizing our recovery and our NAV.

Okay. Thank you. And then on the strategic transaction, that $0.01 no-recurring expense that was mentioned. Can we have some color there?

What were you looking at? Is there a reason, a specific reason why it ended up not occurring, or are you looking for other transactions similarly now?

I think it the best way to answer that is it did not occur for Apollo, certainly we are always on the lookout to engage in transactions that we think make sense long term for our Company and we'll continue to do so. But in this case, it did not result in a positive outcome for Apollo Investment Corp.

Okay. And then on the repurchases, just a quick question on that. Obviously a little bit restrained because of leverage when it's there, what kind of pace do you feel like the Apollo Investment Corp will be able to hold up? And then will that be balanced more by the manager's ability at Apollo Global to repurchase?

I would say we are excited about buying our stock. When appropriate, we will be actively repurchasing. I think when we think about the overall message that we are delivering today, we would like to operate at a little bit lower leverage than we had historically. And the numbers you saw today are a result of that. But now we have some flexibility to buy some stock, and we would expect to actively fulfill the program that our Board has put in place.

Okay, all right. And then last question, on the exit of Extraction since quarter end, any color there?

Yes, the company was able to do a high yield bond offering and was able to take out our debt at 101% accordingly.

Perfect. All right. Thank you. Appreciate it.

Thank you.

Your next question comes from Jack Mawarder of SunTrust.

Hello, good morning.

First, a bigger picture question. We've been seeing some talk about how there has not a lot of deal volume in the middle market, middle and upper middle market, and things are a little more competitive because there is this flood of yield seeking capital coming in chasing these deals and some of the multiples are getting out of hand.

I guess how does that square with what you're trying to do with taking on more traditional corporate direct origination? And of course that's mindful that I understand MidCap has some niches that are little off the beaten path that might help give you differentiation. But are you -- how does that affect what you are trying to do and your plan right now?

Right, one is as you said is the niches are hopefully and are a little bit more immune to those trends. But with regard to the core origination strategy, I think as Jim said in the beginning of his comments, we want to differentiate it on things other than price. And so one of that is size and speed of execution.

And we have now combined across the Apollo platform led by AINV and MidCap, the ability to underwrite as much as pretty much anybody else we compete with in the marketplace. So if we can deliver certainty and we have a comprehensive coverage effort, which we do, so we have as many people out there looking for deals and we can deliver something that other people can't. We can basically be on the favorable end of that trend you're talking about.

No matter what, that trend is there and the market drives a lot of things. But certainty and size really matter. And given the amount of actually assets that need to be originated each quarter at AINV, we believe that we can originate enough assets in that category that we don't need to be directed by the market. Certainly as much is some people that are either much bigger or have much less coverage.

Great. And just a follow up on still on the subject of MidCap. I just wanted to clarify something just for my knowledge purposes. On MidCap you talk about an ABL niche, is that retail inventory supported ABL or is that healthcare receivable factoring ABL or something different?

Yes to all three, it is. There is a healthcare ABL business of which MidCap is a leader in the market, so there is a significant presence there. And there is also just a general all industry asset-based lending of business that is led by receivables as opposed to inventory, but inventory is always component and sometimes a significant component of those loans.

There is not a specific retail focus, and in fact, it is far less retail as a percentage than most ABL portfolios, but certainly retail could be part of it. So it could be IT distributor with receivables, it could be a steel company, it could be a helicopter company, it could be a retail brand, any of those things.

Okay, great. Thanks. That's all my questions.

Thank you.

Your next question comes from Ryan Lynch of KBW.

Good morning. You mentioned transitioning away from some of your specialty finance or specialty verticals, obviously I'm assuming the energy vertical is one of them. But are there any other specialty verticals that you plan on transitioning away from and why?

I think anywhere our goal would be putting Merx aside because of its value as a diversified platform. For us to not have any concentrations in a way that you all would flag.

And so if you look at our business now, renewables, CLO equity all are relatively concentrated positions versus a whole and actually have more volatile cash flows because they are inherently levered. And so those would be places that we would also expect over time to be (technical difficulty).

Okay. And then I was looking at your balance sheet, the leverage obviously came down a little bit in the quarter. The way you are leveraged today it looks like you could grow your portfolio.

However, based on your guys commentary about transitioning the portfolio and maybe churning out of some assets, should we expect some portfolio net repayments over the next several quarters as you guys transition? Even though leverage levels on the balance sheet tells you you could actually have growth?

Yes, I think it's possible. And the reason why I say it's possible is we do have a good pipeline, and we expect to have good gross origination. But it is also possible that we'll have opportunities to exit things we think are appropriate long term that are of size.

So we don't think it will be a long time until we get to the right leverage level, but certainly any given quarter could end with lower leverage if that's appropriate. And we think that's fine for the long-term opportunity, because we like the long-term opportunity.

So it's a good question. It is quite possible, but it just all depends on the timing each of the things we're doing come (inaudible).

I would say, you balance that leverage with earnings too. Certainly we don't want to abandon the ability to achieve our reset dividend, so certainly that's very important to us.

Understood. Those are all the questions from me.

Your next question comes from Chris York of JMP Securities.

Morning, guys, and thanks for taking my questions. Given that the Company and the Board took a comprehensive look at the business and reduced the dividend from declines in income leverage and NAV, I was hoping you could give an update on how you think about the appropriateness of the cost structure of the business longer term.

I think that is part of an annual process that the Board goes through in terms of analyzing the various cost impacts. And certainly, I think the Board wants to see how we are able to succeed on the plan we've put out, but they are very supportive of this plan. And over the course of the next year, we'll have the appropriate dialogue with respect to the attributes you are discussing.

Got it. So then maybe taking it a little bit further, I'm trying to think about the sustainability of the fee waivers. So how should we think about that for the next year? Is there any guidance you can give us on that?

I would suspect that the fee that you've seen is a result of our March meeting staying in place. I think that is what we usually go from year to year, that's how our Board looks at it.

And certainly sustainable for the next year, but at that point in time, we will address that. And depending on how the Board feels about the competitive environment and what our peers are doing, I think we look to be consistent amongst that group.

Understood. Greg, how much of the other G&A in the quarter was one time? Has that picked up meaningfully in the current quarter?

Yes, so it was $2.7 million.

$2.7 million? Okay. Switching gears a little bit, so as I peruse the Company's SOI, a couple things stand out to me on fair-value marks. So could you provide a little bit of color on the mark the Venoco, considering its bankruptcy and then it was written down only 2%? And then also with focus on your structured product portfolio, which historically hasn't shown much volatility.

Yes, with regard to Venoco, as a reminder, this is our Denver-based E&P company with assets in Southern California. The company entered a bankruptcy process during the quarter, and actually has emerged subsequent to quarter end.

Our valuation takes into account all inputs each and every quarter, and the prospect for bankruptcy was accounted for last quarter. And ultimately, still feel similarly with respect to the company's prospects. And again, also worth mentioning the oil price environment obviously improved slightly over that period of time. But I would answer that question by saying, it is all the information is reflected each and every quarter.

I think on our structured product, when we look at it, remember we are not in the broadly syndicated CLO market. So we are middle market. Our CLOs have performed very well and our red cap trades have performed very well.

What you will see, and I think as I mentioned in our dividend, so we are getting the same cash flows out of these CLO's. But as we look out and as you value these on a quarterly basis, if the default rate we believe is potentially going to go up, you take that cash flow that's coming in put more of it toward the cost of your investment versus the yield you are bringing in. And so that is a level yield accounting process, so we have been very comfortably doing that and I think it's a better way to look at the investment.

Got it. That makes sense. Lastly for me, I know Apollo has looked at pace loans and put some on the balance sheet. So maybe given some changes, how are you thinking about that asset and whether or not it fits at Apollo?

So the pace investment has been a really good one, and we continue to have an ongoing commitment with the originator of those loans to continue to take advantage of what they created. So we will definitely see that through in terms of doing that further. We have some options to do that further with them.

It wouldn't fit in to the core strategy we have going forward. So we don't want to give up that option if we think it makes sense, or if there is a way to monetize it in some way. But in terms of replicating that with a new originator, that is not part of the core strategy going forward.

Got it. That's it for me. Thank you.

Your final question comes from the line of Rick Shane of JPMorgan.

Hey, guys. Thanks for taking the questions this morning. I'd love to -- and maybe I've done this so long I'm a little bit of a historian at this point, but love to walk back through the strategy over time for Apollo and think about where we stand now and make sure we understand. When I think about it, Apollo was originally an alternative to the 144A market as a principal as opposed to an agent in the space.

Then as that evolved, moved more into liquid loans. And the last transition we saw in management was back in 2012, and the transformation that the Company has gone through over the last four years is basically a recognition that you were paying up for liquidity on loans where -- that you were going to hold some maturity. So you were giving up yield for liquidity, but never actually needing to take it or never actually claiming to advantage of that liquidity.

The shift over the last four years has been into less liquid loans, and I suppose a little bit further down the capital stack. Is what we are hearing today a move really up the capital stack? I'm a little bit -- I just want to put this all in a historical context.

Sure, Rick. I think what you are hearing us -- so I wouldn't say argue or take issue with what you have laid out in terms of what the past was in terms of what we are today. I think what you are hearing us say today is we find ourselves confronted in 2016 with a track record that generated a lot greater volatility to our NAV than we'd liked in retrospect. And now we find ourselves here with two attributes that we did not have a couple of years ago.

We have the exemptive order across our platform, and we have an embedded origination team with MidCap that really allows us to not just be one of 20 out there. But the one of just a handful that actually has a lot of feet on the street and has a client track record with sourcing that capital.

So in combination with the exemptive order and the MidCap capabilities, we also recognize that you've got to do the math on these vehicles. And reaching for yield in a lower rate environment has not been proven in the path to success. So in acknowledging what the environment is in terms of overall yields an overall ROEs, what we think is a realistic ROE for this asset class is somewhere in the mid-to-high 9%s.

If you book assets, as Howard said, is plus or minus 10% with a little bit of financing that we have. And then the overall predictive or expected credit losses we think that is a much better strategy in terms of trying to fulfill the objectives that we have long term. So you are right in pointing out that we have not had one consistent strategy from day one. It has changed, but certainly the Board and the management team believe this strategy now is what makes sense for us.

And without an exemptive order and without the MidCap portfolio for us wanting to really lead into corporate loans, we would have been a follower rather than a leader. And I think we would not have had as broad a front-end funnel, and we would have been competing on terms that really were not a little bit of -- not the proper portfolio that we wanted to create.

Now we are at a point in time in 2016 when we have exemptive order, we have the MidCap, we're recognizing the environment, and you put that together, that is what is leading our pathway today. And I think that some of you folks out there have published extensively on this in terms of what is the right ROE, what is the right dividend policy. And certainly we believe that we are on a pathway going forward that acknowledges all those issues, as well as takes into consideration the attributes that we have today.

Got it, that's helpful. Again, I'm going to make two comments, and one will probably be perceived a bit as a compliment and the other may be perceived as a criticism.

In 2012, and I can't remember the timing if it was March quarter or June quarter, the manager made a substantial investment in the Company at NAV when the stock was trading substantially below. And in my experience, that stands out as one of the more stand-up things that we have seen along the way across the companies that we follow.

In the following four years, AINV has lost money in roughly half of the quarters. It has, I will point out, had it generated a profit over that time, but it has lost money in more than half the quarters. At the same time, you have modestly tweaked management fees, you've tweaked incentive fees. But it doesn't seem like the concessions over the last four years are necessarily as maybe generous might not be the exact right word, to shareholders as what you did four years ago. I realize that you're not necessarily in a position right now where infusing capital makes sense, what are the alternatives to support shareholders in the way that you did four years ago?

I think that it's -- certainly, not only the announcement but the execution of our buybacks, we think a lot of folks in our field that announced buybacks, few have executed them. We have executed to date, and we continue to believe that we are going to execute going forward. I know that the AINV Board is excited about fulfilling its program, and certainly when we get to the end of that I wouldn't be surprised if they exercised another program that would be consistent with their overall view.

You've heard us put forth what AGM is doing in terms of their buyback program, and I think the acknowledgment of bringing these resources together. So we're looking forward now, we're looking forward in terms of the environment that's put in front of us and trying to achieve the objectives of the environment in terms of yields, what's going on in the yield compression.

And our Board looks at all these attributes and thinking about the relationship that we have with the Company and with the manager. So in our view, it is hard to look at anyone quarter in a vacuum, you need to look at the breadth of the relationship. And I think we're on the right path going forward.

Great. Jim, thank you very much.

Thank you, Rick.

This concludes the question-and-answer session. I will now turn the floor back to Jim Zelter for any additional or closing remarks.

Great. Well first of all, thank you all for participating this morning. A lot of good Q&A.

Elizabeth and Greg and the team have the supplement, but certainly we look forward to spending time with all of you in person or on the phone and look forward to that continued dialogue. Thank you very much.

Thank you for your participation in today's conference. This does conclude today's call. You may now disconnect.