New Mountain Finance Corp (NMFC) 2013 Q2 法說會逐字稿

Good morning and welcome to the New Mountain Finance Corporation Q2 2013 earnings conference call and webcast. (Operator Instructions). Please also note this event is being recorded. I would now like to turn the conference over to Rob Hamwee, CEO. Please go ahead, sir.

Thank you, and good morning, everyone. With me here today is Steve Klinsky, Chairman of NMFC and CEO of New Mountain Capital; and Dave Cordova, CFO of NMFC. Steve Klinsky is going to make some introductory remarks, but before he does, I'd like to ask Dave to make some important statements regarding today's call.

Thank you, Rob. I would like to advise everyone that today's call and webcast are being recorded. Please note that they are the property of New Mountain Finance 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 August 7, 2013, press release and on Page 2 of the slide presentation regarding forward-looking statements.

Today's conference call and webcast may include forward-looking statements and projections, and we ask that you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from those statements and projections. We do not undertake to update our forward-looking statements or projections unless required by law. Any references to New Mountain Capital or New Mountain are referring to New Mountain Capital, L.L.C. or its affiliates and may be referring to our investment advisor, New Mountain Finance Advisors BDC, L.L.C., where appropriate. To obtain copies of our latest SEC filings and to access the slide presentation that we will be referencing throughout this call, please visit our website at www.NewMountainFinance.com or call us at 212-720-0300.

At this time, I'd like to turn the call over to Steve Klinsky, the Chairman of New Mountain Finance Corporation, who will give some highlights beginning on Page 4 of the slide presentation. Steve?

Thanks, everybody. Before turning the call back over to Rob and Dave, I wanted to welcome you all to New Mountain Finance Corporation's second-quarter earnings call for 2013. Rob and Dave will go through the details, but I am once again pleased to present the highlights of another strong quarter for New Mountain Finance.

New Mountain Finance's adjusted net investment income for the quarter ended June 30, 2013, was $0.50 per share. After deducting the one-time YP distribution of $0.12 per share, our pro forma adjusted net investment income was $0.38 per share, which exceeds our previously announced range of $0.33 to $0.35 per share and more than covers our previously announced Q2 dividend of $0.34 per share.

The Company's book value on June 30 was $14.32 per share, an increase of 1% from Q1 and an all-time high for the Company. We are also able to announce our regular dividend for the quarter ending September 30, 2013. The regular dividend will again be $0.34 per share, consistent with our previously communicated view that we have reached a fully-ramped, steady-state dividend level. Additionally, we will be paying a $0.12 per share special dividend this quarter from the proceeds of a distribution we received from one of our equity holdings, YP LLC.

The credit quality of the Company's loan portfolio continues to be strong, with once again no new loans placed on nonaccrual this quarter. We have had only one issuer default since October 2008, when the debt effort began, and it represented just 0.6% of the cost basis of our existing portfolio and under 0.3% of cumulative investments made to date.

New Mountain Finance continued to expand its asset base in Q2. The Company invested $150 million in gross originations in Q2, largely deploying the proceeds from June's $29 million equity capital raise and related credit facility upsizing.

Targeted yields on new investments continue to be consistent with our previously communicated expectations. Our portfolio continues to emphasize positions in recession-resistant acyclical industries pursuant to New Mountain's overall strengths and strategy. We continue to be very pleased with the progress of New Mountain Finance to date, and we are pleased to address you as fellow shareholders as well as management.

With that, let me turn the call over to Rob Hamwee, New Mountain Finance Corporation's Chief Executive Officer.

Thank you, Steve. As always, I'd like to start with a brief review of NMFC and our strategy. As outlined on Page 5 of our presentation, NMFC is externally managed by New Mountain Capital, a leading private equity firm with more than $9 billion of assets under management and approximately 100 staff members, including nearly 60 investment professionals.

NMFC takes New Mountain's approach to private equity and applies it to corporate credit, with a consistent focus on defensive growth business models and extensive fundamental research. Some of the key hallmarks of defensive growth business models include acyclicality, sustainable secular growth drivers, high barriers to competitive entry, niche market dominance, repetitive revenue, variable cost structures, and strong free cash flow. With this historically successful, business-model-focused approach in mind, our mandate since the inception of New Mountain's debt investment program in 2008 has been to primarily target what we believe to be high-quality businesses that demonstrate most or all of the defensive growth attributes that are important to us, and to do so within industries that are already well researched by New Mountain.

Or more simply put, we invest in recession-resistant businesses that we really now and that we really like. We believe this approach results in a differentiated and sustainable model that will allow us to generate attractive, risk-adjusted rates of return across changing market cycles and market conditions. To achieve our mandate, we utilize the existing New Mountain investment team as our primary underwriting resource.

Turning to Page 6, you can see our total return performance from our IPO in May 2011 to August 2, 2013. We continue to be very pleased with both our absolute and relative return performance.

As outlined on Page 7, credit markets saw significant volatility in late May in June as long-term treasury rates spiked by over 100 basis points. This served as a catalyst for meaningful outflows from the high-yield market, which in turn drove credit spreads higher. The market has stabilized so far in Q3, and credit spreads have retraced somewhat.

Recent history has shown that market conditions can change quickly. I'd like to reemphasize that New Mountain Capital, and accordingly NMFC, have always been proactively focused on defensive, acyclical business models, and that our financing is termed out until late 2016 and not subject to traditional mark-to-market margin costs.

Given the recent rise in long-term interest rates and the renewed focus in the market on the possibility of futures' short-term and long-term rate increases, we wanted to highlight NMFC's defensive positioning relative to this potential issue. As you can see on page 8, 88% of our portfolio is invested in floating-rate debt. Therefore, even in the face of a material rise in interest rates, assuming a consistently shaped yield curve, we would not expect to see a significant change in our book value.

Furthermore, as the table at the bottom of the page demonstrates, a meaningful rise in short-term rates will generally increase our NII per share, with the only exception being a modest rise having a negative impact as the cost of our borrowings rise, while our interest income does not initially go up, given the presence of LIBOR floors on our assets.

Our single highest priority continues to be our focus on risk control and credit performance, which we believe over time is the single biggest differentiator of total return of the BDC space. If you refer to page 9, we once again lay out the cost basis of our investments, both the current 6/30/2013 portfolio and our cumulative investments since the inception of our credit business in 2008, and then show what, if anything, has migrated down the performance ladder.

In Q2 no assets had negative credit migration. We continue to have one SLF asset with a cost of $13.5 million and a fair market value of $8.9 million that previously migrated from an internal rating of 2 to an internal rating of 3, indicating operating performance materially below our expectations but no near- or medium-term expectation for nonaccrual. We continue to have only one portfolio company on nonaccrual, representing at cost 0.6% of our total portfolio and under 0.1% of fair market value. Since the inception of our credit efforts in 2008, we have made investments in 116 portfolio companies, of which only 1 has migrated to nonaccrual.

Over 99% of our portfolio at fair market value is currently rated 1 or 2 on our internal scale. Pages 10 and 11 show that the operating Company and SLF respectively leverage multiples for all of our holdings above $7.5 million when we entered into an investment and leverage levels for the same investment as of the end of the current quarter. While not a perfect metric, the asset-by-asset trend in leverage multiple is a good snapshot of credit performance and helps provide some degree of empirical, fundamental support for our internal ratings and marks.

As you can see by looking at the two tables, leverage multiples are in almost all cases trending in the right direction. And even more importantly, no single company on either page has had a material increase in leverage multiple, with the exception of 1 loan in the SLF.

Page 12 provides a little more detail on the $0.12 special dividend for our investment in YP. As you can see, we made a relatively modest investment of $10 million into this business a little over a year ago, primarily in the form of second-lien debt. The business has outperformed our expectations in terms of both operating performance and cash flow generation, resulting in a significant recapitalization transaction.

We have now been fully repaid with 15% interest on our debt position and have cumulatively received $6.9 million of dividends on our $500,000 equity investment. We continue to own approximately 1% of the equity in the company, and as part of the recapitalization, we invested $31 million into a new first-lien term loan.

On Page 13 we show a table depicting how NMFC's publicly-traded float has increased by over 350% based on the 5 equity offerings we have completed since our IPO. We now have 38.1 million shares in our float, representing 85% of the total shares outstanding, and liquidity and daily trading volume have increased commensurately.

The chart on Page 14 helps track the Company's overall economic performance since its IPO. At the top of the page we show how the regular quarterly dividend is being covered out of net investment income. As you can see, we continue to cover 100% of our cumulative regular dividend out of NII.

On the bottom of the page we focus on below-the-line items. First, we look at realized gains and realized credit and other losses. While you can see the individual, annual, and quarterly data, I draw your attention to the number highlighted in blue that shows cumulative net realized gains of $19.1 million since our IPO.

Next, we look at unrealized appreciation and depreciation. As you can see highlighted in grey, we have cumulative net unrealized appreciation of $13 million. For clarity, our mark-to-market loss on our 1 defaulted investment, ATI, of $5.5 million is reflected in this number, along with the various other mark-to-market gains and losses reflected on our schedule of investments.

Finally, we combined net realized with unrealized appreciation to derive the final line on the table, which in the yellow box shows a current cumulative net realized and unrealized appreciation of $32.1 million. The point here is to show that on both a realized and combined realized/unrealized basis, we have offset any credit losses or impairments below the line gains elsewhere in the portfolio.

In fact, by this methodology we have built a $32 million cushion to offset any future credit losses, some of which we have paid out as special dividends. While market-driven volatility around unrealized appreciation and depreciation may cause the bottom-line number to vary over time, true economic gains and losses will accumulate in the realized bucket, where we will strive to retain a positive balance.

Moving on to portfolio activity as seen on page 15, in Q2 we made significant investments in 6 portfolio companies and had total growth originations of $150 million. As you can see, the bulk of the investment activity came later in the quarter, when we were able to take advantage of the market volatility I described earlier. Repayments totaled $115 million, and opportunistic sales were $1 million for total net origination less sales of $34 million. All of the investments, in keeping with our strategy, are in industries and businesses that are well known to us through our historical private equity activities.

For example, Deltek is an enterprise software business we owned in our private equity fund for over 7 years. The in-depth knowledge of the Company derived from our prior ownership gives us great confidence in the accuracy of our underwriting of the prospects for the business going forward.

Pages 16 and 17 show the impact of Q2 investment and disposition activity on asset types and yields, respectively. Asset net origination type was modestly skewed towards first-lien investments. Yields on originations and disposals were broadly consistent. A modest increase in the portfolio yield to maturity from 10.4% to 10.7% was entirely a function of an increase in the forward LIBOR curve.

Moving on to Page 18, we continue to selectively find attractive opportunities to deploy capital. We continue to operate with our credit facilities fully deployed, allowing for an optimized level of earnings. Just like in recent quarters, where we raised only as much capital as we had visibility to deploying in the near-term, any balance sheet expansion from here will be a function of both how the pipeline of attractively priced and structured opportunities develops going forward and the magnitude of repayments received.

In terms of the portfolio review on Page 19, the key statistics as of June 30 look very similar to March 31. As always, we maintain a portfolio comprised of companies in the defensive growth industries, like software, healthcare, Business Services, and education, that we believe will outperform in an uncertain economic environment.

Finally, as illustrated on Page 20, we have a broadly diversified portfolio, with our largest investment at 4.2% of fair value and the top 15 investments accounting for 46% of fair value, consistent with past quarters.

With that, I will now turn it over to our CFO, Dave Cordova, to discuss the financial statements and key financial metrics. David?

Thank you, Rob. For more details on the financial results and today's commentary, please refer to the Form 10-Q that was filed last evening with the SEC.

Before we turn to Slide 21, I want to mention that we have included a structure chart as Appendix A in the presentation. Similar to prior calls, I will spend a moment reviewing the Company's structure as a brief refresher.

The structure was set up similar to an UPREIT structure, whereby the public Company, PubCo, has no direct operations of its own; and its sole asset is its units of our operating business, OpCo. Today the other units of OpCo are held by a private BDC owned by New Mountain's private equity fund, AIV Holdings. This structure is a master feeder whereby the financial statements for OpCo flow to PubCo and AIV Holdings pro rata based on the respective ownership.

All discussion throughout this call and presentation is focused on OpCo and its operations. Additionally, OpCo owns the equity of a nonrecourse vehicle, the SLF. This vehicle originates lower-yielding first-lien loans, but with greater leverage at 2 to 1. For GAAP, asset coverage, and presentation purposes, we consolidate this SLF vehicle into the operations of OpCo.

Now I would like to turn your attention to Slide 21. The OpCo and SLF portfolios had approximately $1.06 billion in investments at fair value at June 30, 2013. We had approximately $15.9 million of cash and about $19.5 million of other assets, which includes approximately $11.2 million of interest and dividend receivable, much of which we've already received; $5.2 million of deferred credit facility costs -- these costs get amortized over the life of our credit facilities; $0.7 million receivable from affiliates; and $2.4 million of other assets, which includes deferred offering costs and other prepaid expenses and assets.

We had total debt outstanding of about $416.5 million on our two credit facilities, which is made up of $209.4 million on our OpCo credit facility, which had $215 million of capacity at June 30; and $207.1 million on our SLF credit facility, which had $215 million of capacity at June 30.

We had about $37.6 million of other liabilities, which is made up of a $19.6 million payable for unsettled securities purchase, which settled in mid-July; approximately $14.5 million of payables to affiliates for management incentive fees, which is further broken down to $3.7 million in management fees; $5.4 million in Part 1 incentive fees; and $5.4 million in capital gains incentive fees; approximately $0.8 million of interest payable and $2.7 million of vendor payables for various expenses.

This all gets us to a net asset value of $640.3 million or $14.32 per share at June 30, 2013. This is an increase of $0.01 per share from the March 31, 2013, NAV of $14.31 per share and an increase of $0.49 per share from the June 30, 2012, NAV of $13.83 per share.

Our consolidated debt-to-equity ratio at June 30 was 0.65 to 1.00, which is at the low end of our targeted debt-to-equity ratio range. As a reminder, our credit facilities allow us advance rates of 25%, 45%, or 70%, depending on the type of the underlying asset.

As our OpCo facility the rate is LIBOR plus 2.75%, and at the SLF facility the rate is approximately LIBOR plus 2%. Both facilities do not mature until October of 2016. Importantly, our credit facility covenants are generally tied to the operating performance of the underlying businesses rather than the marks of our investments at any given time.

On Slide 22 we show our consolidated income statement for the full quarter at the OpCo level. As was discussed in prior quarters, the main reason for the creation of our UPBDC structure was to make sure that the built-in gains that were in the portfolio at the time of the IPO are only allocated to AIV Holdings, therefore not burdening the public shareholders with any of those taxable gains or increased accretion on the predecessor investments over time.

Since we were not able to step up the assets for GAAP, our income statement will generally show greater accretion than if a step-up had occurred until the predecessor assets are sold, mature, or are repaid. Therefore, on this slide we show the GAAP income statement in the left column and then adjust the income statement to reflect it, as if all the assets were stepped up to fair value at the IPO in the normal adjustment column, which are highlighted in blue.

We use the adjusted income statement to judge our performance of the portfolio during the period, and it is also the basis for calculating our dividend and incentive fees. We then make an adjustment for the capital gains incentive fee. This adjustment, which is highlighted in grey, represents the reclassification of the noncash capital gains incentive fee from above to below the adjusted net investment line, as under GAAP we are required to accrue incentive fees, assuming a hypothetical liquidation of the entire portfolio at the balance sheet date.

Lastly, we further deduct the one-time YP distribution, which adjustments are highlighted in yellow, to arrive at our pro forma adjusted net investment income in the far right column. We believe pro forma net investment income represents a more accurate comparison of our earnings results to prior quarters. Focusing on pro forma net adjusted income in the far right column, we earned total investment income of approximately $28.5 million. I will walk through the components of investment income in greater detail when we turn to Slide 23.

For the second quarter we incurred net expenses of approximately $12 million. The increases in management and the Part 1 incentive fees from the prior quarter are primarily attributable to higher total assets as a result of the capital deployment from our June equity offering and higher prepayment fees, respectively.

Our interest expense of $3.1 million is broken out to represent about $2.6 million of actual interest expense on our borrowings; $100,000 of non-usage and custodian fees; and about $378,000 of amortization of our up-front borrowing costs. We have capped the amount of our expenses reimbursable to the administrator for our third year as a public company at $4.25 million.

For this quarter our combined amount of professional fees, administrative expenses, and other general and admin expenses are approximately $1.9 million gross and approximately $1.06 million net of expenses waived and reimbursed. These amounts relate to legal costs other than tax, board costs, other admin expenses, and indirect expenses reimbursable under our administration agreement.

The bottom line is second quarter pro forma adjusted net investment income of $16.5 million or $0.38 per weighted average share, which exceeds the adjusted net investment income range discussed on our May 7, 2013, call of between $0.33 and $0.35 per share and more than covers our Q2 dividend of $0.34 per share. We are pleased that we were able to complete a strategic capital raise in June and still deliver adjusted net investment income that exceeded our expected range.

Shifting to below the pro forma adjusted net investment income line, we had adjusted net realized gains of $0.6 million as a result of prepayments above our adjusted cost basis. Adjusted unrealized losses of $9.1 million were primarily driven by reclassifying approximately $5 million of previously unrealized gains associated with our investment in YP and to dividend income, along with realizations on investments during the quarter previously marked above par and lower marks on the broader portfolio.

As a result of the unrealized losses in the quarter, we reduced our capital gains incentive fee accrual by approximately $1.7 million. However, as of June 30, 2013, cumulative net adjusted realized gains did not exceed cumulative adjusted unrealized appreciation, and therefore we would not pay any capital gains incentive fees if this were year end. In total, for the quarter ended June 30, 2013, we had a net increase in members' capital resulting from operations of $14.8 million.

As previously mentioned, we earned $0.12 from the YP distribution, bringing total adjusted net investment income for the second quarter to $21.6 million or $0.50 per weighted average share, a record for the Company. Turning to slide 23, we break out the components of both interest income and total investment income for the current and prior quarters. As has historically been the case, our total investment income is predominantly paid in cash.

Though the amount of prepayment fees vary from quarter to quarter based on repayments, our historical earnings have consistently shown some material prepayment fee income. Therefore, we show total interest income as a percentage of total investment income both with and without prepayment fees, which is one measurement of the stability and predictability of our investment income. The second-quarter range of 87% to 95% is slightly lower than previous quarters and is a function of an increase in Q2 prepayment fees relative to prior quarters.

During the quarter we received prepayment fees related to the repayment of 5 investments, 4 of which had meaningful call protection. Lastly, other income of approximately $1.4 million was made up of delayed compensation, revolver fees, and consent amendment and forbearance fees.

On Slide 24 we show the quarterly migration of our adjusted net investment income, starting with the current quarter pro forma adjusted net investment income and the prior three quarters' adjusted net investment income. Once again, this highlights that while realizations in unrealized appreciation/depreciation can be volatile below the line, we continue to generate and grow net investment income above the line.

Now I will turn your attention to Slide 25. As previously discussed earlier, the $16.5 million of pro forma adjusted net investment income for the second quarter exceeded the range we discussed on our Q1 earnings call of $13.9 million to $15.1 million or $0.33 to $0.35 per share. We paid a $0.34 per share dividend, which we believe to be our fully ramped, run rate adjusted net investment income.

Therefore, we expect to fall within the range of $14.5 million to $15.9 million of adjusted net investment income in the third quarter of 2013 or $0.33 to $0.35 per share, although this is simply an estimate and could materially change. Given our belief that our fully ramped run rate dividend will continue to fall in the previously declared expected range of $0.33 to $0.35 per share, our Board has declared a Q3 2013 dividend of $0.34 per share, in line with the previous 5 quarters.

The Q3 2013 quarterly dividend of $0.34 per share will be paid on September 30, 2013, to holders of record on September 16, 2013. Additionally, as a result of the YP distribution, our Board has declared a special dividend of $0.12 per share. The special dividend of $0.12 per share will be paid on August 30, 2013, to holders of record on August 20, 2013.

At this time, I would like to turn the call back over to Rob.

Thanks, Dave. While once again we do not plan to give explicit forward guidance, it continues to remain our intention to consistently pay the $0.34 per share on a quarterly basis for future quarters, so long as the adjusted NII covers the dividend in line with our current expectations.

In closing, I would just like to say that we continue to be extremely pleased with our performance to date. Most importantly, from a credit perspective, our portfolio continues to be very healthy.

Once again, we'd like to thank you for your support and interest, and at this point turn things back to the operator to begin Q&A. Operator?

(Operator Instructions). Greg Mason, KBW.

First, could you talk about the -- I believe kind of $9 million of net depreciation in the quarter? Obviously, no new nonaccruals, so that was positive. What would you ascribe as the breakout of mark-to-market versus credit-related in the marks this quarter?

Yes, it was almost all mark -- well, first of all, Greg, remember -- over half of it, $5 million, was just reclassing the YP that was in unrealized gains into the income statement. Right? So the real number is $4 million.

And of that $4 million, I would say the significant majority of that was just the market that moved down from March 31 to June 30 and impacted some marks. And I really would say there was really no material idiosyncratic credit-driven net impact there.

Great, thank you. And then could you talk about one bigger picture and then kind of a smaller picture -- your ability to maintain the yields in the portfolio on the pro forma adjusted? You had 10.7% yield last quarter; 10.7% yield this quarter.

Can you just talk about what you are seeing in terms of yield compression? And then, also, to define that a little more, the Q2 originations were at 10.1% yield, and the sales and repayments were 10.8%. So also struggling a little bit with how to connect the 10.7% last quarter to staying at 10.7% this quarter. So big picture and then smaller picture.

Yes, it's sort of smaller picture. That is just the modest delta between the 10.1% and the 10.8% and the modest ins and outs. So if you rounded it to two decimals, you would obviously see some slight decline. But at one decimal, it is just -- it's not enough, right, the 70 bps differential on 10% portfolio churn. It is just not enough to move it at one decimal place.

Got it.

On the macro, look, that is obviously an important strategy and challenge for us. I think we were getting more worried right until things moved our way in the back half of the second quarter. We have seen this movie three or four times now over the last couple of years, where spread seem to compress and then something happens in the world.

So we are currently -- and you can see it initially in our early originations for this quarter. But just looking at our pipeline, we think we have reasonable comfort at this point that without changing our risk profile, we can maintain those yields. And that is obviously our -- after making sure we have no issues on the credit side, that is our second biggest challenge.

Thank you, guys.

You are welcome. Thank you.

J.T. Rogers, Janney Capital Markets.

First one -- just wondering what you guys are seeing in terms of private equity sponsored activity on the new M&A front. I had some commentary from some of your competitors that that is increasing. And then maybe also willingness of business owners to sell, given the current environment in the middle market.

Yes. I would say we also have very good insight into that through both our own activity, but also through the activity of our P/E business, that we are seeing significantly increased activity and would expect a pretty busy post-Labor Day period through the end of the year. I don't know, Steve, if you want to add anything to that.

Well, for New Mountain itself on private equity, our new acquisition flow is actually very, very good. But I think it's important -- I think it is true of New Mountain Finance as well -- the important thing for an organization is to build its own team up enough that it can deliver whatever the market conditions are.

So I think New Mountain's deal flow is better in private equity because our team has gotten bigger and stronger as the years have gone on, and we're trying to do the exact same thing at New Mountain Finance, to outweigh any kind of market currents with just a stronger team. So I think we feel good on both fronts.

Yes. So to you other point, in terms of sellers' willingness to transact -- look, I think that that has increased, and there are a number of reasons for that. But I think the net effect is you are seeing -- and the other part is valuations are not low. So sellers are not giving their businesses away, by any means. But I do think -- people have -- it took some period of time for people to accustom themselves to this new post-2007 environment that we're in.

But I think, you know, five years later, I think enough time has passed that people's valuation expectations are more consistent with reality. And so I do think that is part of the driver of the increased flow.

Steve, you mentioned building the team. I'm just wondering, how many folks have you guys added at the NMFC level? And are you looking to expand further?

Yes, we have added at all parts of the firm, and all parts of the firm support NMFC. As Rob explains, we use the core team as the underwriting.

So we've gone actually from around 28 investment professionals back in 2007 when we launched private equity Fund 3 -- we now have over 50, including about 20 people who were former corporate COs, or COOs, or management consultants. We built up the specialists on the New Mountain Finance team in parallel to that. And so we just keep trying to continuously improve ourselves as an organization, and it works, we think, for all parts of the organization, including NMFC.

Great. And one last question. I was just wondering, is there any place in the capital structure that you find is offering the best risk return right now? Is it unitranche, mezzanine, first-lien loans, second-lien loans?

I wouldn't say there is any specific outliers. Sometimes in the past we have said that we were seeing particularly compelling value in first-lien; other times in more junior portions. I think it is roughly in balance. So it's more about finding the right businesses and then is there or is there not an opportunity somewhere in the capital structure to attractively deploy capital. But no, there is no obvious dislocation at this point in time, in our judgment, in any particular layer of the capital structure.

Okay, great. Thanks for taking my questions.

(Operator Instructions). Jon Bock, Wells Fargo Securities.

Rob, one question for you as it relates to -- the price is one willing to pay for a certain leverage level. Can you give us a sense of your comfort level in terms of all-in leverage for a deal, whether it is 5, or 6.1, or 6.5 times? And what you believe to be the appropriate rate as leverage continually creeps up for very strong, and acyclical, and very healthy companies that you target.

Yes, that is a good question. Jon, well, we obviously are looking at absolute leverage multiples. I think we start by looking at enterprise value relative to leverage multiples. So I always say, I'd rather be 6 times levered on an 11 times business than 4.5 times levered on a 5 times business.

And that obviously means you have to have a high degree of confidence in your judgments around that denominator, because that's a critical component, right? If you think it is 11 but it's really worth 7, you're going to find yourself in a bad place. And so that is where I think the private equity DNA and team is so critical in helping us make those judgments and really making those judgments.

So that being said, obviously, as absolute leverage creeps up you do have to look at coverage ratios and make sure that companies are appropriately hedging themselves from an interest rate perspective. And you obviously will want to charge more for any given level of leverage for the same company. I can't sit here and give you a hard and fast rule about -- you know, 5 times leverage equals X% and 6 times leverage equals Y%. It really is going to be situation-specific.

And we also look not just at, obviously, the last dollar of leverage, but the average dollar of leverage. There's a difference between being a thin 5 to 6 slice of mezz than there is being a 2 to 6 thick second-lien, or something like that. So we have to take that into account as well.

All I can say is we are quite comfortable, and I think certainly the margin -- we could be getting more yield if we wanted to, but we are focused first and foremost on what we call zero-loss underwriting, where we are not taking a portfolio approach, assuming some percent are going to go bad. We are really -- each and every one of the investments we make we believe has, in our minds, an obvious path to full repayment.

Obviously, at some point we are going to make a mistake or two, but we are focused on keeping our yield consistent with a minimal amount of risk. And I still think we are able to pull that off, despite the modest creeping we have seen in leverage multiples, like you say, in the highest-quality businesses.

Appreciate that. And let's say the current environment remains the same and perhaps gets tighter, assuming the Fed, etc. -- I mean, there's a lot of big assumptions in that, but let's just assume that is the case. What would you say portfolio velocity, or more importantly, repayment activity looks like in the event the status quo in the current market remains the same?

I think we have always guided towards roughly a third of the portfolio churning in an environment like you described. I think that's still our expectation. Maybe if it gets even tighter from here, you will see that move up to 35% or 40%. So that is how we are running the business against, and I think the data validates that, as well as just our insight into looking ahead from what we know about processes towards the -- for the next two or three months where we do have visibility.

And that is really how we manage the business. And we always talk about -- we always first and foremost make sure that we have enough quality originations to replace our churn, which is significant. And then and only then do we think about raising incremental capital to fund incremental deal flow.

Appreciate that. And then lastly, as we look at maybe a few newer transactions that were perhaps done at relatively attractive yields, just perhaps interested in the 17% rate that one is getting on preferred shares in Black Elk, which we find very attractive in this environment. Maybe what are some of the unique items that are part of that investment that allows you to earn such a substantial risk-adjusted return relative to, perhaps, the markets today, which are closer to 10% to 12%?

Yes, I think one of the items to note there is it's a bit of a short-term security. So it's not -- we expect this to get taken out in the first half of next year. So we were able, I think, for that type of callability for this type of junior security, we were able to charge a near-term rate. So it's not quite as attractive, sadly, as it appears. I would like to be getting 17% for the next three or four years, but that is not the case.

And then secondly, there was a timing element where we were -- there was a reason why the issuer and needed to move quickly, and we were able to do that, given some relationships and knowledge that we had, and get paid for that. And thirdly, I think the fact that it is back to preferred as opposed to debt -- I think you always get paid extra for that, because there's just lots of other natural buyers who don't have a bucket for preferred.

And last question, I understand YP -- congrats; that was an excellent investment. And so as one participated in the refinance, which is also part of a very large dividend recap, what percentage of new investments today were recap -- dividend recapitalization?

Just for the quarter?

Yes, from about the $150 million in originations that you made, maybe ballpark? How many of those transactions were involved in dividend recapitalizations?

I would tell you the exact number is going to be about 30%.

Okay, great. Congratulations on a good quarter. Thank you.

Great. Thanks.

And this concludes our question-and-answer session. I would like to turn the conference back over to our leaders for any final remarks.

Okay. Thanks, everyone, for your time, and your interest, and your support. We appreciate it and look forward to speaking next quarter. And of course, in the interim, always happy to take calls at any point in time. So thanks again and enjoy the day. Bye-bye.

The conference is now concluded, and we thank you all for attending today's presentation. You may now disconnect and have a wonderful day.