Saratoga Investment Corp (SAR) 2021 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to Saratoga Investment Corp.'s Fiscal Fourth Quarter and Fiscal Year 2021 Financial Results Conference Call. Please note that today's call is being recorded. (Operator Instructions)

At this time, I would like to turn the call over to Saratoga Investment Corp.'s Chief Financial and Compliance Officer, Mr. Henri Steenkamp. Sir, please go ahead.

Thank you. I would like to welcome everyone to Saratoga Investment Corp.'s Fiscal Fourth Quarter and Fiscal Year 2021 Earnings Conference Call.

Today's conference call includes forward-looking statements and projections. We ask you to refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these forward-looking statements and projections. We do not undertake to update our forward-looking statements unless required to do so by law.

Today, we will be referencing a presentation during our call. You can find our fiscal fourth quarter and fiscal year 2021 shareholder presentation in the Events and Presentations section of our Investor Relations website. A link to our IR page is in the earnings press release distributed last night. A replay of this conference call will also be available from 4:00 p.m. today through May 13. Please refer to our earnings press release for details.

I would now like to turn the call over to our Chairman and Chief Executive Officer, Christian Oberbeck, who will be making a few introductory remarks.

Thank you, Henri, and welcome, everyone. Our fiscal 2021 results reflect a full 12 months of unprecedented times during which our company and our industry proved resilient as we and our portfolio companies successfully manage through these challenges. Looking ahead, we have confidence that our conservative approach to investing, strong capital structure and levels of liquidity, organization and management experience position and entry experience positions us to effectively capitalize on potential future opportunities and navigate through the inevitable future challenges.

We look forward to presenting our most recent quarterly and full year results and reviewing our solid capitalization and continued improvement in liquidity on today's call. Our annual performance metrics for fiscal 2021 include full year return on equity of 5%, including the full year impact of COVID and adjusted NII per share of $2.02 and last 12-month NAV per share growth of $0.12 or 0.4%. And one of only a handful of BDCs to grow this metric over this period. Our year-end NAV per share of $27.25 represents our highest level yet.

To briefly recap the highlights of the past quarter and year on Slide 2. First, we continue to strengthen our financial foundation this quarter by maintaining a high level of investment credit quality with 93% of our loan investments, continuing to have our highest rating at year-end, generating a return on equity of 5% on a trailing 12-month basis, significantly ahead of the BDC industry mean of 0.4%. And as of year-end, registering a gross unlevered IRR of 13% on our total unrealized portfolio, with our current fair value, 1% above our total cost of our portfolio and a gross unlevered IRR of 16.5% on total realizations to date of $561 million.

Second, our assets under management increased slightly this quarter to $554 million, a 1% increase relative to Q3, including the impact of the refinancing of the CLO at quarter end, which included an upsizing of the CLO from $500 million to $650 million and extending the reinvestment period by a further 3 years. For the year, our AUM is up 14% from $487 million as of last year-end. With $130 million of repayments this year, we again demonstrated the ability of our origination platform to keep pace with ongoing redemptions, with $202 million of new investments originated during fiscal 2021. We continued to originate both new investments and follow-ons throughout the year despite the many market challenges, which has been a great differentiator for us. Mike will discuss this more in detail later.

Third, despite improving economic conditions, balance sheet strength, liquidity and NAV preservation remain paramount for us. Our capital structure remains strong with $304 million of mark-to-market equity at year-end, supporting $123 million of long-term covenant free non-SBIC debt. This translates into regulatory leverage of 347% with substantial cushion over our 150% requirement. Our liquidity and credit facilities of $216 million at year-end are available to support our portfolio companies with $141 million of the total dedicated to new opportunities in our SBIC II Fund. The all-in cost of this new SBIC II debt is currently approximately 2%. Total committed undrawn lending commitments outstanding, the existing portfolio companies, are just $13 million. Subsequent to year-end, we issued a $50 million 4.375% 5-year unsecured bond that strengthens both our capital and liquidity position and also importantly, reduces our current cost of non-SBIC capital by almost 200 basis points.

Finally, reflecting on our improved liquidity and overall portfolio resiliency, the Board of Directors decided to again increase our quarterly dividend by $0.01 to $0.43 per share for the quarter ended February 28, 2021, paid on April 22, 2021. We will continue to evaluate our dividend payments on at least a quarterly basis as we gain better visibility on the intermediate term economy and fundamental portfolio performance. This quarter saw a continued solid performance within our key performance indicators as compared to the quarter ended November 30, 2020. Our adjusted NII is $5.8 million this quarter, up 5% versus $5.5 million last quarter. Our adjusted NII per share is $0.52 this quarter, up from 50% -- $0.5 last quarter. Latest 12 months return on equity is 5% this quarter, down from 11% last quarter. Our NAV per share is $27.25, up 2% from $26.84 last quarter. Henri will provide more detail later.

As you can see on Slide 3, AUM has steadily risen since we took over management of BDC more than 10 years ago, and the quality of our credits continue to remain high. We are working diligently to continue this trend as we deploy our available capital, while at the same time being appropriately cautious in this evolving credit environment.

With that, I would like to now turn the call back over to Henri to review our financial results as well as the composition and performance of our portfolio.

Thank you, Chris. Slide 4 highlights our key performance metrics for the quarter ended February 28, 2021. When adjusting for the incentive fee accrual on net capital gains, adjusted NII of $5.8 million was up 5% from $5.5 million last quarter and down 15% from $6.8 million as compared to last year's Q4. Adjusted NII per share was $0.52, up $0.02 from $0.50 per share last quarter and down $0.09 from $0.61 per share last year. Across the 3 quarters, weighted average common shares outstanding remain largely unchanged for each quarter.

The sequential quarterly increase in adjusted NII per share is primarily due to the full period impact of last quarter's originations and a growing AUM base. The year-over-year decrease is primarily due to last year's fourth quarter, including $4.4 million of nonrecurring advisory fee income and prepayment premiums related to the Easy Ice realization and the weighted average current coupon on non-CLO BDC investments decreasing to 9.6% this quarter from 9.8% last year. Both of these were partially offset by an investment base that has grown by 14.1% since last year. Adjusted NII yield was 7.7% when adjusted for the incentive fee accrual. This yield is up from 7.4% last quarter, but down from 9.3% last year due to the reasons noted above.

For this fourth quarter, we experienced a net gain on investments of $5.1 million or $0.46 per weighted average share and a realized loss on extinguishment of debt of $0.1 million or $0.01 per weighted average share, resulting in a total increase in net assets from operations of $9.3 million or $0.83 per share. The $5.1 million net gain on investments was primarily comprised of $14.3 million in net unrealized appreciation on investments, offset by $8.7 million in net realized loss. The $8.7 million net realized loss primarily relates to the sale of the company's Elyria equity investment. The last remaining investment that dates back to before Saratoga took over management of the BDC in 2010.

The $14.3 million net unrealized depreciation primarily reflects: one, the $8.7 million reversal of previously recognized depreciation following the realization of Elyria; and two, a 1% increase in the total value of the remaining portfolio, primarily related to improvements in market spreads, EBITDA multiples and/or revised portfolio company performance. Therefore, all but $1.4 million or 95% of the net reduction in the value of the non-CLO portfolio in the first quarter has been reversed since May 31, 2020. The $0.1 million loss in extinguishment relates to the repayment of $26 million of SBA debentures in our first SBIC license. This is reflected in its own line item in the statement of operations.

As this quarter is also year-end, we also highlight the key performance metrics for the year ended February 28 on Slide 5. When adjusting for the incentive fee accrual on net capital gains, adjusted NII of $22.6 million was down 3% from $23.2 million last year. Adjusted NII per share was $2.02 per share, down $0.47 from $2.49 last year. The decrease in adjusted NII per share is largely a result of a 20% year-on-year increase in weighted average shares outstanding and the nonrecurring Easy Ice impacts noted above, partially offset by AUM up 14% year-over-year. Adjusted NII yield was 7.6% when adjusted for the incentive fee accrual, down from 9.9% last year.

For the full year, we experienced a net realized and unrealized loss on investments of $8.2 million or $0.73 per weighted average share, resulting in a total increase in net assets from operations of $14.8 million or $1.32 per share. The $8.2 million net loss on investments was primarily comprised of the same $8.7 million Elyria realized loss and $3.9 million of income tax provision on realized gains on investments paid in Q3. This was offset by $5 million in net unrealized appreciation on investments. Return on equity, which includes both realized and unrealized gains, remains an important performance indicator for us. Our return on equity was 5.0% for the last 12 months, well above the BDC industry average of 0.4%.

Quickly touching on expenses for the year. Total expenses, excluding interest and debt financing expenses, base and incentive management fees and income tax and excise tax expense increased to $6.3 million this year from $5.7 million in the same period last year, but remained unchanged as 1.1% of average total assets. And we have also added the historical KPIs in Slides 28 through 31 in the Appendix at the end of the presentation that shows our income statement and balance sheet metrics for the past 14 quarters and the upward trends we have maintained. Of particular note is Slide 31, highlighting how our net interest margin run rate has quadrupled since Saratoga took over management of the BDC and also increased by 14% just this past year.

Moving on to Slide 6. NAV was $304.2 million as of year-end, basically unchanged from last year. Looking at just Q4, NAV was up $4.3 million or 1.4%. NAV per share was $27.25 at year-end, up 1.5% from $26.84 as of last quarter and up 0.4% from $27.13 as of 12 months ago. NAV per share has increased in all but 2 of the last 14 quarters, and we remain one of the few BDCs to have grown NAV per share in the past year. In fiscal 2021, NAV also includes $2.4 million of stock dividend distributions made through the company's dividend reinvestment plan, offset by $3.6 million in repurchases of common stock. During Q4, 50,000 shares were repurchased at a cost of $1.1 million at an average price of $22.88 per share.

On Slide 7, you will see a simple reconciliation of the major changes in NII and NAV per share on a sequential quarterly basis. Starting at the top, the $0.02 increase to adjusted NII per share of $0.52 as compared to last quarter was primarily due to a $0.07 increase in non-CLO net interest income, offset by a $0.06 increase in base management fees and operating expenses.

Moving on to the lower half of the slide. This slide reconciles the $0.41 NAV per share increase for the quarter. The $0.38 generated by our NII in Q4, and the $0.50 net realized and unrealized gains on investments were partially offset by the $0.05 net change on deferred taxes and unrealized appreciation on investments, $0.01 realized loss on extinguishment of debt, $0.42 dividend declared for Q3 with a Q4 record date and $0.01 accretive net impact of our ATM and DRIP programs in Q4.

Slide 8 has the same reconciliation, but this time for the full year. Starting at the top, NII per share decreased $0.47 from $2.49 per share last year to $2.02 per share this year. The significant changes were a $0.33 increase in non-CLO net interest income, offset by a $0.30 decrease in other income, primarily due to the Easy Ice fees previously noted, a $0.07 reduction from an increase in base management fees due to increased AUM and a $0.41 dilution due to the 20% increase in shares from the ATM and DRIP programs.

The lower half of the slide reconciles the $0.12 NAV per share increase for the year. The $2.07 generated by our fiscal NII and $0.02 accretive impact of our ATM and DRIP programs for the year were partially offset by $0.33 net realized losses and unrealized depreciation, the $1.23 dividend declared for FY '21, $0.35 for income tax provision from realized gains and a $0.01 realized loss on extinguishment of debt.

Slide 9 outlines the dry powder available to us as of year-end, which totals $215.9 million. This consists of our available cash, undrawn SBA debentures and undrawn Madison facility. This year-end level of available liquidity allows us to grow our assets by an additional 39% without the need for external financing, with $30 million of it being cash and that's fully accretive to NII when deployed and $141 million in SBA debentures with an all-in cost of under 2%, also very accretive.

In addition, on March 10, 2021, we closed a public offering of $50 million 4.375% notes due 2026, resulting in net proceeds of approximately $48.8 million. This liquidity is accretive to the year-end Saratoga investment available liquidity on this slide.

We remain pleased with our liquidity and leverage position, especially taking into account the overall conservative nature of our balance sheet and the fact that all our debt is long-term in nature with no non-SBIC debt maturing within the next 4 years and mostly fixed rate.

Now we'd like to move on to Slides 10 through 13 and quickly review the composition and yield of our investment portfolio. Starting with Slide 10. Our $554 million of assets are invested in 40 portfolio companies and one CLO fund, and 80% of our investments are in first lien, of which 8% of that is in first lien last-out positions.

On Slide 11, you can see how the yield on our core BDC assets, excluding our CLO, remains just above 9% as short-term LIBOR continued to decline this year and as of year-end. Our overall yield decreased 30 basis points to 9.1% from 9.4% last quarter. But with LIBOR already below floors, this was mainly because of the increase in our overall portfolio fair value back to above cost. This is demonstrated by our core asset yields increasing slightly to 9.6% from 9.5% last quarter. As a reminder, 100 basis points is generally our lowest floor, so we do not expect to see further decreases in LIBOR greatly impact interest income. Our CLO yield of 11.6% is similar to last quarter, and our CLO is current and performing.

Turning to Slide 12. Our investments remain highly diversified by type as well as in terms of geography. During the past quarter, we made investments of $80 million in 2 new portfolio companies and 11 follow-ons and had $79 million in 5 exits plus amortization, resulting in a net increase in investments of $0.9 million for the quarter.

On Slide 13, you can see the industry breadth and diversity that our portfolio represents. Our investments are spread over 31 distinct industries with a large focus on education software, IT services and education and health care services. In addition, our total investment in the CLO is reflected as structured finance securities on this slide. Of our total investment portfolio, 6.7% consists of equity interest, which remain an important part of our overall investment strategy.

For the past 9 fiscal years and as demonstrated on Slide 14, we had a combined $59.6 million of net realized gains on investments originated by the Saratoga team from the sale of equity interest or sale or early redemption of other investments. Over 2/3 of these gains were fully accretive to NAV due to the unused capital loss carryforwards that were carried over from when Saratoga took over management of the BDC. Following the realization of our legacy Elyria position, this creates new capital loss carryforwards that future capital gains will be offset by. This overall consistent performance highlights our portfolio credit quality has helped grow our NAV and is reflected in our healthy long-term ROE.

That concludes my financial and portfolio review. I will now turn the call over to Michael Grisius, our President and Chief Investment Officer, for an overview of the investment market.

Thank you, Henri. I'll take a couple of minutes to describe the current state of the market as we see it and then comment on our current portfolio performance and investment strategy. Market conditions continue to be affected by COVID-19, but mainly in certain pockets and to a far lesser extent than earlier in the crisis. Liquidity conditions remain exceptionally robust. We are seeing rebounding and even increasing transaction volumes, tightening credit yields and greater leverage multiples back to pre-COVID levels and a willingness to accept greater risk.

Earlier in the crisis, deals were mostly limited to existing portfolio companies, either pursuing growth initiatives or seeking liquidity. This started to change in Q2 of last year and has accelerated since then. Significant competition for quality deals is helping widen leverage and tighten pricing even back to pre-COVID levels. Calendar Q1 was quite robust, and there appears to be a positive outlook for calendar year 2021. Lenders in our market are, for the most part, staying disciplined with covenants and requiring deals to have a healthy equity capitalization. Our underwriting bar remains high as usual, yet we are actively seeking and finding opportunities to deploy capital. We believe that compelling risk-adjusted returns can be achieved by deploying capital in support of businesses that have demonstrated strength and durability throughout the Covid environment.

Follow-on investments with existing borrowers with strong business models and balance sheets continue to be an important avenue of capital deployment, as demonstrated with 11 follow-ons this past quarter. Most notably, we have invested in 12 new platform investments since the onset of the pandemic, including 2 in this past calendar quarter. Portfolio management continues to be critically important, and we remain actively engaged with our portfolio companies.

We have found that they have generally taken the right steps to help mitigate both the near and long-term effect of COVID-19 on their businesses. As we've mentioned before, many of them were also able to avail themselves of the Paycheck Protection Program, or PPP, loan relief. All of our loans in our portfolio are paying according to their payment terms, including Roscoe that returned to accrual this quarter. Taco Mac and My Alarm are the 2 investments that remain on nonaccrual. There have been no new nonaccruals prior to and through COVID.

We also recognized an additional $5.6 million in unrealized appreciation this quarter, which means that our overall portfolio has recovered over 95% of the unrealized depreciation in Q1, and the fair value of Saratoga's assets has recovered to 1% over its cost basis. Now we believe this strong performance reflects certain attributes of our portfolio that bolster its overall durability. 80% of our portfolio is in first lien debt and generally supported by strong enterprise values in industries that have historically performed well in stressed situations.

We have no direct energy or commodities exposure. In addition, the majority of our portfolio is comprised of businesses that produce a high degree of recurring revenue and have historically demonstrated strong revenue retention. There remains potential future adverse effects of COVID-19 on the market conditions and the overall economy, including, but not limited to, the related declines in market multiples, increases in underlying market credit spreads and company-specific negative impacts on operating performance and could lead to unrealized and potentially realized depreciation being recognized in our portfolio in the future.

Now despite this lack of clarity, we continue to believe that our well-constructed capital structure and liquidity will help us to navigate beyond the challenges presented by COVID-19 and the broader macro environment. Our approach has always been to stick to our strategy and focus on the quality of our underwriting. And as you can see on Slide 15, this approach has resulted in our portfolio performance being at the top of the BDC list that has only 7 BDCs with a positive net realized gain as a percentage of portfolio cost over the past 3 years.

A strong underwriting culture remains paramount at Saratoga. We approach each investment working directly with management and ownership to thoroughly assess the long-term strength of the company and its business model. We endeavor to appear as deeply as possible into a business in order to understand accurately its underlying strengths and characteristics. We always have sought durable businesses and invested capital with the objective of producing the best risk-adjusted accretive returns for our shareholders over the long term. Our internal credit quality rating reflects the impact of COVID and shows 93% of our portfolio at our highest rating as of year-end.

Now looking at Slide 16. Total leverage for the overall portfolio for investments underwritten using EBITDA was 3.63x, down from 4.03x in the previous quarter, reflecting strengthened portfolio company capitalization and the lower leverage of certain new deals. Our leverage is also below the average year-to-date market leverage multiples, which are above 5x across our industry. Through past volatility, we have been able to maintain a relatively modest risk profile throughout, although we never consider leverage in isolation, rather focusing on investing in credits with attractive risk-return profiles and exceptionally strong business models where we are confident the enterprise value of the business will sustainably exceed the last dollar of our investment.

In addition, this slide illustrates our strengthening ability to generate new investments over the long term, even in the midst of the difficult market dynamics. During the calendar year 2020, we added 11 new portfolio companies and made 26 follow on investments, including 8 follow-ons that supported portfolio companies' liquidity during COVID-19. We also added 2 platforms and 5 follow-on investments in the first calendar quarter of 2021. That we were able to accomplish this in the face of COVID challenges underscores the ongoing emphasis on broadening our origination capabilities.

Now, subsequent to fiscal year end, including investments that are either closed today or will be closing in the next couple of days, we have executed approximately $90 million of new originations in 3 new portfolio companies, and 6 existing portfolio companies, and also had 1 repayment of approximately $14 million, for net new investments originated of approximately $76 million.

Moving onto slide 17, our team's skill set, experience, and relationships continue to mature, and our significant focus on business development has led to new strategic relationships that have become sources of new deals. Our number of deals sourced has dropped, reflecting the difficult sourcing environment during much of last year, although we are beginning to see a more active deal pipeline in this year.

The 52 term sheets issued during the last 12 months is also markedly up from last year's pace. What is especially pleasing to us is that almost 1/5 of our term sheets issued over the past 12 months, and 4 of our 10 new portfolio company investments are from newly formed relationships, reflecting notable progress as we expand our business development efforts.

There are a number of factors that give us measured confidence that we can continue to grow our AUM steadily in this environment as well as over the long term. First, we continue to grow our reach into the marketplace as is evidenced by several investments we have recently made with newly formed relationships. Second, we have developed numerous deep, long-term relationships with active and established firms that look to us as their preferred source of financing. Third, we continue to see plenty of investment opportunities in industry segments that are experiencing long-term secular growth trends, and within which we have intentionally developed expertise.

As you can see on slide 18, our overall track record is very strong on almost $1.1 billion of originations. On the chart on the right, you can see the total gross unlevered IRR on our $514 million of combined weighted SBIC and BDC unrealized investments is 13% since Saratoga took over management. The 2 largest unrealized appreciations remaining due to COVID are in our Nolan Group and C2 Education investments, both of which are more dependent on in-person human interaction.

We do not believe the remaining unrealized appreciation changes our view of their fundamental long-term performance. Even with those current markdowns, our overall portfolio fair value is now 1% above its total cost. Our investment approach has yielded exceptional realized returns. Our gross unlevered IRR on realized investments is 16.5% on approximately $561 million of realizations.

Subsequent to year end, we also had some developments on our My Alarm Center investment, which had a remaining fair value of $181,000. The senior debt burden of the company, plus the cost of acquiring and retaining new customers resulted in significant pressure on cash flow and liquidity. As a result, a new senior lender took a majority position in the credit and has accelerated its debt through a recent prepackaged Chapter 11 filing. With the equity sponsor choosing not to infuse additional capital into the business at this time, there is very little prospect for recovery of the junior capital.

Moving onto slide 19, you can see our first SBIC license is fully funded, with $208 million invested as of year end. We have started paying down some of our SBIC I debentures using repayment proceeds, with $26 million repaid in Q4. Repayments of debentures occur on a semi-annual basis.

Our second SBIC license has already been funded with $69 million of equity, of which $107 million of equity and SBA debentures have been deployed. There are still $3.4 million of cash, and $104 million of debentures currently available against that equity. We still have $18.5 million of unfunded equity, which when dropped down into the SBIC would increase our debenture availability by $37 million.

Looking back over the whole year, the way the portfolio has proven itself to be well constructed and resilient against the impact of COVID-19 really came to the fore, demonstrating the strength of our team, platform, and portfolio, and our overall underwriting and due diligence procedures. Credit quality is always our primary focus. And while the world has changed significantly this year, we remain intensely focused on preserving asset value, and remain confident in our team and the future for Saratoga Investment.

This concludes my review of the market and our portfolio. And I'd like to turn the call back over to our CEO. Chris.

Thank you, Mike. As outlined on Slide 20, following recent capital raises and the current performance of our portfolio, the Board of Directors declared a $0.43 per share dividend for the quarter ended February 28, 2021. This reflected a $0.01 increase from last quarter, the third sequential quarterly dividend increase. The Board of Directors will continue to reassess this on at least a quarterly basis, considering both company-specific and economic factors.

Moving onto slide 21. Our total return for the last 12 months, which includes both capital appreciation and dividends, has generated total returns of 153%, outpacing the BDC Index of 121%.

Our longer term performance is outlined on Slide 22, our next slide. Our 5 year return places us near the top of all BDCs, with both the 5-, 3-, and 1-year returns easily beating the BDC industry averages. Over the past 3 years, our 62% return outperformed the 34% return of the index. And over the past 5 years, our 148% return greatly exceeded the index's 59%.

On Slide 23 you can further see our outperformance placed in the context of the broader industry, and specific to certain key performance metrics. We continue to achieve high marks and outperform the industry across diverse categories, including interest yield on the portfolio, latest 12 months return on equity, and latest 12 months net asset value per share growth.

Notably, our latest 12 months return on equity and NAV per share outperformance reflects the growing value our shareholders have been consistently receiving. First, not only are we one of the very few BDCs to have grown NAV, we have done it accretively by also growing NAV per share 12 of the last 14 quarters, and only 1 of 7 BDCs growing it in the past 12 months. And second, our 7 year average return on equity is now 11.4%, one of the highest in the industry.

Moving onto Slide 24, all of our initiatives, decisions, and achievements discussed today on this call are designed to make Saratoga Investment a highly competitive BDC that is attractive to the capital markets community. We believe that our differentiated characteristics outlined in this slide will help drive the size and quality of our investor base, including adding more institutions.

Our differentiating characteristics include: maintaining one of the highest levels of management ownership in the industry at 15%, access to low cost and long-term liquidity with which to support our portfolio and make accretive investments, receipt of our second SBIC license providing sub-2% cost liquidity, a BBB-plus investment grade rating that was recently upgraded, an active public and private baby bond issuances, solid historic earnings per share and NII yield, strong and industry-leading historic and long-term return on equity, accompanied by growing NAV and NAV per share putting us at the top of the industry for both, high quality expansion of AUM and an attractive risk profile.

In addition, our historically high credit quality portfolio contains minimal exposure to conventionally cyclical industries, including the oil and gas industry. We remain confident that our experienced management team, historically strong underwriting standards and tested investment strategy will serve us well in battling through the substantial challenges in this current environment, and that our balance sheet, capital structure and liquidity will benefit Saratoga's shareholders in the near and long term.

In closing, I would again like to thank all of our shareholders for their ongoing support, and I would like to now open the call for questions.

(Operator Instructions) Our first question comes from Bryce Rowe with Hovde Group.

Wanted to maybe start on pricing. Good to see stability from a yield on the debt portfolio. And so wanted to get a feel for what you've seen hear in the current quarter, Mike. You talked about the $90 million of activity subsequent to February, and then kind of what your expectations are from the CLO perspective? I know once those get reset, you kind of start with a lower yield into the portfolio, and then it could possibly build as we move through time.

Let me take that in 2 parts, and I'll let Henri address the CLO. But as it relates to the market in general, we're definitely seeing reflections of a lot of capital available to invest in private credit, and, as a consequence, yields have come in, I would say, to the point where yields are below even where we were seeing them pre-COVID.

But having said that, I'll remind you that where we operate at the lower end of the middle market, there are literally thousands of companies out there, good companies that we feel we'll continue to find very good opportunities to invest in those businesses at rates that are very accretive for our shareholders. Certainly the fact that our debt capital has come down, as well, is helpful to that end. But pricing certainly has come in a bit.

Bryce, and then on the CLO you're absolutely right. As the CLO gets closer to the end of its reinvestment period, the weighted average effective interest rate, which reflects the future cash flows that is now sort of shortening and you're seeing more clarity on the performance of the portfolio, the weighted average effective interest rate grows. So you would have seen in the last couple of quarters our weighted average effective interest rates being closer to 20%, 22%.

As you then reset it, and we've seen this each time, and obviously we haven't done a valuation yet for Q1 because the interest rate is an output of the valuation, but our expectation is that it will behave similarly to what it did last time. And last time, what it did was it probably went to about half or maybe just slightly better than that of what the weighted average effective interest rate was just before the repricing. That's on the interest side, and that's obviously 1 component of the income that the CLO generates.

But in addition to that, it also has the management fee that the BDC earns, and that management fee in the new CLO remains the same, 50 basis points on the AUM, but now instead of it being on 500 million, it'll obviously be on 650 million going forward, once we're fully ramped up. And so that will be additional income to the BDC on the larger size.

Okay. That's helpful, Henri. I wanted to maybe shift gears a little bit, and ask one more question of you. You guys ended the calendar year with undistributed taxable income. And so kind of -- and there was an excise tax in this quarter to account for that. Can you talk about kind of how you plan to manage that? I know in the past you've preferred to possibly not carry UTI. So just kind of curious how you're thinking about that now.

Well, I think on the actual way we are at the moment here, right, Bryce, as you probably saw in the 10-K, so we start this year now, which is March 1 for us, with spillover effectively taxable income related to last year of just under $8 million. As you know, our dividend on a quarterly basis, the last couple have been around between $4.5 million and $5 million. So this dividend that we just declared and then the next one, will take care of the spillover.

But in addition to that, obviously, we also, I think historically, actually have been more conservative in the way we've managed capital so that we hadn't had spillover in the past. This is now obviously a reflection of our earnings power that we've had as well as the fact from the dividends we paid last year. That means we have some spillover this year, but it should be taken care of by the next dividend.

Yes. And then -- this is Chris. Just to further in terms of how we look at it, I think we spent a lot of time last year in the height of the COVID crisis pointing out how much flexibility to spillover -- the absence of spillover gave us in terms of potential liquidity, should it have been needed. I think somebody mentioned, thankfully, this past year has turned out to be quite a good year, as opposed to what it looked like it could have been in the past. We did move into the spillover realm to the tune of $8 million, as Henri mentioned.

In terms of you asked specifically in managing it, it's not something that needs to be managed, if you will. There's nothing, the ordinary course will just take care of the spillover. The cost of the spillover of the excise taxes, I believe Henri, it's 4% on whatever that outstanding amount is. So the absolute cost of it viewed in the context of the totality of our liability cost structure on our balance sheet is not high.

So we're obviously looking at it, aware of it. We have a little less spillover flexibility than we had before, but we still have substantial spillover flexibility on top of it should that prove needed in the future. And as we -- depending on our earnings and dividends and the interplay between those 2 elements, that spillover, we would anticipate -- we wouldn't anticipate it growing much from here and then possibly shrinking.

Our next question comes from Mickey Schleien with Ladenburg.

Good morning. Just one question for Mike. You mentioned new relationships created last year, I wanted to ask that given that these are private funds, could you describe to us the due diligence that you do on new sponsors that you conduct before you decide to work with them?

Happy to. And thankfully, most of the groups that are sponsored private equity firms have undergone a lot of diligence to attract the capital from investors that are pretty sophisticated as well. But having said that, we're pretty deep in the marketplace and kind of know who most of the players are and continue to develop our network.

But when we get to meet a firm that we haven't done deals with in the past, the starting point is looking at the team, looking at their backgrounds. As long as we've been in the marketplace, we typically know people who know them, or we know people that were at their prior firms. And we may even know some of them, at least maybe one step removed, what have you. And so the starting point is always with the team and invariably, we're able to get a lot of very strong and -- very strong references on the experience that the people have had investing with those teams.

The second place that we go is just looking at their portfolio. What kind of deals are they doing, how are they capitalizing their deals, what's their reputation in dealing with lenders? It's a pretty robust process. And then the best way you get to know somebody -- we don't -- when we issue a term sheet, the deal is by no means done. The best way you really get to know somebody is to work with them directly. And what drives our decision making more so than anything is, is it a good business opportunity? Do we feel very good that our capital is in a good position and that the businesses has all the durable characteristics that we always talk about? And the combination of that factor plus the work that we do to get comfortable with the sponsor is how we get there.

Mike, you just mentioned behavior with lenders and I'd probably put that in top 3, right, in terms of gauging your interest in working with a sponsor. Do you look at that just anecdotally? Or do they provide you information on troubled deals and how they worked out in the past?

It tends to be more anecdotally, candidly. And it's also the kind of thing where if a sponsor develops a bad reputation, that word spreads pretty quickly. So when I say it's anecdotally, it's not without good background knowledge.

The thing I would remind you though that is important, certainly the relationships in the sponsors that we work with are very important. I wish our business were such that you could just find a sponsor and the minute a deal got into a little bit of trouble, they'd come to the rescue with a big equity check and so forth.

We don't do underwriting that way. So even if a sponsor is the very best private equity sponsor at the lower end of the middle market, and they like a deal a lot, we turn plenty of those down. So we tend to -- it's not to diminish the importance of the sponsor, it's a very important part of our underwriting. But we're not underwriting the sponsor and hoping that they're going to save the day if things go wrong.

We're always, when we're looking at an investment, saying, make the assumption that the sponsor's not there, and that if we're in a position where this business underperforms, what are our ways out? Where are we in the capital structure? How good do we feel about the durability of the business model? Is it going to face cyclical pressures? Do they produce a lot of free cash flow so that even if they underperform a little bit, they can continue to pay our loan and even pay it down over time? All of those elements come into play. But certainly, the sponsor and their relationship is one of them.

Our next question comes from Sarkis Sherbetchyan with B. Riley Securities.

Just wanted to touch a little bit on the PIK income side. It was up meaningfully this quarter. And just wondering if that jump was attributable to the Roscoe Medical investment returning to accrual?

Sarkis, this is Henri. Yes, absolutely. That was because we released the Roscoe reserve that what's PIK. We released back into income as it's gone back on accrual, actually last quarter already, our Q3 -- and so we released that reserve. That's really the jump. So if you take that out and you sort of look at PIK at a run rate as of Q4, it's under 2% from a total interest income perspective, that Roscoe just skews it.

Got you. And just to be clear, how much of that was one time in nature and how much did that continues?

Sure. The one time sort of release of the reserve was $941,000. And I think Roscoe on a quarterly basis, I would have to double check, but I believe it's around $45,000 a quarter.

I just wanted to verify the $0.9 million there. And then you talked about the sale on the Elyria position. You mentioned that there was a new capital loss that kind of comes with that. Any -- I guess, what's the level of the capital loss? And obviously, that helps you for the future. So just trying to understand what that level is.

Yes. So when we had the Easy Ice gain last year, so that's February 2020, that cleaned out our capital loss carry forwards we had, and then ended up in us having a realized gain on which we paid the federal income tax that you saw now in this year in Q3. So we sort of cleaned out our loss position, gain position back to 0. And then with Elyria now being sold in Q4, that realizes the full loss on Elyria that's been written down over many, many years. And so the total position we're in from the Elyria loss is $8.7 million, which is obviously a new capital loss carry forward that can be put against future realized gains.

And just one further point on Elyria is that investment predates our ownership and management of the BDC. That was one of our legacy positions.

Yes.

Speaker 2: I'm showing no further questions in queue at this time. I'd like to turn the call back to Chris Oberbeck for closing remarks.

Well, we'd like to thank everyone for joining us today, and we look forward to speaking with you next quarter.

This concludes today's conference call. Thank you for participating. You may now disconnect.