MidCap Financial Investment Corporation (MFIC) Q3 2016 Earnings Report, Transcript and Summary

Good morning and welcome to Apollo Investment Corporation’s Earnings Conference Call for the period ending December 31, 2015. At this time, all participants have been placed in listen-only mode. The call will be opened for a question-and-answer session following the speakers’ prepared remarks. [Operator Instructions] I will now turn the call over to Elizabeth Besen, Investor Relations Manager for Apollo Investment Corporation.

Thank you, operator and thank you everyone for joining us today. With me are Jim Zelter, Chief Executive Officer, Ted Goldthorpe, President and Chief Investment Officer; and Greg Hunt, Chief Financial Officer. I would like to advise everyone that today’s call and webcast are being recorded. Please note that they are the property of Apollo Investment Corporation and that any unauthorized broadcast in any form is strictly prohibited. Information about the audio replay of this call is available in our earnings press release. I would also like to call your attention to the customary Safe Harbor disclosure in our press release regarding forward-looking information. Today’s conference call and webcast may include forward-looking statements. Forward-looking statements involve risks and uncertainties, including but not limited to statements as to our future results, our business prospects and the prospects of our portfolio of companies. You should refer to our registration statement and shareholder reports for risks that apply to our business and that may adversely affect any forward-looking statements we make. We do not undertake to update our forward-looking statements or projections, unless required by law. To obtain copies of our SEC filings, please visit our website at www.apolloic.com. I would also like to remind everyone that we have posted a supplemental financial information package on our website, which contains information about the portfolio as well as the Company’s financial performance. At this time, I would like to turn the call over to Jim Zelter.

Thank you, Elizabeth and good morning to everyone on the call today. This morning we reported earnings for the quarter ended December 31, 2015 and filed our 10-Q. I will begin with some brief comments on the market conditions and describe how we are operating during this period of volatility. I will then provide a brief overview of our results for the quarter and discuss some additional business highlights. Next, Ted will discuss our investment activity for the quarter with the detailed discussion of our energy book and then Greg will discuss our financial results in greater detail. We will then open the call for questions. As you are all aware, the December quarter was a period of increased volatility. Global growth concerns, volatility in commodities including further weakening of oil prices, adjusting Fed expectations and growing credit concerns dominated market sentiment in the quarter. The leveraged finance markets were clearly impacted by the negative sentiments as spreads widened and yields rose. Regarding our oil and gas exposure, we continue to closely monitor our investments and work with our companies as they operate during this period of low prices. Ted will provide a detailed review of each of our core oil and gas investments. For the quarter, we reported net investment income of $0.21 per share which highlights higher dividend income offset by decline in fee and prepayment income. Net asset value declined 3.4% to $7.56 per share during the quarter, as we were negatively impacted by the dislocation in the credit markets. The decline in net asset value was driven by our oil and gas investments as well as unrealized appreciation due to spread widening. Oil and gas investments accounted for $0.15 of the NAV decline and quoted investments accounted for $0.14 of decline. And in addition, there was also a $0.04 per share accretive impact to NAV from stock buybacks partially offsetting this decline. During this period, we will be proactive with respect to potential restructurings or future funding requirements in our portfolio. In many instances, we are the lead lender and in position to drive outcomes that will maximize shareholder value. The challenging market environment did present us with what we believe as an attractive opportunity to repurchase our stock. As you saw in an earlier announcement in December, we announced the completion of an initial $50 million buyback program and our board authorized the second [Audio Gap] program. Greg will provide specific details in his remarks on our progress to-date. We are pleased to have unsuccessfully announced and also executed against this program. Turning our discussions to our dividend, the board approved a $0.20 dividend to shareholders of record as of March 21, 2016. With that, I will turn the call over to Ted.

Thank you, Jim. First, I will discuss our investment activity for the quarter and then I will provide an update on each of our core oil and gas positions. As Jim mentioned, the leverage credit markets clearly impacted by negative sentiment as high yield and leveraged loan spreads widened and yields rose. The middle-market, while not immune, is generally insulated from trends in the broadly syndicated market and typically reacts to the lag, the changes in liquid credit markets. Middle-market new issue activity declined dramatically. Nevertheless, we’ve seen spread widening as banks remain reticent to commit capital driving demand for private capital. We believe middle-market spreads continue to offer interesting risk adjusted returns. With this backdrop, our origination activity was somewhat muted. During the period, we invested $205 million in four new portfolio companies and 19 existing companies. Our weighted average yield on investments made was 11% and our origination activity focused on investing in existing portfolio companies which accounted for 79% of the investments made during the period. We continue to focus on secured debt opportunities, which accounted for 61% of the investments made during the period. During the period, we exited $262 million of investments of which 53% were proactive sales and the remaining balance was repayments. The yield on debt investment sold was 11.2% and the yield on debt repayments was 11.3%. During the quarter, we exited our investments in CIT Co., [ph] Vertafore and Caza Petroleum. Repayments for the quarter total of $122 million, which included the full repayment of Golden Hill, a middle market loan warehouse within our structured product portfolio. Moving to specific investment activity, as I mentioned, we focused on in the existing -- investing in existing portfolio companies during the period. Beginning with renewal energy, we have two primary investments; Solarplicity formerly known is AMP UK and Renewable Funding, also known as Golden Bear. Renewable energy accounted for 7.7% of the overall portfolio at the end of quarter and we expect renewable energy investments to generally be between 5% and 8% of the portfolio. Our investment approach in renewable energy has been to one, prioritize asset quality and counterparty risk with government backed payments or programs where the risk of capital loss is limited; and two, a focus on financing assets versus financing platforms. For the quarter, we invested $44.3 million in the sector. Moving to aircraft, Merx Aviation continues to pursue opportunities as well as manages existing portfolio including the monetization and refinancing of aircraft. During the quarter, we increased our debt investment in Merx Aviation by $30 million for bespoke financing arrangement with Delta Air Lines. In addition, Merx repaid approximately $9 million of equity during the period and also paid a $3 million dividend. At the end of December, aviation was 15.2% of the portfolio, up from 14.4% last quarter. Year-to-date, Merx returned $78 million of capital to Apollo Investment Corporation. Moving to oil and gas exposure, we’ve continue to work closely with the management teams of each of our investments. As we’ve said before, our portfolio is well-diversified by borrower geography. Our investments are generally structured with strong legal documents, which provide us with significant protections. We believe our marks reflect the underlying fundamentals of each borrower and the stress in the industry. Oil and gas represented 12.9% of our portfolio or $395 million at the end of December, down from 15% or $480 million at the end of September on a fair value basis. The decline was due to the repayment of our investment in Caza as well as fair value adjustments. Regarding Caza, the company completed a debt and equity restructuring, which included the full repayment of our investment. The exit of Caza is a good example of our ability to monetize in oil investment at attractive value during a difficult energy environment. We exited this investment at 11.5% IRR. We are extremely pleased with this outcome, particularly given the challenging market environment. At the end of December, our portfolio had eight core borrowers and 81% of it was in secured debt. I will now provide an update on each of the eight core borrowers. Beginning with Canacol, a Canadian E&P company located in Colombia, we have a $73 million unsecured investment marked at 97% of costs; the investment has a risk rating of two. Although, it is unsecured, the note has significant structural protections including limitations on the incurrence of debt. The company’s investments and assets are primarily gas related and benefit from higher pricing and long fixed contracts with local power plants. In addition, the company recently raised approximately $60 million to equity, representing 20% of the company’s market cap, which was in addition to already strong liquidity. Moving to Pelican Energy, an entity financing certain wells of Chesapeake Energy, we have $28 million first lien investment marked at 83% of cost. The risk rate of this investment remains 3. The company’s investments in assets are more tied to gas with approximately 68% of its assets dedicated to gas products. In order to preserve cash, the company is exercising its non-consent rights on most wells that are being drilled. Moving to Deep Gulf, an E&P company with wells located in the Gulf of Mexico with $50 million first lien investment marked at 91% of cost. This investment has a risk rating of 2. The company is backed by first reserves, strong sponsor exclusively focused on energy. During the period, the company successfully raised $75 million of new capital from other non-affiliates at $0.91 to the dollar, consistent with we are marked. The company has no liquidity issues for its foreseeable future. Moving to Extraction Oil & Gas, an E&P company with assets located in the core of the Wattenberg Field; we have $52 million of the second lien marked at cost. This investment has a risk rating of 2. The company has low breakeven oil prices of around $30 to $35 and recently raised a $100 million of preferred equity below our debt. The company has slowed drilling to preserve liquidity. Moving to Miller Energy, a gas E&P company with significant oil assets in Alaska’s Cook Inlet with $89 million second lien investment marked at 72% of costs. This investment has a risk rating of 4. As previously mentioned, the company filed for bankruptcy in early October and the investments are nonaccrual. The debt is most senior positioned in the capital structure and we expect the company will emerge from bankruptcy by the second calendar quarter. The company has significantly reduced its G&A, is conserving cash and deferring projects. The current plan of reorganization has its receiving a combination of debt and equity. Osage Exploration, an E&P company with assets in Oklahoma; we have $25 million of first lien investment marked at 18% of cost. The risk rating of this investment was downgraded from 4 to 5 and the investment was placed on non-accrual status during the quarter. Due to limited liquidity, the company filed for a negotiated bankruptcy on February 3rd and this is reflected in our valuation methodology. Spotted Hawk is an E&P company with the core Bakken assets. We have $84 million of first lien investment marked at 81% of cost. The risk rating on this investment was downgraded from 2 to 3. Despite being in the core of a good basin, having really good drilling results, taking steps to preserve cash, the company’s liquidity is constrained but we believe in the underlying asset value. And lastly, moving to Venoco, an E&P company with assets located primarily in southern California; as a reminder, last year we participated in a strategic exchange where we rolled our unsecured notes into second lien notes and invested additional capital in the first lien notes. We now have $41 million in first lien investments marked at 91% of costs and $46 million second lien marked at 55% of costs. The risk rating of the first lien was downgraded from 2 to 3 and the second lien was downgraded from 3 to 4 during the period. We would like to clarify a point of confusion in the marketplace around our second lien investment in Venoco. Our second lien investment has the same coupon and maturity as the company’s unsecured notes. However, some people have been confused in the two investments with respect to valuation. The unsecured notes are quoted while the second lien position we owned is not quoted and is valued by third party. To summarize of our eight core oil and gas positions, Miller and Osage have been valued on our restructuring or recovery basis and we anticipate the two investments Spotted Hawk and Venoco, they need additional capital or go through restructuring. We believe our marks reflect the underlying fundamentals and increased challenges faced by these four companies. We think our remaining four positions are covered given the factors I mentioned before. Now, moving to overall credit quality, the portfolio’s weighted average risk weighting on a cost basis increased to 2.4 at the end of December, up from 2.3 at the end of September and our fair value remained at 2.2 over the same period. Weighted average net leverage of our investments is 5.4 times and the weighted average interest coverage remained at 2.5 times. As mentioned, we placed our first lien investment of Osage on non-accrual status during the quarter and also placed our DIP loan in Magnetation on non-accrual status. At the end of December, investments in non-accrual represented 2.5% of the fair value of the portfolio and 6% on a cost basis, compared to 2.2% and 4.7% respectively at the end of September. With that I will now turn the call over to Greg who’ll discuss the financial performance for the quarter.

Thank you, Ted. Total investments income for the quarter was $94.3 million, down 4% quarter-on-quarter and down 14% year-over-year. The decline quarter-over-quarter is primarily attributable to lower prepayment income, a lower asset base and two investments being placed on non-accrual status, partially offset by higher dividend income. It was approximately $1 million of prepayment and fee income in the December quarter, compared to $7.4 million in the September quarter and $13.9 million in the year ago quarter, offsetting the decline with an increase in dividend income derived from our investments in aviation and shipping. Our quarterly run-rate for dividend should be approximately $10 million to $11 million. Expenses for the December quarter totaled $46.2 million, compared to $48.9 million last quarter and $53.4 million for the same period a year ago. The sequential decrease for the quarter was primarily a result of the decrease in interest expense associated with the repayment of $225 million of senior secured notes. On a year-over-year basis, the decline was primarily associated with lower management and incentive fee. As you recall, our investment advisory and management agreements include two waivers and offset for fees received from sign on. Inclusive of these waivers and offset, our effective base management fee was 1.54% and our effective incentive fee was 17.15% for the quarter. Regarding our funding sources, in addition to the prepayment of the senior notes, $200 million of convertible debt matured in January 2016. Both positions were refinanced using our revolver and as a result our effective weighted average interest cost has declined from 5.5% to 4.3%. On a year-over-year basis, annual interest expense will decline by approximately $17 million or $0.06 per share, per year of net investment income from both of these maturities. Net investment income was $48.1 million or $0.21 per share for the quarter. This compares to $49.6 million or $0.21 per share for the September quarter and $56.7 million or $0.24 per share for the year ago quarter. For the quarter, the net loss on the portfolio totaled to $73.9 million or $0.32 per share, compared to a net loss of $51 million or $0.22 per share for the September quarter and net loss of $76 million or $0.32 per share for the year ago quarter. The net loss of $73.9 million includes $9.3 million of realized losses; approximately $5.5 million of those realized losses were previously recognized as unrealized depreciation. Negative contributors to the performance for the quarter included our investments in Spotted Hawk, Osage, Magnetation, Aveta, Venoco and Garden Fresh. Positive contributors to the performance for the period included our investments in Fidji Luxco, Renewable Funding, Golden Bear, and Merx Aviation. In total, our quarterly operating results decreased net assets by $25.8 million or $0.11 per share, compared to a decrease of $1.8 million or $0.01 per share for the September quarter and a decrease of $19.5 million or $0.09 per quarter for the year ago quarter. On a liability side of our balance sheet, we had $1.4 billion of debt outstanding at the end of the quarter, essentially unchanged quarter-over-quarter. The Company’s net leverage ratio, which includes the impact of cash and unsettled transactions stood at 0.76 times at the end of December, up slightly from 0.73 times at the end of September. During the December quarter, we purchased an additional 5.2 million shares for $31.2 million. And since the beginning of January, we have purchased an additional 2 million shares for approximately $10 million. Since commencing our purchase program, we have repurchased $10.6 million shares or 4.5% of our shares outstanding for a total cost of $62 million. At the end of December, our portfolio had a fair value of $3.1 billion and consisted of 95 companies across 25 industries. Weighted average yield on the debt portfolio at cost was 11.4%, down 20 basis points quarter-over-quarter. The decrease in the overall yield was primarily due to the placement of two of our investments on non-accrual and the conversion of our investments in Solarplicity from preferred equity to secured debt during the period. This concludes our remarks. Operator, please open the call to questions.

The floor is now open for questions. [Operator Instructions] Your first question comes from Arren Cyganovich of D.A. Davidson.

Growth investment activity was relatively slow, I guess not overly surprising. But what are your thoughts in terms of the environment and being able to put, I guess the gross amount of investment activity? I know that on a net basis you expect to be kind of flattish but on the gross basis, what are you expecting in this environment?

Yes. So, the leveraged finance markets really began to get challenged in the fourth quarter of last year and that really slowed down activity levels, just overall sponsor activity. And we’ve seen that pick up a little bit in the first quarter. But in our own current situation, we weigh any new origination versus buying back stock. And so spreads have widened in the middle market quite materially and people are willing to pay up for certainty, particularly around things like the unit tranches and for sponsor activity. So, I think our activity levels are really focused in the core middle market sponsor business, by and large. And I would say also we’re really, really being prudent about new originations, as you’ve seen vis-à-vis holding liquidity and potentially buying back stock.

And then, could you give a little bit more detail as to what elevated the dividend income for the quarter? I am sorry; I missed the specifics on that. And what specifically was higher than your normal run-rate?

So, we have our Solarplicity investment, which was originally on preferred stock which they converted to senior debt; that was one piece; and also our investment in Golden Hill, our equity investment there which was repaid during the quarter, which was a structured product warehouse. Those are the two larger differences when you look at it quarter-on-quarter.

Your next question comes from Doug Mewhirter of SunTrust.

First question, I noticed that the publicly traded aircraft lessors have come under quite a bit of pressure, the whole market is down. But it seems like if you look at AerCap and Air Lease, they’ve really taken a hit. Is that just mostly sentiment or is there something internally in the aircraft leasing market which is maybe showing worse internals or worse fundamentals that -- I don’t follow that industry that closely to really know. What are you seeing from Merx’s perspective; are they playing defense or are they still finding opportunities?

I’d say the answer is a bit of both. I mean fundamentals still remain very strong. And if you look at December passenger data for example, it was very, very strong. So, I think you have not seen real weakness and the order book size vis-à-vis passenger demand actually are pretty matched. That being said, if you look at our activity levels at Merx, the portfolio really hasn’t grown much over the last 12 months. I think it’s a combination of we’re being a little bit more cautious about deploying capital in that business. And number two is we have seen certain instances where it’s been more competitive. And so, I don’t think you will see the amount of our Merx portfolio really go up or down that much. We continue to see kind of idiosyncratic opportunities. But when we go through all the fundamentals and we see what valuations are and we see kind of what we’re seeing in the business, we don’t really see real weakness. The other thing we’re obviously focused on is, again, we own the actual physical airplanes, so kind of theoretically you’re not taking country risk. So, I think there is big focus of the management team to really look at our lessors and really do real hard credit underwrites of our lessors particularly in jurisdictions and emerging market economies, which are more challenged. So, our lessors all pay us in U.S. dollars. So, we are not exposed to currency risk. But again, some of our lessors are in countries that -- or in the states in general, there is obviously lessors all over the world and so we’re trying to be more prudent about where we are actually leasing aircraft.

My second question, could you talk a little bit about Aveta? I know you actually took a markdown there. It looks like it’s still accruing though. Is this something you can get through relatively quickly; is it something structures have changed; is it deal with regulations that might be a more longer term problem?

So, if you take a step back, this is a quoted security, so it’s marked in line with the quote. They say managed care provider in Puerto Rico for various reasons the whole sector -- it’s not company specific sector related, underperforms. That being said, if you look in the fourth quarter, the company’s debt was actually upgraded and there is just a number of changes. So, I don’t think it’s something that’s going to turn around very quickly; it’s our own opinion here. With that being said, given it’s first dollar risk, the leverage level through our piece is at a level where we feel comfortable with. And I don’t feel like a turnaround is -- I don’t think -- we aren’t expecting a big fundamental turnaround overall anytime and any soon but we are not overly concerned vis-à-vis where we’re marked.

Your next question comes from Kyle Joseph with Jefferies.

I was hoping to get a little more -- thank you for all the color on both energy and aviation, but I was hoping to get a little more color on the portfolio performance outside of those industries. If you could talk about A, little bit on revenue and EBITDA growth trends; and then, if you could branch that into more of a discussion on your outlook for the broader macro-economic environment will be helpful.

So, I’ll answer the first part of that and then I’ll push it over to Jim for the second part of it. So, again, our companies outside of oil and gas, and aircraft are largely leveraged U.S. economy. And a lot of the headwinds that are being faced by the stock markets more than everything else in terms of China and currency risk and global growth slowdowns, a lot of that doesn’t overly impacts our companies because they generally do business in United States and are in middle market. That being said, revenues for our portfolio performed actually pretty well this past quarter for us like in our core corporate book. I would say we are a seeing a little bit of like margin stability. We’ve had margin growth last couple of years we’re having a little bit of margin stability or even in some cases slight declines. And it’s all company idiosyncratic; some of it is wage inflation; some of it is weighted to other factors. But in general, we are not seeing economic weakness in our overall portfolio. But obviously that’s backward looking. And I’ll pass over to Jim on macro.

Without getting too macro with regard to this portfolio, as Ted has mentioned, I think that we are obviously -- we’re living in a market where the headlines in the last 60-90 days have been dreadful and negative and concerning about two things, really Asian growth and the impact of what’s going on in the oil sector with currencies. And I think we’re respecting that and as Greg said earlier and Ted said, we’re really trying to hunker down on our portfolio, [indiscernible] liquidity and be very thoughtful about existing investments before we make new ones. And certainly, I expect we’re going to be in this environment for a period of time. Now, we as a firm are not predicting a major recession in 2016. But certainly a lot of the recent activity you wonder, if it could be a cause and fact issue where the concern about global growth turns into more of recession. But as Ted said, our domestic portfolio is not showing dramatic signs of strain as one would see as you approach recession notwithstanding our commodities and energy book domestically.

And then just in terms of portfolio composition and investment strategy from here; saw some changes in the portfolio. I think the percentage of fixed rate investments actually went up in the quarter. And then it looks like you guys sold a decent chunk of the structured products investments. Is there anything strategically that’s changing or is that more of a function of timing of maturities and what not?

Yes. I think it’s somewhat the latter. I mean, I think today -- and I hope you all recognize and appreciate the color that Ted gave on our line-by-line energy book. I think right now, we are -- when we have a maturity like that in our structured credit book or we have a case like Caza, certainly we want to be thoughtful about that capital. And we also gave ranges of what we expect certain strategies to be, as Ted talked about renewables, Greg talked about Merx. So, we don’t believe that there is any dramatic change in the overall portfolio construction right now. It really is more about the -- around the edge just trying to really optimize and create an efficient liquid portfolio as we continue to invest in a pretty turbulent environment.

Yes. So, our activity level going forward will be mainly in secured debt. But really, as Jim said, the repayment of Golden Hill, which is a very large structure product investment, skewed the numbers in this past quarter.

Your next question comes from Terry Ma of Barclays.

I just wanted to get a sense of your appetite for buybacks. I think you mentioned spreads are wider right now, so the investment environment potentially looks more attractive. So I just want to get some color on how you thought about that and maybe what areas look more attractive relative to buying back the stock?

So, I think when we think about our stock buyback, obviously we think it’s very attractive. I mean as Jim said in his commentary, the market volatility is obviously -- provides us an opportunity buy back our stock at pretty discount. And I think what we mentioned in the last call is our intention is to use the buyback program. Obviously that is weighed against liquidity, overall leverage and other factors. But as Jim mentioned earlier, if you look at our investment activity, it is predominantly focused on existing portfolio of companies. And a lot of our excess liquidity is used to buy back stocks.

Yes. I would just additional; we’re happy. There is a lot of fanfare about announcements. We’re happy that we’ve actually announced and executed. It’s certainly accretive to us, looking where our stock is priced right now and our dividend yield. It’s a very attractive investment. You just have to balance that, as Ted said, with the other objectives of liquidity and leverage. So, at this point in time, we intend to continue our execution of the existing plan in place.

And then just on the management fee waivers. Has there been any talk about maybe potentially looking at permanent rather than renewing it every year? [Ph]

Well certainly, glad you asked it; our board working with management goes through a pretty arduous process every year. They are very cognizant and up-to-date to-date on the current marketplace and what has happened away from us and various other vehicles and entities. And balancing that out with the waivers that have been put in place historically that will go for both the big input into the yearly process occurs later in this year. So that’s how I should be -- really answer right now.

Your next question comes from Christopher Testa of National Securities.

Good morning, thanks for taking my questions. Just with the weighted average debt-to-EBITDA coming down slightly, just how much of that is from structuring of new loans at possibly lower [indiscernible] points versus improvement in your existing portfolio?

I mean, I think the answer is a combination of both. I think this past quarter is mainly driven by EBITDA growth versus new investments because as we mentioned, new investment activity is pretty needed. But you are seeing more discipline on the leverage side in the market overall. I don’t think leverage levels have come down dramatically, but you’re definitely seeing much better structures, much better leverage terms on new investments but are specific leverages mainly driven by just organic EBITDA growth.

And how much of the more disciplined leverage levels is coming from the actual companies possibly pushing back on not wanting more leverage as opposed to Apollo accurately speaking lower leverage levels?

I guess more the latter to be honest. So, I think -- because often guys are dealing with sponsors. And I think it’s latter. I think in general there is a very different discussion than ten years ago where everyone maxed [ph] on leverage and I think people want to be prudent about the amount of leverage put on companies. So, I think a lot of that has to with the fact that I think the overall middle market sector is being more disciplined about terms and conditions they are giving borrowers. So, I think it’s more being driven by I would ourselves; I think it’s more being driven by some markets vis-à-vis borrowers.

And how much of your non-energy investments, how many of those have exposure to regions where oil and gas is a significant part employment in those areas? And do you see that as an issue that can potentially impact non-energy and non-metal and mining companies going forward?

Yes, we’ve actually looked at that and the answer is we don’t feel like we have a lot of -- I call it knock on exposure. We look at not only the risk that you just cited but also things like companies that service those industries, or companies that have indirect exposure to those industries like housing in the Bakken and places like that. And when we go through our portfolio, in our corporate book, we have a very little -- we see very little in the way of knock on exposure.

And I know that you’ve been picking up on the non-sponsor side of the business, given the sponsor size being very challenging, to say the least. Is there some sort of infrastructure that needs to be built out to capture more non-sponsored finance business or is this something that’s just kind of occurring naturally as the sponsored side slows and therefore your non-sponsored business is taking up at a greater composition?

I would say in the last four or five years the firm has invested a lot of money and headcount into building out other verticals away from -- so, it requires additional investment on behalf of the manager. That being said, in our case, a lot of infrastructure already exists. I mean it’s one of the benefits of the Apollo relationship. So, a lot of these kind of non-sponsored verticals exist within the firm which is why we are very happy to be affiliated with Apollo.

And last one from me, sorry if I missed it. How much of the NAV decline was from spread widening versus actual portfolio company deterioration?

Well, I would say that I think as you go through it, probably about half of it was in the -- our more liquid securities. That was from a spread widening and it was from underlying fundamentals of the company.

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

Good morning. I’ve just got a couple of quick questions. First one, I don’t know if I missed at the beginning but what is the weighted average EBITDA right now on the current portfolio and the newer investments in the quarter?

On a weighted average basis, the EBITDA is 5.4%. The majority of the investments made during the quarter were into our specialty verticals whereby they are more equity and debt focused shipping and renewable. So, they don’t have an EBITDA measurement basis.

And then on those extractions you guys were giving color on at the beginning, talking about the price deck having a breakeven or 30 to 35 market cost at the end of the quarter. And in December oil was just at 35. Can you talk about how we get to kind of a market par cost there with it kind of being added to breakeven level?

Yes. So, if you recall, I remember you asked the question about cost the last quarter too. We mark these things on -- what is much more important when we mark these positions is the forward curves vis-à-vis the spot. And if you look at where the forward curve is even today, but also as of December 31, the forward curve was pretty far above where spot was. So, the spot just because we value this thing on a reserve basis and that company specifically has got a lot of embedded reserves, the forward curve has much bigger impacts on valuations. And also you saw during my remarks the company also raised the substantial amount of capital loss, $100 million. So, the company is obviously showed off [ph] liquidity in a pretty big way.

And then final question, so with price being what right now and looking at the forward curve being higher there, looking at possibly increasing some energy lending getting back in right now?

I think from the management team’s perspective, it’s a big focus of ours to shrink our overall oil and gas exposure or maintain it. I don’t think you’ll see us -- we are open to doing new business; we’re open to doing new loans. But quite frankly, we lend against what we think are very, very high quality assets and very, very high quality management teams. And the high quality assets today A, aren’t really looking for new debt, they’re doing other things like cutting CapEx, sign assets, looking to sell the whole company. So, I think we’re open-minded too, but we really don’t want to increase the overall percentage of our portfolio devoted to energy.

Your next question comes from the line of Vince [ph] of KBW.

Approximately, how much of your dividend income this quarter could be considered non-recurring?

I would say it’s probably $5 million to $6 million.

And then just could you guys talk about how the competitive environment has changed from maybe a year ago, from a competitive standpoint? Is there a big pullback at competition; are participants still acting rational and are you guys still seeing banks being active in the market?

Yes. So I would say, you have to bifurcate the market in a bunch of different ways. So, in terms of first lien senior debt, we still see it as very competitive, very, very competitive where terms and -- spreads have widened a little bit, but that’s still very competitive. For what I call stretched senior unit tranche, secondly lien that market has become a lot less competitive, because there is certain players in that market who are in the market at all times, and a lot of those people are falling away just given what’s happening in the rest of the market. So I’d say bifurcate it by types of risk. And so, it depends on which asset class we’re talking about.

And then just one last one, following up on Terry’s question on fee waivers; I do appreciate the fee waivers you guys have provided so far. But I just want to get your thoughts on potentially implementing a total return or high water mark?

Yes, I would say like I said in my last question, the board and management are assembling a lot of information with regard to the process it goes through an annual basis. We’re cognizant of what’s going on in the market out there today. And historic fee structures and current fee structures along with the impact of our waivers. And I think the board is weighing what they think is in the best interest of the company and our shareholders.

Your next question comes from Chris York of JMP Securities.

I’d like to get an update on how you guys are thinking about the management of balance sheet leverage, considering that debt to equity expanded to about 0.8 times and that either stock repurchases or additional fair value write-downs in core energy positions pushing closer to that one-to-one ratio?

I think it’s a great question and thanks for asking it. I think that we’re very focused on it. We’ve said in the past that we want to operate closer to 0.65, 0.75 and so, we’re in a little bit on outer range right now; we feel comfortable. But I think that what the message you are hitting [ph] from all us today is really, we’re really focused on the current portfolio and optimizing liquidity and husbanding [ph] liquidity as we can. And while we like to buy back cash stock and make new investments where the first dollar in, we’re going to be focused on making sure that we’re appropriately leveraged. So with that regard, the ability -- we’re happy we did buy back some stock right now. And with prepayments slowing down, we’re going to be laser focused on where we end the quarter and our liquidity in our existing book. So, every quarter any BDC has to weigh the options of making new investments, adding leverage, in our case buying back stock. And in this case, we’re certainly, I’d probably prioritize making sure we’re focused on our leverage, a little bit higher than our stock, but those are really neck and neck right now, before we think about new investments.

And then switching gears a little bit, so outside Spotted Hawk and Osage, you don’t have any near-term maturities in your energy portfolio. So, maybe kind of put a frame of reference for us in thinking about what needs to happen in the price of crude, maybe this year or 2017 where you guys start thinking about the potential to get all your money back?

I think it’s name-by-name. So, some of these assets will be auctioned off at some period of time. But I think the answer is there is no near-term maturities, so obviously the bigger focus with all these companies on liquidity. So, every company is doing everything they can to manage liquidity and obviously we are being very vocal with our borrowers about them managing their liquidity. So, as we always mention, each of these companies is going through different challenges and different processes to potentially raise new money or do other things. So, it’s hard to say oil stays at x for x period of time, what happens exactly. But a lot of these companies -- comes you’re right, the more acute issue is liquidity versus maturity issues.

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

I’d probably reiterate a bit of a congratulations and that keeping the fees low, focusing on the waivers as well as buying back stock. I mean that’s credit that should be given to you Jim, Ted and Greg and Elizabeth, as well as your board. I know you as you go into discuss future wage [ph] shareholder value is certainly a great inertia. And people are very pleased. So, thank you for that. Rather than just beat the horse on stock buyback versus new investment, I’d like to ask a question about the Solarplicity investment. Only because when we think about project finance and we see that this is funded a bit later in the quarter, trying to understand the relative risks that come in building out a solar platform, or solar farm or solar project, excuse me, over the next three years in light of the low cost of energy. Clearly you’ve paid attention to what the oil markets are doing, so you’ve obviously had that diligence but the question really fits is to how can that investment go wrong?

Yes, it’s a good question. So, let’s just describe what the investment is. As I mentioned before, we have basically two solar platforms and really they’re focused on assets, not on platforms. We are not looking to make venture capital bets here. So, Solarplicity specifically, the UK government has got a feed in tariff whereby they will contract with you to pay you a certain price per megawatt hour, if you produce power using green energy. And so these assets are -- we have a long term PPA with the UK government. So, if oil goes up or oil goes down, it doesn’t affect the actual PPA. So, the risk is that UK government rips up the contracts, which they’ve never done before, and that really is the big risk. We’re not taking things like cost of acquisition risk or ramp risk or other things because again we’re mainly exposed to city [ph] assets. Your question is there is a lot of stress in the solar space, so people might scratch their heads a little bit. But again, if you look at the underlying risk we’re taking in both of our platforms, really again, the assets we are purchasing are contracted assets.

So, that’s fair. And I think of the 600 million, you were 150, who are your other partners that you went alongside to finance that project?

In that one, it’s just us. That’s we control it; we have a partner who is an operator but we don’t have a financial partner.

Okay, got it. And then so clearly, attractive investment, focusing on the government which -- it’s hard to say what happens at the end of the day if passage [ph] generally prolong. But then you kind of want to ask yourself a question because investors look at Solarplicity investment and say that’s excellent but then perhaps look at a stock buyback versus an investment in Belk and then might ask why’d you buy Belk?

Yes, Belk is a very, very small position. It’s first lien senior secured risk that we were able to buy at a big discount. I think it’s a fair question, but again I think it’s -- if you look at the size of the Belk position, it’s...

It’s 10 million; it is small. You are right.

As the overall portfolio.

You are right, I get it and I appreciate. Then the next question we’ve got focusing in on underlying kind of credit quality. So, I think you mentioned Magnetation on non-accrual, understand the difficulties and that on mining. But am I correct, this is the DIP loan that went on non-accrual, right?

Correct.

So, I am just curious because we’re not credit operators such as you, but how do DIP loans go on non-accrual; you still proceed almost everything else?

John, that’s a good question. I think that you can understand our desire, certainly we have had a more engaged discussion on various credits; this is one that’s still in process. So, you are right, usually DIP loans are ones that are senior, senior secured ahead of everything else. And historically they have been good investments. This has some challenge because of the underlying fundamentals and what’s going on specifically in the company. But I think it’s probably best because it’s an ongoing situation that we don’t have a further discussion on that publically.

That’s -- totally understand that and I understand those rules. So, then the next question sort of question -- and Greg this would be helpful for us to understand because at times we hear from BDCs saying we are going to value this company on an assets basis. And if you sell all the trucks and you sell all the wells and you sell the power lines and there is just magical buyer, and then often we hear this “in an orderly market”. And I am curious if you go through the valuation process for some of these oil and gas investments, is the value that you are generating, based on a sale that you could transact today or your valuation firms says could happen today or does it assume that you break this up and in six months everything is going well and then what we are going to do is sell it to the MLPs because they are hungry for assets anyway? And I hate questions of fair value; valuations are like opinion, everybody has got one. But in a period of credit turmoil, the market always wants to focus on today versus six months from now, just like you do when you underwrite new investments. So, help us understand that process, particularly as it relates to energy assets because people believe those values continue to fall?

Right, Jonathan. And I think we’ve had this discussion, I think before on valuation. When you think of fair value, you think first of all, the underlying cash flow of the investment and the underlying asset value that are there. And we take that into account as we look at the positions that we have. Relative to a willing buyer out there and seller, if there are markets there so jointed where we have fundamental assets cash flow coverage, but the technicals in the marketplace are saying something different, we wouldn’t value it that way; we would value it based upon the fair value of the underlying position that we have. So that’s the way we go about it. So, hopefully, is that answer to your question?

I appreciate it. I mean look, it’s a bit of a question with no easy answer; you can kind of understand that. Relative to what you’re doing for your shareholders with buybacks et cetera, generally when you set that precedent, people want to make sure and could come alongside to understand that NAV is best mark. But when you have management teams perhaps taking other liberates elsewhere in their book, it creates a bit of cloud over the entire space. And so I appreciate you’re trying to answer that, it’s not an easy question to answer, but one that every client is asking. And then lastly just in light…

Jon, it’s Jim. I do think I really want to because I think you’re asking a critical question. But I think and I don’t want to sound defensive but I believe that we have a best-in-class valuation process. And the energy space is one where there is a lot of inputs, certainly a company’s liquidity and ability to stay afloat is a critical one right now. And we certainly wanted to point out the confusion on Venoco, which we are focused on, because when one comes under potential questioning about valuation, we take that quite seriously here. But I am of the view, and I think our board shares it that the broad valuation processes of big public company that we go through, not only in our current book and our energy book and our Merx and structure credit, we believe, we are best in class, we have valuation firms tell us that. So certainly in periods right now of extreme volatility and extreme syncretism and concern, the valuation process should come under consideration. But we stand hand on heart knowing that we believe we have best practices.

I appreciate that and thanks Jim for the additional color. And then just lastly as relates to the structured products book, particularly the Golden Hill certainly a positive. I’ve also noticed there’s quite a bit of return that you received in the management and capital bills. And I think those have been around a while. I even know they were named Kirkwood before, but my mind continues to go. But I would say that -- here is the question. So, you received some good middle market returns on those CLOs. Ted, in light of the near-term duplication that could possibly occur in middle market credit, would it be your view to perhaps expand that partnership with Madison Capital in light of the performance of the MCS deals that you’ve had?

I mean we’re always open-minded to it. And obviously we’ve dialogued with lots of different people about, lots of different structures. Anytime you do a structure like that, again that was -- you have to benefit from two things, one is great assets and also great liabilities. I’d say we’re just not today really looking to expand the amount of embedded leverage in our overall portfolio. So, I don’t think you’ll see us do another Madison/Kirkwood transaction in the near-term, but obviously we’re always open-minded to them.

And I would add Jonathan, I appreciate you’re having the insight to differentiating between the middle market Kirkwood transactions Madison versus the large syndicator which are very small amount in our book. And we differentiate the value of those based on the structure and the leverage and the underlying collateral and those have done quite well for us to-date.

And I mean Mad Cap has been as an excellent operator and credit to you for investing in those partnerships. So that’s it from me guys, thank you so much.

Great. Well, thank you all. We really appreciate the detailed questions and the knowledge of our company and support. Certainly a challenging environment, but we appreciate having these opportunities to talk about our portfolio and our strategy. So, thank you very much.

Thank you. This concludes your conference. You may now disconnect.