MidCap Financial Investment Corporation (MFIC) Q1 2017 Earnings Report, Transcript and Summary

Good morning and welcome to Apollo Investment Corporation's Earnings Conference Call for the period ended June 30, 2016. At this time, all participants have been placed in listen-only mode. The call will be open for 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. Speaking on today's call are Jim Zelter, Chief Executive Officer; Howard Widra, President; Tanner Powell, 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 to strictly prohibited. Information about the audio replay of the 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 company. 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 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. Before we begin this morning, I would like to briefly discuss the management change that was announced in June. Howard Widra who has worked with Apollo affiliates for the last several years as Co-Head of Direct Origination and now Head of Direct Origination, was appointed President of AINV. Howard is an industry veteran and Co-Founder of MidCap Financial, a company acquired by an Entity Managed by Apollo Global Management in 2013. Since that time we have worked closely with Howard, who came into this role through a thorough understanding of Apollo Investment Corp. Howard has a strong credit track record and brings a breadth of direct lending experience to the role. For those of you who are not in familiar with MidCap, the company was founded in 2008 and is a middle market focused specialty finance firm with nearly $7 billion in assets under management that provide senior debt solutions to businesses across the verity of industries. We are excited to have Howard join the AINV team and look forward to him and his team furthering the company's strategic initiatives. We are taking this opportunity with the management change and the recent receipt of co-investment relief from the SEC to redefine AINV's strategy in a direction which we believe is designed to provide shareholders with a more consistent return and a stable NAV. On today's call, I will discuss our go-forward strategy as well as our dividend policy and some additional business highlights. Howard will then discuss our plans to execute the strategy in greater detail, Tanner will then cover our investment activity for the quarter and provide an update on credit quality, and finally, Greg will go through our financial results before we open the call for questions. The AINV Board and our management team are focused on driving long-term shareholder value. Over the last several years our strategy sought to capture incremental yield by prioritizing complexity over underlying liquidity, which resulted in NAV volatility. Going forward, we intend to reposition our portfolio in such a way that we believe is designed to have a lower risk profile, less volatility and to provide more stable return for shareholders. We intend to achieve this by repositioning a portion of the portfolio in traditional -- into traditional corporate loans, primarily floating rate directly sourced from the Apollo platform, while adding additional product offerings via MidCap. We expect to also transition the portfolio away from some of our existing specialty verticals and we will endeavor to continue to proactively work through some of our more challenging investments which continue to impact results. About a year ago we developed a unified direct origination effort between AINV and MidCap's origination teams. We believe that our platform is one of the largest and most diverse origination change in the competitive marketplace. This origination platform extended the funnel of opportunities available to AINV and as a result we are now seeing more opportunities, which allow us to be even more selective in credit quality. With the coordinated calling effort under combined leadership, seamless underwriting and portfolio management process, we believe the collective Apollo platform should have one of the broadest product offerings for middle market companies. We have already made great progress at the unified origination platform penetrating the sponsor world and we have seen robots and increased deal flow. Our ability to investment in direct resource loans is also being greatly enhanced by the recent receipt of co-investment exemptive relief from SEC, which is also expected to drive more deal flow. This relief provides AINV the ability to participate in negotiated joined transactions with MidCap and other funds managed by Apollo, among other things. In summary, we believe our strategy is designed to achieve a more stable return to shareholders, inclusive of credit losses. As we have seen over the last past several years, the investing environment remains attractive given the secular changes in credit extension by the banks. With the successful execution of this plan and relatively stable market conditions, we believe the portfolio should generate more sustainable ROEs, although returns in the short term may be volatile as we position the portfolio. Moving onto our dividend policy which is based on a few key fundamentals. We believe our target dividend payout ratio payout should be a function of our desired portfolio construction. We believe it is important to strike the right balance between generating investment income and preserving NAV. We believe the dividend level should reflect the current market environment, which as you know has experienced considerable yield compression over the last over years and should be aligned with the earnings power of the existing portfolio. Consequently, our decision to adjust the dividend was based on the input of all of these factors with the view toward the ultimate portfolio construction, the ability to resolve assets are non-accrual today and operating within a prudent leverage range. Accordingly, the Board approved the $0.15 dividend to shareholders of record as of September 21, 2016. As credit investors some amount of loss is expected. However, we believe that the strategy that we are outlining today is designed to reduce future losses resulting in a more consistent and stable return for shareholders over the longer term. I will now turn the call over to Howard.

Thanks, Jim. In the short time I've been President of AINV, I've had the opportunity to speak to several of you, and I look forward to on going dialogue with all of you. We've completed a comprehensive review of the business which included the detail assessment of our performance and the assets in the portfolio. Our review underscored the benefits of investing in directly source transactions which historically have had lower loss experienced, lower attachment points and greater all in return. Going forward, our investment strategy is expected to continue to focus on corporate loans source from Apollo's broad and deep platform. With the unified direct origination platform, we expect to focus even more on loans with lower loss given default characteristics primarily floating rate with a substantial portion in first lien loans. We are emphasizing portfolio diversification and avoiding outside single name or industry concentrations. We are right sizing our portfolio segmentation by reducing several of our existing specialty verticals, as well as lowering commodity dependent and highly cyclical credit exposures. A key element of our portfolio construction is building a credit portfolio with a relatively low level of correlation to any single risk factor. As credit investors some losses over cycle are expected. However with the unified direct origination platform combined with exemptive relief to co-invest, we can be even more selective and we believe that our strategy is designed to produce results that should be more consistent and predictable. We intend to reallocate a portion of the portfolio in a steady and measured manner into traditional corporate loans source by Apollo's integrated direct origination team while adding additional specialties in life sciences asset base lending and lender finance via MidCap. Access to these additional products should not only help diversify the portfolio, but it should also provide returns that are less correlated with the liquid credit market. Given the liquid nature of many of our investments you should expect that the prepositioning will take some time. In certain cases we may seek to accelerate the disposition of assets which are not core to our strategy. As mentioned last quarter we received co-investment exemptive relief from the SEC which provides AINV the ability to participate in negotiated joined transactions with other funds and entities managed by Apollo, including MidCap. We believe this relief is critical to our future success since it allows us to compete for investments along with the broader Apollo platform, and in so doing should improve our competitive positioning by allowing us to compete more on the basis of size and certainty of execution rather than just price. We believe the scale of AINV, MidCap and other Apollo managed capital on a combined basis makes this one of the largest market participants uniquely positioned to take on large commitment. We have already made what we believe to be good progress in the past few months repositioning the portfolio with the resolution of certain legacy positions and lowering our oil and gas exposure to less than 10% post quarter end. In the coming months and quarters you should see further progress in this repositioning, with the continued reduction of positions higher on the risk spectrum that have more volatile returns. As we continue to exit investments, we expect to put more capital work and assets where MidCap has an excellent track record. MidCap has focused on the direct origination of asset based loans, leverage loans, real estate loans, life sciences loans and lender finance. While MidCap is largely a complimentary platform to AINV, there are opportunities were mandates to overlap particularly an asset-based life sciences and lender finance. We expect to diversify your portfolio by ramping each of these areas over the next two to three years. By the end of fiscal year 2019 we currently believe that these three asset categories should represent approximately 15% to 25% of the portfolio with yields of around 10% to 10.5%. We are already seeing a strong pipeline of co-investment opportunities with MidCap. In fact, three co-investment deals to be closed or have been approved since the end of the quarter. We look forward to reporting our continued progress with respect to repositioning the portfolio over the coming quarters. With that, I'll now turn the call over to Tanner who will discuss investment activity and credit quality.

Thanks, Howard. As mentioned on our last call, we ended the March quarter slightly above our target leverage ratio due to anticipated sales and repayment activity. During the period we exited $339 million of investments of which 57% were repayments and revolver paydown and the balance with proactive sale. We invested $123 million in five new portfolio companies and 12 existing companies. Accordingly, net investment activity was negative $217 million in quarter. The weighted average yield on investments made during the quarter was 10.8%. The yield on debt investment sold with 11.9% and the yield on debt repayments with 9.9%. Repayments for the quarter totaled $193 million which included the full repayment of GTCR Valor Companies, Novolex, Osage, Pabst and Transfers. Sales for the quarter totaled $146 million which included Aveta, Deep Gulf and Generation Brands amongst others. We used the strength in the broader CLO market to exit our remaining two broadly syndicated CLO positions in the quarter, Jamestown and Highbridge. Our structured product asset class primarily consisted middle market CLO's and regulatory capital trades. We have no exposure to broadly syndicated CLOs. Regarding aircraft, we continue to be very pleased with our investment in Merx Aviation as the underlying portfolio continues to perform well. At the end of June Merx represented 18.6% of the portfolio, a function of the lower overall portfolio size. Our aircraft portfolio continued to be well diversified by aircraft type, lessee and geography. Over the last 12 months Merx has returned approximately $42 million of capital to AINV. I will now give a brief update on our energy exposure. At the end of June oil and gas represented 11.6% of our portfolio or $304 million, down from 11.9% or $347 million at the end of March on a fair value basis. The decline was primarily due to the exit of our investments in Deep Gulf, Osage, and Renaissance Umiat. Subsequent to quarter end, Extraction repaid our loan at -- 101 as the company issued high yield bond. Pro forma for the exit of Extraction, of oil and gas is now approximately $250 million representing less than 10% of the total portfolio. Over the last 12 months, we have considerably reduced our exposure to the sector and have received approximately 156 million proceeds from the sale and repayment of our oil and gas investment. At the end of June the portfolio included six-company. We continued to closely monitor our investments in this space and we will continue to seek to reduce our existing exposure when possible, and we will be patient with our more challenged names. Three oil and gas positions remain on non-accrual Pelican, Spotted Hawk and our second lien investment in Venoco. In each of these cases we are working closely with the respective management team. Moving to overall portfolio of credit quality. Fixed investment in three companies were placed on non-accrual status. During the quarter these investments are all challenged and we continue to look for ways to improve value and maximize the recovery. Both Garden Fresh and Delta Education were undergoing sales processes in the quarter and in June both processes faced significant challenges which adversely impacted our position. Additionally, Square Two continues to be impacted by the regulatory environment, as industry supply of charge-off receivables remains at depressed levels. During the company completed a recapitalization that will provide an improved capital structure and interesting savings to better operate during the difficult market conditions. In aggregate, at the end of June, we had 13 investment on non-accrual status, across seven different portfolio companies. Investment on non-accrual status represent 4.5% of fair value of portfolio and 11.8% on a cost basis compared to 4.2% and 8.4% respectively at the end of March. The portfolio's weighted average risk rating on a cost basis remained at 2.4% and on a fair value basis remained at 2.2%. The current weighted average net leverage of our investments was 5.4 times, unchanged quarter-over-quarter and the current weighted average interest coverage improved to 2.8 times, up from 2.7 times. With that, I'll turn it over to Greg who will discuss financial performance for the quarter.

Thank you, Tanner. Total investment income for the quarter was $76.5 million, down 10.4% quarter-over-quarter. The decline was primarily attributable to a lower asset base and increase in investment in non-accrual. Fee and prepayment income was $6.9 million in the quarter compared to $4.5 million in the March quarter. Dividend income for the quarter was $8.9 million, down $2.5 million quarter-over-quarter primarily due to a lower dividend from Merx Aviation as we retained earnings, as well as a lower yield on to of our middle market CLO equity investments. Expenses for the quarter on a comparative basis totaled $37.7 million versus $40.7 million last quarter, the June comparative expenses excluded approximately $2.7 million of non-recurring expenses related to a strategic transaction that was considered, but did not incur. The manager also bore a similar level of direct expenses associated with the strategic transaction. Management fees were lower given the reduced asset base, give the reduced base management fee rate and the decrease in the average portfolio. Incentive fees were lower given the decreased level of investment income and the performance adjustment in our fee structure. Given the net loss experienced during the quarter the incentive fee was 15%. Furthermore, interest expense decreased during the quarter due to a lower average debt balance. Net investment income was $38.8 million or $0.17 per share for the quarter excluding the previously mentioned non-recurring expenses, which were $0.01 per share. This compares to $44.6 million or $0.20 per share for the March quarter. For the quarter the net loss on the portfolio totaled $78 million or $0.35 per share compared to a net loss to $68 million or $0.30 per share for the March quarter. Approximately $63 million of the net loss for the quarter related to three legacy investments Garden Fresh, Square Two and Delta Education. The net loss of $70 million included $12.6 million as realized losses which approximately $11.3 million of those realized losses were previously recognized as unrealized depreciation. In total, excluding the non-recurring expenses are quarterly operating results increased net assets by $39.4 million or $0.18 per share compared to a decrease of $23.4 million or $0.10 per share in the March quarter. Net asset value per share declined $0.38 or 5.2% to $6.90 per share during the quarter, largely driven by the credit driven markdown on several of our legacy investments. There was a $0.01 per share accretive impact to NAV from our stock repurchases. Turning to the portfolio composition. At the end of June, our portfolio had a fair value of $2.6 billion and consisted of 81 companies across 25 industries. First lien debt represented 40% of the portfolio, second lien debt represented 25%, unsecured debt represented 9%, structured products represented 12%, and preferred and common equity represented 14%. The weighted average yield on our debt portfolio at cost was 11% unchanged quarter-over-quarter. On the liabilities side of the balance sheet we had $1.1 billion of debt outstanding at the end of the quarter. The company's net leverage ratio which include the impact of cash and unsettled transactions stood at 0.66 times at the end of June compared to 0.75 times at the end of March. The company's debt equity ratio was 0.71 times at the end of June, down from 0.8 at the end of March. Regarding stock buybacks, we continue to see the stock market discounts to NAV as an attractive opportunity to accretively repurchase stock. During the period, we repurchased 1.1 million shares for approximately $6 million. Since the inception of the program a year ago we have purchased 12 million shares or approximately 5% of our outstanding shares, for a total investment of $69 million and we have $31 million remaining under our current board authorization. At this time we expect to continue to actively repurchase our common stock. In addition Apollo Global Management continues to execute its share repurchase program. As a reminder AGM initiated program to repurchase up to $50 million of AINV stock in the open market, of which 5 million has been utilized to date. AGM owns approximately 8.9 million or 4% of the outstanding shares of the company. Let me conclude by saying that the Board and management team considered many factors in the decision to reduce the dividend including our desired portfolio construction, a prudent target leverage ratio and the current market environment, we believe it was a successful execution of the repositioning strategy that we have outlined today. We will be well-positioned to provide shareholders with a more consistent return and stable NAV. This concludes our remarks. And operator, please open the call to questions.

The floor is now open for your questions. [Operator Instructions] Your first question comes from Jonathan Bock of Wells Fargo Securities.

Hi. Good morning and thank you for taking my questions, and Jim and team, it’s -- very appreciate as you focus on stability both in NAV and cash flow stream going forward. That's very valuable to investors. One question we want to -- to try to understand a bit is now at the new underlying required yield as you lower the dividend on an absolute basis, what type of yields one needs to originate at in order to maintain the dividend yield and perhaps grow it over time, if it’s appropriate. Can you give us a sense on what you would expect to be your target all the way requirement in order to meet kind of the new dividend obligation that the Board set for us?

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

Got it. So then -- appreciate that. So clearly -- certainly achievable. And then the question folks will ask you to understand Apollo has such a wide variety of avenues to originate credit in two different buckets and so Howard can give us a sense of the MidCap's core asset base, what the average yields were? But then also you talk about the specialty verticals where there is overlap and clearly you outlined ABL or life sciences as 10% return. Just trying to get an understanding of kind of now that you'll be partnering more where MidCap's score really is and where the Apollo AINV's score, is in the areas that you work together I think you already outlined, but just try to understand the differences between the two vehicles so we can understand where they will partner and where they will not?

Right. So MidCap is does all senior debt so and its yields can range anywhere from 6% to 10% -- 6% to 12%. That to the extent that the products that MidCap offers ex real estate are, you know, in the yield range that we just -- I just talked about before 10% that's where the overlap is. With the only other overlapping, you know, the assets being of enough size that it makes sense for AINV for the scale perspective to invest. And so it's a subset of what MidCap does and that's something that falls in the category that we describe, lender finance, asset based lending and life sciences. But in all cases, you know…

Got it. How -- I if you kind of think about kind of just the dollar amount that have been originated in those types of three categories how would you describe just general relative size? Certainly, it's going to get bigger now that you can speak for larger hold sizes and do more together, but how much is already kind of been done in that portfolio over a normal course of two to three years in each of those categories?

So two things you -- it's a growing platform with growing market share because of its ability to invest together. The past is not necessarily prologue that the numbers are pretty high. it's just bifurcating it out to once the have historically been in AINV participated deal and one that had not, I don't have that exact numbers. But MidCap originates multiple billion dollars of investments every year.

Got it. And then -- great, that the two can partner together. Turning to new investments very quickly. Just looking at -- for an update on the AIC SVB holdings, so certainly investment vehicle with common equity interest. Can you kind of outline the investment itself and I just believe once you saw the opportunity because when folks common equity, it always generally raises a small bit of question in terms of where we are in the credit cycle, but then again there's always Merk et cetera there are some unique exceptions to the rule.

Jonathan, yeah, that's our investment in Square Two.

Okay.

We restructured into that put a combination of debt and preferred into an SPV base.

Okay. Great. And then also looking at the energy kind of opportunity so, for the investments that you did or choosing to kind of disposed, so are we -- now that you sold down to 10% are we did it to take under advisement that that's kind of the comfortable level you'll be operating at going forward or would you expect that to fall further over time if nothing changes? Clearly if things get better, great there's more opportunity to sell, but static is that kind of where you're going to choose to keep it on a go-forward basis for -- next four quarters.

Yeah, Jonathan, I think our intention is to continue to work through our exposure there and we would like to get that percentage down lower as Howard alluded to. We are going to be very discriminating and when and how we reposition and clearly in cases such as Extraction it was a function of the performance of the underlying company. But all things being equal and you're right to point out depending on market environment, this may change, but it is our intention to try to manage that exposure down.

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

Yeah, sure, thanks, Jonathan. We would -- we continue to the classify our Merx's team as best-in-class and the opportunities that ebbs and flows and we continue to think that irrespective of market environment, they've demonstrated ability to source attractive risk/reward asset. We are cognizant of where our percentage is -- at the moment at 18 6 as I alluded to that had more to do with the decline of the overall portfolio than in the underlying or any additional investment at Merx. And so the -- I think the take away is we really like the exposure. We're cognizant of how big it is and we are going to evaluate opportunities as they arrived and certainly all things being equal as that portfolio manages down we certainly see opportunity to reinvest should repayment be more robust than expected.

Got it. We appreciate…

I would say that -- and Tanner is right we feel like our team is best-in-class and I think that we feel we got in early vis-à-vis a lot of our competitors, so we're not in a rush to put new assets to work. Right now we're very patient just to let our portfolio do what is doing day in and day out, and over time is the cycle changes -- I know it's been a lot of concern about, you know, the new leasing market, as you know our portfolio is a bit more of the leases and aircraft that have a bit more mature in their life. So we're pretty comfortable to -- we don't need to be an aggressive investor right now. And as Tanner said it's increased because of other challenges in our portfolio, but we were cognizant of the overall size as well,

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

No problem.

Your next question comes from Kyle Joseph of Jefferies.

Morning, guys. Thanks for taking my questions. Greg, I just wanted to get your thoughts a little bit on dividend and other income in the quarter. Obviously, other income is pretty volatile, dividend income dropped. Is this a good new run rate level that we're at right now?

I mean, I think what we have indicated previously is a -- we said it 10 to 11, you know, I think that nine to 10 is probably given where we are with some of our equity positions. So I think that it is a good run right, yeah.

All right. Thank you. And then also I wanted to talk about a little bit of the delevering in the quarter. Was it somewhat back weighted? Because if I just take in the average -- or if I calculate your cost of funds in the quarter, it looked like it ticked up a little bit, is that related to some timing of the delevering in the quarter? And then just your outlook for cost of funds going forward. Do you have and more sort of tailwinds for margins there?

So you're absolutely right that we had a number of our repayment towards the end of the quarter, so therefore we had more leverage on average during the quarter than we ended the quarter with. And we do have on -- you know, we will be paying down a secured piece of indebtedness that has about $28 million or so in the quarter that has a cost of about five and seven eight, so that will get the minor impact on our cost of capital for the next -- with that later in the quarter, so affect is going forward.

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

Your next question comes from Terry Ma of Barclays.

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

Yeah, sure. When you -- so as we mentioned 18.6% I think per our earlier comments we like the risk reward there. So, our current outlook is perhaps a little bit lower, but we are comfortable with the current percentage. In terms of the structure of our investment, we have an equity investment in Merx that we characterize as partially debt security and partially in equity which you see on our balance sheet. But the nature of the investment within the vehicle are such that many -- and in fact just about all have underlying leverage on them and we are the equity -- we own the underlying planes. And so the leverage resides in the -- on a trade basis in the underlying investments.

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

Yeah, it's a very good question. And as Jim alluded to we are less focused on the new lease market and new leases can be 10 to 12 years. On average we are buying planes, you know, kind of already for four to seven years old and so take -- do the math, you know, kind of five to six years remaining on lease term. But we have invoked the strategy that asset agnostic. And in fact we endeavor to be diversified by aircraft type and more importantly have our least maturities not concentrated in any one year, so we do not have planes coming back into any one specific market. So there are numerous factors that we look to in ensuring diversification in the total Merx portfolio.

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

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

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

Sure. In the ABL space, as a general matter there is more and more opportunities for non-bank lenders that sort of the regulatory scrutiny for bank sort of expand, and so there's an increasing amount of strongly collateralized adequate credit assets that are being moved out of banks for, you know, reasons that I think that, you know, the banks would prefer not to happen. And so that is a continually expanding market in terms of opportunity. Yet there's a fairly meaningful barriers to entry because you need to have a platform that can manage collateral and fund people every day and things like that. And so there is good -- really good secular tailwind in that area, so that's one. The life sciences business is steady. There are a few competitors in the market that have been there for a long time Hercules in DDC space and then a few private companies of which, you know, MidCap is one that effectively have been in the market for a long time and sort of remains there. The competitive market has been pretty steady. There's always a good set of opportunities. It's sometimes a function of alternative sources of capital for those companies, so partnerships in pharma and IPO markets sometimes compete against that capital and so that can ebb and flow. But it has generally been pretty study and has been study for extended period of time.

Okay. Great. Thank you.

Your next question comes from Leslie Vandegrift of Raymond James.

Hi. Good morning. Thank you for the really good color at the beginning of the call. I have got one question on the shift that you guys were talking about to the more secure credit assets there, kind of the timeline here we're talking about. I know you said the target you were heading forward was a 10% yield. Are we looking at kind of the three-year of life there moving over, or as organically repayments come in, or are we going to see more of looking to sell off some of these assets subordinated, even some second lien to move to that 10% overall yield more rapidly?

So I think it's a combination of everything, but our strategy does not exclude second lien going forward, originated second lien through the middle market. So there are set of assets that would not -- we would not want to move off the balance sheet long term for strategy anyway. But I think the answer is we're going to do -- we have an ultimate goal, a picture of the portfolio that, you know, if you do the math, produces the yields we want and long term dividend and growth that everybody wants and vast stability. And certain assets don't match out and those are the ones we will look to exit, but only at an attractive price versus where we think they're ultimately worth. So that goes back to, you know, what your initial point was. Over three years we would expect the whole portfolio in a normal case to run off, that's generally average three-year life. And so we will accelerate that when we have opportunities for ones that don't fit and we will replace those with the new origination as they come. So, you know, the sooner we can do it the better, but only if it meets the long term goals sort of maximizing our recovery and our NAV.

Okay. All right. Thank you. And then on the strategic transaction, that $0.01 no-recurring expense, that was mentioned. Can we have some color there? I mean, what were you guys looking at? Is there a reason -- a specific reason why it ended up not occurring, or are you looking for other transactions similarly now?

I think the best way to answer that is, you know, it did not occur for Apollo. Certainly, we are always on the lookout to our engage in transactions that we think makes sense long term for our company and we will continue to do so. But in this case it did not result in a positive outcome for Apollo Investment Corp.

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

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

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

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

Perfect. All right. Thank you. Appreciate it.

Thank you.

Your next question comes from Doug Mewhirter of Suntrust.

Hi. Good morning. First, a bigger picture question. We've been seeing some talk about how -- there has not a lot of deal volume in the middle market -- middle and upper middle market, things -- and things are a little more competitive because there is this flood of yield seeking capital coming in, chasing these deals and some of the multiples are getting out of hand. I guess how does sort of square with what you're trying to do with taking on more traditional corporate direct origination? And, of course, that's mindful that I understand MidCap has some niches that are little off the beaten path that might help give you differentiation. But are you -- how does that affect what you are trying to do and your plan right now?

Yeah, so, right, I mean, one is as you said is, you know, the niches are hopefully in our like a little bit more immune to those trends. But with regard to sort of the core origination strategy, I think as Jim said in the beginning as comments we want to differentiate on things other than price, and so one of that is size and speed of execution. And we had now combined across the Apollo platform, you know, led by AINV and MidCap the ability to underwrite as much as pretty much anybody else we can be within the marketplace. So if we can deliver certainty and we have a comprehensive coverage effort, which we do, so we have as many people out there looking for deals and we can deliver something that other people can’t, we can basically be on a favorable end of that trend you’re talking about. No matter what that trends there and you know the market drives a lot of things, but certainty and size really matter and given the amount of actually assets that need to be originated each quarter at AINV, we believe that we can originate enough assets in that category that we don't need to be directed by the market, certainly as much as some other people that are either much bigger or have much less coverage.

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

Yeah.

Or something?

No, no, and yes to all three. It is. There is a healthcare ABL business of which MidCap is the leader in the market and so there's a significant presence there and there is also just a general all-industry asset-based lending business that is led by receivables as opposed to inventory, but inventory is always component and sometimes a significant component of those loans. There is not a specific retail focus, and in fact, it is far less retail as a percentage than most ABL portfolios, but it's certainly retail, could be part of it. So it could be IT distributor with receivables, it could be a steel company, it could be a helicopter company, it could be a retail brand, any of those things.

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

Thank you.

Your next question comes from Ryan Lynch of KBW.

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

I think anywhere our goal would be putting Merx aside because of its value and a diversified platform, for us to not have any sort of concentrations in a way that you all would flag. And so if you look at our business now, renewables, CLO equity, all are relatively concentrated positions versus a whole and actually have more volatile cash flows because they're inherently levered. And so those would be places that we would also expect over time to be…

Okay. Then as I look at you guys’ balance sheet, leverage obviously came down a little bit in the quarter. The way you guys are levered today, it looks like you could grow your asset portfolio. However, based on you guys commentary about transitioning the portfolio and maybe churning out of some assets, should we expect some portfolio net pre-payments over the next several quarters as you guys transition, even though leverage levels on the balance sheet tell you guys, you guys could actually have growth?

Yeah, I think it's possible and the reason why I say it’s possible is we do have a good pipeline and we expect to be have good gross origination, but it's also possible that we’ll have opportunities to exit things we think are appropriate long term that are of size. And so we don't think it will be a long time until we get to the right leverage level, but certainly any given quarter could end with lower leverage if that's appropriate, and we think that's fine for the long-term opportunity, because we like the long-term opportunity. All right, so it's a good question. It is quite possible, but it just all depends on the timing of each of the things we're doing coming closer.

And I’ll just add, you balance that leverage with earnings too. Certainly we don't want to abandon the ability to achieve our reset dividend. So certainly that's very important to us.

Understood. Those are all the questions for me.

Your next question comes from Chris York of JMP Securities.

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

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

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

I would suspect that the fee that you’ve seen as a result of our March meeting staying in place. I think that that's what – we usually go from year to year. That’s how our board looks at it, and certainly sustainable for next year. But at that point in time, we will address that. And depending on how the board feels about the competitive environment and what our peers are doing, I think we look to be consistent amongst that group.

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

Yeah, so it was $2.7 million.

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

Yeah. With regard to Venoco, as a reminder, this is our Denver-based E&P company with assets in Southern California. The company entered a bankruptcy process during the quarter and actually has emerged subsequent to quarter end. Our valuation takes into account all inputs each and every quarter, and the prospect for bankruptcy was accounted for last quarter and ultimately I still feel similarly with respect to the company's prospects. And again it’s also worth mentioning the oil price environment obviously improved slightly over that period of time. But I would answer that question by saying, all the information is reflected each and every quarter. And then…

And I think on our structured product, when we look at it, remember we're not in the broadly syndicated CLO market. So we’re middle market. Our CLOs have performed very well, and our reg cap trades have performed very well. What you will see is – and I think as I mentioned in our dividend, so we're getting the same cash flows out of these CLOs, but as we look out and as you value these on a quarterly basis, if the default rate we believe is potentially going to go up, you take that cash flow that's coming in, put more toward the cost of your investment versus the yield you're bringing in. And so that's a level yield accounting process. And on so we've been very comfortable doing that and I think it’s a better way to look at investment.

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

Well, so the PACE investment has been a really good one and we continue to have like an ongoing commitment with the originator of those loans to continue to take advantage of what they’ve created. So we will definitely see that through. In terms of doing that doing that further, we have some options to do that further with them. It wouldn't fit into the core strategy we have going forward. So we don't want to give up that option if we think it makes sense or if there's a way to monetize it in some way, but in terms of replicating that with a new originator that is not part of the core strategy going forward.

Got it. That’s it for me. Thank you.

Your final question comes from the Rick Shane of JPMorgan.

Hey, guy. Thanks for taking my questions this morning. I'd love to – and maybe I've done this so long, I'm a little bit of a historian at this point, but love to walk back through the strategy over time for Apollo and think about where we stand now and make sure we understand. When I think about it, Apollo was originally an alternative to the 144A market as a principal as opposed to an agent in the space. Then as that evolved, moved more into liquid loans. And the last transition we saw in management was back in 2012, and the transformation that the company has gone through over the last four years is basically a recognition that you were paying up for liquidity on loans that you were going to hold to maturity. So you were giving up yield for liquidity, but never actually claiming to advantage of that liquidity. And so the shift over the last four years has been into less liquid loans, and I suppose a little bit further down the capital stack. Is what we are hearing today a move really up the capital stack? I just want to put this all in a historical context.

Sure, Rick. I think what you're hearing us – so I wouldn't argue or take issue with what you have laid out in terms of what the past was in terms of what we are taking. I think what you're hearing us say today is we find ourselves confronted in 2016 with a track record that generated a lot greater volatility to our NAV than we liked in retrospect. And now we find ourselves here with two attributes that we didn't have a couple of years ago. We have the exemptive order across our platform and we have an embedded origination team with mid-cap that really allows us to not just be one of 20 out there, but be one of just a handful that actually has a lot of feet on the street and has a client track record with sourcing that capital. So in combination with the exemptive order and the mid-cap capabilities, we also recognize that you’ve got to do the math on these vehicles and reaching for yield in a lower rate environment has not been proven the path to success. So in acknowledging what the environment is in terms of overall yields and overall ROEs what we think is a realistic ROE for this asset class is somewhere in the mid-to-high 9%s. If you book assets, as Howard said, its plus or minus 10% with a little bit of financing that we have on and then the overall predictable or expected credit losses, we think that's a much better strategy in terms of trying to fulfill the objectives that we have long term. So you are right in pointing out that we have not had one consistent strategy from day one. It has changed, but certainly the board and the management team believe this strategy now is what makes sense for us. And without an exemptive order and without the mid-cap portfolio, for us wanting to really lead into corporate loans, we would have been a follower rather than a leader, and I think we wouldn't have had as broader front-end funnel and we would have been competing on terms that really were not a little bit of not the proper portfolio that we wanted to create. So now we're at a point in time in 2016 where we have the exemptive order, we have the mid-cap, we’re recognizing the environment, and you put that all together, that was leading our pathway today. And I think that some of you some of you folks out there have published extensively on this in terms of what is the right ROE, what is the right dividend policy, and certainly we believe that we're on a pathway going forward that acknowledges all those issues as well it takes into consideration the attributes that we have today.

Got it. Okay. That's helpful. And again, I'm going to make two comments, and one will probably be perceived a bit as a compliment and the other may be perceived as a criticism. In 2012, and I can't remember the timing if it was March quarter or June quarter, the manager made a substantial investment in the company at NAV when the stock was trading substantially below. And in my experience, that stands out as one of the more stand-up things that we’ve seen along the way across the companies that we follow. In the following four years, AINV has lost money in roughly half of the quarters. It has, I will point out, had it generated a profit over that time, but it has lost money in more than half the quarters. At the same time, you guys have modestly tweaked management fees, you've tweaked incentive fees. But it doesn't seem like the concessions over the last four years are necessarily as maybe generous might not be the exact right word to shareholders as what you did four years ago. I realize that you're not necessarily in a position right now where infusing capital makes sense. What are the alternatives to support shareholders in the way that you did four years ago?

Well, I think certainly not only the announcement but the execution of our buybacks, we think you know a lot of folks in our field have announced buybacks, few have executed them. We've executed to date and we continue to believe that we're going to execute going forward. I know that the AINV board is excited about fulfilling its program, and certainly when we get to the end of that, I wouldn't be surprised if they exercised another program that would be consistent with their overall view. You’ve heard us put forth what AGM is doing in terms of their buyback program and I think the acknowledgement of bringing these resources together. So we're looking forward now. We're looking forward in terms of the environment that's put in front of us, and trying to achieve the objectives of the environment in terms of yields, what's going on in the yield compression, and our board looks at all these attributes in thinking about the relationship that we have with the company and with the manager. So in our view it's hard to look at any one quarter in a vacuum. You need to look at the breadth of the relationship, and I think we're on the right path going forward.

Okay, great. Hey, Jim, thank you very much.

Thank you, Rick.

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

Great. Well, first of all, thank you all for participating this morning, a lot of good Q&A, Elizabeth and Greg and the team have the supplement, but certainly we look forward to spending time with all of you in person or on the phone and look forward to that continued dialog. So thank you very much.

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