MidCap Financial Investment Corporation (MFIC) Q3 2019 Earnings Report, Transcript and Summary

Good afternoon and welcome to the Apollo Investment Corporation's Earnings Conference Call for the period ended December 31, 2018. At this time, all participants have been placed in a 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. Speaking on today's call are Howard Widra, Chief Executive Officer; Tanner Powell, President and Chief Investment Officer; and Greg Hunt, Chief Financial Officer. I'd like to advise everyone that today's call and webcast are being recorded. Please note that they are the property of Apollo Investment Corporation and that any unauthorized broadcast in any form is strictly prohibited. Information about the audio replay of this call is available in our Earnings Press Release. I'd also like to call your attention to the customary safe harbor disclosure in our Press Release regarding forward-looking information. Today's conference call and webcast may include forward-looking statements. Forward-looking statements involve risks and uncertainties, including, but not limited to statements as to our future results, our business prospects and the prospects of our portfolio companies. You should refer to our registration statement and shareholder reports for risks that apply to our business and that may adversely affect any forward-looking statements we make. We do not undertake to update our forward-looking statements or projections unless required by law. To obtain copies of our SEC filings, please visit our website at www.apolloic.com. I'd also like to remind everyone that we posted a supplemental financial information package on our website, which contains information about the portfolio, as well as the company's financial performance. Please note that all share and per share data discussed on today's call have been adjusted for the one-for-three reverse stock split, which was completed during the quarter. At this time, I'd like to turn the call over to Howard Widra.

Thanks, Elizabeth. I will begin today's call by providing a brief overview of our financial results for the quarter, followed by an update on the execution of our derisking investment strategy. I will then discuss a couple of business highlights. Following my remarks, Tanner will discuss the market environment, our third quarter investment activity. And we'll provide an update on credit quality. Greg will then review our financial results in greater detail. We will then open the call to questions. Let me begin with an overview of our financial results for the quarter. Net investment income for the quarter was $0.45 per share. Net asset value was $19.03 at the end of the period, a decrease of 1.9% quarter-over-quarter. The decline in NAV is primarily attributable to certain non-core assets on our quoted positions given the selloff in liquid credit markets in December, partially offset by the accretive impact of stock buybacks. Moving to an update on the execution of our investment strategy, we continue to derisk and reposition the portfolio through active management and opportunistic sales, reducing our exposure to concentrated positions and non-core assets, and shifting the portfolio into higher quality, lower risk, true first lien diversified corporate loans sourced by the Apollo Direct Origination platform. We continue to proactively manage position size and concentration risk as evidenced by the downward trend in our average position size. Our ability to co-invest with other Apollo entities continues to be an advantage allowing us to compete with other major market participants. The Apollo platform is able to win deals based on size and certainty of execution, while at the same time allowing AINV to maintain its desired hold size. In addition, we continue to avoid capital in life sciences, asset based lending and lender finance, areas with significant barriers to entry and in which mid-cap financial has expertise. Since receiving our co-investment order in 2016, the platform has made over $8 billion of commitments, of which AINV committed to 22% or $1.8 billion of this amount. During the quarter, we invested $221 million, excluding revolver activity across 28 companies, $162 million or 73% in 12 new portfolio companies, $58 million or 27% in 16 existing companies. Consistent with our strategy, new investment activity focused on first lien term loans, backing sponsors with proven track records. A 100% of deployment was floating rate, 94% was first lien and 84% was in investments made pursuant to the co-investment order. Sales and repayments totaled $213 million excluding revolver activity, resulting in net investment activity of $8 million. In addition, net revolver funding totaled approximately $8 million. And we had a net repayment from Merx of $1 million during the quarter. We ended the quarter with core assets representing 80% of the portfolio, up from 78% at the end of September and compared to 74% a year ago. Non-core assets decreased to 16.7% of the portfolio at the end of December, down from 18.3% at the end of September, driven in part by receipt of $17.6 million of cash from the return of capital from two of our oil and gas investments, and the partial sale of one of our remaining structured credit investments. In addition, at the end of December, investments made pursuant to our co-investment order represented 35% of the total portfolio and 59% of the corporate lending portfolio. Moving to other topics, we completed the one-for-three reverse stock split during the quarter. The reverse stock split took effect at the close of business on Nov 30 and AINV began trading on a split adjusted basis on December 3. The selloff in the equity market did present us with what we believe was an attractive opportunity to repurchase our stock. We consider stock buybacks below NAVs to be a component of our plan to deliver value to our shareholders. Since the inception of our share repurchase program and through the end of December we have repurchased $166.1 million or 12.3% of the initial shares outstanding, which has added approximately $0.56 to NAV per share, which is again adjusted for the reverse stock split. As you've seen in today's press release, we are pleased to announce that our Board has approved another $50 million share repurchase plan, which brings the total authorization since 2015 to $250 million, of which $83.9 million remains available. We intend to continue to repurchase our stock should it continue to trade at a meaningful discount to NAV. Turning to other announcements, as you have seen in mid-January, we filed an 8-K announcing that Gary Rothschild, the President and Chief Executive Officer of Merx, our aircraft leasing portfolio company, became an employee of Apollo Global Management, while retaining his roles as President and CEO of Merx. Let me provide some color regarding this move and the benefits to AINV. As you're aware, given AINV's large concentration in aircraft leasing, we have been selectively recycling our capital within Merx and building out our servicing capabilities over the last couple of years. During this time, Merx has also successfully sourced transactions for other Apollo funds, which generate servicing fee income for Merx. In order to maximize our value in Merx, we believe it was necessary to improve the connectivity between Merx and Apollo, thereby enhancing Merx's ability to source transactions for the entire Apollo platform and availing itself of the opportunity to access Apollo's fundraising capabilities. AINV will benefit from a fee offset against fees due to the company's investment advisor, under the investment advisory management agreement. The fee offset agreement is included as an exhibit in the Form 10-Q we filed today. The amount of the fee offset will be 20% of all fees earned by Apollo in connection with managing new investments in aviation assets covered by the agreement. We do not expect any fee offset from this agreement in the near and medium term, as no capital has been raised. Over time we believe this arrangement will allow us to reduce the concentration of aviation assets on AINV's balance sheet while retaining earnings through increased servicing income and the fee offset. Turning to our distribution, the Board has approved a $0.45 per share distribution to shareholders of record as of March 21, 2019. With that, I'll turn the call over to Tanner.

Thank you, Howard. Beginning with the current market environment, as you are aware, during the quarter the leverage loan market was negatively impacted by record breaking retail fund outflows and an increase in risk aversion. The middle market, while not immune, is generally insulated from broader credit market volatility and typically reacts with a lag to the changes in the liquid credit markets. Accordingly, we saw little to no impact of dislocation in the private debt market, which remains highly competitive primarily due to the tremendous amount of capital being raised for direct lending, which is estimated to be a record $85 billion in 2018 according to data from Refinitiv. This capital formation has led to the continuation of a highly competitive borrower friendly market, where most deals continue to have aggressive structures in pricing. Against this competitive market backdrop, we are focused on opportunities to capitalize on Apollo's scale and areas of expertise and that can also take advantage of our ability to co-invest with other capital managed by Apollo. Turning to our investment activity, we funded approximately $221 million during the quarter, excluding revolver activity. Although, the reduction in our minimum asset coverage ratio will become effective in early April, the investments that were made in our core strategies during the quarter were consistent with the reduced risk profile we are targeting for incremental assets. The weighted average yield on funded debt investments made was 9.3% and the weighted average spread of new debt investments was 647 basis points within our target range of 500 to 700 basis points for incremental assets. So weighted average net leverage of investments made during the quarter was 4.9 times, within our target range of 4 to 5.5 times for incremental assets. Co-investment activity accounted for 84% of funded activity in our core strategies during the quarter, including U.S. Legal Support, [GNG Crust and MY COM] [ph] among other investments. Sales totaled $16 million in repayments, excluding revolver pay downs totaled $197 million. Sales included half of our investment in Craft 2015-2, our only remaining structured credit investment. Repayments included our $80 million investment in the U.S. Security, which eliminate our exposure to unsecured debt and our $30 million second lien investment in Smokey Merger Sub AKA SmartBear. As previously mentioned, we also saw a partial repayment from some of our non-core investments, including Pelican energy and Glacier Oil and Gas as well as some of our second lien investments, including grocery outlet and [Digitser] [ph], and the full exit of our investment in [Comfis Euros] [ph]. The weighted average yield on debt sales and repayments was 10.4%. In addition, net funding our revolvers for the quarter was $8 million. Now let me spend a few minutes discussing overall credit quality. Our first lien debt investment in Crown Automotive was placed on non-accrual status. As mentioned on our last call, AINV's participation in the credit was part of a larger commitment made by the Apollo opportunistic group. The company is in the process of selling its various businesses and our market based on the expected recovery - and our market is based on the expected recovery from these six. At the end of December investments on non-accrual status represented 2.8% of the portfolio fair value, up from 2.6% last quarter and 3.4% at cost up from 3.2% last quarter. Moving on the risk profile of our portfolio is measured by weighted average leverage and interest coverage were unchanged quarter-over-quarter. The current weighted average net leverage of the portfolio remained at 5.5 times and the current weighted average interest coverage remained at 2.3 times. Let me provide some additional data, which we believe shows the health of our portfolio company. The corporate lending portfolio saw revenue growth of 7.7% and 8.5% quarter-over-quarter and year-over-year respectively. Similarly, median adjusted EBITDA growth was 7.5% and 7.2% quarter-over-quarter and year-over-year respectively. As you can see revenue growth is outpacing EBITDA growth, which is partially due to acquisitions. With that, I'll now turn the call over to Greg, who will discuss the financial performance for the quarter.

Thank you, Tanner. Revenue for the quarter was $64 million, down 3% quarter-over-quarter, primarily due to lower recurring interest income and lower prepayment income partially offset by higher dividends and fee income. Recurring interest income declined due to a lower average portfolio given the timing of investment activity in the quarter as well as the placement of one of our investments on non-accrual. Dividend income increased quarter-over-quarter due to higher dividends from both Merx and MSEA. Prepayment income was approximately $2.9 million in the quarter compared to $3.6 million in the September quarter, and fee income was $3.8 million double the prior quarter. Expenses for the quarter were $32.6 million, down 4% quarter-over-quarter, primarily due to lower management fees, lower interest expense and lower G&A. Management fees decreased due to the lower average portfolio balance. Interest expense decreased due to a decrease in the average debt outstanding balance, partially offset by the movement in LIBOR. Incentive fees increased slightly quarter-over-quarter, as the prior period included the reversal of $1 million of incentive fees related to PIK income. The incentive fee rate for the quarter was 15%. Moving on net investment income with $31.5 million or $0.45 per share for the quarter. This compares to $32.2 million or $0.45 per share for the September quarter. The net loss on the portfolio for the quarter was $32.7 million or $0.47 per share compared to a net loss of $4.1 million or $0.06 per share during the September quarter. Negative contributors for the quarter included oil and gas investments and our renewable energy investments. The impact in NAV per share from the net loss on the portfolio was partially offset by the accretive impact from stock repurchases during the quarter, which totaled $0.10 per share. Net asset value per share was $19.03 at the end of the quarter, down 1.9% quarter-over-quarter. Turning to the portfolio composition. At the end of December, our portfolio had a fair value of $2.3 billion and consisted of 103 companies across 24 industries. First lien debt represented 64% of the portfolio, second lien debt represented 24%, structured products 3%, preferred and common equity approximately 9%. As previously mentioned, we exceeded our exposure to unsecured debt during the period. The weighted average yield on our portfolio at cost remained at 10.7% is the impact from rising LIBOR was partially offset by lower yields on new investments. On the liability side of the balance sheet, we had approximately $994 million of debt outstanding at the end of the quarter. Our net leverage stood at 0.74 times at the end of December compared to 0.68 times at the end of September. As previously announced, we amended, extended and upsized our senior secured revolving credit facility in November. The amended facility lowered the asset coverage requirement from 200% to 150%. This amendment follow the passage of the Small Business Credit Availability Act in March, and our board's approval of the modified asset coverage requirement for the company in April 2018. Our reduced asset cover requirement will become effective on April 4, 2019. In addition, we extended the final maturity of the credit facility by approximately 2 years and increase commitment by $400 million to $1.59 billion for both new - from both new and existing lenders. There is no change to the borrowing costs in connection with the amendments. We greatly appreciate the support from our lending community in this important amendment to our facility, which allows us to continue to shift our portfolio mix to more senior first lien floating rate loans sourced by the Apollo Direct Origination platform. Lastly, regarding stock buybacks we repurchased approximately 1.5 million shares in an average price of $14.73 adjusted for the reverse split, for a total cost of $22 million during the quarter. Since the inception of their stock repurchase program, we have repurchased 9.7 million shares or 12.3% of our initial shares outstanding, adjusted for the stock split, for a total cost of $166 million. The company now has approximately $83 million available for stock repurchases, which includes the recent $50 million increase announced today. This concludes our prepared remarks and we'll open the call to questions.

[Operator Instructions] Your first question comes from the line of Rick Shane with JP Morgan.

Hey, guys. Thanks for taking my question this afternoon. Look, you guys described an environment - a market environment that is pretty stable for middle market loans during the fourth quarter. I am curious as you sort of entered 2019 and we've seen the volatility, but we're also in an environment, as you point out, where there's a lot of capital inflows and there is going to be a turn to leverage to - for the BDC industry. How you think about the competitive framework? Should we expect further spread compression? And is there more room for sort of compression of deal terms as well?

I think we had reached a point putting aside the couple of weeks at the end of December, which actually really didn't sort of strike the liquid market all that much, where things had compressed pretty far and deal terms had widened a reasonable amount. And I would not expect that to improve from a lender's perspective. But I don't know if I would expect it to get meaningfully worse for a few reasons, in that a significant amount of capital has already come in, including the BDCs that are investing, either because their leverage has been proved to go up or they expect it to go up. And there's just been a enough capital formation to meet most of the needs already. And more so, there is sort of a natural end to how aggressive they could get, because companies have to be able to service their debt. So I don't know if I expected to get meaningfully worse for lenders. But I don't necessarily expect it to get better until there is a longer term disconnect in the market than a couple weeks at the end of December.

I'd add one thing to that, Howard. And if you think about while the volatility perhaps did not percolate to the deals that we were competing on, we are hopeful - if you think about it in the context of the middle market, in particular the upper middle market, where opportunities had been crowded out to a certain extent by banks underwriting. And we're hopeful that some of this volatility will influence banks and make them more reticent to underwrite the $200 million to $500 million term loans, which would otherwise getting syndicated to CLO buyers and the like. But on a go forward basis had the opportunity be taken down by private lenders such as ourselves, enhance our opportunity that way. But other than that, I would echo Howard's comments that we did see some amount of stabilization in terms of spreads in 2018, things remain competitive and we don't forecast a material change, tightening or widening as it relates to our core of middle market business.

Got it. Okay, that's helpful. And look, you can make bad loans in good environments. You can make good loans in bad environments. You are in a position over the next 12 to 24 months where you have - you will have a great deal of capital to deploy. Talk about sort of strategically how you will approach that, because again in the spirit of you can make good loans in tough environments.

Yeah, so let's talk about portfolio composition first. So the first thing we focus on is obviously, as we said being much more granular and from a portfolio construction basis and not to have concentrated positions in any sort of given industry or something like that. So let's assume we continue on that path, so we then - we've taken out sort of single credit event risk for our performance. I think our focus is in the way we think about projecting our performance going forward outside or non-core assets is we have a certain set of loans that are more proprietary asset base loans, life sciences loans, lender finance loans, which over our long history of doing those loans have very low loss given default. And so for us, we don't feel like this market has changed that. It may be more competitive. There may be some price pressure at times, but credit terms don't really reflect all that much in those product areas. And so to the extent we have those loans we would expect credit losses to stay about the same. So then the next thing is, well, what does the rest of the portfolio look like, what are we doing today to try to ensure that our losses are within a band. And if you if you looked at what we were doing today, almost - not all, but almost all of our first lien loans that we've done over the last three quarters have covenants. And so - but the average leverage on a senior debt basis is on the high end of where it is on the continuum of recycle, both because there's more senior stretch getting down and also because leverage is pushed up. So if you looked historically at middle market loan loss given default rates, it's in the - I don't know - 20% to 25% range. And I think now it's more realistic to sort of think those will be 30% to 35%. So if you model that, so assume we're no better or worse than the market. We hope and think we're better. Our track record has been better. But we need to prove that, but assume we're at market levels, and assume default rates go up like they do in a normal recession to something like 5% or 6%, if you have 30% loss as you're talking about 1.8% of those assets over an extended period of time and you blend that with our proprietary assets that don't have a whole lot of losses, that's how you get into sort of very measured loss rates that we guided people to. Hopefully, that wasn't too much math.

No, that was great. And I appreciate your willingness to take on the strategic question. And I also appreciate the intellectual honesty of differentiating almost all in all, because we know that we're not in the world with absolute true. I appreciate that.

Sure.

Your next question comes from the line of Kyle Joseph with Jefferies.

Hey, afternoon, and thanks for taking my questions. Just related to the unrealized depreciation in the quarter, how much - can you give us a sense for how much of that was just 12/31 marks versus company specific issue and just trying to essentially see how much of that you would have gotten back already.

Well, so I would say, yeah, like I'm - so I'm trying to clear out the numbers. We had a 10% positive impact from buybacks, right. So if you clear that out and you say there's $0.40 negative impact from marks, about three quarters of that was from volatility either in the liquid markets as you're asking or in the oil and gas, which is the result of the value of the commodity, which was also down. I can't say even though the market is fully recovered, all those marks are fully recovered, because oil is a little bit different and it's based on sort of certain curve. But basically, three quarters of the write-down was attributable to things that have to do with the change in the value of the assets based on short term volatility. I just don't know if they're all going to return exactly at the same levels they went down, because obviously it's hard to predict and obviously we don't know where it will be March 30. But it's about three quarters of everything was related to non-credit related unrealized loss.

Got it. That's helpful. And then just one other one, Greg, I know you touched on this a little bit, but just looking for a little bit more color on the interest income decline Q-on-Q. How much of that was related to the sale of - I think you guys sold a $80 million sub-debt P. How much of it was timing? And then I think the other thing was the non-accrual. I think you'd kind of give us a sense for how each of those…

The non-accrual - right, so the non-accrual was very relatively minor. For the quarter, it was just the investment activity. We had - basically the $80 million with U.S. Security it was basically repaid in October, if you think about our average position size, which is less than 20, I mean, you have to replace it with four other positions. And a lot of that activity ended up being after Thanksgiving, between Thanksgiving and December 15. So you can kind of really barbelled in the quarter, the activity, and that just drove. So I mean it literally is just a function of that, nothing more.

Okay. Got it. Thanks a lot for answering my questions.

Your next question comes from the line of Chris York with JMP Securities.

Good afternoon guys, and thanks for taking the questions. So the questions on valuation, so in reviewing the valuation inputs in your first and second lien loans for Level 3 investments in the Q. It appears the discount rate for both the yield and DCF valuations were unchanged, despite the spread widening. So the question is, I'm curious, how are you viewing the spread widening in the liquid credit markets? Are you viewing it almost entirely as liquidity driven and then not applicable to the valuation of the middle-market loans?

Yeah. So thanks for the question. A couple comments there, the first would be, when - those inputs when we look at the liquid market certainly we did not tighten things down as things were compressing over the last 18 or so months. And so there would not be the same volatility on the widening side, owing to the fact that that was not fully calibrated in our valuations. And then the second point would draw on some of the comments that I've made in the prepared remarks with respect to the illiquid private debt senior loans don't have that same amount of volatility, and while we are cognizant of the moves in the liquid markets, it is not as influential and how we think about valuation. And then the other point, I think that you referenced in your question is, we agree and I think some of the recovery that you've seen not a full recovery in the year-to-date period bears out that at least a portion of the decline was a function of the liquidity of the market, and hence, to some extent temporary.

Got it. Okay. That makes a lot of sense. And then just a couple other questions. Is a new buyback program at 10b5-1 or is it more of a self-tracted open market purchase program?

We could - it depends on the portion in the quarter, right. We basically have both of them. We have a 10b5-1 in place for when we don't have the window open, when the window closes.

Okay. And then, when the liquid markets froze throughout the quarter, did sponsors increasingly turn to you? As Howard said in your prepared remarks as a result of your certainty of close and essentially kind of reinforce the franchise value in your direct lending platform?

Yeah, I mean it was a pretty narrow window towards the end of the year, when a lot of people weren't. So I think it was hard to see that yet. You certainly saw on deals that needed to get executed right, then people are looking for a little bit more certainty. But the - sort of the sales cycle for middle-market loans. It's different then when the big underwriters come to the market and price changes immediately when - if you committed to a sponsor to a certain deal on December 5, you can't see the market's changed and not do that if you want to stay in the market. By the same token if you say on December 20, here's the pricing, because the markets wind out. By January 15 and the market is back, they'll sort of call seven other lenders and move you back. And so I just - it was just too short a window.

Yeah. Did that change at all in January anything? I mean…

Well, somebody - so I would say our pipeline is good right now. I do think that there are a few more opportunities in that pipeline that are related to deals that could be executed broadly. So that would be my indication they don't come from sponsors indicating clearly that they feel concerned about things, because that's not what they do. They always come from strength, even when they're not strong. But we have seen a few more of those deals. So I think people are still a little bit aware, especially if they have like an [HSR filing] [ph] or something's going to extended timeframe. So they're taking more market risk. They are still, I think a little more skittish than they were in November.

Got it. Excellent. That's it for me. Thanks, guys.

Your next question comes from the line of Finian O'Shea with Wells Fargo Securities.

Hi, guys, good afternoon. Thanks for taking my question. Can you first just kind of walk us through the logic on the new arrangement with Merx, appreciating that you're constructing those economics on balance sheet given they may be a bit volatile going forward. Why not set up just sort of an advisor, an RIA, and have that perhaps grow and - or ebb and flow and invaluable over time?

So we look at every alternative in terms of sort of what are the options. There are some potential sort of regulatory hoops you have to jump through and set up an RIA. But let's just put that aside for a second. The question is do you want to set up an RIA or do you want to set up an asset management function at Marx and raise money and have the costs and stuff. The cost and the infrastructure and the challenge related to that. And what are the economics to that versus doing it in sort of effectively like a JV like way we did with Apollo, where we take advantage of not only their reach, which we sort of have anyway as part of Marx, but more directly as well as all the cost being absorbed by them. So if you look at the amount of assets you have to raise, in order to make as much money as we would make by just having a gross revenue share from €1. It was a relatively no brainer on the asset management side. And that doesn't even include the fact that if we raise more money in that way, and there's a bigger platform we generate a lot more servicing income too. So it was actually sort of a win-win, we don't have to put any money out. And we're totally aligned with somebody who can really raise money who's directly focused on that.

Thank you. That's really helpful. Next question for Greg, looking at the pretty impressive commitments on the facility especially during this quarter, can you kind of talk about the sort of breadth of new entrants or was this increase in commit from your existing bank base? Or did you kind of expand, say, with non-U.S. banks abroad, et cetera? Any color you can provide there.

It was actually very successful not only did we get increased commitments from existing lenders. But within a facility that probably has 15, 16 lenders we added another five lenders to it. It's a very broad - broadly marketed. I would say to you that it really shows the power of the Apollo platform and that people wanting to participate not only in our facility they participate in the mid-cap facilities, but also part of Apollo, and Apollo in raising their own capital. So it's really a reflection of being part of a larger platform, where we can take advantage of the relationships that we have there.

Thank you. And one more small one if I may just going to the Q. It looks like you may have allowed the energy puts to roll off. Correct me, if I'm wrong, and why the change in approach there? Or are these positions small now or is this a market call?

It sort of either - they were small, they were winding down and fading off. And I think we have all been sort of - there have been a mismatch between how they performed in the way the underlying investments performed. And so over the time with which we had those hedges we have sort of increased our - increase the pressure that we put on the companies make sure that they were hedge appropriate at their level. And so when the oil drop down, we just see - we exit at a time when we could sort of mitigate some of the loss in this quarter. And just have the hedges done at the really the two company level - the two companies that we have remaining other than small.

Okay. Thank you so much.

Your next question comes from the line of Terry Ma with Barclays.

Hi, I just want to follow-up on Merx, and just wanted to understand correctly. But it sounds like you want to grow your servicing revenue from Merx well over time, between lease and revenue and exposure the just leased aircraft. Is that correct?

Yeah, I mean, we like our lease exposure. We would like Merx to be about 10% over the long term of our overall portfolio. Some of that will happen by virtue of our portfolio growing, as we increase leverage and some of that will happen by having sort of more money that we can utilize to invest in these planes, where we generate good income often. So the servicing income really allows us to sort of move that portfolio down, while retaining sort of the outsized earnings from the capital involved there. So it - but again, I mean, we're deemphasizing leasing and we still will have as an important pool of capital for Apollo, access to do whatever transactions we like. So we expect continue to invest in the aircraft space, but we have an overall view as to I think a lot of the investors in our platform. That it's more appropriate for this to be closer to 10% because of the 20%.

Got it. And so just in terms of the return profile of Marx longer term, is servicing plus leasing mix comparable to what you're earning just leasing out of Marx right now?

Well, right. It depends on how much servicing we get. Servicing has an unlimited return on capital, right. Because it's just so the answer is if we raise a - if we are successful in building out this third-party asset management platform. In a way, we believe we can be, but which will take some time and work. We will have a servicing platform that will replace the earnings that we're losing by shrinking our leases. So in other words will be earning as much money on less capital that's sort of the ultimate goal, but there's execution to be done and that doesn't mean that there isn't a gap in timing, when we're building up the servicing [we've shrunk the] [ph] leasing. But the goal would be - I mean, you could think about it differently, you could just say, okay, you're going to have a leasing platform that's three quarters as big. And that's been around the same returns on a percentage basis before and you're separately going over servicing company that just make money. That's sort of probably more how we think about it.

Okay. That's helpful. Thank you.

[Operator Instructions] Your next question comes from the line of Robert Dodd with Raymond James.

Hi. So kind of almost following up to Rick's question at the beginning where it was a lot of information you gave us about the market environment. My question is about how much embedded excess spread remains in your portfolio today. Obviously the current markets spreads stay flat now. But when we look at your deployments at 9.3% versus repayments 10.4%, right, some of your older assets on the books higher spread that coming often the markets competitively tied up plus the fact obviously the first lien still rising, a year ago it was 50% today at 64%. So there's some excess spread embedded in the co-earnings today maybe from a question of older vintage and portfolio mix. So when that all normalize is out. How much would you think not on a like for like versus the markets? But today being stable, but how much excess that is embedded in the portfolio today given the vintage and mix dynamics over the last several years?

I think, one way we can answer the question, and I'll refer to our earnings presentation. But important piece of our strategy as we get the increase in leverage is to overemphasize or deploy in a more pronounced way in the first lien versus second lien. And on that page it's actually Page 12, we quote within our corporate book. What the average spread is for second lien versus first lien, and first lien being 650 and second lien being roughly 850. And so if you think about as we replace assets, and in fact this has been quite a bit in the current quarter where deployments were disproportionately in first lean, I think the number was 94%. And the exits were a sizable portion of which was second lien, and that's one, I think directional that's - as changeable of data as we can give you with the assumption that we're originating at kind of that same 650 and the roll off will disproportionately be the second lien as we choose not - or choose to deploy less in the second lien on a go forward basis.

Just to put a little math on it, I mean, we have continually sort guided I think for the past 18 months to say, we - as we ramp up our portfolio going to 10% yield. And we believe that we can have the type of coverage that people want to see at a ramped portfolio at 10% yield. We are still now at 10.7% or between 10.6% and 10.7%. And if you look at our portfolio you would say we have - we don't have that much excess yield in there. So there's some question. The reason why there's some cushion is because LIBOR has moved. So we continue to believe that we can have this rotation with more current things and remain above the 10 that we've guided. That's sort of I think how we think about it long term.

Got it. Got it. And on just the second question, tied to exactly that LIBOR move, right, if we look a quarter ago the forward LIBOR curve went into the mid-3, well, low-3s by the end of this year. The forward curve now is barely above mid-2s, 2.5, 2.6. Is that, A, affecting your target of 10%; B, having any effect on market dynamics so if it might be much more willing to compress spreads a little bit if I thought I was going to pick up 50 basis points in LIBOR versus if I think I'm not going to pick up 50 basis points in LIBOR, so any impact on you and/or market from the shift in the curve?

It's hard to say, because there's lots of inputs, right, in the market than just this. What I would say is I don't personally feel like spreads have changed as much versus LIBOR versus sort of liquidity being built in the market. In fact, spreads have held up better than leverage in terms. If you put those in categories - the increase in LIBOR helps everybody. Most people have spent that or - I shouldn't say most people. A lot of people had spent that by moving more to first lien, that's sort of how we spent. And so, it's sort of - it basically subsidizes that strategy in a way that's pretty meaningful and that's how I would sort of view it as you know what it's done. It's moved more money into first lien. So really if you look at the market and say, there's a lot more stuff getting done senior stretch by BDCs if you will, than first lien from a bank and second lien by BDCs. Basically, people have sort of moved into sort of taking $1 risk.

Okay, appreciate it. Thank you.

Your last question comes from the line of Christopher Testa with National Securities.

Hi. Thanks for taking my questions. Just, Howard, if you could comment on Mr. Rothschild joining from Merx, whether we should expect potentially more total aviation exposure, but a greater diversification of maybe aviation companies. And if you don't mind, a bit on Terry's questions too, could you just provide a breakdown generally on Merx and servicing for first leasing income there?

I'll answer the first part then I'll have Tanner answer the second part. We don't think there's any change with regard to how Merx operates and runs. Gary continues to be the CEO of Merx. We expect to try to augment our activity over time in the aviation space with raising more third party money. And then over time, therefore, probably have less invested there. It may be spread over more planes, because we'll take more pieces and more transactions. But it's pretty diversified already. So I think we just view it as enhancing the income streams. We now have leasing income. We have asset management income we'll share in over time. And you'll have increased servicing income. I mean, in terms of where we are today.

Yeah, yeah, I'd say - I'd make few comments there. The first of which is the servicing revenue doesn't drop all the way to the bottom line. We've had to invest heavily in the platform to build up technical resources to actually perform the services. So there's a cost component to it in any event. Secondly, the second point I'd make is that, we are in the early stages of transitioning. And in fact there's a portion of our existing book, where we are not the servicer. And so over time, what we do in the existing [Merx] [ph] balance sheet and/or by taking over those servicing responsibilities, we would expect that to be accretive. In a given transaction, it could be a handful of percent low, kind of 2% or 3%, and at current juncture owing to the fact that we're in the process of hiring –we've hired the infrastructure to perform such services. And we are not servicer on all our planes. And at this juncture, not for trades or investments that are done at the Apollo balance sheet. It is relatively modest in the handful of $1 million per year.

Got it. Okay. That's really good color, Tanner. And would you say so the vast majority of the existing books are not the servicers, so there is a really good runway for growth there?

No, I'd say, it's probably above 50% at this juncture. So it's not a huge opportunity. But again, I would calibrate everyone to that. It's early, and as I alluded to, and so the risk of being redundant, there has been costs assumed as we've built up the expertise in order to perform such services.

Okay. Got it. Thank you. And obviously, this was a big quarter for originations, not just for you guys, but generally the direct lending market across the Board. Just wondering, do you think that any borrowers were kind of rushing to get things in before the New Year and pull the new volume from the 3/31 quarter or are you still seeing the same sort of amount of activities so far in the quarter?

Yeah, we, I mean, I think it's anecdotal for us. We had a few significant transactions spill over. So we didn't have the opposite. So, no, we did not see that.

Got it. And how did the technical marks from spreads widening impact your mid-cap assets versus the more legacy higher yielding assets, kind of what was the differential in marks there?

Yeah, well, so that was sort of what somebody asked before, those all the level 3 assets. And basically, that market didn't change. It didn't change on the ground. And it didn't change with regard to what those assets would have traded by. Put differently, if we would have said those assets market 99 and now worth 98.5, and ask people to buy them, everybody we compete with would have bought them all. And we would have bought them from them. It just wasn't what drove values for that short period of time. So obviously the totally liquid names are marked in a different way. They're just marked by a quote. The truth is you couldn't buy them at those quotes either, like the - they were quoted there, but there wasn't a lot of volume there. So the level 3 names didn't change in value much. I think you'll see that. I would be surprised if you don't see that throughout the BDC universe, not a whole bunch of movement.

Okay. Got it. That's helpful. And that's all for me. Thanks for taking my questions.

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

Thank you. On behalf of our team, we thank you for your time today and your continued support. Please feel free to reach out to any of us, if you have any other questions. Have a good night.

This concludes today's call. You may now disconnect.