Saratoga Investment Corp. (SAR) Q3 2017 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Saratoga Investment Corp.’s Fiscal Third Quarter 2017 Financial Results Conference Call. Please note that today’s call is being recorded. [Operator Instructions] At this time, I would like to turn the call over to Saratoga Investment Corp.’s Chief Financial Officer, Mr. Henri Steenkamp. Sir, please go ahead.

Thank you. I would like to welcome everyone to the Saratoga Investment Corp.’s fiscal third quarter 2017 earnings conference call. Today’s conference call includes forward-looking statements and projections. We ask you to refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these forward-looking statements and projections. We do not undertake to update our forward-looking statements unless required to do so by law. Today, we will be referencing a presentation during our call. You can find our fiscal third quarter 2017 shareholder presentation in the Events & Presentations section of our Investor Relations website. A link to our IR page is in the earnings press release distributed last night. A replay of this conference call will also be available from 1 p.m. today through January 19. Please refer to our earnings press release for details. I would now like to turn the call over to our Chief Executive Officer, Christian Oberbeck, who will be making a few introductory remarks.

Thank you, Henri and welcome everyone. This quarter was a very gratifying quarter for us. In addition to continued strong financial results, we achieved two significant objectives by refinancing both our CLO investment in November as well as our existing baby bonds shortly after quarter end. These important steps continued to strengthen our financial foundation and assist in our singular focus and long-term objectives to increase the quality and size of our asset base, with the ultimate purpose of building Saratoga Investment Corp. into a best-in-class BDC, generating meaningful returns for our shareholders. Before we go into greater detail on our fiscal third quarter 2017 results, we are pleased to say that this quarter continued our trend of outperformance and steady growth. Slide 2 highlights some of the continued progress and achievements during the past quarter. To briefly recap; first, we continued the strengthening of our financial foundation this quarter by maintaining a high level of investment credit quality with 96.7% of our loan investments having our highest rating and generating a return on equity of 7.7% on a trailing 12-month basis, greatly outperforming last 12 months’ BDC industry average of approximately 1.1%. Excluding the $5.7 million realized in unrealized losses in our legacy investments, Targus Group International and Elyria Foundry Company LLC over the past 12 months, the return on equity for the last 12 months ended November 30, 2016 was 12.1%. Both Targus and Elyria are legacy investments that predate Saratoga’s management of the BDC. Second, we expanded our assets under management to $278 million, a 15% increase from $241 million as of November 30, 2015 and a sequential increase of 2% from $273 million as of August 31, 2016. Year-to-date, assets under management are slightly down from $284 million, our highpoint at the end of fiscal 2016. From a longer-term perspective, this quarter also reflects a 193% increase or $95 million at the end of fiscal year 2012. In addition, this quarter is illustrative of the success of our growing origination platform. In Q3, we originated investments totaling $30.1 million, which more than offset the repayments of $23.8 million we again experienced this quarter. Our growth in AUM over the past 2 years is evidence of our continued long-term upward trajectory and asset growth despite the significant repayments we have experienced this year and recognizing the originations and repayments can be lumpy when viewed on a quarterly basis. Third, we have recently completed two significant refinancings that are important to our long-term objectives and strategy. On November 15, 2016, we completed the second refinancing of the Saratoga CLO. The Saratoga CLO refinancing, among other things, extended this investment period to October 2018 as well as its legacy maturity date – I am sorry, as well as its legal maturity date to October 2025. Following the refinancing, the Saratoga CLO portfolio maintains a similar size and capital structure to that which it had before, with approximately $300 million in aggregate principal amount of predominantly senior secured first-lien term loans. In addition to refinancing its liabilities, we also purchased $4.5 million in aggregate principal amount of the Class F notes tranche of the CLO at par with a coupon of LIBOR plus 8.5%. And on December 21, 2016, we issued $74.5 million in aggregate principal amount of 6.75% fixed rate notes due 2023 for net proceeds of approximately $72.1 million after deducting underwriting commissions and offering costs. The issuance included the exercise of substantially all of the legal – of the underwriter’s option to purchase an additional $9.8 million aggregate principal amount of 2023 notes within 30 days. The 2023 notes mature on December 20, 2023 and commencing on December 21, 2019 maybe redeemed in whole or in part at any time or from time-to-time at Saratoga’s option. The proceeds from the offering will be used to repay all the outstanding indebtedness under the existing 2020 notes, which amounts to $61.8 million. This issuance of 7-year fixed rate covenant free notes extends the maturity of this part of our capital structure by almost 4 years and reduces interest expense by 75 basis points. Fourth, the continued strengthening of our financial foundation has enabled us to increase our quarterly dividend for the ninth consecutive quarter. We will pay a quarterly dividend of $0.45 per share for the third fiscal quarter of 2017 payable on February 9, 2016 to all stockholders of record on January 31, 2016. This is an increase of $0.01 over the past quarter’s dividend of $0.44 per share. All of our dividend payments have been exceeded by our adjusted net investment income for the same periods. As a result, we are comfortably over-earning our dividend by 13%, which distinguishes us from most other BDCs. Fifth, our base of liquidity remains strong and promises to improve. The new baby bond issuance extends the maturity of our capital structure and reduces our weighted average financing costs. And we continue to have significant dry powder to meet future potential opportunities in a changing credit and pricing environment. Our existing available quarter end liquidity, including the additional $10 million of cash generated from the new baby bonds issuance, allows us to grow our current assets under management by 42% without any new external financing. This incremental investment capacity places us in the leading position vis-à-vis our competitors whose existing capacity averages 8.9%. And finally, on October 5, 2016, we extended our existing share repurchase plan for another year and increased it to 600,000 shares through October 15, 2017. As of January 10, 2017, we repurchased 218,491 shares at a weighted average price of $16.87 per share under this plan. And we will continue to assess this as a way of deploying our capital and improving shareholder returns. This quarter also saw continued steady performance with our key performance indicators as compared to the previous quarters ended November 30, 2015 and August 31, 2016. Our adjusted NII and adjusted NII per share of $3.1 million and $0.53 per share, respectively, was nearly 30% up from the same quarter last year, which was $2.3 million and $0.42 per share respectively and remained unchanged compared to last quarter. Our adjusted NII yield of 9.5% was up 210 basis points from 7.4% for the same quarter last year and unchanged from last quarter. And our last 12 months’ return on equity for November 30, 2016 was 7.7% or 12.1%, excluding the unrealized depreciation of the legacy investments we mentioned earlier, comfortably beating the industry average of approximately 1.1%. Overall, we remain extremely pleased with these accomplishments and we will go into greater detail on each one in today’s call. As I have mentioned earlier, we remain committed to further advancing the overall size and quality of our asset base. As you can see on Slide 3, our upward trend of quality and quantity of assets remained stable, our assets under management this year has steadily risen since an initial drop in the first quarter of the fiscal year. And with $278 million in assets under management in our BDC as of November 30, 2016, we have seen a 15% increase in assets as compared with last year this quarter and a 2% quarter-on-quarter increase. This increase in Q3 reflects originations of $30.1 million during the quarter, more than offsetting the $23.8 million of repayments. As we have shared in the past, we expect that repayments and originations will remain lumpy in the short-term, and this quarter for the second quarter in a row, we saw reasonably high level of both. In terms of portfolio quality, 96.7% of our loan investments hold the highest internal rating that we award at quarter end. Thus, our overall loan quality continues to remain high while we pursue measured asset growth. With that, I would now like to now turn the call back over to Henri to review in greater detail our full financial results as well as the composition and performance of our portfolio.

Thank you, Chris. Looking at our quarterly key performance metrics on Slide 4, we see that for the quarter ended November 30, 2016, our net investment income was $3.4 million or $0.60 on a weighted average per share basis. Adjusted for the incentive fee accrual related to net unrealized capital gains in the second incentive fee calculation, our net investment income was $3.0 million or $0.53 per share. This represents that an increase of $0.7 million compared to the same period last year and no change compared to the quarter end at August 31, 2016. For this year’s third quarter, total investment income was $8.4 million, essentially the same as compared to this year’s second quarter and an increase of 21.7% from $6.9 million for the same quarterly period last year. This increased investment income was generated from an investment base that has grown by 15% from the third quarter last year and by 2% on a sequential quarterly basis. In addition, total investment income benefited from an increase of $0.3 million in other income this quarter compared to last year as the higher levels of originations and repayments this quarter led to increased advisory fees and prepayment penalties received. As compared to last year’s third quarter, the investment income increase was offset by; one, increased debt and financing expenses from higher outstanding notes payable and SBA debentures this year, reflective of the growing average investment in asset base. And two, slightly increased base and incentive management fees generated from the management of this larger pool of investments. Finally, net investment income this quarter benefited from decreased total expenses, excluding interest and debt financing expenses, base management fees and incentive fees, reflecting primarily lower general and administrative expenses. As compared to this year’s second quarter’s debt and financing expenses, base and incentive management fees and general, administrative expenses, were relatively unchanged. In the third quarter of fiscal 2017, we experienced a net loss on investments of $1.8 million or $0.52 on a weighted average per share basis, resulting in a total increase in net assets from operations of $1.6 million or $0.27 per share. The $1.8 million net loss on investments was largely comprised of $0.3 million of net realized gains, offset by $2.1 million of net unrealized depreciation. The net unrealized depreciation for the quarter is primarily due to $0.9 million unrealized depreciation on our CLO investment due to increased financing costs and fees related to the refinancing of our CLO in November as well as $0.7 million unrealized depreciation on our Taco Mac investment, reflecting declining fundamentals of that investment. With regards to the CLO depreciation, it is important to note that the depreciation is net of $1.66 million distribution that was received by the BDC this past quarter. Net investment income yield as a percentage of average net asset value was 10.7% for the quarter ended November 30, 2016. Adjusted for the incentive fee accrual related to net unrealized capital gains, the net investment income yield was 9.5%, up from 7.4% for the same period last year while remaining unchanged on a sequential quarter-over-quarter basis. In addition to the appropriate focus on net investment income, we also highlight our return on equity as an important performance indicator, which includes both realized and unrealized gains. Annualized return on equity was 4.9% for this quarter due to the unrealized depreciation mentioned above. This is down from 16.5% last quarter and 10.8% for the same period last year. Importantly, our last 12 months’ ROE is 7.7%, which is significantly beating the current BDC industry average of 1.1%. And as Chris mentioned earlier, excluding the $5.7 million realized and unrealized losses in our two legacy investments, Targus Group International and Elyria Foundry Company LLC, the return on equity for the last 12 months ended November 30, 2016, was 12.1%. Both Targus and Elyria are legacy investments that predate Saratoga’s management of the company. We believe our strong track record of ROE growth is an important indicator of our success in pursuing our strategy of growing the asset base, building scale and generating competitive yield while continuing to focus on the quality of our portfolio. Our total operating expenses were $5.0 million for the third quarter and consisted of $2.4 million in interest and debt financing expenses, $1.6 million in base and incentive management fees, $0.7 million in professional fees and administrative expenses and $0.4 million in insurance expenses, Directors fees and general, administrative and other expenses. For the fiscal third quarter of 2017, total operating expenses increased by $0.2 million as compared to the same period last year. This increase was primarily due to higher base and – base management fee and higher interest and credit facility financing expenses this year, reflecting our growing asset base. Total expenses, excluding interest and debt financing expenses, base management fees and incentive management fees, decreased from $1.2 million for the quarter ended November 30, 2015, to $1.0 million for this past quarter. [Technical Difficulty] total assets both quarters, we expect to further benefit from scale as our assets continue to increase while our cost structure remains relatively consistent. Overall, our ROE and other financial performance measures continued to improve long-term as the benefits of scale become more visible and our operating expenses stabilize and diminish as a percentage of our total assets. Moving on to Slide 5, this is a new waterfall slide we are presenting for the first time and helps reconcile the major changes in NII and NAV per share on a sequential quarterly basis as it is generally only a couple of items that drive the changes period-over-period. Starting at the top of this slide and looking at NII per share. Although it remained unchanged at $0.53 per share from Q2 to Q3, the significant movements were a $0.02 increase in total interest income, offset by a $0.02 reduction in other income, resulting in an unchanged NII per share. At the slide footnotes, operating expenses and a lower weighted average shares outstanding had a very minimal impact and all changes are shown net of incentive fees. Moving to the lower half of this slide, this part reconciles NAV per share from $22.39 at Q2 to $22.21 this quarter. The major changes are due to $0.59 generated by our NII for the quarter, offset by a $0.52 net appreciation of investment. In addition to these changes, NAV per share was further reduced by the $0.44 Q2 dividend declared and $0.02 dilution from an increased share count, offset by a $0.01 positive impact from our stock dividend and share repurchase plan. As you can see on Slide 6, net asset value has steadily increased since 2011, continuing to benefit from the history of consistent realized gains we will discuss later. NAV this quarter was $127.7 million as of November 30, 2016, a $0.9 million decrease from an NAV of $128.6 million for the quarter ended August 31, 2016, but up $2.6 million from an NAV of $125.1 million as of year end. NAV per share was $22.21 as of quarter end compared to $22.39 as of August 31, 2016 and $22.06 as of February 29, 2016. During the past 9-month period, NAV per share increased by $0.15 per share primarily reflecting the $10.1 million or $0.28 per share increase in net assets, which is net of the $1.48 per share dividend paid during the 9-month period. This was offset by the dilutive impact of the net 76,020 shares issued during the 9-month period, representing 1.3% of the shares outstanding. These shares consisted of 264,994 shares issued pursuant to the dividend reinvestment plan, representing three quarters’ dividend payment and a special dividend offset by 188,974 shares that were repurchased. Slide 7 outlines the dry powder available to us as of November 30, 2016. As of this date, we had zero outstanding in borrowings and our revolving credit facility with Madison Capital and $112.7 million in outstanding SBA debentures. Our existing baby bonds have been refinanced subsequent to quarter end and had a carrying amount and fair value of $61.8 million and $62.3 million respectively. With the $45 million available on the credit facility, $37.3 million additional borrowing capacity at our SBIC subsidiary and $23.3 million in cash and cash equivalents, primarily in our SBIC subsidiary, we had a total of $105.6 million of available liquidity at our disposal as of the end of our third quarter 2017. Including the incremental cash from our 2023 baby bonds offering completed in December, this available liquidity increases to $115.6 million, meaning we can grow our current assets under management by a further 42% without any additional external financing. As we demonstrated subsequent to quarter end with the refinancing of our existing baby bonds, we continued to assess all our various capital and liquidity sources and will manage our sources and uses on a real-time basis to ensure optimization. This baby bonds issuance highlights the importance we place on extending the maturity of our capital structure and reducing the weighted average cost of capital, both of which are achieved through this new issuance. We remain pleased with our liquidity position especially taking into account the overall conservative composition of our balance sheet and the ability we continue to have to substantially grow our assets without the need for external financing. To that end, on December 31, 2016, we issued $74.5 million in aggregate principal amount of 6.75% fixed rate notes due 2023 for net proceeds of approximately $72 million after deducting underwriting commissions and offering costs. The issuance included the exercise of substantially all of the underwriter’s option to purchase an additional $9.8 million aggregate principal amount of 2023 notes within 30 days. The proceeds from the offering will be used to repay all of the outstanding indebtedness under the existing 2020 notes, which amounts to $61.8 million. The redemption date is tomorrow. The accounting impact of the baby bonds issuance in Q4 is highlighted on Slide 8. There will be two non-recurring financial impacts related to the baby bonds refinancing. First, there will be a write-down of deferred financing costs related to the previous baby bonds and ATM program of approximately $1.6 million. This will be disclosed as a loss on extinguishment of debt in the income statement. And second, there will be an additional interest expense related to the capital management decision to only call the 2020 bonds once the 2023 bonds had been issued. We perpetually delayed the calling of our existing bonds until the new bonds were issued. The required call period is 30 days and we expect the approximate impact of this additional interest while having both baby bond issuances outstanding to be approximately $400,000 in Q4. We are very pleased with this refinancing, not only does it increase our liquidity base and extend the maturity by almost 4 years, but also locks in a reduction in interest rate of 75 basis points in a rising interest rate environment. Now, I would like to move on to Slides 9 through 11 and review the composition and yields of our investment portfolio. Slide 9 highlights the portfolio composition and yields at the end of the quarter. As of November 30, 2016, the fair value of the company’s investment portfolio was $278 million principally invested in 30 portfolio companies and 1 CLO fund. Saratoga Investment’s portfolio was composed of 57.8% of first-lien term loans, 28.9% of second-lien term loans, 5.5% of subordinated notes in our CLO, 3.5% of syndicated loans and 4.3% of equity interest. The weighted average current yield was 10.8%, which was comprised of a weighted average current yield of 10.5% on first-lien term loan, 11.7% on second-lien, 5.4% on syndicated loans and 12.2% on our CLO subordinated notes. Despite downward pressure on yields due to continued competition, our yields have remained strong as compared to the previous fiscal quarters. To further illustrate this point, Slide 10 demonstrates how the yield on our core BDC assets, excluding our CLO and syndicated loans as well as our total assets yield, have remained consistently around 11% for the past several years. Following the originations and repayments during this quarter, the core BDC assets and also the syndicated loan’s yield increased slightly. This was offset by the CLO yields decreasing this quarter as it now includes the initial impact of the refinancing as well as the new investment in the CLO’s F note which has a rate of LIBOR plus 8.5%. All these changes resulted in the total yield of approximately 10.8%. Moving on to Slide 11, during the third quarter 2017, we made investments of $30.1 million in three new or existing portfolio companies and had $23.8 million in 3 exits and repayments, resulting in a net increase in investments of $6.3 million for the quarter at our BDC. As you can see on Slide 11, our investments continue to be highly diversified by type as well as in terms of geography and industry, with a large focus on business, consumer and healthcare services while spread over 11 distinct industries. It is worth noting that we have no direct exposure to the oil and gas industry, a fact that has served us extremely well during this past fiscal year. Of our total investment portfolio, 4.3% consist of equity interest. Equity investments are and will continue to be an important part of our overall investment strategy. As we discussed earlier, we have had consistent realized gains over the past years that has helped grow our NAV. Slide 12 demonstrates how realized gains from the sale of equity investments, combined with other investments, have helped enhance shareholder capital. For the past five fiscal years, we have had a combined $17.6 million of net realized gains from the sale of equity interest or sale of early redemption of other investments. This consistent performance continues to be a good indicator of our portfolio credit quality. In the third quarter 2017, we continued this trend and we are able to show a net realized gain of $0.3 million. Year-to-date fiscal 2017, total net realized gains are $12.3 million. That concludes my financial and portfolio review. I will now turn the call over to Michael Grisius, our President and Chief Investment Officer, for an overview of the investment market.

Thank you, Henri. I would like to start by taking a couple of minutes to update everyone on the current market as we see it. The market’s extremely competitive conditions persist. Slide 13 indicates that the number of transactions for deal sizes in the U.S. below $25 million in 2016 was down 28% through 11 months. At this pace, we anticipate calendar year 2016 will post much lighter transaction volume than 2015. As a result, pricing remains under pressure as demands per assets has outpaced supply. Yields across the broader middle-market for most credit types have declined and spreads have tightened marginally over the last quarter. Generally, we have seen no change in spreads in the lower middle-market where we operate. Our experience this whole year has been that strong credits are aggressively sought after and this has not changed in the current environment. In the broader market, where there is an abundance of capital, competitive dynamics have led to tighter pricing, higher leverage and looser terms especially for high-quality credits. By contrast, in our view, the lower middle-market where we operate is the most attractive market segment to deploy capital and the fundamentals here remains strong leading to the best risk-adjusted returns. In our case, we have created a primary originated portfolio of healthy, low leverage assets with a robust average yield of just under 11%. In addition, powerful long-term secular trends bode well for the BDC industry as a whole. Banks continued to shift toward large borrowers due in part to the regulatory hurdles facing smaller banks serving the middle market. In addition, Saratoga Investment’s target market is rich with potential opportunities. Small businesses with revenues between $10 million and $150 million in revenues represent nearly 90% of this opportunity set. In the chart on Slide 14, you can see that multiples in the industry seem to have increased slightly over the last three months. According to KeyBanc metrics, 63% of all middle market deals as of September 30, 2016, were leveraged over 4.1x as compared to 58% in June 2016. In general, we continue to see total leverage multiples creep upwards across the industry especially for high quality credits. However, irrespective of the fluctuation of market leverage levels historically, we have been able to invest in deals with relatively low multiples. This quarter, our total leverage was 4x, down slightly from 4.1x during the previous quarter. The majority of our deals closed remain beneath overall market levels as they have been consistently in the past. We are very careful to exercise extraordinary investment discipline and invest only in credits with attractive risk return profiles. We will, of course make selective higher leverage loans, provided that to our own underwriting, we conclude the credit characteristics of each business can support a higher debt profile. What’s important to us when doing deals with higher leverage is to ensure that our dollars are invested in companies with exceptionally strong business models where we are confident that the enterprise value of the businesses will sustainably exceed the last dollar of our investment. In addition, this slide demonstrates that we have been able to close a consistent number of deals without sacrificing quality, while the overall deal environment has generally gotten more difficult across the board. This reflects our increased investment in business development and our growing base of relationships in the market. As you can see, on the slide, our overall investment volume has increased consistently over the past several years, growing from 7 in fiscal 2013 to 16 this calendar year. We also had significant repayments this quarter with two investments paying off. Although payoffs present challenges because they curtail our natural growth, we have generated healthy un-levered IRRs from our repayments that we are very happy about and we will discuss shortly in more detail. Having invested capital through multiple economic cycles, we understand the importance of never allowing our desire to grow assets to interfere with our credit judgment. This is foundational and we believe this is why our portfolio and our stock performance have outperformed most of our peers. Moving on to Slide 15, you can see that the number of deals that we have sourced and evaluated has increased materially despite competitive market conditions. 50% of these deals come from companies without institutional ownership. The rest come from private equity sponsors primarily. While our deal flow has continued to grow, the number of term sheets issued has declined, a confluence of factors are producing this result. The more robust origination platform that we have invested in over the past couple of years, the difficult market conditions and lack of quality deals and the prudence that comes with disciplined investment judgment. In short, we continue to see more deals, but are also turning more down. One of our strengths is that we have been able to grow due to current soft market for quality deals in three main ways; first, by deploying capital in support of existing portfolio of companies that are healthy and growing, second, by gaining repeat business from existing relationships and third, by building targeted new relationships with top quality investors and deal sources. In this most recent calendar year, our transaction volume reflected a healthy mix of all three of these avenues of growth. We believe the strength of our deal flow will allow us to continue to grow our portfolio at a pace consistent with the past. This will be lumpy and not linear as we have always said. Our disciplined underwriting approach will naturally produce lumpy origination volume. Nonetheless, we feel confident we will be able to consistently grow over time. Using our own internal valuation system, we have grown our Tier 1 deal sourcing relationships from 8 in 2012 to over 100 today. We believe this will allow us to further accelerate our pace of investment while we remain diligent and careful in our investment approach. Since taking over management of the BDC, we have understood the importance of getting the assets right. As a consequence, our highest priority has been to build one of the premier execution teams in the business. We believe we have accomplished that and we view our professional staff as best-in-class. We also remain focused on continuously adding to our talent as we have over the last 5 years. Our overall portfolio quality is strong and even stronger when taking into account only the assets originated by us since taking over the BDC management in 2010. As you can see on Slide 16, the gross un-leveraged IRR unrealized investments made by the Saratoga management team is 17.6% on approximately $135.5 million of investments in our SBIC and 14.7% on approximately $48.6 million of investments in the rest of our BDC. Similarly, for the first nine months of fiscal 2017, we have seen 13 realizations, which generated a gross un-levered IRR of 20.6%. The two exits during this past fiscal quarter generated an un-leveraged IRR of 16.1%. Now, while repayments naturally curtail our asset growth, we believe they are also a strong indicator of the strength of our investment team and our investment selection process. Realizations mostly occur when companies have performed well and they are either entering into a change of control transaction or are refinanced with cheaper capital. On the chart on the right, you can also see the gross un-levered IRR on our $227.7 million of SBIC unrealized investments is 14.5%. In addition, our gross returns from the SBIC have remained consistently strong across vintage years. The total gross un-levered IRR on the rest of our BDC unrealized investments since Saratoga took over management is 11.4% on $38.4 million of investments. This includes some mark to market valuation activity. Combined, our total SBIC and BDC unrealized investments of $266.1 million are producing a gross un-levered IRR of 14%. It is important to note that within the track record, numbers discussed above is a $9.3 million first lien investment called Taco Mac that currently carries $0.9 million of unrealized depreciation, reflecting declining business fundamentals. Subsequent to quarter end, we were notified by management and the sponsor that they will postpone payment of interest from December onwards. We are working closely with them while they restructure and appropriately pursue various options. While we remain in a first lien position in the capital structure, we will be putting this investment on non-accrual from Q4 until this is resolved. With respect to our SBIC, our objective remains to maximize our risk adjusted returns in a manner that utilizes the low cost of capital in two to one leverage advantage we possess through our SBIC license. By focusing on the smaller, less competitive end of the market, we are able to reduce the risk profile of our portfolio while delivering highly accretive returns to our investors. As you can see on Slide 17, the mix of securities in our portfolio is conservative, and the leverage profile of these 20 investments remains low at 3.7x, especially compared to the overall market leverage that is well above that. Because of the leverage and low cost of capital advantages inherent in the SBIC program, we can achieve strong returns for our shareholders without moving out on the risk spectrum. As of November 30, 2016, 58% of the SBIC portfolio is comprised of senior debt, up from 54.6% on August 31, 2016. Therefore and as demonstrated this past year, we intend to grow our investment income by continuing to focus on growing that portion of our portfolio. Moving on to Slide 18, you can see our SBIC assets increase slightly to $208.5 million as of November 30, 2016, from $200.6 million as of year end. Also it is important to note that as of quarter ended November 30, 2016, we have $44 million total available SBIC investment capacity, including cash, of which $37 million is leverage capacity within our current SBIC license. In our view, our team and platform are among the very best in the industry. By growing our relationships and expanding our presence in the marketplace, we are seeing a steady flow of SBIC eligible investments. As a result, despite an unusually high pace of exits, we are optimistic about our ability to grow our portfolio at a healthy rate while remaining extremely diligent in our overall underwriting and due diligence procedures. Credit quality remains our top focus. This concludes my review of the market. I would like to turn the call back over to Chris.

Thank you, Mike. From the start of our quarterly cash dividend program just over 2 years ago, our expectation was this dividend would increase substantially and it has, growing by 150% since the program launched. As outlined on Slide 19, during fiscal year 2016, we declared and paid dividends of $2.36 per share gradually raising the dividend through the year from $0.27 for the quarter ended February 28, 2015 to $0.40 per share for the quarter ended November 30, 2015. Last year also included a special dividend of $1 per share. In addition, during fiscal year 2017 so far, we have declared and paid dividends of $1.48 per share further raising the dividend from $0.41 per share for the fiscal quarter ended February 29, 2016 to $0.44 per share for the fiscal quarter ended August 31, 2016 and a special dividend of $0.20 per share paid on September 5, 2016. On January 10, 2016, our Board of Directors declared a dividend of $0.45 per share for the quarter ended November 30, 2016 to be paid on February 9, 2017 to all stockholders of record at the close of business on January 31, 2017. This is a further increase of $0.01 to our quarterly dividend. Therefore, in total, we have already declared dividends of $1.93 per share during this fiscal year. Shareholders continue to have the option to receive payment of the dividend in cash or receive shares of common stock pursuant to our dividend reinvestment plan, or DRIP plan, which we adopted in conjunction with the new dividend policy and provides for the reinvestment of dividends on behalf of our stockholders. For more information, see the stock information section of our Investor Relations section on our website. Slide 19 also shows how we are currently still over-earning our dividend. This quarter’s dividend of $0.45 per share compares to our adjusted average NII per share of $0.51 for fiscal 2017, which means we are currently over-earning our dividend by 13%. This gives us one of the higher dividend coverages in the BDC industry. We also further exercised our share repurchase plan during the quarter ended November 30, 2016. During fiscal year 2015, we announced the approval of an open market share repurchase plan that allowed us to repurchase up to 200,000 shares of our common stock at prices below our NAV as reported in our then most recently published financial statements. This plan was doubled in size last year. And on October 2016, this share repurchase plan was extended for another year and increased to 600,000 shares to October 2017. As of January 10, 2017, we repurchased 218,491 shares at a weighted average price of $16.87 per share under this plan. We are also pleased to see our relative standing in the industry consistently improve over time. As you can see on Slide 20 and reflecting our strong key performance indicators we have discussed earlier, our total return for the last 12 months, which includes both capital appreciation and dividends, has generated total returns of 50.8%, significantly beating the BDC index at 24%. This is after the rally of the industry have seen – after the rally the industry has seen over the last couple of months. Turning to Slide 21, when viewed over a longer time horizon such as 6 years, which is when we took over the management of the BDC, we have performed the distinction relative to the rest of the industry. Our 6-year total return is 257%, which places us second in the industry overall compared to other BDCs. Our 3-year total return is also very strong at 70%, also placing us second overall. Finally, the 51% total return for the last 12 months I mentioned on the last slide places us first, in first place in the entire industry over the most recent period. Despite putting up these strong historical total returns, our price to NAV still remains at around a 10% discount, reflecting the opportunity for future incremental returns. Moving on to Slide 22, you will see how our dividend yield has dramatically improved relative to the rest of the industry over the last couple of years. We have moved from consistently below the BDC average to now slightly beating the BDC average and the average of internally-managed BDCs while moving much closer to the basket of externally-managed BDCs. With the incremental benefit of higher margin SBIC assets, increased scale and growing dividends, we believe we will see this continuing to improve going forward. On Slide 23, you can see our outperformance placed in the context of the broader industry. We continue to achieve high marks across a diversity of categories yielding interest yield on the portfolio, latest 12 months’ return on equity, dividend coverage, dividend growth and investment capacity. Latest 12 months’ NII yield is also now very much in line with the industry actually beating the mean. We would also like to particularly point out our outperformance on return of equity of the last 12 months as this reflects overall financial performance, including portfolio credit quality. During the last 12 months, our return on equity is 7.7% as compared to the BDC industry average of 1.1%. Again, excluding the legacy investments we mentioned earlier, our LTM return on equity is 12.1%. We are very pleased with all these outcomes, particularly since the market has only gotten more competitive and outperformance more difficult to achieve over the last couple of quarters. Before we summarize our outstanding performance characteristics on the following page, it is also worth pointing out that we feel confident in the face of potential future interest rate risk from rising rates, 82% of our investments have floating interest rates and while a significant portion of those have 75 to 100 basis point floors, we will continue to benefit from rising rates on the asset side. This benefit is even greater on the liability side when you consider that all of our debt, except our Madison facility, which is currently undrawn, is fixed rate and now long-term in nature, following the successful refinancing of our baby bonds that we discussed earlier. Maturities have been extended to 7 years for baby bonds and are of 10 years for outstanding SBA debentures, both with fixed rates. Moving on to Slide 24, all of our initiatives as we have discussed on this call, are designed to make Saratoga Investment a highly competitive BDC that is attractive to the capital markets community. We believe that our differentiated characteristics outlined on this slide will help drive the size and quality of our investor base, including the addition of more institutions. These characteristics include the strong and growing dividend; industry leading return on equity; ample low cost available and long-term liquidity with which to grow current asset base; solid earnings per share and NII yield, with substantial growth potential; steady high-quality expansion of AUM; and an attractive risk profile, with protection against potential interest rate risk. The high credit quality of our portfolio is buttressed by our minimal exposure to the oil and gas industry. This speaks to attractive risk profile that we have built into the portfolio. Importantly, our stock trading volume has increased substantially from an average of 11,300 shares traded per day during Q3 last year to 22,500 shares per day during the most recent quarter thereby providing increased liquidity for our investors. With this overall performance, Saratoga Investment is solidly on the path of being a premier BDC in the marketplace. Moving on to Slide 25, our final slide, we have accomplished a lot this quarter and are proud of our financial results. We remain on course and there is no change to our simple and consistent objectives continue to execute our long-term strategy to expand our asset base without sacrificing credit quality while benefiting from scale. We also continue to increase our capacity to source, analyze, close and manage our investments by adding to our management team and capabilities. Continue to execute on these objectives should result in our continued industry leadership in the shareholder return performance. In closing, I would again like to thank all of our shareholders for their ongoing support. We are excited for the growth and profitability that lies ahead for Saratoga Investment Corp. I would now like to open the call for questions.

[Operator Instructions] Our first question comes from the line of Mickey Schleien with Ladenburg. Your line is open.

Yes, good morning everyone and Happy New Year. Can you hear me okay?

Yes, we can. Hi, Mickey.

Hi, Mickey.

I wanted to start with the new investments; Apex, Erwin, and Gray, were these deals you led or were they deals where you participated in a club where someone else led or were these syndicated?

The investments that we made this quarter were deals that we led and the vast majority of the deals that we do, we are leading as a primary origination function and that means that we are not only leading and most of the time by ourselves, we occasionally bring in some partners, etcetera. But not only performing all of the underwriting but as well all the negotiation of the documents, et cetera. And then of course the team that’s underwriting it continues to manage that investment after it’s been originated, which we think is the right way to structure an investment.

And Mike, were these sponsored transactions?

A mix, which is consistent with the mix of origination activity that we got, I think as I have referenced on the call and we have some slides in here as well. We actually are very proud of the number of non-sponsored deals that we see. Our closing rate on non-sponsored deals is naturally quite a bit lower than what they are on sponsored deals. But the ones that we get done typically have – we are able to negotiate better terms, better pricing and things of that nature. So it’s an important part of our business as well. So yes, it’s a mix of both.

And could you give us a sense of their average EBITDA at least within a range?

I would have to go look. I mean we are – if you think about our business in general, we are investing in businesses that may have as little as a couple of million dollars in EBITDA. And the ones that are on the smaller end of the range, we tend to be more focused on being in a unitranche security at the top of the capital stack. And then when the EBITDA grows, those are deals that tend to be, as you get kind of north of $8 million, sometimes $5 million, that’s sort of in the $8 million EBITDA range, those transactions tend to be more competitive and are often structured in a way where there is a bifurcated structure, so there is many times a senior lender as well as a junior capital provider. So if you looked across our portfolio, the larger deals tend to be ones where we are more in the junior capital position, the companies with larger EBITDA and the ones that are smaller, we tend to be more in a unitranche position.

So is it your sense that these are the former or the latter, what I am trying to get at Mike is that, I completely agree with the prepared remarks that the market is extremely competitive and given Saratoga’s relatively small scale, which precludes you from participating in uncertain transactions, I am trying to get a sense of how you are getting the deals done that you are doing and it feels like it’s because you are operating truly perhaps below $5 million of EBITDA, which is less competitive?

Well, it is a mix, but yes, when we see a deal, that’s less than $5 million in EBITDA, that’s right in our sweet spot, and we are very competitive on those transactions. And quite honestly, we don’t run into as many of our BDC compatriots at that end of the market. So yes, that’s – it’s part of what I said in the prepared remarks, we actually like that. We find – now we have to be extremely selective, but as you get below that where that threshold is, it’s hard to put a bright line on it, but let’s call it below $5 million in EBITDA, there is fewer people chasing those deals. We will certainly do the work to get comfortable with of the right types of businesses, and you have to be very, very careful and that’s what we have demonstrated an ability to do over the many years. When you find the right ones though, you can structure a very good deal with the terrific risk adjusted return.

Okay, I understand. Moving on to the current quarter, we are now more than halfway through it, and rally in the leverage loan market has continued, spreads continue to tighten, I am talking about loan spreads, right, both first and second lien, can you give us any color on the investment activity to-date and also the repayment activity and how you view the attractiveness, given the market is getting more and more difficult?

There is no doubt that the market continues to be competitive. And we know that if we stay the course that will change. But nonetheless, we are in that market. And it really is there are a lot of factors that are influencing it, but at the end of the day, there is a lot more capital out there than there are transactions, so that’s always a tough dynamic to face as a lender. I think focusing on the areas of the market that we have focused on do give us some competitive advantages that will allow us to continue to grow. We also benefit from the fact that – I say this a lot, but it’s just as true. We started at a standing start in 2011 when we took over management. And so there are a lot of people that still don’t know us. Every time we do a transaction, it creates a new relationship and a new opportunity for us to see a future transaction. That’s why I emphasize the fact that there is really three primary ways for us to do deals; one is to do another investment with a relationship that we have already formed. We have done a great job of building relationships and then getting repeat business. Another is to support existing portfolio of companies that are performing very well and advance more capital to them to continue to grow and we have done that fabulously well. And then really we spend most of our effort and we can’t get enough of these, if you ever feel satisfied is to build new relationships. But in this past year, we have built our portfolio with the combination of all three. You asked also about the repayments. Candidly, the exits that we have had, we are proud of because you can see the returns that we talked about. They really are the terrific returns, especially on a risk adjusted basis because we feel very, very good about these investments that we are making and the returns relative to kind of the risk free rate are just fabulous. But the challenge is that as those assets come back, you can feel like you are a little bit on a wrap wheel where as you are investing capital, there is so much coming back that you are not growing at the pace that you would like. We are absolutely confident that over time, our origination activity will outpace our redemptions. I think if you looked at the payoffs that we have had through the first three quarters of this year relative to last year, just to give you a flavor, we had $94.7 million of payoffs through the first three quarters. Our origination activity was up – for the first three quarters was almost $86 million, which is up about 50% from this same period last year. So here we are growing all these things that we are talking about, we are being very successful with but the pace of payoffs has been a bit of a source of frustration now. That’s not going to remain the case forever. The way we look about it is, if you look at a portfolio of our flavor of investments, generally and this is generally because some of them are longer dated, some of them are shorter, but generally you should think about the duration of these assets being 3 years to 3.5 years. So if you use some simple math, that means that about 28% to maybe a third of your portfolio should turn every year. And we have had roughly a third of our portfolio turn just year-to-date, we know we are going to exceed that. So that’s been a challenge, but that’s not going to remain the case. That’s largely reflective of the fact that the capital markets are hot. And we are making good investment decisions and so when these companies perform very well, they either get sold or perhaps after they have used our capital for a while, they are legitimized that much further, the company has grown and they can go to more traditional means of capital than we get refinanced. But that’s not going to remain the case. I mean we are absolutely confident with the platform that we are building, have built and continue to build that our pace of originations will outpace the payoffs.

Mickey and just one comment on the new originations, so Apex and Gray Heller were new originations this quarter. Erwin was actually a new origination in Q2. It just had a name change this quarter from PCF4 on the schedule of investments to Erwin.

Okay. Thanks for that clarification. A few more portfolio questions, I am curious what attracted you to the CLO’s debt rather than taking on a larger chunk of the equity, given that the equity should generate, everything remaining equal, higher return?

Mickey, this is Chris. That was a reflection of sort of the capital markets, if you will, at the time. In other words, right now there is a lot going on in the CLO market refinancing market. I believe it was December, was it 24 or December 20, there was a deadline for the imposition of new rules and regulations in terms of risk retention for CLOs. So, there was a huge volume of, they call them resets, which is what we did, which is basically refinancing existing CLOs as opposed to new CLOs. So, there is a lot of activity in the marketplace and so we were able to avail ourselves of that healthy market. This tranche that we bought was actually the tranche just above our equity. So arguably, it could be viewed potentially as equity, but it had been – when we refinanced last time, there was appetite for that. That had actually changed hands at a discount earlier in the year, you recall, a year ago at this time, it was pretty bleak outlook and certainly in the CLO market, there was a lot of very difficult performance for all the various tranches. And an investor actually had brought this on a discount on the secondary basis and that investor was more of a hedge fund short-term investor. And so when it came to refinance, they were not interested in rolling over for a long-term. They were interested in basically realizing a very good purchase. They bought it at a substantial discount and then we took them out at par. So, they did very well on that tranche and it really wasn’t a market at the time we did that for that tranche. So, we bought it ourselves. It’s marked as somewhat of a market, the interest rates – and that’s something we are keeping our eyes open. If we could place that ultimately or sell that ultimately we would consider doing that. So, it’s setup to be sold again from us if we can find an adequate purchaser for that.

Okay, that makes sense. And Chris, what drove the declines in the valuation of, I don’t know, is it pronounced Courion and Targus as well?

I will take that, I think. And did you mean Targus or Taco Mac perhaps?

Well, I was going to end with Taco Mac, but all three.

Yes, Targus has already been substantially written down and see if there shouldn’t really be much of a change.

I think most of the Targus write-downs had already been taken place in previous quarters.

Well, the TLB fell some more, right? I am just curious whether this thing is ever going to turnaround or is it sort of in a death spiral?

Well, it’s hard to say. I think the management team and those involved feel like it has stabilized generally, but it certainly plays in a difficult market for sure. As I said, that’s a legacy investment and that’s one that we are doing our best to try to realize the most return we can out of it. But let me...

Courion and Taco Mac?

Yes, happy to address that. So, Courion has been written down really to reflect a yield adjustment and that’s mostly reflective of the fact that the company is repositioning itself and is investing very significantly in growth, which is creating some noise in the numbers. As a consequence, when we look at it and we look at the pricing on the deals with the noise in the numbers, we feel like it probably needs a write-down. It deserves a write-down to reflect that. But fundamentally, we feel like we are well covered in the enterprise value that’s a sponsored transaction with a significant amount of capital underneath it in a business that fundamentally we feel very good about and is sound. As it relates to Taco Mac, that’s a first-lien security, that is a business that is underperforming. It’s having some challenges with its fundamentals. It operates in the competitive restaurant market. We are working closely with the sponsor and the other lenders to evaluate our options right now. And in the recent to and fro of negotiation, the sponsor has elected to suspend interest payments currently, but we are working with them and that’s not an uncommon thing to happen when you are in negotiations around that, but we are, as I said, in a first-lien position and actively working with the company to evaluate our options in that credit.

Mike, but fundamentally, are they facing pricing pressures or what are the operational issues that they have to deal with?

Well, we always have to be a bit careful, because these are private companies, so we have to sort of give you what you need, but not get too much into the weeds. It is a restaurant business. The casual restaurant space in general is down quite a bit. It has pretty competitive dynamics there. So much of it is really just the competition that they are facing in the market, but they are doing some things – they have undertaken some initiatives to try to stabilize that as well.

Okay. One last question, I appreciate your time this morning. Just when I do the math and maybe this is for Henri and you take into the consideration of the write-off of the deferred financing costs on the 2020 notes, it could cause your pre-incentive fee NII to drop below the hurdle, obviously that there is a lot of assumptions in there. But if that were to be the case, I just want to confirm that in that event, you would not accrue an incentive fee?

We feel sort of working through all the accounting and review of the contract. We have just been focusing on the presentation for now, Mickey. So we haven’t done the accounting for that yet. I guess I will update you guys when we complete that.

Well, I guess I could ask the question a little differently. With the write-off of the deferred financing costs under the management agreement be excluded from the calculation of the pre-incentive fee NII?

Well, as I said, I am still working through sort of all the accounting. But I think just looking at our contract – our contract excludes operating expenses only. And so this is obviously, we view it as a one-time sort of non-recurring expense which is not operating in nature. So without having completed the assessment, I think it’s most likely that it will be excluded from the formula that we use for the calculation of our incentive fee.

Okay, that’s fair. I appreciate all your time this morning. Thank you.

Thank you. [Operator Instructions] Our next question comes from the line of Casey Alexander with Compass Point Research. Your line is open.

Hi, good morning. You guys covered a lot of ground with Mickey there. So, I just have a few questions left. Although, Michael, I am not sure that you have actually addressed one question regarding what you have kind of seen to-date in fiscal 4Q regarding the sort of balance of new investments versus payments?

We – that’s a good catch on your part and it was unintentional, but we make a practice of not getting too much into the weeds as we are into Q4 sort of saying where exactly where our origination activity is, how we really know when the dust settles. I would say that we feel very confident as I said before that our origination activity and our pace will be consistent with the past. I also think that the environment that we are facing is still going to – hasn’t changed enough that we would say that the payoffs are going to stop and suddenly, our origination activity is going to outpace the payoffs by a big degree. So, the fourth quarter is just – we are in the midst of the fourth quarter, so we don’t know exactly how it’s all going to work out, but we do feel pretty confident that we have got a number of interesting deals that we are looking at.

Okay. When I look at a couple of factors coming together, the fact that you kind of – you had issued the baby bonds to redeem the previous baby bond, but you did issue $13 million more. And when I throw that together with the fact that TM is now on non-accrual, you have some additional interest expense and some decreased interest expense. Do you feel as though your origination pace is going to be enough to absorb some of that additional interest expense and decreased additional interest expense and decreased investment income?

Well, we don’t look at it on a quarter by quarter basis. I think you could get me talking a little bit about the BDC market. That’s what I think too many people on our industry are guilty of. We think about things in a longer term perspective at least year-over-year. And over a longer term horizon, we absolutely feel like we can deploy that capital and that as we continue to do so, our NII is going to increase, reflective of that.

Casey, particularly on that question, I think certainly you have had vast experience in the capital markets. And one of the principles is that when you are raising capital, especially long-term capital, you generally will raise as much as you can. And our first objective was to refinance the existing notes, which were effectively – we are extending our maturities by almost 4 years and we are reducing our interest rate by 75 basis points. In and of itself refinancing of those notes was a good opportunity. I think obviously, the broader marketplace is full of a chatter of rising long-term rates. So we felt like we were catching the window. Whether it turns out to be a window or not, time will tell. But certainly, the whole feeling out there is that rates are going to be rising. So this was a chance for us to lock in sort of the current rates before the whole yield curve moves up. If it moves up, I mean it may not, but certainly you talk to most people, they would expect a significantly increased yield curve out there. So that was our number one objective. We went to market, we had a very favorable response and in terms of appetite and we are able to get the whole deal done in just really a couple of days, not even a road show, I mean just a few phone calls. So our reputation is very good in that marketplace and so we basically upsized the deal to the maximum parameters around the way the deal went. So we maxed out what we were sort of allowed to do inside of the green shoe and the upsizing for us. And so with all that, we raised that excess capital. So that was sort of the tactical decisions around that financing. And as Mike said, that’s sort of core bedrock financing that’s got 7-year maturity on it. And again, as Mike was talking about, I mean our originations have been tremendous and our increased originations have been tremendous. And the issue which we can’t control and we don’t really have a lot of visibility on is redemptions. And so if these redemptions continue, we have a 20% - redemptions this year, we had a 20% IRR, so we are not necessarily growing this fast on a net basis as we would like to. On the investment performance side, it’s exceptionally good performance. On the asset origination side, it’s very good performance – exceptional performance with potential increase. And the issue really is the pace of these redemptions. As Mike said, we don’t necessarily believe that’s all going to continue. But even if it does, our origination continues to increase. So we believe it’s important to access in the capital markets especially for long-term capital to max out, if you can, at favorable terms and conditions. And we feel highly confident in our ability to deploy that capital, whether it’s this quarter or next quarter, that’s something that we can’t control. I think you have seen, in terms of our historical performance, we have not been a chaser of absolute assets under management growth. We have been very much focused on growing credit quality in our portfolio for the long run.

Okay, great. Thank you for that. The movement for TM to non-accrual, I mean it sounds like that came sort of after the pricing for this quarter, is it reasonable for us to expect that there would be a further mark on that when 4Q is recorded?

We are still in the back and forth of negotiation. We think that, that mark is the appropriate mark based on what we knew then. And we are still learning more about the business and we will be working hard to make sure that we get the maximum return for our shareholders.

Okay. So can I at least say that this mark at $0.90 on the dollar or so is sort of before you knew that it was going on non-accrual?

Okay. See, I mean I think we factored in, obviously we were talking to the company long before it went into non-accrual on a regular basis. But we factored into sort of what’s going on from a sort of a day-to-day operational perspective and the steps they are taking into that. The non-accrual is not just an extra element but it doesn’t change sort of some of the actions that they are taking.

Well, let me tell you, it was not on non-accrual at that past period and we put it on non-accrual now. There are, we are – we have got to obviously be very careful on what we disclose at this point. But I would say that there is nothing that we have learned since that time that would cause us to currently – if we were to look at this and value it this today, it wouldn’t cause us to change the valuation.

Okay, understood. Regarding Elyria, that revolver comes due here in a couple of months, do you have any clear idea, because that’s obviously you guys have a long history with this particular credit, do you expect that to be redeemed or do you think that you are going to end up extending the maturity date on that revolver?

That’s open to discussion right now and we are considering a few different options. We feel good about that piece of capital in the balance sheet, but that’s to be determined.

Okay. And lastly on Polar Holding, that shows a maturity date of September 30, 2016, on the November 30 schedule of investments, it’s marked right at par, I am just wondering why it’s still there?

It’s paid off.

Okay, alright, great. Thank you very much. Thank you for taking my questions.

Thanks Casey.

Thank you. And our next question comes from the line of Jim Young with West Family Investment. Your line is open.

Yes. Hi. Could you give us a sense for the overall portfolio, what percent is in sponsored transactions versus un-sponsored transactions? And secondly, with some of the recent deals that you closed, could give us a sense as to what’s the pricing premium and the change in the terms relative for sponsored to un-sponsored deals? Thank you.

Well, that’s – as it relates to the composition, yes I believe it, I think it’s 40% un-sponsored, 60% sponsored for what we have executed in our portfolio, roughly.

And that is we think a significant differentiator for us. I think the team to be built here is, as I have said, I think there is not a better team in the BDC industry, including all the big guys and that allows us to execute successfully on these non-sponsored transactions, that take more work, involve a lot more underwriting and there is just a lot more involvement with the management team. But there certainly is a premium to get from those transactions. Hard to put an exact number on it though, because the credit profile is different, typically. Sometimes you have a sponsored transaction and they are going to write a real big equity checks as some of that’s reflective of their ideas for growth and therefore, the balance sheet is going to have a big implied equity piece in there and as a result of the pricing on those transactions, tends to be less. But it’s hard to put a real peg on the difference. It’s certainly at least 100 basis points, but it may be more than that.

Okay, thank you.

Thank you. And our next question comes from the line of David Miyazaki with Confluence Investment Management. Your line is open.

Hi, good morning. Thank you for your time. Just to follow-up a little bit on the sponsored and un-sponsored nature, wanted to hear your thoughts on the risk side of it, do you find that the default risk tends to be higher with un-sponsored deals and if there is a default, how does the recovery look?

It is a good question. We are cognizant of who our partners are in every deal that we do. So when we are looking at non-sponsored transaction, we recognize that oftentimes, there is not a big institutional partner in there that could potentially write a check if there is difficulty. So the way we think about that is the bar is higher and we are making sure that we position ourselves in the balance sheet, where we feel very, very comfortable that the enterprise value is well in excess of our last dollar in the balance sheet. As a result, I think we – as we said, we see a lot more non-sponsored transactions than we do, so the ratio of our portfolio as Henri said, it’s about 40% of our portfolio is non-sponsored. We are seeing more non-sponsored deals than that just in our origination pipeline. Fortunately, our portfolio has performed very well. So we don’t have an experience that to point to say what the outcomes are. I would say this, there are a number of people in the marketplace and we and our team kind of scratch our head who falls themselves into thinking, because there is a sponsor there and they are writing write a big check that it’s kind of easy and you just lower your pricing and just chase those deals all day long. I think that’s a very undifferentiated model. And I think if there is real trouble in the portfolio, the sponsors aren’t going to write a check to save the day. That would be irrational. So, we tend to keep that in mind when they are underwriting at the front end and are cognizant of it, but instead we really get to the core of the fundamentals of the business and what’s driving that enterprise value and likely to drive the sustainability of that enterprise value. Hopefully, that’s helpful.

Yes. If I could add a little to that as well, I mean, I think that what you get with a sponsored transaction, a quality sponsored transactions is, in effect, you get a high quality leadership with relatively deep pockets. But as Mike said, they are economic animals, the sponsors and they are not going to just throw money in there. They might have minor money to buy a little bit of time, but they are not going to save a bad credit. They are going to restructure. They will invest on a fully restructuring to market. So they are very market savvy. And so when you do a sponsored deal, basically everything is market, generally the sponsors paying a market price, generally the financing is a market price and that’s what you get and it’s highly negotiated in that markets very, very tough. So, you get the benefit of the leadership and you get the benefit of really professional due diligence, etcetera. In the non-sponsored world, in effect, there is this non-market elements. There is auto relationship involved. There is particular situations involved that make that entire transaction not necessarily a market transaction. And then inside of that, because of that and because of the non-sponsored nature, generally, the financing doesn’t get bid out like it would in a sponsored situation. So, it’s much more negotiated capital structure and negotiated deal and it’s all kind of one piece. And then another thing we like to add is that our organization has a history of being an equity sponsor. And everyone on our team has been an equity sponsor at some point in time in terms of owning the equity and doing complete buyouts outstanding themselves. So, we are not uncomfortable with, if we had to take over the companies and run it as a sponsor, we have the skill base, we have the experience to do that. So, we think that gives us more confidence in moving into these situations. And also, it helps us in the management of these situations. I mean, we had one of our non-sponsored deals that was kind of going sideways and we basically did kind of some things that the sponsor would do because of our role, because of our authority, because we had more power than we would have if we were just a lender to help reorient the business plan, refocus the management team and the company was able to sort of turn from sort of one trajectory of sort of a little less disciplined spending, if they needed to a much more focused investment program with an eye on proper margins in addition to growth kind of thing. That kind of work the sponsor would do. So we were able to deliver that kind of value add and relationship that a sponsor would have in the non-sponsored credit, so that, that has actually outperformed since we are involved on that basis. So we think all of those things together give us a very strong appetite for non-sponsored deals. I mean, actually, our favorite deals, if we can get them in the right way.

That’s very helpful. It’s obviously important to be able to help management team work through problems and provide that guidance if you don’t have a sponsor. So, that’s very good to hear. But if you don’t have a pattern within your own underwriting since you have taken over Saratoga with regard to whether or not they default more frequently or they have more problems, I presume like most BDCs, you are only doing a small proportion of your overall deals that you see. So, when you look at the deals that you didn’t do, is there a clear pattern between the defaults and non-defaults between the sponsored and non-sponsored opportunities?

I think that’s a very difficult question to answer. I mean, we are coming out of a period of probably the lowest default rates in the history of LBOs since the downturn into the fall, very, very small. In our portfolio, we haven’t had any defaults to-date on ones we have originated. So, we don’t have hard data on that. In terms of deals we didn’t do, it’s very hard to track exactly what happens. And I think if you look across maybe the BDC industry and you look at where some of the credit problems have arisen, certainly in retrospect, a number of those deals were sort of questionable structure, there are some sort of obvious credit problems with them. And so the main inside the bell curve of the type of credits have been underwritten, there is really not a lot of default history. And so it’s very difficult. And in the environment we have had over the last – since 2008, ‘09, has been sort of really slow, steady growth, which has not been a robust recovery, but it also has not been in much risk of recession. You look at recent reports, Goldman Sachs just came out with a big report they think there is basically zero risk of a recession in 2017, so not that that’s possible, but it would be hard to really answer that question without having gone through a full cycle and we have really had not a full cycle with what’s happened in the economy.

Okay, great. Thanks. Even if you don’t have a specific answer, it’s helpful to hear your thoughts on that. Just one last question, you mentioned that some of your origination is working with companies that are smaller, say with EBITDA of less than $5 million. One of the things that credit agencies stress is that larger companies tend to be safer for creditors, all things being the same, because they are just more bigger with more resources. So, if you are looking at companies that are of that size, do you think that, that risk is – which is greater in your eyes, the size of the company that you are underwriting and lending to or the nature of whether or not there is a sponsor involved?

Well, I mean, that’s a very profound question and it goes to the heart of credit, right. And yes, it’s sort of like physics. I mean the body in motion – the big company has more momentum, right? And so the more momentum they have and the less knock they can be. There are some large companies that has some very dramatic negative offense.

Absolutely. Sure.

But I think if you are a credit investor that’s looking to be sort of a highly diversified, broad participant in the credit marketplace, you definitely want to be with higher – you re taking 1% or 2% positions and 150 credits or something, like in our CLO, for example, you definitely want to be in substantially larger credits because they are safer on average, right? If you are doing statistically, yes, they are better. And so in our CLO, we adhere to that. The average EBITDA in our CLO, I think is in the hundreds of millions of dollars of EBITDA. So, we agree with that premise. But when we go below $5 million, these are situations where we are generally the dollar one lender, we have a lot of power, we also have equity investments and so we have – we are much closer to a sponsor-like relationship. So we are not just a passive creditor that just hopes everything is going to work out. If things aren’t working out, we have the ability, we have covenants, we have metrics, we have board observation rights, we have defined powers, so that we can actually act as we see things either deteriorating or whatever. So, in these smaller deals, we have a much greater degree of involvement. And so with that, that takes – it doesn’t take all the risk out of it, but it takes a chunk of risk out of it, because we can help manage that. The other is investment selection. There are some companies below $5 million EBITDA that have really strong, persistent customers, number of the software-as-a-service companies that we have been investing in that are small and growing, I mean, they have highly diversified customers, very embedded software solutions for those customers that really don’t allow for much switching. And as Mike said in some of these investments, we might be lending to 4x or 5x EBITDA, but the sponsors are coming and writing checks of 4x or 5x or more EBITDA. So, there is a lot of equity coming in behind them and that doesn’t necessarily help you in terms of the credit, but that speaks to overall valuation. So, some of these smaller companies if they were to get into trouble, there is – there are strategic acquirers that could buy them and we have covenants that allow us to get involved before there is a dramatic depreciation. And so we can force sales of those companies or other activity, other actions that could mitigate credit loss. And then the last piece to it is just absolute selection. We are selecting management teams and franchises. There is a lot of great franchises in America. It’s a highly diversified economy. The beauty of these businesses is they are not correlated to the overall economy. A lot of the bigger businesses are highly correlated to GNP, but these smaller businesses, they have their own market niches therefore we are not as recession sensitive in a lot of these deals. So excellent question and I think the answer really comes down to investment management, which is what we do which is proper underwriting, proper documentation, proper rights and proper oversight to stay on top of these.

Let me add a little bit to that too. Just to further emphasize what Chris said, the rating agencies are right, because they are looking at a broad, broad portfolio of companies. And what they are really saying is that by and large, large companies have more durable cash flow. And that really is the trick of credit is you are spending all of this time and energy analyzing the business to reach a conclusion that you think it has a durable cash flow, that’s going to pay interest on your debt and ultimately be a source of repayment of your debt when you get paid off. And we are sure, larger companies and what rating agencies are saying is, the larger companies tend to have really good management teams, they have got a diverse customer base, they have got a very strong market position and they are typically offering a very strong and compelling value proposition to their customers. Now it’s easy to say that a broad level, so if you look at a basket of big companies and a basket of small companies, they are right in saying that large companies are less risky than small ones. Our job and what we spend all our time doing and that’s why originations are so lumpy. This is exactly why originations are so lumpy, is trying to find those small companies that have those characteristics, strong management teams, diverse customer bases, a great market position in the little niche they operate in, may be a regional niche, it could be – or a smaller market that they dominate and did they offer a value proposition to their customers that’s sustainable. And when you find those, even if they are small, their credit profile and the risk adjusted returns there could be fabulous. And we will do those with sponsor transactions as well as un-sponsored transactions. And I would say it’s interesting when you ask a question about outcomes, it is a very good question. And as Chris said, it’s very hard to judge credit decisions in a benign credit environment. People for sure have made some investment decisions on deals that we have passed on. And we know what many where those deals didn’t do well and the folks that did them are suffering with them. There is plenty others where they are doing fine, but they didn’t necessarily make the right investment decision. It’s just that things worked out and just because the outcome was doesn’t necessarily mean that they took the right underwriting – made the right underwriting decision. You only know that over a longer period of time. We sort of look at things – so you can remember back to statistics where you had type 1 and type 2 error, one of them was, you decide to take a path on a deal that ends up working out, it end up being a fine deal. And the other is that you end up deciding to do a deal that goes bad. We will much, much prefer taking the type 1 error, we decided to take a pass on a deal that works out than the type 2 error here we make that investment decisions. And you know our investors want us to do that. And that’s again why our origination – originations are lumpy because we are very, very careful.

I think the one place where there has been some pretty broad gauge evidence of credit decisions and credit results has been the energy sector. And there was quite a heavy cycle to the energy sector and that caught a lot of people out. And I think we as a firm, specifically avoided that sector. There were lots of sub-$5 million companies that were growing very rapidly. We have made some type 1 errors, as Mike said. There was a number of those companies we didn’t do that did pretty well. And part of the reason they did well is because they cycled really fast and that was maybe investment – the debt investment was made and they were out.

It was a timing play...

But if in for 3 years, they would have may be lost all of their money. And so that’s one test is it’s going to say who invested in energy and who didn’t and we did because again, that’s not our credit philosophy to be exposed in the debt markets. On the equity side, we consider investing in energy because we think it’s an asymmetric game, right. I mean we think in debt, you can lose 100% and really just get your interest, where in equity, in energy especially, you could make 10x on your equity and just lose 1x. So we don’t like that asymmetry. We want the other way. So our focus has been in sort of non-cyclical niche type of companies. And one of the things to repeat something Mike had said earlier is that in the less than $5 million investments, we are pretty much – we are exclusively dollar one in unitranches. So that if we are lending 4x or 5x, we are also lending 1x, 2x, and 3x. So if there is exposure, it comes down the chain, but there is no creditor ahead of us.

There may be one or two exceptions for that.

What they are, it’s kind of a revolver or something like that. And so that really mitigates a lot of risk. Where in the larger companies where – in the companies with higher EBITDA, again as Mike had said, there would be maybe down the capital structure. We might be more towards a mezzanine or second lien type of investment. And that’s because we have better faith in the durability of that company and less need for that role. And so it’s a combination of management selection and structure that helps us navigate our way through these credit questions that you just asked.

Very helpful and really helps me better understand your underwriting and management philosophy. Thank you very much.

Thank you. And I am showing no further questions at this time. I would like to turn the call back to Mr. Oberbeck for closing remarks.

Okay. Well, thank you, everyone. We very much appreciate your support. We appreciate the discussion we always on these calls with you and we look forward to speaking with you next quarter. Thank you.

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone, have a wonderful day.