Saratoga Investment Corp. (SAR) Q2 2019 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Saratoga Investment Corp’s Fiscal Second Quarter 2019 Financial Results Conference Call. Please note that today’s call is being recorded. During today’s presentation, all parties will be in a listen-only mode. Following management’s prepared remarks, we will open the line for questions. At this time, I would now like to turn the call over to Saratoga Investment Corp’s Chief Financial and Compliance Officer, Mr. Henri Steenkamp. Sir, please go ahead.

Thank you. I would like to welcome everyone to Saratoga Investment Corp’s fiscal second quarter 2019 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 second quarter 2019 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 1:00 PM today through October 18. Please refer to our earnings press release for details. I would now like to turn the call over to our Chairman and Chief Executive Officer, Christian Oberbeck who will be making a few introductory remarks.

Thank you, Henri and welcome everyone. As we look back at this most recent fiscal quarter, we are pleased to highlight both the important steps taken to strengthen our capital structure as well as our continued progress of generating new investments, maintaining strong credit quality and delivering growth in earnings. All of these factors contribute to continuing our leading performance within the BDC sector. To briefly recap the past quarter on Slide 2, first, we continue to strengthen our financial foundation this quarter by maintaining a high level investment credit quality with 99.4% of our loan investments having our highest rating, our strongest level yet, generating a return on equity of 11.6% on a trailing 12-month basis, up from 8.3% last year and beating the BDC industry mean of 9.9% and maintaining a gross un-levered IRR of 13.2% on our total unrealized portfolio with gross un-levered IRR of 13.4% on total realizations of $299 million. Second, we expanded our assets under management to $393 million, an increase of 14% from $343 million as of Q1 and up from $333 million as of the same time last year. From a longer term perspective, our current AUM reflects a 154% increase from a $155 million over the past 5 years. This quarter continues to demonstrate the success of our growing origination platform with a healthy $52 million of originations, including investments in four new portfolio companies, bringing the total to 7 new platforms since May through quarter end. Third, the continued strengthening of our financial foundation has enabled us to increase our quarterly dividend for the 16th consecutive quarter. We paid a quarterly dividend of $0.52 per share for the second fiscal quarter 2019 on September 27, 2018. This was an increase of $0.01 per share over the past quarter’s dividend of $0.51 per share. All of our dividend payments have been exceeded by our adjusted net investment income for the same periods. And when looking at Q2 and assuming our weighted average shares are fully diluted for the recent equity issuance, we are still comfortably over-earning our dividend currently by 23%, which distinguishes us from most other BDCs. We are only 1 of 7 BDCs having increased dividends over the past year. And finally, our base of liquidity remains strong with various important and positive steps taken in this quarter. On July 13, 2018, we issued 28.75 million in new equity at an 8.4% premium to NAV, increasing our outstanding shares by 1.15 million shares. Very importantly, this has led to a substantial increase in our share float by more than 43%, improving our trading liquidity for our investors. On August 28, 2018, we successfully raised $40 million of new seven-year 6.25% fixed-rate notes under the ticker symbol SAF, and on September 27, 2018, the SBA issued a green light letter inviting us to file a formal license application for a second SBIC license. If approved in the future, the additional license will allow us to issue $175 million of additional SBA debentures based on our investment of $87.5 million of equity. We continue to preserve significant dry powder to meet future potential opportunities in a changing credit and pricing environment. Our existing available quarter-end liquidity of $88 million excluding the second SBIC license allows us to grow our Q2 assets under management by 22% without any new external financing. Importantly, our healthy and growing sourcing and origination process has already allowed us as of today to invest most of the capital raised and cash available as of the end of Q2. We did not issue any further stock under our ATM in Q2. This quarter saw continued strong performance within our key performance indicators as compared to the quarters ended May 31, 2018 and August 31, 2017. Our adjusted NII is $4.8 million this quarter, up 29% versus $3.7 million last year, and up 19% versus $4 million last quarter. Our adjusted NII per share is $0.69 this quarter, up 11% from $0.62 last year, and up 8% from $0.64 last quarter. Our latest 12 months return on equity is 11.6%, up from 8.3% last year, and our NAV per share is $23.16, up 3.5% from $22.37 last year Q2, and up from 23 – and up from $23.06 last quarter. Henri will provide more detail later. We remain extremely pleased with our performance and these recent accomplishments. As we've often mentioned in the past, we remain committed to further advancing the overall long-term size of our asset base while maintaining its high quality. As you can see on Slide 3, our assets under management have steadily risen since 2011 and the quality of our credit is at its highest level yet. We look forward to continuing this positive long-term trend. With that, I would like to now turn the call back over to Henri to review our financial results, as well as the composition and performance of our portfolio.

Thank you, Chris. Slide 4 highlights our key performance metrics for the quarter ended August 31, 2018. Across all these metrics, you can see the positive impact of increased assets and strong credit quality on our results. When adjusting for the incentive fee accrual related to net unrealized capital gains in the second incentive fee calculation, adjusted NII of $4.8 million was up 19% from $4.0 million last quarter, and up 29% from $3.7 million as compared to last year's Q2. Adjusted NII per share was $0.69, up $0.07 from $0.62 per share last year and up $0.05 from $0.64 per share last quarter. The increase from last year primarily reflects our higher level of investments and results in higher interest income with AUM up 18% from last year. The sequential quarterly increase was primarily due to increased interest income as both the Q1 quarter-end cash, as well as some of the new capital raised this quarter was immediately invested, including investments in four new portfolio companies. Adjusted NII yield was 11.9%. This yield is up 60 basis points from 11.3% last year, and up 80 basis points from 11.1% last quarter. For the second quarter we experienced a net loss on investments of $2.0 million or $0.29 per weighted average share, resulting in a total increase in net assets resulting from operations of $3.1 million or $0.45 per share. The $2 million net loss on investments was comprised of $2.2 million in net unrealized depreciation, offset by $0.2 million of net deferred tax benefit on unrealized losses in Saratoga Investment’s blocker subsidiaries. The $2.2 million unrealized depreciation includes $0.8 million unrealized depreciation on our My Alarm Center investments, primarily the preferred equity Class B units, $0.9 million unrealized depreciation on our Elyria Foundry investment and $0.4 million unrealized depreciation on our investment in Tile Redi Holdings. Return on equity remains an important performance indicator for us, which includes both realized and unrealized gains. Our return on equity was 11.6% for the last 12 months, up from 8.3% last year and is well above the BDC industry average of 9.9%. Quickly touching on expenses, total expenses, excluding interest and debt financing expenses, base management fees and incentive management fees decreased to $0.9 million this quarter from $1.2 million in the same period last year, reflecting primarily our recognition of a $0.3 million deferred income tax benefit generated by equity investments held in taxable blockers generating net operating losses. Expenses as a percentage of average total assets therefore decreased from 1.4% to 0.9%. We have also again added the KPI slides starting from Slide 27 in the appendix at the end of the presentation that shows our income statement and balance sheet metrics for the past 10 quarters and the upward trends we have maintained. Of particular note is Slide 30 highlighting how our net interest margin run-rate has more than tripled since Saratoga took over management of the BDC. Moving on to Slide 5, NAV this quarter was $172.7 million as of this quarter end, a $29 million increase from NAV of $143.7 million at year end and a $59 million increase from NAV of $133.5 million as of 12 months ago. NAV per share was $23.16 as of quarter end, up from $22.96 as of year end and $22.37 as of the same period last year. For the 6 months ended August 31, 2018, $9.1 million of net investment income and $0.2 million of net realized gains were earned partially offset by $0.8 million of deferred tax expense on net unrealized gains in our blocker subsidiaries, $1.5 million net unrealized depreciation on investments and $6.3 million of dividends declared. In addition, $27.4 million of common stock was issued net of operating costs and $1 million of stock dividend distributions were made through the company’s DRIP plan. No shares were sold through the company’s ATM equity offering during this period. Our net asset value has steadily increased since 2011 and we continue to benefit from our history of consistent realized gains. On Slide 6, you will see a simple reconciliation of the major changes in NII and NAV per share on a sequential quarterly basis. Starting at the top, NII per share increased from $0.64 per share last quarter to $0.69 per share this quarter. The significant changes were an $0.08 increase in total interest income reflecting the increase in our asset base, $0.03 increase in other income, $0.03 decrease in operating expenses and $0.01 increase in deferred tax benefit. These increases were offset by a $0.07 dilution from increased shares due to the equity offering and DRIP issuance, $0.02 increase in interest expense and $0.01 increase in base management fees. All changes on this graph are shown net of incentive fees. Moving on to the lower half of the slide, this reconciled the NAV per share increase from $23.06 at Q1 to $23.16 for this quarter. The $0.74 generated by our NII for the quarter and $0.16 accretive net impact of the equity offering and DRIP issuance was offset by the $0.51 dividend declared for Q1 with a Q2 record date and a $0.29 net unrealized loss on investments. Slide 7 outlines the dry powder available to us as of quarter end, which totaled $88.3 million. This is spread between our available cash and undrawn Madison facility. Subsequent to quarter end, we have invested most of the quarter end cash and cash equivalents in new originations. This quarter, we also took significant steps to strengthen and increase our capital and liquidity. In addition to increasing our equity through the $28.75 million of secondary offering, we also issued more long-term fixed rate debt. Importantly, this new debt with the ticker SAF was issued 50 basis points below our other baby bond and also allowed us to stagger the maturities of our baby bond issuances by having a new 7-year maturity versus our existing SAB baby bond that matures in just over 5 years. This is the start of a process of ensuring we have staggered maturities across our capital structure. We remain pleased with our liquidity position, especially taking into account the overall conservative nature of our balance sheet and the fact that all our debt is long-term in nature, actually all 5 years plus. For the most part, we have also primarily fixed our interest cost in this rising rate environment with all our borrowings except our Madison facility being fixed rate. Moving across now to the asset side of our balance sheet on Slide 8, 82% of our investments have floating rates. And although they have LIBOR floors, we are through all of them which means we remain a big beneficiary of rising short-term rates. Assuming that our investments as of quarter end were to remain constant for a full fiscal quarter and no actions were taken to alter the existing interest rate terms, a hypothetical increase of 100 basis points in interest rates would increase our interest income by approximately $0.7 million per quarter or 7% more than our current interest income. This is all incremental to our existing earnings without any other changes. Now, I would like to move on to Slides 9 through 11 and review the composition and yield of our investment portfolio. Slide 9 shows that our composition and weighted average current yields remain consistent with the past with $393 million invested in 55 portfolio companies and 1 CLO fund and 58% of our investments in first lien. On Slide 10, you can see how the yield on our core BDC assets, excluding our CLO and syndicated loans as well as our total assets yield has remained relatively consistent in the 11% range for the past several years, despite high levels of repayments and the continued replacement of these assets. This quarter, our overall yield decreased slightly to 10.8% primarily due to our non-interest earning equity bucket, increasing from approximately 8% to 9% with the increase in our overall AUM. Core asset yields, excluding our CLO and syndicated loans, remained relatively consistent above 11%. LIBOR rates hardly moved this past quarter. Also, our last syndicated assets were repaid in Q1. Turning to Slide 11, during the second fiscal quarter, we made investments of $51.7 million in 4 new portfolio companies and full follow-ons and had $1.0 million in amortizations, resulting in a net increase in investments of $50.7 million for the quarter. Our investments remain highly diversified by type as well as in terms of geography and industry spread over 10 distinct industries with a large focus on business, healthcare and education services. Business services, also is spread amongst numerous end markets. We continue to have no direct exposure to the oil and gas industry. Of our total investment portfolio, 9.1% consists of equity interest which remained an important part of our overall investment strategy. For the past 6 fiscal years, including Q2, we had a combined $12 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, has helped grow our NAV and is reflected in our healthy long-term ROE. That concludes my financial and portfolio review. I will now turn the call over to Michael Grisius, our President and Chief Investment Officer for an overview of the investment market.

Thank you, Henri. I will take a few minutes to describe market conditions as we see them. Then I will comment on our portfolio performance and investment strategy. The market’s extremely competitive conditions have remained challenging since our last call in July. We are actually observing growing deal activity again, but the overabundance of capital in part due to fund formation persists and competition has been significant. This has resulted in the narrowing of spreads this year and increasingly borrower-friendly deal terms leading us to be very disciplined and focused on deal structure and documentation during our credit process. Thankfully, LIBOR increases earlier in the year have provided some counterbalance to spread compression this year. For Q2, our strong results have been generated while LIBOR remained relatively unchanged during the quarter. We remain well positioned to benefit should LIBOR rates rise further. We continue to believe the lower-middle market, our target market is the most attractive one to deploy capital in. While our market has become more competitive, we believe it is far less competitive than the larger end of the middle-market. The sheer number of companies that are into the market and our experience there allows us to sip through and find transactions that we believe are most likely to deliver the best risk-adjusted returns to our shareholders regardless of market dynamics. And on Slide 13, you can see that industry debt multiples remain extremely high and increased significantly from last year as lenders continued to be aggressive in their pursuit of putting money to work. As of August 31, 2018, average leverage multiples were well above 5 times, with 3 out of 4 deals on average now being executed above that level. With this as a backdrop, we have been able to achieve our results while maintaining a relatively modest risk profile. Total leverage for our overall portfolio is 4.35 times, down a quarter term from the previous quarter reflecting primarily the origination this quarter of numerous lower leverage deals. Nevertheless, we continue to focus our investing on credits with attractive risk return profiles and exceptionally strong business models where we are confident that the enterprise value of the businesses will sustainably exceed the last dollar of our investment. Importantly, this slide also illustrates our consistent ability to not only generate new investments over the long-term despite difficult market dynamics, but also the strength of our growing sourcing platform. With 19 originations through the third calendar quarter, including 8 new portfolio companies and 11 follow-ons, we have established an origination level that is ahead of last year’s record pace, while applying consistent investment criteria. Several of our new platform investments are with recently formed relationships that could serve as sources of future deals. We are also pleased to have closed one further investment in the new portfolio company since fiscal quarter end, which is included above as well as five follow-ons, thereby already putting most of our available cash as of Q2 to work. We remain confident that we can continue to grow our AUM steadily over the long-term, and this quarter’s originations both size and nature illustrate the health and growth of our pipeline. Now that said, we continue to believe successful investing rests on sound judgment and steady continuous discipline, taken one decision at a time and on a basis focused purely on credit quality. We do not labor on this critical criteria, which remains first and foremost in all decisions and believe that this approach is the most prudent strategy as we do not seek to predict or time macroeconomic cycles. Moving on to Slide 14, our team’s skill set, experience and relationships continue to mature and our significant focus on business development has led to new strategic relationships that have become sources for new deals. As you can see on the slide, our number of deals sourced and evaluated has increased materially over the past couple of years despite competitive market conditions. 50% of these deals come from companies without institutional ownership underscoring the importance of proprietary relationships in our deal sourcing. The rest come from private equity sponsors. The chart also underscores our originations discipline. While the size of the funnel at the top has grown significantly, term sheets issued have not increased at the same rate. In fact, due to inconsistent quality, we are looking at many more deals now in order to find those that meet our standards. We have to work harder to find deals of quality, something we recognize as the cost of doing business in today’s market. Nevertheless, it’s worth underscoring that no matter how many deals we see at the top, our overarching goal is to maintain the same high level of credit quality. Especially noteworthy, recently is the strength of our pipeline has enabled us to close deals with 8 new portfolio companies in the past 4 months, giving further validation of our strengthening business development platform. New portfolio companies have the added benefit of frequently serving as a foundation for future deal flow with us consistently demonstrating our ability to deliver outsized returns for our shareholders by recognizing fundamental value in businesses and supporting their growth over time. Our overall portfolio of credit quality is strong. As you can see on Slide 15, the gross unleveraged IRR on realized investments made by the Saratoga investment management team is 13.8% on approximately $209 million invested in our SBIC and 12.5% on approximately $90 million invested in our rest of our BDC. On a combined basis, the gross unlevered IRR is 13.4% on $299 million of realizations. On the chart on the right, you can also see that gross unlevered IRR on our $379 million of combined weighted SBIC and BDC unrealized investments is 13.2% since Saratoga took over management. Slide 16 highlights that the mix of securities in our SBIC portfolio was conservative, with 52.7% of our investment comprised of senior debt first lien investments. The leverage profile of these 23 investments remains relatively low at 4.53 times, especially when compared to overall market leverage. Our favorable cost of capital from this program allows us to deliver highly accretive returns to our shareholders without stretching out on the risk spectrum. Moving on to Slide 17, you can see our SBIC assets increase to $237.3 million as of quarter end, up from $223.5 million last quarter. This now represents 60% of our overall portfolio. As of quarter end, we have $5 million total available SBIC investment capacity, all cash within our current SBIC license. This represents only 6% of our total available firm capacity as of quarter end. As Chris mentioned earlier, SBA recently issued a Green Light letter inviting us to file a formal license application for a second license. If approved, this would allow us to issue subject to SBA approval up to $175 million of additional SBA guaranteed debentures on $87.5 million of new equity. Overall, this quarter’s operating results again demonstrated the growing strength of our sourcing and origination capabilities leading to a growing base of high-quality assets over long-term. High-quality growth continues to come from both new platforms as well as follow-ons. We have always spoken about the power of increased scale on our operating results, but producing these results has required us to remain extremely diligent in our overall underwriting and due diligence procedures, culminating an high-quality asset selection within the tough market. Credit quality remains our top focus and we remain committed to this approach. This concludes my review of the market. I would like to turn the call back over to our CEO, Chris.

Thank you, Mike. As outlined on Slide 18 following our most recent increase to our first quarter dividend to $0.52, our quarterly cash dividend payment program has grown by a 189% since the program launched. This represents 16 sequential quarters of dividend increases. Despite these consistent increases, we are still also over-earning our dividend by 23.1% based on the full impact of the secondary offerings outstanding shares giving us one of the higher dividend coverages in the BDC industry. As you can see on Slide 19, we have had an 8.3% year-over-year dividend growth, which easily places us near the very top of our peers and one of only 7 BDCs have grown dividends the past year. This was to also include some BDCs at the top of the list that have variable dividend policies therefore not directly comparable. We have now had 16 sequential quarters of dividend increases, while most BDCs have either had no increases or decrease the size of their dividend payments. We believe our continually increasing dividend has truly differentiated us within the marketplace. We also continue to see SAR outperform the industry. Moving to Slide 20, our total return for the last 12 months, which includes both capital appreciation and dividends, has generated total returns of 28%, significantly beating the BDC index of 9%. And when viewed over a longer time horizon, as you can see on Slide 21, which is when we took over management of the BDC, our 3-year and 5-year return places us in the top 2 of all BDCs for both time horizons. Over the past 3 years, our 99% return exceeded the 31% return of the index and alternatively as compared to when our management team became the investment manager of the BDC 8 years ago, our 390% return exceeded the index’s 114% return. Slide 22, you can further see our outperformance placed in the context of the broader industry and specific to certain key performance metrics. As we continue to achieve high marks across diverse categories, including interest yield on the portfolio, latest 12 months NII yield, latest 12 months return on equity, dividend coverage, year-over-year dividend growth, NAV per share, and investment capacity. Of note, as our assets have grown and we are starting to reach scale, our expense ratio is moving closer towards the industry averages, while we’re outperforming the industry in most other metrics. We continue to emphasize our latest 12 months return on equity and NAV per share outperformance, which reflects the growing value our shareholders are receiving. Moving on to Slide 23, all of our initiatives 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 maintain 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 maintaining one of the highest levels of management ownership in the industry at 20%, a strong and growing dividend over earning adjusted latest 12 months NII by 23% based on pro forma fully diluted Q2 fiscal year 2019 earnings, strong long-term return on equity, available low cost and long-term liquidity with which to grow our current asset base, including the recent equity and baby bond offerings, obtaining a BBB investment grade rating, solid earnings per share, and NII yield with substantial growth potential, steady and high-quality expansion of AUM, and an attractive risk profile with protection against potential interest rate risk. Our high-quality credit portfolio contains minimal exposure to cyclical industries, including the oil and gas industry. With this overall performance, Saratoga Investment has achieved recognition among the premier BDCs in the marketplace. Finally, looking at Slide 24, we've accomplished a lot in this quarter and are proud of our financial results. We remain on course with our long-term goal 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. Executing on our simple and consistent objectives should result in our continued industry leadership and shareholder total return performance. In closing, I would again like to thank all of our shareholders for their ongoing support. We're excited for the growth and profitability that lies ahead for Saratoga Investment Corp, and we’d like to now open the call for questions.

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

Good morning, everyone. I wanted to start by asking you about your other income, which doubled this quarter versus the previous quarter. Was that due to origination fees? Do you book those at closing or do you amortize them, and if it wasn't origination fees, what was the nature of the increase?

Sure, Mickey, it's Henri, and hi. Yes, it was primarily reflective of our increased originations. We obviously didn't have repayments, so there wouldn't be any prepayment penalties in there, which we’d obviously book if we had repayments. So it's effectively driven by originations and our consistent policy that we've had and always have is that generally our fee is split between a advisory of structuring portion and a closing portion, which is like OID. So the advisory piece, which is half of the fee generally goes to income immediately when we close the deal and then the closing fee gets amortized over the life of the investment as OID, and that doesn't go through other income, that goes through the interest income line, but to your question on sort of the variance primarily driven by the originations.

Okay, Henri. That’s helpful. And then a few questions on the CLO. I noticed that the estimated yield on the equity portion of the investment declined pretty meaningfully quarter-to-quarter. What caused that change?

It's mainly a reflection, Mickey, of the sort of the remaining, I guess, period of our CLO. As you know and you probably saw in our filings we are getting closer to the end of our reinvestment period and is going through the process currently of potentially refinancing our CLO and not only refinancing, but as you probably saw in our 10-Q we actually have a warehouse out there, so there is a possibility of even upsizing our CLO. And as we get closer to that moment in time, the effective interest rate, the weighted average effective interest rate on that does sort of shrink until that’s resolved or refinanced.

Actually that is a segue into my next couple of questions, my understanding is that the reinvestment period ends this month, I don’t know if that means the end of the month or some other date, but I saw the warehouse line, so presumably you are looking to upsize it as you indicated and we set the liabilities, so are you deep into that process at this point, Henri?

Mickey, this is Chris. Yes, I mean I think this would be our third reset and so we have obviously been through this process before. And yes, we are in the process of evaluating alternatives for a combination of our refinancing and in upsizing. And as Henri mentioned and we disclosed in our 10-Q we do have a warehouse line that allows us to accumulate assets in sort of in a orderly fashion towards that upsizing.

And Chris, presumably you are looking to take advantage of the tighter spreads that exist in the market today, so can you give us a sense of how if you do capture those through refinancing the CLO, what can we expect in terms of the impact on the management and incentive fees you collect from the CLO?

Well, Mickey, as you can imagine until a transaction like this actually closes, it’s difficult to predict exactly where we are going to be, both in terms of the size, rate and composition. And so that’s really not something we can give good color on right now. I think after we do refinance it and all that obviously we will have all that information, but at this point in time, it’s premature to be able to present that.

Because obviously, Mickey, as you know the management fee would be driven obviously by the size of the assets in the CLO and then the incentive fee could be impacted by also the term of the refinancing. So, obviously it could be 2, 3 or 4 years and that could drive the incentive fee. So it’s sort of first, you got to get to the end result of the refinancing before you can assess the impact.

So, is this something we can expect to see completed in the fourth calendar quarter?

Our expectation would be completed financing either this quarter or the following quarter.

Okay. And just a couple of last questions on leverage, what are your thoughts on capitalizing the second SBIC license if you are approved and does your credit facility allow you to draw on it to begin to inject equity into the new license?

I think as we have presented we have a fair amount of available liquidity for investment and SBIC license would be just more deployment along those lines. And so we feel comfortable that we have capital to be able to capitalize that license. We don’t have that license yet. I think at the time when we fully secure that license we would consider additional financing sources as well.

Okay. My last question it would probably be helpful if you can just remind us what your target leverage is particularly since you got the Green Light letter both in terms of total debt to equity and regulatory debt to equity? That would be really helpful.

I will let Henri talk about the specific numbers. I think as you know and as was disclosed we did get a Board approval to increase our leverage to 2 to 1 at the BDC level. And that approval takes effect, the date that we will be allowed to do that would be April 18. As you know, Mickey, we have been operating with an SBIC subsidiary for 6 years now. And so we have had this ability to have this incremental leverage and then that’s all been factored into the total performance and the total leverage ratios that we have demonstrated to-date. So, we don’t – certainly in the next couple of quarters, we don’t anticipate a radical change in the general leverage ratios that we've been operating under.

Okay, I appreciate that, Chris. Thanks for all of your time this morning.

Thanks, Mickey.

Thank you. Our next question comes from the line of Tim Hayes with B. Riley. Your line is now open.

Hey, good morning, guys. My first question, just wondering, would you be able to provide a rough estimate of the earnings drag recognized in the quarter either on a yield or NII per share perspective, just from undeployed capital or the timing mismatch between when you received the proceeds from the capital raises and when those proceeds were deployed?

Yes.

Well, Tim, there’s obviously a lot of different factors that would go into an assumptions that would go into that. I would add though that sort of I think a way to think about is what I tried to do in the presentation is say as a start you should take the quarter and obviously ensure that you've got the fully dilutive impact of all of the shares. And so that's how sort of we got to that – you get to that $0.64 if you just fully dilute Q2 sort of on a pro forma basis. I think two other considerations if you can think of is firstly, we did the baby bond at the end of the quarter, so obviously baby bond interest will be outstanding from Q3 onwards as well. And then as we had also said in our prepared remarks, we've put most of the $43 million cash that we had on hand at quarter-end to work in new investments in the last six weeks. So, I think those are sort of some of the assumptions I would think you can consider as you sort of look at your model.

Okay, makes sense. And then saw that the My Alarm Center Class A preferred investment was moved to non-accrual, it seemed like since the restructuring last year it seemed like your outlook had been improving. And so just wondering kind of what's happening there and how you feel about the company?

Yes, let me address that. So, I think as you referenced, we – when there was a change of controlled transaction last year, we exchanged our debt securities for both Class A and Class B equity securities. Since that time, the new owner of the business has recently decided to make an investment in the business into the infrastructure of the business. That investment is structured in a way where it is senior to the A and B securities. It also has pretty significant economics attached to it such that the Class B securities are being diluted in our valuation by that investment. Now what you don’t see in the balance sheet is that subsequent to quarter-end, we also invested in that new round of equity securities about $600,000. And so the hope is that if things go as planned that the appreciation of that $600,000 investment in the business while it – while that security, that new security will over time trump and probably – likely devalue the Class B securities, it in turn will grow. And the other thing I'd add is that of that $600,000, some of it is more than our pro rata portion of what we are – had a right to invest in. So the hope is that if things go the way we would like them to that we'll recover a good deal of that investment to that new security.

Okay, thanks for that. That was very helpful. And then just another credit I noticed had been marked down a little bit was Roscoe Medical. Just wondering, if there is any material change in outlook there, just how you feel about the credit?

No, that's one that we continue to work with the sponsor, who has been supportive of the business. The business has continued to have some challenges, but it's no very significant change in the outlook of the business.

Okay, got it. That's helpful. And one more from me. Earlier you had touched on leverage multiples on your deals versus the industry and your commitment to maintaining structure. And just wondering exactly how documentation and structure today on the deals that you completed in the quarter just compared to those that you may be closed a year or two ago. Is there really no difference at all or has it gotten maybe slightly come lighter or just any color around that would be helpful?

I think at the margin, the terms and the agreements that we see are more borrower friendly, but I would tell you that where we sit in the marketplace at the lower end of the middle-market the terms are much more traditional that is the vast majority of the deals that we do we have very strong covenants, all the protections that you would ordinarily look for at the margin that the sponsors can kind of pressure you to give him a little bit more covenant cushion and things of that nature just due to the competitive nature of the marketplace, but where we sit, we are not seeing the same types of terms you use the term cov light, we are not seeing those same types of terms that you see at the larger end of the middle-market.

Alright, that’s helpful. Thanks for taking my questions today.

Thank you. Our next question comes from the line of Christopher Testa with National Securities Corp. Your line is now open.

Hi, good morning. Thanks for taking my questions. Just wanted to extend a little bit on kind of what Mickey was asking on the CLO, so as I understand it, if the reinvestment period is set to expire in a month or so, would you have the ability to basically reset this either before or shortly after that ends and then start call it another 4 to 5 year life of reinvestment period and then maybe use the warehouse facility to then fund a separate CLO. Where I am getting is if you are going to warehouse loans and then put them into a CLO upside that can take some long time and you could be in the position where the CLO was not in the reinvestment period and the effective yields going down for quite some time as you gather those loans. So, I am just curious if that’s a possibility?

A couple of points on that, yes, while the reinvestment period ends, the warehouse kind of works in parallel. So, the warehouse allows us to stay in the marketplace pass that to end period, so if we don’t re-price it immediately, we still have plenty of time to re-price it. And at different points in the past, we have re-priced our CLO well into the calendar Q1. So it’s really a question of us and in the marketplace coming together and whether that happens exactly before the reinvestment period ends or quarter afterwards is not really that critical in the grand scheme of it all. And then the warehouse itself has been in place since August and while we are not liberty to talk about exactly how full the warehouse is, the point of the warehouse is to accumulate loans in kind of the ordinary course of business, so you are not forced to go buy them very rapidly and maybe – and so you can buy them at a sort of a proper market value as opposed to maybe sometimes if you have to buy a lot in a short period of time and might distort a little bit the market pricing on it. So, the warehouse is designed so that when you re-price the CLO the warehouse folds into the CLO at that time.

Got it. Yes, now that makes sense.

And I would just add, so it’s definitely a warehouse that is a wholly owned subsidiary of our existing CLO. So it’s for the purposes, as Chris said, to upsize the existing CLO. And as you know, our 10-Q actually has our CLO financial statements in it and the warehouse is consolidated with the CLO in those financials, so you can actually see how the assets – what assets we had in the combined entity as of August 31.

Got it. Okay, that’s helpful. So it’s going to end up upsizing this and won’t be using another one. And I guess just remind me when was the last time the CLO was repriced or reset?

2 years ago.

Okay. So, this would be pretty material cost savings, would that be in the ballpark to say that your weighted average spread over LIBOR would probably be reduced by 80 basis points or so?

I think it’s premature for us to discuss exactly the pricing. There is a lot of factors going on in the marketplace. So, it’s just – it’s hard for us to comment in general about how we are going to price this in particular. And again, I think as said earlier, we would anticipate pricing this either later this quarter or in the next quarter. So, we will have good, hard, firm information then, it’s just not really something that we would feel comfortable putting out specifics right now.

Okay, now that’s fair. I appreciate the color. And did you guys have a good deal of the investment growth in the quarter close relatively later in the quarter, so you had a 7% increase in investment income and the portfolio grew by about 14%?

I think it was. I have to look specifically, Chris, and you can actually again, it's in the schedule of investments you see the actual investment date. But I think it is actually – it was pretty even during the quarter I think, although some of it definitely did happen after the deal – after the equity offering.

Got it. Okay, now that makes sense. And prepayment activity was light in the quarter, but your other income was increased pretty significantly. Just wondering, if you could provide some color on what drove that?

Yes. The other income as I mentioned earlier was, it was really not prepayment-related at all, it was all driven by the new origination, pretty big origination quarter and then the 1% fee that generally we recognized upfront on origination.

Got it, okay. So when we're – in the context of you guys recognizing 100 bps of that upfront, should we expect the dividend to sort of remain these conservative step-ups that you had although obviously the past three fiscal quarters you guys have had pretty robust volume and driven that much higher?

Chris, as you would imagine and anticipate, we generally declare our dividends when we get close to quarter-end, and we've got to take and we've to take everything into account when we do that. And so it's just we were – we've been cautioned not to give forward-looking statements on our dividend.

Got it, okay. And last one for me, I mean, Easy Ice has been an excellent performer for you guys and congrats on making that investment to begin with. Just looking – so backing out the performance and looking at this, I'm just curious, how do you guys view this in terms of concentration risk having a large equity position in the portfolio and the optics of this. I mean, is this something where you get to a point in one day you monetize this even if it's still doing well just for those reasons or is this something that you're looking to hold long-term and just the general growth in the portfolio will make this a smaller piece of the pie as you go forward?

Well, I think that's a good question. And I think some of the challenges that you mentioned about optics and concentration are driven by very positive performance metrics coming out of the investment itself.

Right.

We think that – I think what's important and part of the way we do is, we kind of look through Easy Ice at to its fundamentals, and Easy Ice is a highly distributed – has a highly distributed customer base. There is really no concentration at all and it's a very persistent and very fundamental service that they offer, highly diversified across geography and across entities. And so we don't think that in and of itself it's highly concentrated anywhere. And so we think it's an investment that is very – works well with BDC and works well with a credit portfolio mindset in terms of diversification and diversified sources of income. And so with that said, we do expect additional growth. We don't have any plans one way or the other with regard to any kind of exit activity, if you will, but as you kind of appreciate, we evaluate our alternatives for our investments continuously as opportunities arise.

Got it.

The thing I’d add to that – let me just add to that too, because it is an important investment for us and it obviously gets a fair amount of attention. Just as a reminder, this is an investment that we've been in for quite some time. And so it started as a small debt investment, we came to know the management team very well, we did an awful lot of diligence to get comfortable with the business when it was quite small and would not have made an investment of this size without having the history that we do with the business and the comfort level that we do. When you look at the return and Chris mentioned the diversity which we – is a characteristic that we like quite a bit. In addition to that, if you look at the return on assets, just the assets that they have deployed throughout the country, they're really fantastic returns. That's why we've structured the investment securities the way we have. We are anxious to see and happy to support management in reinvesting as much capital as they can into growth in the business, because we feel confident that they continue to perform the way they have historically that, that will yield nice increase in our equity value over time. We don’t see any dynamics in the marketplace that change our view on that. We continue to be very bullish on this business and think that there is a lot of runway for it to grow and to see its equity value grow. Now, we have got to go deliver on that, but that’s our perspective on it. As it relates to concentration though, I do want to emphasize to do an investment of this nature and of that size, we wouldn’t have done that, but for the history and confidence we have in the business.

Got it, that’s great color as always and appreciate your time this morning.

Thank you. Our next question comes from the line of Mitch Weiman with Sumner Financial Advisors. Your line is now open.

Hi, I just had one question. I was wondering if you are doing any kind of scenario, I guess analysis as to how big of a jump in interest rates do you need to really start affecting credit quality?

Is that a question in our portfolio or a more general economic question?

Yes, more on your portfolio.

Okay, well taking that into two parts, let’s talk about the first part as how it affects the BDC. As we are capitalized right now, all of our debt is fixed rate and as Henri mentioned earlier all our….

No, I am talking about your loan portfolio?

Sure. So we are protected there. When you ask how big a jump, I mean, I think that this is obviously an important question broadly in the economy, but as we see it in particular, our portfolio companies and you see our credit quality is at a highest level. Then I think a lot of the increase in interest rates, are result of the increase in the economic activity and so we are seeing strong performance across our portfolio companies. I think as Mike had mentioned earlier, our overall leverage ratios are not at the highest level. So, there is an increase in cost of these companies as interest rates rise, but they are also benefiting on the revenue and the earnings sides from increased economic activity growth. So to mention it, I mean, if there was a 1% growth in interest rates do we think that would effect the credit quality of our portfolio, we don’t think so even 2% probably not. If we have the super spike, the question would be where does that come from, does that come from a crisis or does that come from general economic growth and what we see is the rise in interest rates are really a reaction to an improving economy, which benefits of course.

So, it would take a real spike that really hit the credit quality of the portfolio, it’s not a 1% or 2% move you think, it have to be some Black Swan out there?

Yes, right. And again, the way we look at our portfolio and have looked at it, we don’t even really see that much economic sensitivity necessarily even to sort of broader recessions, because we are trying to – our focus is not investing in cyclical companies, we are looking for secularly growing companies and niche oriented businesses that can kind of perform in all weather if you will. And so being at the small end, we think that’s one of the advantages of being at the small end of the middle-market as a lot of our companies are kind of – they are not dependent on the broader economic trends, they have specific market opportunities of their own that they are able to develop and take advantage of.

Having said that, no business is immune to economic cycles, the thing I’d emphasize is that when we underwrite each credit, we are looking at it as if we don’t predict macroeconomic cycles, but when we are underwriting a credit, we always sensitize it to a downturn in the economy. So, we are underwriting as if next month there is a downturn in the economy, what does this business look like over time, what we consider when we are looking at the capital structure and if we get comfortable making an investment, we are looking at leverage and the business model and among the things that we look at is also just the interest rate environment and how sensitive the capital structure and the business is to a rising rate environment. As Chris points out though it’s been our experience that typically when rates are rising over time, that correlates very well with strong economy and generally our businesses are going to perform well when the economy is performing well.

Okay, thank you.

Thank you. This concludes our question-and-answer session. I would now like to turn the call back over to Christian Oberbeck for his closing remarks.

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

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