Saratoga Investment Corp. (SAR) Q3 2025 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Saratoga Investment Corp.'s 2025 Fiscal Third Quarter 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 and Chief Compliance Officer, Mr. Henri Steenkamp. Please go ahead, sir.

Thank you. I would like to welcome everyone to Saratoga Investment Corp.'s 2025 Fiscal Third Quarter 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 2025 shareholder presentation in the Events and 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. 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. Saratoga Investment Corp. highlights this quarter include sequential quarterly increase of adjusted NII, excluding the effect of onetime Knowland interest reserve reversal, improved latest 12 months return on equity of 9.2%, reflecting the solid high-quality nature of our existing portfolio. Another increase in total NAV and steady NAV per share, healthy originations in both new and existing portfolio companies, while also experiencing outsized redemptions of successful investments and continued over-earning of our dividends. The substantial over-earning of the dividend this quarter continues to support the current level of dividends, increases NAV, supports increased portfolio growth and provides a cushion against adverse events. This quarter's earnings reflects the impact of the past 6-month trend of decreasing levels of interest rates and spreads on Saratoga Investment's largely floating rate assets, while not yet recognizing the full-time impact of the recent outsized repayments seen this quarter. The cost of most long-term balance sheet liabilities are largely fixed though callable either now or in the near future, in the context of the significant level of available cash currently creating a negative arbitrage, management is evaluating the use of such calls prospectively to reduce current debt. From an overall investment value and current yield perspective, our annualized third quarter dividend of $0.74 per share implies a 12.2% dividend yield based on the stock price of $24.21 per share on January 7, 2025, or 90% of our third quarter's NAV. During the quarter, we began to see the early stages of a potential increase in M&A in the lower middle market, reflecting in multiple repayments during the quarter in addition to significant new originations. As was the case in previous quarters, our strong reputation and differentiated market positioning, combined with our ongoing development of sponsor relationships, continues to create attractive investment opportunities from high-quality sponsors despite lower overall mergers and acquisitions volumes and elevated interest rate levels. We believe Saratoga continues to be favorably situated for potential future economic opportunities as well as challenges. At the foundation of our strong operating performance is the high-quality nature resilience and balance of our $960 million portfolio in the current environment. Where we have encountered significant challenges in four of our portfolio companies over the past year, we've completed decisive action and resolved all four of these companies' challenges through two sales and two restructurings. Our current core non-CLO portfolio was marked down slightly by $1.4 million this quarter, and the CLO and JV were marked down by $4 million. This was offset by net realized gains of $1.2 million this quarter on various repayments, most notably the [ Invita ] investment and $0.7 million of escrow realized gains, mainly from the former Netreo investment resulting in $3.5 million of total net reduction in portfolio value during the quarter. Our total portfolio fair value is now 0.7% below cost while our core non-CLO portfolio is 3% above cost. Our originations this quarter were elevated as we began to see the effect of declining interest rates and increased M&A activity in the market. Deployments during the quarter included $85 million in 2 new portfolio company investments and 8 follow-on investments in existing portfolio companies that we know well, all with sound business models and strong balance sheets. Our quarter end cash position grew to $250 million, largely due to an outsized $160 million of repayments of successful investments in 5 portfolio companies and amortizations, exceeding the substantial $85 million of originations. The repayments include the recognition of a $4.8 million realized gain along with $67 million of debt repayments from our successful 5-year Invita investment. This increase in our cash position improved our effective leverage from 160.1% regulatory leverage to 183.2% net leverage, netting available cash against outstanding debt. Our overall credit quality for this quarter remained steady with 99.7% of credits rated in our highest category with the two investments currently still on nonaccrual status being Zollege and Pepper Palace both of which have been successfully restructured, each representing only 0.3% of both fair value and cost. With 86.8% of our investments at quarter end and first lien debt our overall portfolio generally supported by strong enterprise values and balance sheets in industries that have historically performed well in stress situations, we believe our portfolio and leverage are well structured for challenging economic conditions and further changes in interest rates in either direction. As always, and particularly in the current uncertain environment, balance sheet strength, liquidity and NAV preservation remain paramount for us. At quarter end, we maintained a substantial $474 million of investment capacity to support our portfolio companies with $136 million available through our existing SBIC II license, $87.5 million from our two revolving credit facilities and $250 million in cash. Saratoga Investment's third quarter of fiscal 2025 demonstrated a solid level of performance with our key performance indicators as compared to the quarters ended November 30, 2023, and August 31, 2024. Our adjusted NII is $12.4 million this quarter, down 5.3% from last year and 31.7% from last quarter. Our adjusted NII per share is $0.90 this quarter, down 10.9% from $1.01 last year and down 32.3% from $1.33 last quarter. When excluding the $7.6 million, which is equivalent to $0.44 per share, net impact of the nonrecurring Knowland investment interest reserve released in the previous and current quarter from its successful sale, adjusted NII increased $0.01 per share from $0.89 to $0.90 as compared to the previous quarter. Adjusted NII yield is 13.3% this quarter, down from 14.6% last year and from 19.7% last quarter. Latest 12 months return on equity is 9.2%, up from 6.6% last year and up from 5.8% last quarter, and beating the industry average of 8.5%. Our NAV per share is 26.95, down 1.7% from 27.42 last year and down 0.4% from 27.07 last quarter. And our quarter end NAV was $374.9 million, up from $359.6 million last year, and up from $372.1 million last quarter. The $2.8 million increase in NAV sequentially resulted primarily from at-the-market sales of 108,000 shares at NAV. In addition, a further 356,000 shares were sold to the market at NAV for $9.6 million subsequent to quarter end, resulting in total sales of $12.6 million. While the past 12 months have seen markdowns to a small number of credits in our core BDC portfolio, Slide 3 illustrates how our recent strong results have delivered a return on equity of 9.2% for the last 12 months above the industry average of 8.5%. Additionally, our long-term average return on equity over the last 10 years of 10.4% remains well above the BDC industry average of 6.9%, and has remained consistently strong over the past decade, beating the industry 8 of the past 10 years. As you can see on Slide 4, our assets under management have steadily and consistently risen since we took over the BDC 14 years ago. Outsized repayments offset strong originations this quarter, resulting in our AUM declining if this does not impact our expectation of long-term AUM growth. The quality of our credits remain solid with only the two recently restructured Pepper Palace and Zollege credits on nonaccrual consistent with last quarter. Our management team is working diligently to continue this positive trend as we deploy our significant levels of available capital into our pipeline while at the same time being appropriately cautious in this evolving credit environment. 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 5 highlights our key performance metrics for the fiscal third quarter ended November 30, 2024, most of which Chris already highlighted. Of note, the weighted average common shares outstanding in Q3 of this year was 13.8 million shares, increasing from 13.7 million and 13.1 million as compared to last quarter and last year's third quarter, respectively. Adjusted NII decreased this quarter, down 5.3% from last year and 51.7% from last quarter. This quarter's investment income decreases as compared to last quarter were primarily due to the impact of the nonrecurring Knowland interest reserve reversal of $7.9 million last quarter, following the investments full repayment, including accrued interest, offset by higher prepayment and structuring and advisory fees this quarter, reflective of the high level of both originations and repayments in Q3. Excluding the Knowland interest reserve reversal, adjusted NII per share increased $0.01 per share to $0.90 per share as compared to the previous quarter. Investment income reflects a weighted average interest rate of 11.8% as compared to 12.5% as of the previous year and 12.6% last quarter. Approximately 2/3 of the interest rate reduction is due to SOFR base rate decreases and 1/3 due to the higher yields of the recent repayments. The impact of this quarter's outsized repayments is not yet fully reflected in this quarter's results as most repayments occurred in the last month of the quarter. Total expenses for this year's third quarter, excluding interest and debt financing expenses, base management fees and incentive fees and income and excise taxes increased to $2.8 million as compared to $2.3 million last year and $2.2 million last quarter. This represented 0.9% of average total assets on an annualized basis, up from 0.8% last year and 0.7% last quarter. Also, we have again added the KPI slides 26 through 29 in the appendix at the end of the presentation that shows our income statement and balance sheet metrics for the past 9 quarters and the upward trends we have largely maintained. Moving on to Slide 6. NAV was $374.9 million as of this quarter end, a $2.8 million increase from last quarter and a $15.3 million increase from the same quarter last year. This chart also includes our historical NAV per share, which highlights how this important metric has increased 22 of the past 29 quarters and has stabilized over the past couple of quarters since the resolution of the recent discrete nonaccruals. Over the long term, our net asset value has steadily increased since 2011 and grown by 33% over the past 5 years, and this growth has been accretive, as demonstrated by the long-term increase in NAV per share. Over the past 4.5 years, NAV per share is up $1.84 per share or over 7%. We continue to benefit from our history of consistent realized and unrealized gains. On Slide 7, you will see a simple reconciliation of the major changes in adjusted NII and NAV per share on a sequential quarterly basis. Starting at the top, adjusted NII per share was down $0.43, primarily due to, first, the impact of the nonrecurring Knowland interest reserve reversal last quarter as previously noted. And second, the decrease in non-CLO net interest income reflecting a lower SOFR rate in Q3 and the partial impact of the quarter's repayments. These decreases were partially offset by higher prepayment and structuring and advisory fees this quarter reflective of the high level of originations and repayments. On the lower half of the slide, NAV per share decreased by $0.12, primarily due to the $0.16 over earning of the dividend being more than offset by the $0.25 quarterly net realized gains and unrealized depreciation on investments. Slide 8 outlines the dry powder available to us as of quarter end, which totaled $473.7 million. This was spread between our available cash, undrawn SBA debentures and and undrawn secured credit facility. This quarter end level of available liquidity allows us to grow our assets by an additional 49% without the need for external financing, with $250 million of quarter end cash available and thus fully accretive to NII when deployed, and $136 million of available SBA debentures with its low-cost pricing, also very accretive. We also include a column showing any call options of our debt. This shows that $321 million of baby bond, effectively all of our 6% plus debt is callable, either now or within the next 4 months, creating a natural protection against potential continuing future decreasing interest rates, which should allow us to protect our net interest margin, if needed. These calls are also available to be used prospectively to reduce current debt. We remain pleased with our available liquidity and leverage position, including our access to diverse sources of both public and private liquidity and especially taking into account the overall conservative nature of our balance sheet, the fact that almost all our debt is long term in nature and with almost no non-SBIC debt maturing within the next 2 years. Also, our debt is structured in such a way that we have no BDC covenant that can be stressed during such volatile times. Now I would like to move on to Slides 9 through 12 and review the composition and yield of our investment portfolio. Slide 9 highlights that we have $960.1 million of AUM at fair value and this is invested in 48 portfolio companies, 1 CLO fund and 1 joint venture. Our first lien percentage is 86.8% of our total investments, of which 25.7% is in first lien last out positions. On Slide 10, you can see how the yield on our core BDC assets, excluding our CLO has changed over time, especially this past quarter, reflecting the recent decreases to interest rates. This quarter, our core BDC yield decreased to 11.8% from 12.6% with about 2/3 of the decrease due to core SOFR base rates decreasing during the fiscal quarter. The CLO yield increased to 24.6% from 13.0% last quarter, purely reflecting lower fair value. the CLO is performing and current. Slide 11 shows how our investments are diversified throughout the U.S. And on Slide 12, you can see the industry breadth and diversity that our portfolio represents, spread over 40 distinct industries in addition to our investments in the CLO and joint venture, which are included as structured finance securities. Moving on to Slide 13. 9.0% of our investment portfolio consists of equity interest, which remain a very important part of our overall investment strategy. This slide shows that for the past 12 fiscal years, we had a combined $32.4 million of net realized gains from the sale of equity interest or sale of early redemption of other investments. This is net of the Zollege, Netreo and Pepper Palace realized losses this year. This long-term realized gain performance highlights 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. Our Chief Investment Officer, Michael Grisius, will now provide an overview of the investment market.

Thank you, Henri. Today, I will focus on our perspective on the changes in the market since we last spoke with everyone and then comment on our current portfolio performance and investment strategy. While broader middle market deal volumes are showing signs of improvement, deal activity in the lower middle market where we operate has yet to pick up. Year-to-date deal volumes through calendar Q4 for transactions below $150 million are down significantly over prior year by more than 34% and down further still as compared to 2021 and 2022. We believe a number of factors are influencing the decline in the lower middle market deal activity, including a disconnect between where buyers and sellers are willing to transact, elevated interest rates making debt financing more expensive and a trend toward PE firms holding on to assets longer in order to meet their return expectations. The combination of historically low M&A volume and an abundant supply of capital is causing spreads to tighten and leverage to remain full as lenders compete to win deals, especially premium ones. This was evidenced this past quarter, with outsized repayments being experienced in some cases, due to lenders offering extremely aggressive pricing on some of our low-leverage assets. The historically low deal volume we're experiencing currently has made it more difficult to find quality new platform investments than in prior periods. Now that said, the relationships and overall presence we've built in the marketplace, combined with our ongoing business development initiatives, give us confidence in our ability to achieve healthy portfolio growth in a manner that we expect to be accretive to our shareholders in the long run. This quarter, we closed two new platform investments and our investment pipeline is solid. I'll also point out that we continue to believe that the lower middle market is the best place to be in terms of capital deployment. As compared to the larger end of the middle market, the due diligence we're able to perform when evaluating an investment is much more robust. The capital structures are generally more conservative with less leverage and more equity. The legal protections and covenant features in our documents are considerably stronger. And our ability to actively manage our portfolio through ongoing interaction with management and ownership is greater. As a result, we continue to believe that the lower middle market offers the best risk-adjusted returns, and our track record of realized returns reflects this. The Saratoga management team has successfully managed through a number of credit cycles, and that experience has made us particularly aware of the importance of first, being disciplined when making investment decisions; and second, being proactive in managing our portfolio. Our underwriting bar remains high as usual, yet we continue to find opportunities to deploy capital. As seen on Slide 14, our more recent performance has been characterized by continued asset deployment to existing portfolio companies, as demonstrated with 40 follow-ons this calendar year versus 2 investments in new platform portfolio companies. During the fiscal quarter, we invested $85 million through a combination of 2 new platform investments and 8 follow-on investments. Overall, our origination platform remains strong and our consistent ability to generate new investments over the long term, despite ever-changing and increasingly competitive market dynamics is a strength of ours. Portfolio management continues to be critically important, and we remain actively engaged with our portfolio companies and in close contact with our management teams. There remain 2 portfolio companies that we are actively managing as discussed in previous quarters, and I will touch on them shortly. But in general, our portfolio companies are healthy and the fair value of our core BDC portfolio is 3% above its cost. 86.8% of our portfolio is in first lien debt and generally supported by strong enterprise values in industries that have historically performed well in stressed situations. We have no direct energy or commodities exposure. In addition, the majority of our portfolio is comprised of businesses that produce a high degree of recurring revenue and have historically demonstrated strong revenue retention. We have the same 2 investments on nonaccrual, namely Pepper Palace and Zollege consistent with last quarter. We continue to hold them on nonaccrual following their restructurings, but their combined remaining value, including equity is just $5.8 million or 0.6% of total portfolio fair value, with Zollege's fair value being written up this quarter, reflecting positive company performance. Looking at leverage on the same slide, you can see that industry debt multiples remain above 5x. Total leverage of our overall portfolio increased to 5.56x, excluding Pepper Palace and Zollege reflecting both the repayment of a handful of low leverage investments as well as follow-on debt this quarter by some of -- by us to some of our existing investments. Slide 15 provides more data on our deal flow. As you can see, the top of our deal pipeline is down from last year, in part because we made a conscious effort to improve the quality of our deal pipeline and in part because market activity is down considerably as previously discussed. Despite these macro trends, our investment volume was the highest we've had in the past 6 quarters. Overall, the significant progress we've made in building broader and deeper relationships in the marketplace is noteworthy because it strengthens the dependability of our deal flow and reinforces our ability to remain highly selective as we rigorously screen opportunities to execute on the best investments. As you can see on Slide 16, our overall portfolio credit quality and returns remain solid. As demonstrated by the actions taken and outcomes achieved on the nonaccrual and watch list credits we had over the past year, our team remains focused on deploying capital in strong business models where we are confident that under all reasonable scenarios, the enterprise value of the businesses will sustainably exceed the last dollar of our investment. Our approach and underwriting strategy has always been focused on being thorough and cautious at the same time. Since our management team began working together a dozen plus years ago, we've invested $2.24 billion in 119 portfolio companies and have had just 3 realized economic losses on these investments. Over that same timeframe, we've successfully exited 78 of those investments, achieving gross unlevered realized returns up 15% on $1.2 billion of realizations. Even taking into account the recent write-downs of a few discrete credits, our combined realized and unrealized returns on all capital invested equal 13.6%. We think this performance profile is particularly attractive for a portfolio predominantly constructed with first lien senior debt. As was the case in the previous quarter, with Knowland repaid, we have only 2 investments on nonaccrual. Although both Pepper Palace and Zollege have been successfully restructured, we are still classifying Pepper Palace as red, while Zollege has been elevated back to yellow, with a combined fair value of only $5.8 million, including equity. During the previous quarter, the Pepper Palace restructuring was successfully completed with us taking over a majority control of the business. The turnaround specialists we have been working with who has substantial successful experience in similar situations, has invested significant equity in the business and became the CEO and a Board member. The total fair value of the remaining investment is $1.6 million. And following the Zollege restructuring of the balance sheet during the first quarter that resulted in us taking over the company and starting to actively manage the investment. The founder and previous owner has invested meaningful dollars in the business and is leading the enterprise and has reassembled some of the former senior leadership. He and the management team are working in partnership with us with the immediate goal of returning the business to its former profitability levels and the ultimate objective of exceeding those levels. We still have equity in a first lien term loan in the company with a current fair value of $4.2 million, with the equity marked up this quarter to reflect the recent positive financial performance of the company. In addition, we recognized a $4.8 million realized gain on our Invita equity resulting from the sale of the company and recognized $0.7 million of realized gain on a Netreo escrow payment, further improving the overall positive outcome of that investment sold earlier this year. The CLO and JV had $4 million of unrealized depreciation this quarter, reflecting primarily markdowns due to individual credits, most notably in the first CLO. Our overall investment approach has yielded exceptional realized returns and recovery of our invested capital and our long-term performance remains strong as seen by our track record on this slide. Moving on to Slide 17. You can see our second SBIC license is fully funded and deployed, although there is cash available there to invest in follow-ons, and we are currently ramping up our new SBIC III license with $136 million of lower cost, undrawn debentures available, allowing us to continue to support U.S. small businesses, both new and existing. This concludes my review of the market, and I'd like to turn the call back over to our CEO. Chris?

Thank you, Mike. As outlined on Slide 18, our latest dividend of $0.74 per share for the quarter ended November 30, 2024, was paid on December 19, 2024. Though unchanged from last quarter, this reflects a 3% and a 9% increase over the past 1 and 2 years, respectively. Additionally, we paid a special dividend of $0.35 per share concurrently with $1.09 per share of total distribution fulfilling our fiscal 2024 requirements. Board of Directors will continue to evaluate the dividend level on at least a quarterly basis, considering both company and general economic factors, including the current interest rate environment's impact on our earnings. Moving to Slide 19. Our total return for the last 12 months, which includes both capital appreciation and dividends, has generated total returns of 4% which is uncharacteristically low and underperforms the BDC index of 13% for the same period. Our longer-term performance is outlined on our next Slide 20. Our 5-year return places us in line with the BDC index while our 3-year performance is slightly below the index, reflecting the impact of the recent latest 12 months' performance and discrete credit issues. Since Saratoga took over management of the BDC in 2010, our total return has been 740% versus the industry's 284%. On Slide 21, you can further see our differentiated performance placed in the context of the broader industry and specific to certain key performance metrics. We continue to focus on our long-term metrics such as return on equity, NAV per share, NII yield and dividend growth and coverage, all five of which are above industry averages, reflecting the growing value our shareholders are receiving. The negative NAV per share metric this past year is primarily due to the two discrete nonaccruals, Zollege and Pepper Palace previously discussed. Yet we continue to be 3x better than the industry average at negative 0.4% versus negative 1.2% for the industry. Our dividend coverage and dividend growth has been one of the strongest in the industry. We also continue to be one of the few BDCs to have grown NAV over the long term, and we have done it accretively, and our long-term return on equity is 1.5x the long-term industry average. Moving on to Slide 22. All of our initiatives discussed on this call are designed to make Saratoga Investment a leading BDC that is attractive to the capital markets community. We believe that our differentiated performance characteristics outlined on this slide will help drive the size and quality of our investor base, including adding more institutions. These differentiating characteristics, many previously discussed, include maintaining one of the highest levels of management ownership in the industry at 12.1%, ensuring we are aligned with our shareholders. Looking ahead on Slide 23, as we navigate through a reshaped yield curve environment, with decreasing short term and increasing long-term rates and an uncertain economic outlook, we remain confident that our reputation, experienced management team, robust pipeline and historically strong underwriting standards and time and market tested investment strategy will serve us well to continue to steadily increase our portfolio size, quality and investment performance over the long term. This will allow us to deliver exceptional risk-adjusted returns to shareholders and to navigate through the current challenges in the market and uncover opportunities in the current and future environment. We also believe that our strong balance sheet, capital structure and liquidity will benefit Saratoga's shareholders in the near and long term. In closing, I would like to again thank all of our shareholders for their ongoing support. I would like to now open the call for questions.

[Operator Instructions] Our first question will come from Eric Zwick of Lucid Capital Markets.

So I wanted to start first and just looking at Slide 23, since we kind of just wrapped up there. You remain committed to expanding the asset base and growing the investment portfolio. You made comments during the call that the pipeline remains solid and then you had a pretty good quarter. Here the one that just wrapped up. So I guess maybe the harder part for me and maybe for you guys as well to have a longer-term view, and it's just the pace of repayments, which was obviously strong in the most recent quarter. So to the degree that you have some sort of sightline, at least over the next maybe 3 to 6 months. What are your expectations there, just given that some of it seemed to be the repayments in this most recent quarter were driven by the pickup in the M&A market and you expect that to continue as well. So just just trying to kind of balance the outlook for new growth versus repayments as well.

I guess I'll start and then Mike can follow up. I think if you look at the last quarter, we had $85 million of originations, which is a pretty robust origination amount. And then we also -- our Invita investment, a 5-year investment, essentially was about half of the $160 million of redemption. So -- if you just take that one out, basically, we were kind of neutral on that. And these things happen. I mean, you have different cycles of investment redemption and investments made. And it's hard to predict exactly when over that 5-year period of time that investment would come home. I mean, I think, Mike, what that investment started out is, what, $6 million investment?

Yes. It's actually a hallmark investment for us in a lot of ways just in terms of what we do and where we play in the marketplace. So that was initially a $6 million debt deal, accompanied with $2 million of equity. We were in it for roughly 5 years and we're able to support the company's growth, and I think the debt position got well into the high 60s as the company successfully grew. And then, of course, we realized a $4.8 million gain on our equity investment. So the gross return that our shareholders received on that deal was quite substantial over that 5-year time. One of the challenges that we get when you deploy this model, but it's -- we think in the long run, the best way to deploy capital in our market and a really healthy thing is that when you add new portfolio companies, they tend to be on the smaller side, a little bit more granular. And then the really successful ones, and you've seen this in our portfolio for some of our larger positions, we have an opportunity to support them with growth over time. Now ultimately, when they pay off, they can be pretty lumpy. And it takes more platform companies to replace those lumpy payoffs. And in this particular quarter, as Chris was pointing out, we happened to have a couple of pretty sizable lumpy payoffs that were out of the ordinary, if you will, in general.

Yes. And so it's just -- it's hard to predict precisely what our origination will be. And we have a pretty robust portfolio, a pretty large portfolio. And we get we get calls from our portfolio, they want to do a large acquisition, and we have a big follow-on investment. So it's not really something we're able to predict. I mean, I think if you look forward, you say, yes, we've got a lot of cash on hand. And yes, we've got sort of what we've done historically on our pipeline. But what the redemptions and what the origination is going to be, it's not really something that is -- something that's really able to be predicted, and it's probably not prudent for us to try and predict that. .

And Eric, we often talk about how quarters can be lumpy, right, either that you have a lot of originations and repayments in one quarter or even none. And Slide 4 is the best slide to sort of illustrate how we think of things, which is long term and being able to grow on a long-term basis rather than quarterly that could be a lot more volatile.

I'd add to and just to chime in because it is obviously, something that we as a management team are very focused on. The market, in general, is characterized by lots of add-on activity. And that's particularly true at the lower end of the middle market where new M&A activity is way down. And it continues to be down. We're hopeful that some of the things that have been driving the decline in M&A volume will reverse themselves as interest rates potentially come down and some other things sort of work in our favor. We're confident that, that will reach a new equilibrium, and that there'll be an uptick in M&A activity, and we'll capitalize on that. To date, most recently, if you looked at our portfolio, we certainly were not on an origination pace that was as healthy as it was, let's say, a couple of years ago. But interestingly enough, because M&A activity was down, our repayments were down as well. And we, in most of the last several quarters, many quarters, we actually grew through that. So we didn't have as high of origination activity, but we didn't have much repayments, so we were able to grow our portfolio through that. In this most recent quarter, despite pretty healthy production, we happen to have some pretty lumpy repayments. And I think in the long run -- in the intermediate to long run, we have a great degree of confidence that with our origination efforts, with the relationships that we have in the market, with those relationships continuing to grow and we're doubling down on all our business development activity that our pace of deployment will outpace any repayments that we have over time.

That's helpful. I appreciate all the color there. And you're right, looking at some of the slides you've put in there you've demonstrated your ability to do just what you guys have have mentioned there. Second line of questioning, looking at Slide 8, and I think, Henri, you addressed that the opportunities to potentially with the publicly traded notes, I think SAT is at like 6%, JY are all above 8%, so there's opportunity to realize some savings there if you were to pay those down or refinance. Looking at the SBIC ventures, I've seen the call period calm, as now for those -- but I'm curious how the mechanics of potentially calling those or trying to reprice those would -- how that would play out given that those are kind of tied to specific assets? Or maybe I should have started maybe remind me what the current average cost of those debentures are now and maybe that's not even a topic for us.

Yes. No, I think the most important thing when you're in a license is whether you're still in the reinvestment period, Eric. So SBIC III, for example, it's a newer license. If we get a repayment, we obviously get cash, but we can -- we would use that cash and redeploy it in new assets. We wouldn't repay debentures. Once you get outside of your reinvestment period, which we are in SBIC II, you can only use cash for -- when you get a repayment, you can only use cash for follow-ons of existing investments to continue to support them. So you then have a decision to make when you have cash in a license that is outside of its reinvestment period, whether you feel like you're going to hold the cash and then because you believe that you know the companies and you think they might have some follow-on needs or whether you repay existing SBIC debentures. And the mechanics, how it works is pretty straightforward. You have two opportunities in a year, at the end of August and at the end of February to make a decision whether you want to repay the debentures. If you decide not to, let's say, at the end of August, then you're holding those debentures until the next 6-month period comes around. But -- that's why I say they're callable because for us, for example, now in February, we'll have a decision to make whether we want to use some of the cash in SBIC II to repay some of the existing debenture. SBIC II though was -- a lot of those debentures were issued when rates were pretty low. And so there is an arbitrage there to think through on whether we want to just continue earning for example, cash and keep it for potential follow-on opportunities or whether we want to repay it, and we'll assess that again come mid-February.

Got it. And then last one for me. You noted your success in the past with realizing some equity gains with your investments there. Remind me just how you think about the potential to realize future gains? Is it really just tied to if the company sells in those transactions? Or do you typically sometimes proactively go out and seek to commoditize where a fair value might be well above kind of your holding.

On the equity side, typically, we're a minority investor in the equity. And we think it's a really kind of key element of our investment strategy to augment our returns on the debt with co-investments in the equity. And most of the relationships that we have, whether they be PE sponsors or management teams, et cetera, kind of value that alignment of interest that we can achieve by co-investing in the equity. What happens, though, as a minority investor is you're not typically controlling the exit. Instead, you have the right to exit when the company is sold or there's some realization along those lines. And that's generally when we realize a return on equity. From a strategy standpoint, the way we think about it is that we do such thorough work on these businesses that we feel like as part of that work we're pretty well equipped to feel like we can make an assessment as to whether the co-investment opportunity and the equity makes sense. And it's also been our experience that there's -- if you were to draw a Venn diagram in the overlap between what you would like for a really solid credit and what you'd like for a business that likely a very good equity investment, massive overlap. There are businesses that generally distinguish themselves in markets that have really strong dynamics, really good management teams, producing really high free cash flow characteristics. A lot of the things that we look for in businesses are the very same things that make them good equity investments. And that's the reason why we've been able to get 15% unlevered returns on our portfolio over time. It's -- the majority of that is coming from the debt return, but certainly getting to 15%, that's been as a result of successful equity co-investments. And we continue to think that's a kind of cornerstone of our strategy.

And our next question will be coming from the line of Casey Alexander of Compass Point Research & Trading.

I do find it interesting when we all sound sort of disappointed when you get large repayments because that's kind of the goal, right? And I get you're a platform that originates small and repays big. I get that. But one question I would ask is that you discussed kind of the reduction in weighted average yields as being 2/3 rate and 1/3 higher-yielding loans paying off. Looking at the quarter-over-quarter, it looks like your portfolio yields declined by about 80 basis points. So would it be fair to say that you're only about halfway through the resetting function of the 100 rates that base rates have gone down, you still have about half way to go. I mean, that seems like the reasonable math to me.

Okay. So it's a little more than half. I'd say we're more about 2/3 of it being reflected in the way our loans reset, and when they reset, I'd say about 2/3 of the decrease has been reflected. We definitely haven't -- because there's been a sort of a reset in -- for us, September already. And so I'd say about 2/3. And then there's obviously, since quarter end, there has been still a slight decline in SOFR since then as well.

So right. Well, that's what I mean. I mean, when I look at it across the entire 100 basis points of what the Fed has done, it would seem to me that you've reflected about 50 basis points in your results as of the end of November and maybe there's another 50 bps to go counting what the Fed has done subsequent to the end of your quarter.

Yes. I haven't done like the exact count, but I would guess it's again, slightly more than that, probably in the like low 60s.

Okay. When I think in terms of decline in rates, higher yielding loans paying off, clearly a reduced portfolio balance that's going to take some time to build up. Do you still feel comfortable? Or is there maybe a quarter or two here where maybe it might seem reasonable to actually under-earn the dividend a little bit until you can build the portfolio back up? .

Well, Casey, as you can appreciate, I don't think we've really ever under-earned our dividend, and that's certainly not something that we would welcome doing. Obviously, some things are not in our control, like rate of repayments and deployments. But we do have a -- we have a solid pipeline, and we also as Mike was discussing earlier, there's been a real holdback in M&A activity. A lot of times, a lot of private equity firms are holding on to assets that aren't meeting their goals, but there's a tremendous pressure in the system. And it may well be with the new administration, et cetera, that sort of a new era, different antitrust approaches, different types of things like that, that there may be a real resurgence in deal activity coming up and people have been waiting. I mean there was -- some deals which have been turned down by the Justice department that you sort of really shake your head at why they would turn down some of these $8 billion deals being projected as antitrust type things. And so I think the -- I think not to overplay that. But I think on a macro level, I think there's a lot of people on the sidelines that are ready to do more business going forward. And so the timing and the pace of that is not something that we are in a position to predict, but we certainly feel that there is going to be a fair amount of activity going forward. And exactly how that shapes up for us on a quarter-on-quarter basis, we don't know. But we don't -- we aren't anticipating under-earning our dividend, but that's not something we can control.

Okay. Looking at Slide 17, with $77 million of cash in SBIC II and as Henri said, you're no longer in the reinvestment period there. Is it reasonable to think that there could be that much follow-on activity? Or does it make sense to at least start paying down some of those? And when do you start dusting off the paperwork on SBIC IV.

Well, first of all, Casey, I mean -- I think, Henri, it's fair to say that I think the current rate on cash is higher than the cost of the debentures in SBIC II. And so there's a positive arbitrage in not paying off the debt inside of that equation. And so that -- if it was the reverse, we probably would decrease it. And so we're watching that very carefully. To the extent it goes to a negative arbitrage, it makes sense to pay it off. And then obviously, we have to look carefully on what type of acquisition activity we're anticipating from those companies. With regard to SBIC IV, you should have seen Henri roll his eyes, that is a major paperwork exercise, but we still have a long way to go on SBIC III. And we've had a very successful program down there. We don't anticipate having problems with getting the next license, it's more of a timing issue. I think there's also some metrics, right, in terms of investment levels before you start that. .

But definitely, there's a new process in licensing with like a repeat -- when your repeat issuer effectively. That has definitely streamlined the process of which is wonderful. I know Casey, you're very familiar with it, too, which has been great. But but we do still have $136 million of debentures, and we haven't had much realizations in SBIC III yet, and actual realizations in the fund is one of the things I look at very closely as part of that sort of assessment.

All right. My last question here is you knew at the end of the quarter that you were going to have very high repayments. I'm not sure using -- selling equity into the market when you have $250 million in cash seems to be rational, and that was done right at the end of the quarter and at the beginning of the succeeding quarter. Can you explain the rationale for that? Because it doesn't seem rational when compared against the cash balance of $250 million where you're talking about a negative arbitrage and paying down some of your debt?

Sure. Casey, I think that's a good question. That's something that we discussed substantially internally. But I think if you look at the history of BDCs in general and certainly our BDC, the ability to raise equity, really, which has to do with whether you're able to sell stock at NAV. And in this instance, we were very close, and the manager subsidized the sales to get us to NAV. Those are not -- those moments to sell in size do not come that often. And this adage on Wall Street that I'm sure everyone on this call is familiar with, which is you don't -- it's hard to -- sometimes it's hard to raise money when you need it and it's easier to raise money when you don't need it. And equity is permanent capital. And when you have the opportunity to raise it, I think one needs to take advantage of it. And I think in other calls, we've been -- it's been discussed like our leverage levels. And there's several ways to address leverage. And one is to repay debt and the others to build up your equity. Obviously, our most desired way to build up equity is through capital gains, and we've done that successfully throughout our time period here, but also selling new equity we have done periodically. And so we view the sale of equity as more of a long-term strategic decision, and not necessarily colored by what our cash balance is at this moment in time. We have $250 million of cash right now, but there have been times where we sort of didn't have much cash at all, and we are struggling to find liquidity to invest in our pipeline. And so we view the cash as kind of a short-term issue and the equity as really kind of a long-term issue and really the cornerstone for long-term growth of our BDC. And we see -- we don't see -- I mean, other than sort of deal volumes, but the opportunity set for the type of investment we make is vast. And so we don't see a slowdown on that on a long-term basis, and we see a lot of growth in our future. And so all of that went into the decision.

And our next question will come from the line of Mickey Schleien of Ladenburg.

First question I'd like to ask is, could you give us a sense of how much more refinancing risk you believe exists in the portfolio given the current terms available in the market? .

That's a good question, Mickey, just in terms of what we could see in terms of pace of repayments. Hard to answer it candidly. You could see for several quarters, we were getting almost no repayments, and a lot of that was just due to the fact that there wasn't much M&A activity. We have seen some deals that have exited our portfolio because somebody approached the owner with terms that were just way below kind of the rates that we play in, in the marketplace. But we don't see generally when we look at our portfolio now, a lot of exposure to that dynamic. It doesn't mean it doesn't exist, but I don't think we're highly vulnerable to that. Our expectation is that when M&A activity picks up, our origination pipeline will pick up in earnest, and that will probably be the same time that we'll start to see payoffs kind of resume to their normal pace. And we think that this last quarter was a bit of an anomaly, just having some pretty chunky payoffs all at once.

Okay. That's helpful. And a question for Henri. Could you give us a sense of where your spillover taxable income stands net of the special, and are you envisioning more special dividends to get that number down a little bit and reduce some of the drag from the excise tax?

Sure, Mickey. So the most recent dividend that included the special dividend covered our fiscal 2024. So February '24 tax year, and so it's cleaned out our spillover fully. We're now in our February '25, fiscal '25 tax year. And so we're effectively about 3 quarters in, which means it's just over the $3 in spillover at the moment, reflecting the taxable income of the last 3 quarters.

And that's still relatively high, Henri, and there is an excise tax that you pay on that. Is the Board thinking about distributing some more of that to shareholders?

Well, I think, Mickey, on the excise tax, as interest rates have changed and the excise tax is 4%, and it's among the cheapest sources of financing out there right now. So if we were to repay -- want to reduce our liabilities, it would make more sense from a pure economic basis to call some of our higher-priced bonds were at 8.7%, for example, is more than twice -- the marginal cost of doing baby bonds today is somewhere in the 7% to 8%. So the marginal cost of financing is substantially higher than the excise tax. And so the excise tax is a positive -- very -- a good source of financing, if you will.

And in addition, Mickey, excise tax is a point in time tax, it's not an accrual. So in other words, you get no credit for, for example, distributing something today versus like December 30.

Yes, I agree. I understand. I'm just curious how the Board is thinking about it. And Chris, I completely agree with you on the debt. I mean, to me, it seems like at least some of your debt, it's a no-brainer to call that given where you could probably deploy that capital. But those are all my questions this morning. Thank you for your time.

Well, Mick, I'd take a slight issue with your no-brainer. If you look at the yield curve, the increase at the 10-year is sort of the same -- it's gone up as much as the short end has gone down. And the cost of selling 5-year debentures may even go up in the coming years. So I think there's just a lot of considerations on the absolute cost of debt. And then as you point out, relative to what our origination pace is. And again, that -- it's a new year, it's a new administration. It's a new outlook on many things. And so we're going to just be cautious on making too many dramatic moves until we get a little more information about this next environment we're moving into.

Yes. I understand your point, Chris, but you're also -- you have the highest leverage amongst all listed BDCs. So I was also taking that into consideration. But I appreciate your time this morning.

And our next question will be coming from the line of Bryce Rowe of B. Riley.

Most of my questions have been asked and answered. I didn't want to kind of get a feel for -- some of the marks we saw or movement in marks we saw quarter-over-quarter. The debt portfolio continues to be marked at very high levels, only a handful that are even below cost. But from an equity perspective, I think we did see a few consumer -- more consumer-facing investments get marked lower. And obviously, you had some offsets with some other businesses getting marked higher. But just wanted to get a feel for just the overall health of some of the more-consumer-related businesses that you have within the portfolio.

That's a good question. I think the marks that you saw go down in a handful of our portfolio investments were reflective of a bit softer performance generally. And of course, equity is going to be more whippy as a result of an underperformance than debt will be. I don't know that I would tie that to some broader perspective we have on the consumer, while it's a good question, we wouldn't necessarily draw that conclusion to the extent that there's a handful of modest write-downs in some of our portfolio companies, little bit more specific to just the dynamics of those particular businesses and less, in our view, less a result of macro trends that we're seeing, at least from what -- from our vantage point.

Okay. Okay. That's helpful, Mike. And then maybe a different topic. You all are talking about a solid pipeline. From an origination perspective, did that refer to pipeline of new opportunities for both new and existing?

Yes, that's a really good question. And we have certainly enjoyed the ability to continue to grow at a pretty healthy pace by supporting our existing portfolio companies. We expect to be able to continue to do that at a pace that's consistent with what we've done in the past generally. We're not seeing as many new platforms. It is interesting, though, because we always -- at a time like this, you always kind of pause and try to look back or look across your portfolio and what your pipeline consists of. Right now, if you looked at our pipeline, even some of the new opportunities that we're chasing are actually not new opportunities for the sponsor, their upsizing that we're getting an opportunity to look at where the sponsors either outgrown their existing lender or something else is happening in the capital structure where we have a chance to come in and replace the existing lender. So that would be a further sign of owners holding on their businesses longer, looking to drive value in their existing portfolio, not as much uptick in M&A activity. So I'd say more than half of what we're looking at right now, where we have term sheets out and we're chasing things that we're really excited about are not actually new M&A deals. They're upsizing of some sort.

Okay. Okay. One more for me and kind of on the topic of leverage, certainly, it's come up on on past calls. But we've seen just net -- overall net debt to equity come down pretty substantially, especially this quarter with the healthy repayment activity. Any thought -- and if we think about maybe 2 or 3 years ago, it's certainly a little bit higher than it might have been in '22, but lower than what we saw in '23 and '24. Any kind of further thought around how you expect to manage balance sheet leverage going forward, especially given that you do or you have historically carried over the last couple of years, more leverage than almost all BDCs that are out there?

Sure. A couple of thoughts on that, and that is definitely something we spend a lot of time thinking about. I think there's some I'm not going to say unique, but some particular aspects of Saratoga that aren't necessarily shared with the whole BDC universe, and that is our large SBIC portfolio and investments. And the leverage in those is not counted the same as baby bond leverage, for example, in terms of the regulatory leverage. And so I think where regulatory leverage, it's one thing, from a total leverage, it's something else. And the character of the debt, and we've talked about this many times in our quarterly calls, it's really -- leverage -- if you have short-term leverage that's asset based and you're up to the limits of what the asset base formulas are and something goes against you, you can get foreclosed on by your banks, you can have a big accident. And it may be something temporary in nature like when COVID hit and things like that, but if you have leverage like, for example, the SBIC debt leverage, which those are 10-year instruments, interest only with no covenants. And so a lot of things can happen in 10 years, but if your only requirement is to repay the interest, the nature of that debt in terms of being something that's dangerous, if you will, to your -- to the health of the overall company is very, very low. And so -- and then the baby bonds are also very similar in that they are long-term instruments, bullet maturities, interest only, no covenants. So we've got very little -- almost all our debt has no covenants to speak of. Interest -- basically have to cover our interest. The interest is very small relative to our liquidity, relative to our earnings, relative to everything else. And so our overall debt structure is incredibly safe relative to the amount that it is. And so that's the liability side. Then the assets...

Even our asset-based loan that we have, although they're lowly drawn, so they also have no recourse to the BDC and no BDC covenants in them either which is different than the BDC...

And they're all in special-purpose vehicles. So that our leverage is compartmentalized and structured in a very sort of low-impact way. Now our cost of capital as a result of that is slightly higher perhaps than some other BDCs, but it's a whole lot safer. So we've got a very solid, safe long-term debt structure with maturities coming out anywhere from a small amount in the next year, but largely, it's a 2- to 10-year maturities out there. And so -- and that -- and we've been very -- it's been a a lot of work on our part to get that debt structure and have it out there in place. And so you want to be very careful changing that. And then -- so that's the liability side. Now the asset side is something else. And I think as you look at our portfolio, we have talked at length about these discrete portfolio issues, two of which were losses and then the other two, we kind of got back home on in the last year. So -- but if you look past those and you look at what our portfolio is right now in terms of largely 85% plus type of senior debt, senior secured, we are in the most senior lender, and we're involved in all decision-making close to the company, et cetera. And then you look at the credit quality and the performance of that portfolio. We have a very solid performing asset base. So -- we don't -- we think that equation is a sound one, not -- and so I think talking about leverage in isolation or in comparison with other BDCs without talking about these character elements of both the asset side and the liability side doesn't paint -- it's having like a 2-dimensional conversation about like a 4-dimensional situation. And so we don't view our leverage as particularly high or particularly dangerous. We view it as a tremendous asset. And the average cost of this leverage structure is much less than our dividend right now. Our dividend yield is like 12%. Our average cost is what 5% or 6%? So our debt cost is very, very accretive to our equity as structured. And again, if you look at what happened in COVID and just to pick one example, there were a number of BDCs that had some real issues in terms of having to repay or fund or equitize some of their short-term asset-based credit facilities where we didn't. In the period after COVID, we put a lot of capital to work because we were well structured for that type of environment. And that's with a lot of leverage. And that was a tremendous period of growth for us and high-quality growth. And we had some very, very good investments, and we deepened our relationships because we were able to help our sponsors in critical times, all because of the nature of our debt structure was impervious to that type of event in the short term. And so we believe we're very well structured for the environment we're in. And we just don't believe that this debt structure is a negative. We think our debt structure is a positive. .

Thank you. That does conclude today's Q&A session. I would now like to turn the call back over to Christian for closing remarks. Please go ahead.

Okay. We'd like to thank everyone for joining us today, and we look forward to speaking with you next quarter. Thank you.

Thank you all for joining today's conference call. You may now disconnect.