Q2 2020 Earnings Call
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Thank you for joining today's topic on shelf with second quarter 2020, <unk> earnings call.
Trading on the call today, but when do you see Michael Sarner, CFO and Chris Friburgo VP Finance I will now turn the call over to Chris rubber.
Thank you I'd like to remind everyone that in the course of this call we will be making certain forward looking statements. These statements are based on current conditions currently available information and managements expectations assumptions and beliefs. They are not guarantees of future results and are subject to numerous risks uncertainties and assumptions that could cause actual results to differ.
Materially from such statements.
For information concerning these risks and uncertainties see capital southwest publicly available filings with the FCC. The company does not undertake any obligation to update or revise any forward looking statements whether as a result of you information future events changing circumstances or any other reason after the date of this press release, except as required by law.
I'll now hand, the call off to a president and Chief Executive Officer Bowen Diehl.
Thanks, Chris and thank you everyone for joining us for our second quarter fiscal year 2020 earnings call.
Throughout my remarks, we will refer to various slides in our earnings presentation, which can be found on our website at www Dot capital southwest Dot com.
We're pleased to be ready this morning at announce our quarterly results for the second fiscal quarter ended September 32019.
During the quarter, we continue to advance our credit strategy of prudently building, a well performing credit portfolio utilizing conservative late cycle underwriting principle.
We continue to be committed and excited about our core investment strategy of building a predominantly lower middle market portfolio, consisting largely of first lien senior secured debt with equity co investments across the loan portfolio, where we believe significant equity upside exists.
Executing our investment strategy under our shareholder friendly internally managed structure closely aligns the interests of our board and management team with that of our fellow shareholders and generating sustainable long term value through recurring dividends capital preservation, and maybe per share growth and operating cost efficiency.
During the September 32019 quarter as summarized on slide six we generated 42 cents per share a pretax net investment income representing 17% growth over the 36 cents per share generated in the same quarter a year ago.
During the quarter, we incurred 472004, 300 or three cents per share a.
Have a onetime expense for the write off of the deferred operating operate offering costs related to our previous form into registration statement.
We paid out a regular dividend during the quarter, a 40 cents per share achieving 105 per cent dividend coverage on pre tax net investment income per share.
Additionally, we distributed 10 cents per share after our supplemental dividend program funded by our sizeable undistributed taxable income balance or yutai.
It was generated by X excess income and capital gains accumulated from our investment strategy today to date.
As of September 32019, we had approximately 18.3 million dollar two cents per share in Utah, providing visibility to continuing a quarterly supplemental dividend program well into the future.
For the September quarter, the 50 cents per share paid out in total dividends generated a total annualized dividend yield of 9.2% based on our September 32019 share price.
We're also pleased to announce our quarterly regular dividends for the December quarter as our board has again declared dividends a 50 cents per share made up of a 40 cents per share regular dividend and a 10 cents per share supplemental dividend.
During the September quarter, we grew our portfolio on a net basis to 539 million from 533 million as of June 32019, originating approximately 30 million, a new commitments and receiving one prepayment totaling 14 million and proceeds.
Or 45 senior loan fund provided dividends to capital southwest, representing a 16% annualized yield at fair value on our capital in the fund for the quarter.
During the quarter, we successfully completed at 65 million dollar five year institutionally placed bond offering priced at five and three 8%.
Subsequent to quarter in we raised an additional 10 million under the same debenture, bringing the aggregate principal outstanding to 75 million.
In addition, we raised 5 million in gross proceeds through our equity ATM program during the quarter selling over 231000 shares at a weighted average price of 20 $1.62 cents per share representing a 16% premium to book value.
I'm pleased to report that since the initiation of our equity ATM program capital southwest the sold almost 700000 shares at similar premiums to book value.
Raising approximately 15 million in gross proceeds.
Our equity ATM program continues to provide a steady flow of equity capital raised on a just in time basis in lockstep with our ability to thoughtfully put the capital to work.
Turning to slide seven eight we illustrate our continued track record of producing a strong dividend yield.
Assistant dividend coverage.
And value creation since the launch of our credit strategy.
Turning to slide nine as a reminder, our investment strategy has remained consistent since our since its launch in January 2015.
We continue to focus on a blend of both lower middle market and upper middle market assets, providing a strategic group strategic flexibility as we have built the robust capability to seek attractive risk adjusted returns in both markets.
In our core market, the lower middle market, we directly originated opportunities consisting of debt investments in equity co investments.
Building out a highly performing and granular portfolio of equity co investments is important to driving growth and they'd be per share well eating in the mitigation of future credit losses.
At the same time, our capability and presence in the upper middle market provides us the ability to opportunistically invest in a more liquid market when attractive risk adjusted returns exist.
Overall, we believe that maximizing the top end of our deal origination funnel in both markets is critical to generating strong credit investment performance overtime as it ensures that we consider a wide array to be a wide array of deals, allowing us to employ our conservative underwriting standards in a competitive market.
And thoughtfully build a portfolio that will perform through the economic cycle.
Our on balance sheet credit portfolio, excluding I 45 as shown on slide 10 grew to 387 million as of September 32019 from 382 million as of June 39 to 2019, we continue to heavily emphasize first lien senior secured debt lending in the lower middle market and our investment strategy.
As of the ended the quarter, we have 76% of our on balance sheet credit portfolio invested in the lower middle market company.
While having 87% of the credit portfolio in first lien senior secured debt.
Turning to slide 11 during the quarter, we originated 29 million in first lien senior secured debt and a $1 million in equity co investments.
The capital committed with two one lower middle market portfolio company and to add ons to existing portfolio companies.
The new portfolio company when the first lien last out senior secured loan with an equity co investments.
One of the add ons was in the upper middle market, while the other was in <unk> in a lower middle market company, and which capital southwest is a full lender and also an equity investor.
The weighted average yield to maturity on all originations this quarter was 11.7%.
Subsequent to quarter, Ed we have originated 33 million in new commitments to two new portfolio companies.
This included 30 million in first lien senior secured debt 202, and a half million an unfunded revolving credit facility and 1 million in an equity co investments. We're pleased with the pipeline as it stands today and expect that two or three additional deals currently in diligence should close by calendar year end.
As shown on slide 12.
We also had a full prepayment of one credit investment during the quarter for 14 million in total proceeds generating a realized gain of 244000 and an hour of 13.7% on total invested capital.
The portfolio company has grown significantly, giving it the opportunity to refinance the debt with cheaper debt capital.
Capital Southwest continues to have an equity co investment the company with significant unrealized depreciation.
This continues our strong track record of successful exit exits as we have now had 27 portfolio exits since launch of our credit strategy.
Generating 214 million in total proceeds and a cumulative are 15.5%.
On slide 13, we breakout our on balance sheet portfolio again, excluding I 45.
Between the lower middle market and up upper middle market.
As of the ended the quarter. The total portfolio weighted was weighted approximately 76% to the lower middle market and 24% to the upper middle market on a cost basis.
We had 27 lower middle market portfolio companies with an average hold size of 12.2 million a weighted average EBITDA of 8.2 million weighted average yield of 12% and a leverage ratio measured as debt to EBITDA through our security a free to have types.
Within our lower middle market portfolio as of the ended the quarter, we held equity ownership in 70% of our portfolio companies.
Our on balance sheet upper middle market portfolio.
Consisted of 11 companies with an average hold size of 9.2 million.
Weighted average EBITDA of 68.8 million weighted average yield of 8.4% and and a leverage ratio through our security of 3.7 times.
We should note that our on balance sheet upper middle market metrics are shown excluding our investment in American addiction, as the EBITDA is not meaningful and therefore, including it would obscure the ratios of the remainder of the upper middle market portfolio.
With respect to American addiction. The company continues to have challenges as in prior quarters due to being a public company, we want to be careful not to effectively announced developments prior to the American addiction management team appropriately communicating to shareholders.
Well, we will see what we will say is that the lender group continues to work with a company on solutions to the capital structure.
The company's lending leading market position in the substance abuse industry, the company's cost saving and business development initiatives and its large owned real estate portfolio. All provide reasons to remain optimistic on the prospect of a favorable resolution.
American addition was placed on non accrual this quarter and remains a rate rated a three on our internal rating system.
As a reminder, all investments upon origination are initially assigned and investment rating of too on a four point scale with one being the highest rating and for being the lowest rate.
Overall, we're pleased with the performance of the investment portfolio as a whole.
As of the ended the quarter of the 40 loans in the portfolio at fair value. We had three with the highest rating of one representing 13% of the credit portfolio. We had 32 loans rated a too.
Representing 80% of the credit portfolio, we had four loans rated a three representing 5% of the credit portfolio and we had one loan rated four representing 2% of the credit portfolio.
As illustrated on Slide 14, we have established a portfolio well diversified across industries, which we believe is well positioned for late in the economic cycle.
Further our portfolio asset mix should provide strong security for our shareholders capital.
The portfolio remains heavily weighted towards first lien senior secured debt with only 6% in second lien senior secured debt and only 3% and subordinated debt.
Yes, Hi, which does business under the banner spotty represented 10% of the investment portfolio at fair value as of the ended the quarter, while all other equity co investments represented 7% of the investment portfolio.
The sales process for spots he continues to progress all albeit slower than we expected earlier in the year as we all know the current global trade environment is complicated with many elements of uncertainty.
Spots he continues to perform very well despite having over half of its revenue generated by customers outside the United States.
These uncertainties of caused the sale process to take longer than we expected at the beginning of the year all that being said, we continue to expect than a transaction should close in the next few months.
But he is a well performing company with exciting products. It provides customers with a valuable real time information regarding the condition of their assets, both remote and in transit.
To us timing is much less important than ensuring that we completed transaction benefits our shareholder short term and long term.
Shown on slide 15 as of the ended the quarter. The I Port 45 portfolio was 95% first lien with diversity among industries.
An average hold size of 2.2% of the portfolio.
Yeah, I 45 portfolio weighted average EBITDA of approximately 60 69 million and weighted average leverage through the I 45 security of 4.3 times.
We also excluded America addiction from these ratios for the affirmation after mentioned reasons.
I'll now hand, the call over to Michael to review the specifics of our financial performance for the quarter.
Thanks, Boeing as seen on slide 16, our investment portfolio produced $15.2 million of investment income this quarter with a weighted average yield on all investments of 11.1%.
This represents a decrease of approximately $600000 from the previous quarter.
This reduction is attributable to a decrease in dividend income from the I 45 senior loan fund due to a large realized gain received by I 45 during the prior quarter.
Decline in LIBOR during the quarter and American addiction being placed on non accrual during the quarter.
As of the ended the quarter there were two assets on nonaccrual with a fair value of $13.8 million, representing 2.6% of our total investment portfolio. The weighted average yield on our credit portfolio was 11% for the quarter.
Excluding interest expense, we incurred $4.1 million and operating expenses for the quarter, which was a decrease of approximately $200000 from the prior quarter.
During the quarter, we incurred a onetime write off of $472000 worth three cents per share of deferred offering costs related to our previous form to registration statement. Excluding this onetime charge operating expenses would've been approximately $3.6 million.
For the quarter, we arent pretax net investment income of $7.4 million were 42 cents per share again after the onetime deferred offering cost write off.
This compared to 44 cents per share during the prior quarter.
We paid up 40 cents per share in regular dividends for the quarter, an increase of one cents per share over the 39 cents regular dividend per share paid out in the prior quarter.
We've continued our consistent track record of meaningfully covering a regular dividend with pre tax net investment income as demonstrated by EUR, 110% regular dividend coverage over the last 12 months and 108% cumulative regular dividend coverage since the launch of our credit strategy.
As Brian mentioned earlier, we also paid out a supplemental dividend of 10 cents per share during the quarter as part of our supplemental dividend program.
This program allows our shareholders to meaningfully participate in the successful exits of our investment portfolio over time. The program will continue to be funded from Yutai earned from realized gains on both debt and equity as well as undistributed net investment income earned each quarter in excess of our regular dividends.
On slide 17, we illustrate our operating leverage which is.
The ended the quarter was 92.9%, excluding the aforementioned onetime deferred offering cost write off our run rate operating leverage for the quarter would've been approximately 2.6%, which puts us near our initial target operating leverage of 2.5%.
We are fully committed to actively managing our operating cost in lock step, but portfolio growth and will now set our sights on our longer term goal of achieving target operating leverage of 2% or better.
With senior professionals and corporate infrastructure largely in place operating leverage should continue to improve as the investment portfolio grows due to our internally managed structure.
Our NPV per share as of the ended the quarter was $18 in 30 cents per share as seen on slide 18.
The decrease from the prior quarter was largely driven by net depreciation in our upper middle market investment portfolio as well as by the 10 cents per share quarterly dividend paid to shareholders.
The net depreciation in our upper middle market portfolio was offset by appreciation in our lower middle market debt and equity portfolio. Our total pretax net investment return on equity for the quarter was 8.9%.
On slide 19, we laid out our multiple pockets of capital as we have mentioned on prior calls a strategic priority for our company is to continually evaluate approaches to de risk the liability structure of the company, while ensuring that we have adequate investable capital throughout the economic cycle.
To that end, we completed a five year $75 million institutionally placed bond offering attractively priced at five and three 8%.
We believe we are the first BDC with less than 1 billion in market cap to have raised an all institutional bond offering in recent history. The offering was led by Raymond James and JMP Securities at Bookrunners and included investments by 21, institutional investors, who are new to the capital southwest story.
We believe the execution of this transaction stands as a testament to our strong company performance and confirmation that our story resonates with BDC investors.
As Bowen mentioned earlier during the quarter ended September 32019, we sold 231272 shares of capital southwest common stock under the equity ATM program at a weighted average price of $21.62 per share raising $5 million of gross proceeds.
Cumulative to date, we have sold 690477 shares of capital South southwest common stock under the equity ATM program at a weighted average price of $21.57 raising 14.9 million of gross proceeds.
Our balance sheet leverage ended the quarter at a debt to equity ratio.
Seven five to one we're pleased to report that our liquidity is strong with approximately 238 million in cash and undrawn commitments available between our balance sheet and I 45, with the earliest debt maturity at December 2022.
I will now hand, the call back to Boeing for some final comments.
Thanks, Michael and thank you everyone for joining us today.
Capital Southwest has grown in the business and portfolio have developed consistent with the vision and strategy, we communicated to our shareholders almost five years ago.
Our team has done an excellent job building, a robust credit portfolio and generating significant returns for our shareholders.
Everyone here capital southwest is totally dedicated to beginning to being good stewards of our shareholders' capital by continuing to deliver strong performance and create and creating long term sustainable value.
This concludes our prepared remarks, operator, we're ready to open the lines for Q ne.
As a reminder, ladies and gentlemen to ask a question you will need to press star one on your telephone withdraw your question crest Apache.
Please standby we've compiled the culinary roster.
Our first question or comment comes from the line of Tim Hayes from B. Riley FBR. Your line is open.
Hey, Good morning, guys. My first question just on American addiction, I know you've been cautious on this credit for awhile, but can you just remind us what the investment was rated at the end of the fiscal first quarter and what actually triggered placing the investment on non accrual this quarter and whether that was.
Something you may have seen coming.
Yes, Tim So it was rated us the three it at the end to its ratings the same as it was last quarter.
Our non accruals kind of it's obviously judgment call.
And the company's not paying cash interest so honestly, it's yeah, we wanted to.
Kind of judgment on our part that it ought to be we should be incurring after income.
At the moment.
Okay.
And then just on the other investment on non accrual AG Kings should we don't have the Q in front of US was that credit mark up or down at all this quarter and is materially in is there any update to pass along.
Yes companies kind of still on the same you know.
It's just it's kind of bumping along hasn't gotten worse, it really hasn't gotten a whole lot better we did market down by 10 points. This quarter, so down from the mid Eightys to the mid seventies.
Okay.
And so you know just.
Portfolio metrics are still healthy, but this quarter, we saw I guess that AG kings. Good markdown American addiction outage nonaccrual aerated average risk ratings gone up a little bit and portfolio company leverage has also increased in both lower middle market and upper middle market portfolios. So can you just touch on.
This trend and why it is there is not concerning to you or an indicator of broader deteriorating credit quality in the portfolio.
Yes, I know it's good question, obviously some of the leverage metrics moving around has something to do the new deals that were put on the portfolio right. So that's part of it.
We have had some of our portfolio into small handful, but it's a couple of like you've after we reference American addiction and.
Kings.
So we have had.
Some softening in certain names.
No question about it.
Estimates.
It's really more idiosyncratic on a hand small handful of names.
You know cross border follow you and I would say EBITDA performance has softened slightly from what it was the last couple of quarters, maybe blame that little bit on the on the economy.
But generally from a first lien senior secured lender perspective not not.
Yes, disappointing and some of the company's performance, but from an investor perspective sitting in the first lien loan.
Yes, less worrisome, but I mean, everything worries us we're managing the portfolio, obviously, it's our job to worry.
But generally speaking I think the structures are working as designed.
Mhm.
Okay.
And then one more from me Ed just switching to the dividend.
Can you remind me how you think about dividend coverage as it relates to the recurring quarterly dividend you covered it on a pre tax basis, but did not net of tax.
The weighted average debt yield has come down I assume largely related to the non accrual and maybe some of that due to lower lie bar.
These headwinds persist what does your confidence level in your ability to sustain indoor continue to grow the quarterly dividend.
I think we've said in the past.
We look at recurring income and a run rate of net investment income going forward.
So this quarter I think we posted our number we look at the three cents of expense that was encouraged that the onetime and we'd add that back to our run rate to a really are and I for this period was 45 cents and if you look at it.
Net of taxes at 41 cents I'd also note on our 41 cents.
Most of our taxes are actually part of our the accrual on those blocker CSPI.
Not it was not a cash expense and sort of varies based on the estimate.
Future taxable income for those investments held in the blocker.
So I tell you going forward, we think our run rate.
And I have certainly in above the level of our dividend.
We probably are going to be slowing the dividend pace as we just announced 40 cents for this current quarter and then also has to do with our expectations potentially for.
For MRI and the future as well.
During the drives it obviously the originations and so you know we tried to be.
To be transparent on the originations that we've closed since the September quarter end and and we've got two or three deals and diligence right now that we would expect to close by the end of year. So we feel pretty good about the origination pace as well.
And to your point also that the drop in the yield from 11 711, one half of that was from LIBOR and the other half was from the non accrual the square okay.
Good to know Okay. I appreciate the commentary of a couple others thought back into queue.
Thanks. Thanks.
Thank you. Our next question or comment comes from the line of Mickey Schleien from Lindenberg. Your line is open.
Yes, good morning, everyone.
When we looked at the performance of larger companies.
Generally seeing consistent deterioration in some of their fundamentals and that's showing up in metrics like the proportion of leverage loans being downgraded and declines in the revenue growth and margins.
On the other hand in general middle market companies seem to be continuing to perform pretty well.
I'm curious what do you think is causing that divergence and the performance of those two segments.
Yes. Good question a lot of the deteriorate a lot of the deterioration deteriorating performance in the loans in the upper middle market has to do with leverage levels in the market in the upper middle market. So obviously alone alone.
Performance as a function of both the fundamental performance the company as well as the structure of the deal.
And the upper Middle market Oftentimes you have a an agent sitting on a desk that just decides to mark.
Mark.
Changed the quote in the market not really were with respect to necessarily paper. That's trading. So you have a you have a dynamic in the upper middle market, you don't have into lower middle market.
I think thats, probably the main thing I mean are lower middle market portfolio.
Just to give you a reference we referenced in our remarks that the portfolio lower middle market portfolio saw appreciation. This quarter I think you saw in our press release that that was 2.1 million.
That's made up of 100000 on the debt portfolio in 2 million on a lower middle market equity portfolio.
And that includes MRI being held flat for the quarter. So we if you look at our equity co investment bunch of companies.
They did pretty well this quarter and so thats a little bit more of a real time indicator of the poor performance a fundamental performance of the loan book because every one of those equity investments is accompanying alone.
So.
And if you look at our upper middle market portfolio, I mean, it's kind of.
Certain names, we talk about each quarter right I mean, king has enough or middle market American addictions, and the upper middle market.
We've got another company Delphi that that we made a three this quarter. It's also the behavioral health space in the upper middle market.
And so it's you know its.
You know its but if you look at the engine I think I attribute it mainly Mickey to your question really more of the structures.
In the quote dynamic in the upper middle market would be how I would see how would react to that divergence you referenced.
Just one follow on bone, so just thinking about larger companies in general not specifically your portfolio.
The weakness in their trends has caused.
Weakness in the more liquid leverage loan market in general and we're also seeing bifurcation of performance.
I do see that you added a little bit to your upper middle market bucket, but im curious if the recent trends and in the upper middle market are providing you with more pockets of opportunity and if that's the case you know what looks interesting to you on.
Ask adjusted basis.
You mean as far as just does does the upper middle market look interesting risk adjusted in general is that yes, given that theres been a lot of volatility the.
Then weakness was bifurcation there it seems that there may be some fear in the marketing, but generally results in some opportunities. Yes, generally speaking we've seen deal flow in the upper middle market slow.
And frankly, a lot of the the index deterioration you referenced is not always necessarily accompanied by paper that trades.
So as I said earlier me its agents at their desk changing quotes which is what they're supposed to do it by their judgment, but it doesn't necessarily mean that you can trade paper there so.
Just because of those opportunities.
What you said is not wrong, but but really on the ground floor in the market we haven't really.
Seen a whole lot of opportunities that we think are interesting and frankly, we've had a fair amount of demand for our assets for our capital in the lower middle market.
You know asset class that that we like.
So so all else equal right now you prefer the risk adjusted returns in the lower middle market versus a present right. Yes, we do I mean honestly you know that the.
Do you have many in the market.
Market that larger companies are inherently safer than smaller companies.
That's not you know I mean, obviously size of the company has an element in your analysis, but frankly, there are a lot of really interesting companies.
Better capitalized appropriately in the lower middle market and frankly, when we like the equity upside, we often time times have the opportunity to invest in the equity.
Which we liked so overall, yes, we like that asset class risk adjusted basis better than the upper middle market certainly right now.
Okay I understand those are all my questions I. Appreciate your time. Thank you. Thanks, Mick Thanks Mickey.
Thank you. Our next question or comment comes from the line of comp Joseph from Jefferies. Your line is open.
Hey, good morning, guys.
My questions have been been asked that just just two more from me.
This is a follow up but just trying to think about the yield on your portfolio. Obviously, there's a lot of moving parts, there's a shift between lower middle market upper middle market Theres. The forward rate curve and then you guys also have some some equity on your your balance sheet, but can you just.
From either.
For both a shorter term and then longer term perspective give us a sense for where you where you see that heading.
I mean, if I think about yields.
And the market I mean, they certainly have gone down over the last couple of years less so in the last six months I mean, we've kind of saw the down down the trend down.
You know.
We certainly.
Yeah, I don't like what would you say yield going forward I mean.
Yields I mean, they can range right from anywhere from 600 over LIBOR or too.
You know 900 over LIBOR or most of them are kind of.
650 to 750.
Two years ago, our year to have to goes probably 750 day 50, so over the last couple of years, probably seen 100.
We were 100 basis points deterioration, but less less less.
Less really market wide in the last call. It six month I think thats right I think the 11 75 down to 11, I think we probably 11% probably be right going forward, but I will tell you is our cost of debt has come down.
So, though we may be putting on assets that are slightly less yielding I think our our overall cost and our operating leverage can be coming down. So it should we actually should see a net pickup on net investment income honestly, if I can trade some level of yield for you know.
Even better structured safer credits.
Over time, that's probably not a bad trade off and so Thats you know.
Our deals in the market that are going to price tighter because there are lower loan to value.
Higher cash flowing companies at the margin.
And one of the reasons, we want to decrease our cost of capital one of the reasonably want to improve our operating leverage are all expenses to our business model that if we can a fitness at efficiency in those areas. We can compete for safer credits.
And that's a really important dynamics that we in the market that we that we definitely spend time on.
I think it probably noted that we had been pushing for 2% LIBOR floors.
So we've had probably a majority of our floors at one and then another portion at one and a half and then lately, we take thinks about 15% of the portfolio is that too. So it does theres some protection should LIBOR drop in the lower.
Sure that's great color. Thanks, and then Michael one thing you brought up.
It's a good segue to my second question.
On the liability side, obviously you guys.
Very attractive bond deal this quarter, but going forward given the rate environment would we expect further increases to be more from your credit facility and the floating rate type or how are you thinking about the liability side going forward.
Yes, I think we think that the were around 300 million total commitments on the revolver and I think that it's probably going to be where we're going to be for the next let's call. It 12 to 24 months.
I think that we'll look to see if theres opportunistic.
Capital raises on the debt side.
To take out the are older version of the bonds that are at 5.95% I don't think does anything in the foreseeable future.
But it to call period does and in December of this year, so if theres an opportunity to reduce cost and extend the maturity.
Certainly will look like that on the on the fixed rate side.
Got it thanks very much for answering my questions sure. Thank you have a good day.
Thank you. Our next question or comment comes from the line of Chris York from JMP Securities. Your line is open.
Good morning, guys and thanks for taking my questions.
So I want to Michael investors are.
Understandably worried about the turn of the cycle in a downturn.
As in internally managed BDC can you remind us of your approach and the resources in terms of doubt that you can apply towards restructuring or working out a default credit when you are easy to a lower middle market credit to achieve a positive resolution for investors.
Yes. Thanks for the question. So a couple of things I mean, we've spent our staffing increases on the last 12 months have been primarily in the kind of the mid to junior levels in the organization and that's important because that helps leverage the guys that have a lot of experience over multiple.
Decades of through cycles restructuring and kind of can help.
Myself in the investment committee make decisions and so we definitely have increased the capacity of what our guys can do.
But also would say when when you when you have a troubled credits I mean, it's not.
100%.
US doing burning every calorie on restructuring out I mean, you do outsource consultants, you bring consultants and to be on the ground the company.
We have to make decisions with respect to the capital and this strategy of turning around those companies.
But that's that's intellectual decisions based on analysis is being done and so you can you know we saw this in the great recession at our portfolios and the great recession right. I mean, you bring in consultants that can help you understand factually, what's going on at the operating at the operating level.
You can produce spreadsheets and analysis based on that and you can make good investment decision. So.
I think our staff, we're going to we will continue to.
Add people I think it's mainly on the junior mid level junior side.
But in lockstep as we've always said with our portfolio growth because we are very intent on hitting our operating leverage targets.
But I think our.
I think we've we're set up.
Well two to manage that that dynamic that you described.
So hopefully thats helpful as to how we think about it.
It is helpful. In one interesting comment I gathered there. So you would consider hiring consultants to.
To help you there is is that.
Fair.
Yes, I will tell you ask you also have alone goes bad right I mean, there's a couple of things going on right. One one first and foremost is the operating operating of the business right and so the first thing you have to do is get under the covers and figure out exactly what the heck of going on right. We monitor companies. We sit down every every month and we go through financial statements and.
As a team and we're pretty well versed on what we're being told is going all the companies and we understand the businesses in the industry's enough to kind of hopefully decipher, what's right and what's kind of fishy in what we need to dig in on more but when you trip a covenant and now you're getting in the operations of the company. There's there's a myriad of consultants out there that are.
Next operating guys and girls that that have done this all their life and now chosen the profession of going in and really recreating cash flow forecast and strict strategic decisions that are being made and then can advise us on the fundamental operating side of the business and that's obviously in the potential of the business and how long.
Turnaround will take take and what cash flow forecasts are like an all those things.
Yet that we have to have we're making decisions on what to do with our capital to protect our shareholders' capital and to frankly create upside from where we are at that point of the cycle and so you can do a lot of that I mean, it's not like I mean, I don't think into the Bdcs would tell you that hey, we're deal guys. It we're going to go pretend to be operating guys and turn these companies around I mean.
Thats I'd be skeptical anyone that said that and so a lot of what you do in the restructuring turnaround situations is outside.
<unk> expense or cost or labor that obviously attributable to that particular portfolio company.
Got it very helpful. Okay switching gears. So bone appreciate the color on MRI in the prepared remarks questions from Michael and Bohn you can take it to you can you remind investors of your expectations for the impacts of the exit of MRI on quarterly financials, because it's a sizable.
Asset and then we do have the expectation that you're likely to use of proceeds to pay down debt.
Yes. So the current dividend is about $1 million a quarter coming from MRI, obviously thats going to go away.
But we're going to use approximately 50 million of those proceeds are going to come back.
The majority of those proceeds are going to be used to pay down debt initially.
Then be redeployed into debt assets.
Just to be some level of leakage for depending on deemed distribution or special dividend.
But so there'll be initially when we pay down to be our cost of debt is about 5% and the dividend yield was about 8%. So there'll be a slight slight reduction goals at the front end and then as we redeployed and I will be flat.
When we fully transitioned.
We'll grow when we lever backup.
Got it.
That makes sense that's it for me thanks, guys.
Thanks, Chris.
Thank you. Our next question or comment comes from the line of Chris Mccampbell from Hilltop Securities. Your line is open.
Good morning, Thanks for taking the call.
You've talked about the factors that contributed keeping the dividend at the same level quarter over quarter, but.
Can you give some color on I guess your dividend growth goals going forward, whether maybe we should expect.
Year over year kind of gross or are we at the point of the cycle, where it's really kind of hard say.
Well I would say look dividend growth is going to be a function of portfolio growth.
It's a function of a bunch of factors, but but thought the portfolio growth portfolio performance.
And what's really important with a dividend policy in my view is to have a dividend that you that shareholders can rely on and so you know and so we don't want to just increase it just to increase it and then decrease it security right. So so thats why Michaels always talked in terms of kind of recurring run rate.
Earnings kind of as we exit a quarter rights as we exit a quarter. There's there youve there might be deals that we closed very late in the quarter, which from a run rate perspective would be a higher income off those loans than we would if they have been done at the first for the quarter, but in the following quarter that would be a full quarter earnings. So you have you have those loans you have loans that you've exited.
You've got one time prepayment fees and various things that are uncertain quarter that you can't really assume will recur next quarter. You also have expenses like we had this quarter of three cents. A share then also won't be expenses next quarter. So we look at all that and we try to set a dividend at a level that that is a level that you know that.
Frankly shareholders can rely on going forward and then hopefully that high watermark, if you will or that watermark will increase as our portfolio grows.
As as it should based on where we are in a leverage level based on the liquidity, we have available to us and our cash and credit facility availability.
It's just a matter we need to go find the deals that are.
Hi, good deals so we've never really been in a rush to grow portfolio or increase dividends or earnings we want to.
Hustle to find the deals find the opportunities and be very diligent and careful and thoughtful in actually which ones. We close if that makes sense, but so it's a function of a lot of things that we have to manage and continue going forward I would say the good news is we have a substantial amount of liquidity. So we have the capital available when we find those deals.
So we've we've made a lot of effort to decrease as Michael said the risk in the right side of the balance sheet right, so risk being cost to capital.
Covenant levels on capital sources, and then just availability of capital. So we can concentrate on having hit.
Substantial investable capital throughout the cycle.
So.
The result of that is as we go to grow the portfolio then the earnings should increase.
Probably tell you where the dividend level is right now it may.
Stabilized for the moment as we absorbed the capital we just we just received as well and the potential for MRI exit.
But we would have some tell you that we expected to dividend to grow as gasoline phones described as we redeploy capital yes. So when I, it's an important point so when I say growth in the portfolio, obviously growth in the investment portfolio is net growth so its new assets being put on minus assets being prepaid.
We're first lien lenders. So every quarter, we have amortization payments in prepayments and things that come in because we're in a lot of our companies were dollar one risk and so when that company generates cash flow. It goes to the first lien lender first and Thats often times us.
And then you have large exits potentially like anymore I exit.
That would be big capital inflows and obviously, our capital to Chris York's question earlier, you know that immediately our asset base would be lower and then it would deep we'd have to redeploy that capital. So hopefully I clearly, yes would it be safe to say that at this point of the cycle, though.
Your maybe being a little more conservative than you were.
234 years ago and so.
The pace of the growth of the portfolio would likely be slower as well.
Yes, I think thats right, we've always since the beginning had a mentality of we need to prepare for a large bad recession, starting in the next couple of years and obviously it back in 2015, we thought that we didn't think it doesn't matter we think it matters. What we prepare for we were we were preparing for recession 16 and 17.
Didnt happen everyone. On this phone is super happy that that Didnt happen, but we prepared for it and now we're doing the same thing for kind of 20 and 21, obviously, none of us hope for that and whether we expect that or not it doesn't matter.
We prepare it we prepare for it so let me look every year that goes buyer closer to the end of the end of the economic cycle right now.
When is it going to happen none of US no, but we all have to prepare for in our loan portfolio in your clients stock portfolios are about to be preparing for that.
And hopefully it doesn't happen for another several years, but you never know so all that to sell all that said you know I would say that each year, we get closer to the theoretical ended the cycle and so yes at some level were more we're more conservative and how we look at things.
But we've kind of taking that mentality from the beginning.
Well, thanks for being good stewards Scott.
Thanks very much.
Thank you I'm showing no additional questions in the queue at this time I'd like to turn the conference over back over to Mr. Bowen Diehl for any closing remarks.
Great. Thanks, operator, hey, thanks, everybody for joining joining us and we appreciate your off time your support your focus.
And we look forward to talk with you next quarter have a great week.
Ladies and gentlemen. This concludes today's conference call. Thank you for participating you may now disconnect everyone have a wonderful day.