Q1 2021 Capital Southwest Corp Earnings Call
Capital Southwest Corporation earnings call will begin approximately three minutes. Thank for your patience and please standby.
[music].
Thank you for joining todays capital southwest first quarter fiscal year 2021, earning call participating on today's call Apple ideal CEO Michael Garcia.
Three Berger.
I'll now turn the call over the course LIBOR.
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 assumptions that could cause actual results to differ materially from such statements for information concerning these risks and uncertainties seed capital southwest publicly available filings with the FCC.
The company does not undertake any obligation to update or revise any forward looking statements.
There was a result of new 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 first quarter fiscal 2021 year earnings call.
Throughout our prepared remarks, we will refer to various slides in our earnings presentation, which can be found on our website www dot capital southwest Dot com.
We're pleased to be with you. This morning to announce our results for the first fiscal quarter ended June 30 2020.
I want to first say that I hope everyone their families or their employees continue to be safe and well.
Your capital Southwest, we have continued to prioritize the health and safety of our employees and not be employs about portfolio companies.
We remain in regular dialogue with our portfolio company financial sponsors and management teams have been pleased with the quick responses to the pandemic and the rest can cost mitigation work that's been done across the portfolio.
Well the pandemic continues to be an overhang on the market in general we continue to feel good about the quality of the out that's an earnings power of our portfolio.
During the quarter, our portfolio performance stabilized as evidenced by 2.1 million of net appreciation across the portfolio for the quarter, we had two investment rating upgrades.
No investment rating downgrades and no new loans placed on non accrual.
As a well capitalized first lien lender with ample liquidity capital southwest continues to be in a favorable position to seek attractive financing opportunities.
And to provide financial support to our portfolio companies, where warranted receive enhanced economics for doing so.
Executing our investment strategy under our shareholder friendly internally managed structure.
Closely aligns the interests at our board and management team without about fellow shareholders generating sustainable long term value to recurring dividends capital preservation and operating cost efficiency.
On slide six of the earnings presentation, we have summarize some of the key performance highlights for the quarter.
During the quarter, we generated pre tax net investment income of 40 cents per share and paid on a regular dividend of 41 cents for sure.
We also continue to our supplemental dividend program paying out a 10 cents per share quarterly supplemental dividend funded by our sizeable undistributed taxable income balance.
Total dividends for the quarter of 51 cents per share representing an eight representing an annualized dividend yield on last Friday stock price per share 15.3%.
On an annualized yield on in a deeper share of 13.6%.
During the quarter, we grew our total portfolio over 6% to 587 million as of June 30 2020.
Portfolio growth during the quarter was driven by 30 million in total commitments to two new portfolio companies in five existing portfolio companies.
The total originations for the quarter included investing 1.3 million in equity alongside to buy lumps.
Additionally, on the equity capitalization front, despite the recent market volatility.
I used to 5.7 million in gross proceeds during the quarter a few our equity ATM program.
Representing the seventh straight quarter, we have judiciously raise permanent capital for the BDC above any b.
Our diligence in selling limited amounts of equity each quarter, when our stock price is trading above and I'd.
In lockstep with our ability to deploy the capital continues to be one of the key contributors to our financial flexibility in today's environment.
At quarter end, we had approximately 155 million in total liquidity available between our revolving credit facility and cash on the balance sheet, well, having only about 15 million an unfunded revolver commitments to our portfolio companies in which the criteria for drugs have been Matt.
Finally, we're excited to announce it the U.S. small business administration issued capital southwest a green light letter inviting capital southwest to apply for an FDIC license.
Operating an FDIC subsidiary has been a strategic priority for capital southwest and we're looking forward to partnering with the S.P.A. in their mission of providing capital to underserved markets, including business isn't low to moderate income areas and businesses owned by minorities women on veterans.
As a reminder, final approval and issuance to capital southwest of an FDIC license would provide a 10 year commitment to provide capital southwest with up to 175 billion in debt financing.
To be drawn to fund investments in lower middle market companies the qualify as small businesses pretty Sta definition.
Each draw from the FDIC Debenture program separately represents a new debt security in our capital structure with a 10 year maturity from the date of draw.
From a cost perspective, if the treasury rates remain close to today's levels.
The all in cost of the FDIC debentures will be between two and a half and 3%.
This program is clearly a perfect fit for our lower middle market focus and we look forward to continuing to work with U.S.P.A. in completing the application process.
Turning to slide seven eight we illustrate our continued track record of producing a strong dividend yield consistent dividend coverage and value creation since the launch of our credit strategy.
As a reminder, we previously announced that our board declared total dividends up 51 cents per share again for the coming quarter ending September 30 2020.
Consisting of break a regular dividend of 41 cents per share in a supplemental dividend attempts that's for sure.
Turning to slide nine as a reminder, our investment strategy has remained consistent since its launch in January 2015, we continue to focus on our core lower middle market.
While also maintaining the ability to invest in the upper middle market, what when attractive risk adjusted returns exist.
In the lower middle market, we directly originate opportunities consisting of debt investments in equity co investments.
Building out a well performing and granular portfolios equity co investments is important to dry didn't get 80 per share growth as well as eating into mitigation of any credit losses over time.
Overall, we believe that maximizing the top end of our deal origination funnel in both markets is critical to generating strong credit performance overtime is that ensures that we consider a wide array of deals, allowing us to employ our conservative underwriting standards and thoughtfully building a portfolio that will perform to any economic cycle.
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No. We are currently taking a cautious in extremely selective approach towards deploying new capital taking into account, but new normal a potential pandemics. Among other risks. We're pleased to have the capital to invest to support acquisitions in gross growth across our markets.
We have been excited about the opportunities that we have pursued and closed and we continued to find superior risk adjusted return opportunities and the lower middle market, where we can lend at lower leverage and loan to value levels, while maintaining tighter covenants and other terms in the loan documents.
As illustrated on slide 10, our balance sheet credit portfolio. Excluding I 45 grew 3% during the quarter to 487 million as compared to 474 million as at the end of the prior quarter.
Resulting in our credit portfolio now being weighted 85% to lower middle market loans.
We continue to heavily emphasize first lien senior secured debt Wendy with 100% of the debt originations this quarter being first lien senior secured.
As a result as of the ended the quarter, 90% of the credit portfolio was in first lien senior secured debt.
On slide 11, we lay out the $30 million of capital invested in and committed to portfolio companies during the quarter.
This included 20.8 million in first lien senior secured debt provided two new portfolio companies.
And 9.2 billion of additional capital to five existing portfolio companies, which included 8.9 billion, a first lien senior secured debt and $400000 exactly.
Gil flows since the quarter and has remained solid it's post quarter end, we have originated an additional 34 million in commitments.
It's included 27 million invested into new portfolio companies and 7 million to fund add on acquisitions at two existing portfolio companies.
Total commitments post quarter end consisted of 32.2 million in first lien senior secured debt and 2.1 million in equity co investments.
On slide 12, we breakout our on balance sheet portfolio as of the ended the quarter between lower middle market and the upper middle market. Excluding I 45 as of the ended the quarter. The total portfolio included equity co investments, including equity co investments was weighted approximately 85% to the lower middle market and 15% to the upper middle market.
On a fair value basis.
We had 36 million 36, lower middle market portfolio companies with an average hold size of 12.6 million weighted average EBITDA up 8.2 billion.
The weighted average yield of 10.8% and leverage ratio measured as debt to EBITDA. If you are security a 4.1 times.
Well, they're not lower middle market portfolio is at the ended the quarter, we held equity ownership in approximately two thirds of our portfolio companies.
Our on balance sheet upper middle market portfolio. Excluding I 45 consisted of 11 companies with an average hold size and 8.4 million.
Weighted average EBITDA of 73.1 million weighted average yield of 6.8% in a leverage ratio through our security or 4.4 times.
Our on balance sheet upper middle market portfolio leverage metrics are shown excluding our investments in American addiction, and Delphi behavioral health as the EBITDA, while improving in both cases on a run rate basis.
For me because of the ended the quarter at levels that would skew the aggregate portfolio leverage ratios to a degree that would obscure the ratios of the remainder of the upper middle market portfolio.
We should note that post quarter end Delphi was restructured out of core capital southwest now hold that first lien senior secured debt investment and the company, which should come back on a cool this quarter and an equity ownership position in the company with representation representation on the company's board of directors.
We continued to be pleased with the high quality care that Delphi provides its patients and the company's improving financial performance.
We are optimistic about the company's future and the ultimate recovery of our capital.
In the case in American addiction.
As many of you have seen the company has filed bankruptcy.
Very necessary step in restructuring the balance sheet sits at the company up financially for success going forward.
We're also pleased with the high quality care the American addiction provides its patients and its improving financial performance.
Turning to slide 13, we have laid out the rating migration within our portfolio for the quarter.
During the quarter, we had two upgrades in the portfolio for companies that continue to significantly outperform expectations.
Having no further portfolio downgrades.
As a reminder, all the investments upon origination are initially assigned an investment rating of too on a four point scale with one being the highest rating for being the lowest rating.
The upgrades included two loans previously radio to that were upgraded to one rating based on superior performance and de leveraging.
Almost 60% of the portfolio is it fair value now has our highest investment grade.
As of the ended the quarter, we had nine loans or 12% of the investments at fair value rated a three and only two loans or 2% of the portfolio at fair value ready before.
The remaining 70% of the investments at fair value remained regular too.
Given the severity of the economic downturn endured as a result on a pandemic, we're quite pleased that over 82% of our investment portfolio continues to hold one of our top two investment ratings.
As illustrated on slide 14.
We have established a portfolio well diversified across industries with an asset mix that should provide strong security for our shareholders capital.
The portfolio remains heavily weighted towards first lien senior secured debt with only 6% of the portfolio and second lien senior secured debt.
Only 2% of the portfolio in one remaining subordinated debt investment.
Shown on slide 15 as of the ended the quarter, 96% of the I 45 portfolio was invested in first lien senior secured debt with the diversity among industries and an average hold size a 2.4% of the portfolio.
Yeah, I 45 portfolio also showed signs of stabilization.
As our investment and I 45 appreciated by 4.2 million or 8% during the quarter.
I'll now hand, the call over to Michael to review the specifics of our financial performance for the quarter.
Thanks Boeing.
Citic to our performance during the true for the June quarter as summarized on slide 16, we arent pretax net investment income of $7.2 million were 40 cents per share.
This is consistent with the 40 cents per share earned during the prior quarter.
We paid out 41 cents per share in regular dividends for the quarter flat from the 41 cents regular dividend per share paid out in the prior quarter.
As mentioned earlier our board has also declared a further 41 cents regular dividend per share to be paid out during the current September quarter.
In the near and long term, we have built it consistent track record of meaningfully covering our regular dividend we pre tax net investment income as demonstrated by are up 102% regular dividend coverage over the last 12 months and 106% cumulative regular dividend coverage since the launch of our credit strategy.
During the quarter, we maintained our supplemental dividend at 10 cents per share and again our board also declared a further 10 cents per share supplemental dividend to be paid out during the current September quarter.
As a reminder, the supplemental dividend program allows our shareholders to meaningfully participate in the successful exits of our investment portfolio through distributions from our Yutai balance overtime.
Due to the successful sale of media recovery in late 2019, we were able to replenish argue T.I. balance to the maximum allowable level as at the end of 2000, not 19 tax year, providing visibility on the longevity of the program well into the future.
The program will continue to be funded from U.T. <unk> 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.
As of June 32020 are estimated estimated U.T.I. balance was $1.27 per share.
Our investment portfolio produced $15.2 million of investment income this quarter with a weighted average yield on all investments of 10.4%.
This represents an increase of approximately $130000 from the previous quarter.
As Brian mentioned, we had no new non accruals as at the end of the quarter. Currently there remains three assets on nonaccrual with a fair value of $11.3 million, representing 1.9% of our total investment portfolio at fair value the weighted average yield on our credit portfolio was 10.1% for the core.
Sure.
Excluding interest expense, we incurred $3.7 million, an operating expense the quarter, which was approximately $150000 higher than the previous quarter.
As seen on slide 17, we reported operating leverage up 2.4% for the quarter, which puts us below our initial target operating leverage of 2.5%.
We are fully committed to actively managing our operating costs in lockstep with portfolio growth and have our longer term sights set on achieving target operating leverage of 2% or better.
Operating leverage should continue to improve as the investment portfolio grows due to the relatively fixed nature of the operating costs associated with our internally managed structure.
Flipping over to slide 19, the company's NPV per share as at June 32020 was $14 in 95 cents per share as compared to $15.13 per share at March 31 2020.
The main driver of the slight NPV per share decrease was from the annual RSU grants to employees as the 11 cents per share of net appreciation on the portfolio offset the 10 cents per share quarterly supplemental dividend paid.
On slide 20, we lay out our multiple pockets of capital as we have mentioned on prior calls a strategic priority for our company it 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 as though in mentioned earlier, we're happy to report we receive.
The Green light letter from the SBA from a capitalization perspective. This is a significant event for capital southwest in the long term.
We believe this program provides access to efficiently priced long term capital, which will allow us to both be more competitive on deal originations and increase our total returns to shareholders.
We have consistently stated that one of our long term goals is to achieving investment grade rating.
We believe accessing the Sta program further enhances our resonate toward achieving that goal.
As it further diversifies our funding sources.
In addition to the potential of accessing up to 175 million associated with the FDIC license.
Our debt capitalization today includes a $325 million on balance sheet revolving line of credit with 11 Syndicate banks, a 77 million dollar publicly traded baby bond maturing in two and a half years is 75 million dollar institutional bond with 21 institutional investors maturing in four years as well as ever.
150 million dollar revolving credit facility at I 45, with four syndicate banks.
Additionally, we're pleased to report that or liquidity is strong with approximately 155 million in cash and undrawn commitments as of the ended the quarter with ample borrowing base capacity and covenant cushions on our senior secured revolving credit facility.
In addition, approximately 46% of our current capital structure liabilities or unsecured with the earliest debt maturity at December 2022.
Our balance sheet leverage as seen on slide 18 ended the quarter a debt to equity ratio of 1.19 to one.
Finally, despite the heightened market volatility during the quarter, we were able to sell 373177 shares of capital southwest common stock under the equity ATM program at a weighted average price a 15 year $15.38 per share raising $5.7 million of gross proceeds.
We now have raised $51 million, an equity capital over the past seven quarters accessing our ATM program diligently every quarter during that period in lockstep with our investment activity.
I'll now hand, the call back to Bowen for some final comments.
Thanks, Michael and thank you everyone for joining us today [noise] capital southwest has grown in the business and portfolio have developed consistent with the vision strategy, we communicated to our shareholders over five years ago.
Our team has done an excellent job building, both a robust asset base as well as a flexible capital structure that prepares us for tough environments like the one we have experienced over the past few months.
Well, we're not immune to the challenges the economy takes his day, we feel good about the health of our company and the opportunities at the environment will present to us as we consider places to invest capital in what should prove to be less competitive environment.
Everyone here at capital Southwest is totally dedicated to being good stewards of our shareholders' capital by continuing to deliver strong performance and creating long term sustainable value.
And troubled times such as needs.
This concludes our prepared remarks, operator, we're ready to open the lines up with <unk>.
Ladies and gentlemen to ask a question you need to press Star then one and your telephone.
As far your question press the pound Pcie, please standby, we compile Q and a roster.
Our first question comes from Paul Joseph from Jefferies. Your line is open.
Hey, good morning, guys. Congrats on a good quarter and thanks for taking my questions.
First question, just about that deal flow and actually more specifically on repayments I didn't see that repayment level or in the quarter and can you give us a sense for for your expectations for repayment trends in the portfolio given the current environment. We're in.
Yeah. So so repayments were other than amortization and revolvers draws back and forth virtually zero, yeah, I think yeah, yeah, two and half million, maybe the amortization with all [noise].
And secondly, the last part of your question was what.
Would you sort of anticipate a repayment levels being fairly muted given the overall deal environment.
Yeah. This thing so yes, or no we definitely have seen we see deal activity [noise].
Pretty strong at the moment as I mentioned in our prepared remarks, but now we have our in our portfolios you know 16% of the portfolio is now ran at a one so those are clearly companies that are performing very very well and so you know we don't see any in particular that we think are going to be refinanced quickly, but those are strong and very brief.
Unanswerable. So you know that would be the yes to the question potentially but I think it's generally probably.
You know relatively slow prepayments in the future, but subject to that a fairly sizable chunk of our portfolio that a that are outperforming.
Got it and then in terms of the outlook for yield.
Obviously, there's portfolio mix shift.
And it looks like you had some very attractive yields on the on the new deals in the quarter. So can you kind of give us a sense.
Weighing you know mix shifts a yields on new deal the rate environment, just kind of your your your outlet for the yet for the consolidated yield.
Yeah, you want to get one yes sure sure. So you saw we are yield came down from 10.5 to 10.1, mainly due to LIBOR during the period, we saw obviously volatility.
From the previous quarter to now and now it seemed to have flattened out obviously was around 30 or 35 basis point, you will see it re trade up a bit.
Because like you noted some of the assets, we put on during the quarter or higher yield I'd also tell you that the there never was slightly.
Down due to us having investments that were late stage for the previous quarter. So he was even though it was in the balance.
You did a it was in the weighted average balance you didnt see the income so you'll see that in the subsequent quarter. So well thing all of that I think you know 10.5% it seems like the right.
Going forward as far as the market environment I would say right now as we sit here you know spreads.
So why are while earlier in the coded I'm kind of pandemic time period, you know you'd say, maybe 100 150 basis points higher than pre covered I would say now, it's probably 50 to 100 basis points higher.
In the market than pre Kobin, you still have some market participants that are essentially out of the market. But there are you know there are quite a few in the market. You know people tend are being more disciplined as far as spreads that they're offering in the market. So I'd say it kind of feels like it's kind of a 50 to 100 basis point.
Spread difference to the positive now versus pre code.
I assume that was part of your question too.
Yes, absolutely thanks, very much for answering my questions guys that take care. Thank you.
Our next question comes from Tim Hayes of F.B. Riley Your line is open.
Hey, good morning, bone and Michael just a few questions on credit to start the do I guess you had one less non accrual this quarter or did you exit that I guess I guess you said there were no real repayments. This quarter what happened was one credit taken off nonaccrual status because I'm assuming you.
Exit that.
I guess I was curious if that was what drove the realized loss, but if not that credit than what did.
Yeah. So thanks for question for Delphi that I mentioned in my remarks.
It was on non accrual, we restructured that out of court.
And it's back on accrual.
So and you know a transaction its restructured like that can often be a realizable a taxable event. So it you realize attack you realized losses.
But then we've got you know pretty substantial equity ownership and as I said, we've got board representation on the reputation on the board.
And so you know, we actually feel pretty good about recouping, our part at least on that loan overtime.
Okay got it thanks for clarifying that and then how many credits in the portfolio would you say have been extended some type of forbearance, where modification and just wondering if you've seen those request decline.
Oh definitely seen their request decline as it's kinda <unk> you know the whole.
State of play from the coated pandemic, you know kind of shocked everybody in March and then it kind of played out in June right. So in the June quarter. So as we look back at it. We had you know to give you an idea we had three loans.
That that we agreed to to pick a portion of our interest for a period of time.
And I think in all cases in exchange for equities support or the company.
And so and then we had we had six loans that we essentially just amended covenant the exchange for economics.
But but they're all current on interest it wasn't really a cash interest issue. It's just more of a covenant issue and we extracted economics for giving them a little bit more leeway.
Got it got it okay and.
On the on the follow on you funded this quarter, but those all sponsored credits and did you require sponsors jacks more equity.
In order for you to participate as well and then just curious if you denied any follow on request this quarter.
Well, yes in both add on you know, we refinanced a portion of the actions acquisition and sponsors put in put in equity to fund the acquisition. So.
We really look at.
Frankly, we look at leverage pro forma for the acquisition and say what is the appropriate leverage leverage level in this market in this particular industry. In this particular company and then we will finance a leverage them out to to bring leverage up to whatever we deem as the appropriate leverage level and not higher than that so you know virtually always rich.
Adults in the equity equity, putting more equity in to the acquisition as far as do we did we.
Deny any any follow on request I mean, we certainly turned down deals all the time.
I I don't think I can't recall a deal. This quarter were were a sponsor called US and said we want you to finance our acquisition and we said no.
I mean, obviously that would be pretty pretty significant has to reasons. We didnt have any companies that would fall into that bucket.
Okay.
Got it and then can you just help reconcile the unrealized depreciation in the upper middle market portfolio, you said 25 million a depreciation last quarter I think only 5 million of appreciation this quarter, despite spreads coming in and asset values are covering more than just 20% I believe in may.
Most cases, so it was was there some company specific depreciation that offset the mark to market gains this quarter.
No I'm trying to figure out actually when your with your question, where what what you're seeing a different.
And that reconciliation the two things that have happened we saw that depreciation last quarter, we put in capital alongside main street to de lever. The the credit facility from then to now and then we saw 5 million of appreciation I don't know that theres.
What is I'm not sure what the missing pieces.
I guess I was just I would've expected more of a markup on the upper middle market portfolio, given what we've seen in the market and that's that's really the nature of my question sure.
Yeah, Okay, no yeah, I mean, not obviously you know we had we had gives and takes in the portfolio clearly so we had some specific depreciation in the Oh upper market upper middle market portfolio and a and then we had you know the spreads.
The thing about the upper middle market as you guys know it isn't.
There is a secondary market, but it's not.
You know candidly, it's not it's not super liquid. So you know we quote tend to go down faster than they come up it's just a negative bias in the market and like we talked about before.
And so that could have some effect and I think the other piece probably actually now that you're missing Cpk is the one name that I would tell you that you know if it's an idiosyncratic were obviously related to coated it had significant depreciation for the quarter, that's sort of muted what otherwise would have been higher appreciation that might be what your you got it yeah I think that's.
Part of it that's a big part of it right good point.
Yeah. Thanks, Michael that's probably exactly the missing piece there makes sense okay.
Okay, well I'm going to jump back into queue of a couple more but I think you for taking my questions. Thanks.
Our next question comes from Bryce Rowe of National Security. Your line is open.
Thanks, Good good morning bone and Michael.
Good morning.
Did they maybe to follow up on Ted's question there.
And and talking about depreciation within the the lower middle market portfolio I don't know if there was a specific driver.
They are Boeing, but our or Michael but just curious.
What would what fuel that this quarter.
Yes, I mean, if you're thinking about the lower middle market I mean, it's obviously the in the loan indices is a portion of the valuation, but it's a more thorough.
You know modeling type exercise relative yield analysis, and so as everyone asked about last quarter and correctly asked about last quarter a lot at most of the EBITDA offset from the pandemic was in the June quarter not in the March quarter and so so the pick has got to flow through the Python right. So EBITDA in the portfolio as a general.
Matter went down on an LTM basis right.
It's it's usually on an LTM EBITDA basis, and so and so have you saw the the the leverage in our lower middle market and as.
Migrate up to 4.1 times, which is again that.
Thats, a pig kind of go onto the Python and so the good news as we've seen that stabilize and frankly improving.
In the real time basis, but that's kind of what you're seeing so [noise] leverage went up you know so that's going to affect the loan values that affected loan values I guess more than the into the index effect of the loan values. What makes yes, okay. That's fair.
Wanted to ask about the internal ratings obviously the four rated credits went from went from three to two and understand that Delphi get restructured side I would assume.
That might have been one that moved out but.
It was I was curious if that's correct.
And then.
Any any update I saw in the and that did the add ons. This quarter. There is out there was an add on to AG King. So maybe you could provided provide an update there too.
I'm sure. It was the first one question.
The loan from going from four yeah four to three so that was Delphi, you're correct afforded to I'm sorry for it went from four to two.
Because that's ready to the debt security so it's too.
Yes, they do Kings I mean, obviously I don't want to comment on companies in particular, I mean, it's a grocery business right. So you can imagine is doing well in the pandemic you know still.
Happy the management team, it's kind of a long process to kind of worked through.
Restructuring and at what that looks like exactly but so I'm. So I'll leave it that the private company, obviously, so I want to be careful about about commentary on that but just you can you can probably correctly speculate that the grocery business and it's probably doing better from that perspective yep. Okay. That's helpful.
One last one from me in terms of possibly capitalizing the FDIC.
License or subsidiary, Michael maybe maybe you can walk us through.
How you envision that kind of playing out and.
And maybe maybe talk about how you would you might be able to go without accessing that initial tranches of debt and when when that might happen relative to capitalizing that that that that subsidiary sure. So we're going to go through the application process between now and really that should be a two to three week.
Process, it just getting that submitted.
We will we expect based on feedback from the FDA that we should hopefully get through this process. It successfully by maybe November or as late as December.
So therefore would be able to start investing inside that the FDIC, we'd have to put to work. Our first I'd like you said, our first here, which are $40 million capital before we start drawing so we'd expect to start levering up by March or April 2021.
And then started you know if the rates are where they are today I mean, we see this is you know a fairly large a meaningful move to Eni we're assuming.
Without the SP, a debt you'd assume you're using baby bonds, which are obviously less predictable when the markets are open or shot as.
As you've seen great vacillating between five and 7%. So when we look at it our average or are we on an asset is usually around 15% at our current cost I'm using the FDIC. We think that are always going to go up over 20% once the on an asset by asset basis, and we think once it's fully ramped.
You had the whole hundred 75 million put to work this is a.
Pretty significant mover 20 to 25 cents event I a year, so I'm very meaningful so in terms of when do you get to fully ramp we would probably tell you that's going to be somewhere between the end of 22 and 23. That's the books are putting the money to work Yep Yep. That's that's helpful and in terms of kind of target.
Good leverage on a statutory basis.
Is that does that kind of change here, if you're you're adding that level debt.
Hi, I think that we're probably going to be between let me give you a wide range, probably 1.11 0.5 on a total economic leverage from a regulatory perspective, you are probably still be in that 1.11 0.0 to 1.2.
Okay.
Alright. Thank you so much you.
You bet.
Our next question comes from Robert Dodd Raymond James Your line is open.
Hi, guys.
Congrats on the quarter, just sticking with yes, I see for a second can you.
If you've got the data considered the the pipeline of deals that you've seen and exited the say the next last 12 months.
Beyond the pandemic.
What proportion of those would be I see eligibles buses.
Hi, this is there.
City to change targeting in any way to produce SP I see eligible deals. So is that the pipeline just.
Like with them already.
Yes. Good question I mean, its vast majority of them 50, FDIC definition buyer estimation, so it's 90%.
Plus I mean, we don't want to change our strategy at all that's why the program so interesting to us.
Insufficient passing flexible financing that allows us to go out and and a and invest in the exact market market that we invest in today.
Got it. Thank you and then well just obviously, we've done up the schedule investments.
Details yet.
If I presume the realized loss related to Delta.
Utilization.
That was a month so that means you'll.
You had next kind of two and half million of.
Unrealized depreciation except for Telsey 4 million of that seems to have been from the ox 45. So there was some deterioration depreciation.
So the book can you give us any color on on what the drivers that you can stretch out somewhat but you made some comments I spoke about the potential for trailing 12 EBITDA trends to outweigh.
Oh.
A you know kind of market rebounds in valuation multiples and things like that can you give us any any.
I know mix on how that played out in where you came out this quarter.
Yeah sure. So you know as I said a minute ago. If you know it if it's.
Lower middle market credit valuation you know alone index of course across the debt portfolio loan indices are a component to the valuation and that's obviously a positive influence or.
The larger Influencer is really leverage as it relates to LTM EBITDA and so as we move to the pandemic most of the pandemic effect on the portfolio and on the economy was in the March quarter in the June quarter as opposed to the March quarter. So it's really up.
Pig onto the Python type thing so.
You know and as you as you know EBITDA across the portfolio on an LTM basis went down March to June.
And so as you see in our leverage our lower middle market went up to 4.1 time and so you know like you know in the right now we're seeing you know really encouraging stabilization and frankly, improving and performance, but as of the end of the June quarter, where you stood was you had LTM EBITDA come down as the pandemic.
Mark we're a greater percentage of the LTM EBITDA as measured for the valuation and so in the lower middle market. As you would expect the market you know went down slightly although on a.
$415 million portfolio of debt went down by one and a half million so not a huge amount.
Frankly, an increase Dalton, we thought it was pretty up pretty good outcome actually given what one might have expected sitting in March.
But it was but it but it went down as a portfolio primarily for that reason.
Scott I appreciate it.
Then just my cat.
Because I've got one other question I mean.
Obviously when.
[laughter].
The final licenses that capital commitments and you made reference to 40 million. So is the expectation that you'd put an initial 40 million in and if that's the case I mean, what.
What would be the funding mechanism to that obviously, you've got plenty of liquidity, but do you have any particular plans.
Sure. So I mean, the way it works with that 40 million you just a best in you and you originate assets using your capital you haven't available and place those assets into the.
Into the fund.
Obviously, we have 155 million on the revolver and cash we will be opportunistic.
Looking at the bond market as it as it presents opportunities that are attractive and will continue the ATM equity program I'm, assuming we're trading above book. So I think all in all we've we have ample liquidity today.
And we'll certainly continue to raise additional capital makes it and it we're ready to fund.
That equity check so from my perspective at the end of the day, the FDIC as a as a 10 year commitment to provide.
$175 million a capital.
Irrespective of the economy and you know certainly it's a you know we need to find the assets and we continue our performance, but we need to do that anyway, and so it's really a debt commitment that we don't have to rely on the capital markets or anything like that to obtain and and and top of that it's extremely cost effective.
And so I don't know that we do.
Anything differently.
In the future at the same pipeline at the same you know the same sandbox that we plan today.
It just now we have a commitment from a capital provider with a very cost effective long term commitment and then he's tomich draws you know, it's a new 10 year bond, which is also long dated and attractive. So that's kind of I don't really see us doing anything different at all we just going to keep doing what we're doing.
But we have an additional capital source is very attractive and over it from a capitalization perspective over the next few years, we'll start we'll raise bonds as I noted, we'll pay down our revolver will also sort of pack away at the existing bonds as well. So we're making certain that we're keeping a ample liquidity on the revolver as well as making certain there is it.
The large cliff in terms of maturities on the bonds as we get closer to those maturity date.
Got it.
I appreciate all that.
Obviously, you could in principle.
More than one license and they ought to new licenses.
I presume.
This is intended to be the the the first FDIC might not only one.
This is not just <unk>.
No just didnt <unk> decades, this is going to be.
Perpetual Paul multiples the capital structure, the business going forward or maybe even go with the second license would that be.
Yeah. That's a that's absolutely the case I mean were lower middle market first lien lenders I mean, that's what we are we've been the team here has been doing that for.
Decade behalf, plus and so and then and the FDIC as long as good as long as they have that program.
Supporting lower middle market lending and investing where there. So one of the things really important to US is the performance of the first license obviously want the license to perform for our shareholders, but we also want the first license in the form because that's the biggest that's the biggest criteria on getting the second life and so we're already looking ahead of the second license. So so the answer your question is apps.
Absolutely isn't it's a permanent foundational part.
Of our strategy and you know and just backing up it's always been in when we first started the entity in 15. This is going to be part of our process.
They do the nascent stage of a post spin you know they wanted to see if build our resume and we'd heard back from them going through this process that they are glad we did and we certainly are more impressed with the resonate we've put together today.
So this is definitely was an is part of the strategy going forward.
Got it I appreciate it thank you guys.
Take care.
Our next question comes from Chris York of JMP Securities. Your line is open.
Hi, Good morning, this is Kevin bolt on for Chris.
My first question of the dividends from the until left dropped again for the second consecutive quarter of the Q isn't out yet, but what drove the decline and do you expect to me further pressure on that stream of income just yesterday you see.
So for I 45, the biggest impact there was LIBOR. So you know the weighted average floor on our on loans. It in that facility is 80 basis points and where the quarter started will it and its crossed over.
The LIBOR floors, but we took a pretty big hit in terms of a if you think about lower middle market companies the floors tend to be somewhere in the 1% to 2% and you'll see a lot lower priced lower floor on the syndicated credits. So you saw about 275000 dollar hit its almost all due to LIBOR.
Okay that makes sense and then my next question. It's a two part question how much did you say you receive an amendment fees in the quarter and then secondly, when you made amendments to portfolio companies. What was the most common form of amendment ended the borrowers sponsored private equity injection or concession along with your ammonia.
So the first part it was approximately 300000 of onetime amendment fees I think Boeing can speak today to scripts, yes, I must most often.
You know the cobot effect.
On the few companies that affected pretty materially and that I referenced earlier.
There's there's a you know a concern about the future an uncertainty about the future, but but but confident that the co that will pass eventually and so it's usually a request of okay, well, we'd like to kind of store up liquidity at the said portfolio company and so lender would you pick your interest.
For a period of time that usually one or two quarters.
And we own or will contribute X to the cap to the company in exchange for that and you know then maybe their slight covenant relief for a couple of few quarters and there's economic fees paid I mean, that's kinda just a base case conversation.
And then you had other other companies, where you know there wasn't a liquidity issue, but it was like well controlled tight we'd like to little bit a covenant relief in the next for the next couple of few quarters.
We will pay you all fee to do that.
And in those cases, you know we were getting enhanced economics for for the increased leverage a lot of times, we'll put in a rate grid. So LIBOR lets say lets make up a scenario like more 700 loan now is going to get close or even break through the previously negotiated covenant.
So the sponsor comes to us in wants some covenant relief meeting, meaning that the cover they want covenants widened and then we'll put in a rate grid, where as the leverage travels up to the new allowed range. Our yield goes up our spread goes up so that may be a certain leverage level or go to slide four 750, and then library.
800, why were 850 or what have you and then it allows them also as that coded passes in the company continues to perform they can earn their way back into into lower into lower spread maybe something closer to where it was in the original deal if that makes sense and so that's typically how the conversation goes.
Okay that makes sense and appreciate the insight and then next question, we weren't expecting to be active in the h. and this quarter.
Now we think investors appreciate your historical approach to capital management allocation, but how should we think about your future desire for primary equity at these prices.
Yeah, you know, we said before the ATM program is gonna be something that we plan to turn on and stay on whether above any de novo because we don't we don't want to see happening faster if we create a cliff where we need to go out and go to the market with a large equity raise and be subject to whatever discount.
Would you know we negotiate just can't we'd have to take on an average deal on a primary deal would be 7% to 10%. So we're raising it at a 2% fee.
We think thats quite frankly, a better use of.
It's a better process for our shareholders and so we're going to continue to you just I think we're going to turn it on leave it on and continually buildup and equity base over time, yeah, but I wouldn't think about it as okay. Now our stock price is going to be kept in Avi I mean, if not a matter of just sell every share you can above at entity or slightly above the me. It's a full we look at there.
Thing long term and kind of full cycle and so we wanted just diligently likely is just like we've appointed diligently array small amounts of equity each quarter in lockstep with putting the capital to work and again like Michael said, we're taking a 2% spread not a 7% to 10% spread all large marketed deal and so if you look at her over long period of time it.
Yeah, we referenced $51 million, where we raise at that at a lot lower Fred then we would have raised if we went out and marketed deal that size.
And on top of that you can't rely on the capital markets you can't be presumptuous that the market will be there exactly when you need the offering and so.
We think it's better for our shareholders long term does take a little pieces out each quarter and to that point I would point out. We had 5.7 5.7 million we have the ability to do more we actually turned it off about a week before the window closed because we looking at our uses and sources, we didnt need more than that so we're not trying to.
Boeing point bring home every every dollar that we can.
Okay that makes sense and then my last question that we think most investors to your core dividend to be safe.
The shortfall of coverage could worry some investors so looking at your coverage a different way under what conditions do you think you'd need to adjust your dividend.
Well, we tell you that where we are right now the 41 cents. It is stable relative to what our earnings power is with LIBOR, having dropped down to where it is and with everything you read the notion that LIBOR, it's going to be stable. The next 12 18 months barring non accruals, we would expect to see our anti jump up over the next.
[music] quarters and so.
Well, probably likely retain the dividend level at 41 build up additional dividend coverage, but we would tell you we feel very comfortable where the dividend is there would be no plans to have to cut it at any point in time.
Okay, that's very reassuring and that's it for me thanks for taking my questions and congrats on the quarter.
Thanks.
Our next question comes from Greg Mason I'm Irrs management. Your line is open.
Hey, good morning, guys. Thanks for taking my question really just had one left and that was the impact of the realized losses on be undistributed taxable income.
You know how will that impact the U.T.I. spillover and from a tax characteristic and if there are further losses that you know ultimately or realize kind of three this pandemic as you.
We continue to restructure things how will that impact the U.T.I. I going forward.
Great. Thanks to the question. So the good news is.
You CCI balance that you have is not affected by having realized losses. What it does create is sort of a mountain that you have to overcome with realized gain before you're able to book additional pennies into the Yutai bucket, So just five and a half million well need to be.
Well have to have an five and a half million dollars gain over time and do our retained yutai by the holding back on our dividend.
To to continue to put capital.
Into the into depending on the piggyback for now, but what's important is you know as a first lien lender the capital structure collapses meeting the first lien lender become the owners and the equity gets wiped out junior capital gets wiped out you know in case of Delphi, obviously, our equity ownership in that business to the extent the business.
Turns around which we definitely seeing that and then succeeds and is successful retracing devaluation lost in the next couple of years than that that is a mechanism to recoup the realized losses. So if we were to recoup that realized loss and everything else.
Kind of starts.
And can contribute to additional you tie that makes it so it's pretty important to be able to get in those types of situation to be able to get that.
End up owning a piece of that company Yeah, I think the good news on that is I mean with the dollar 27 balance.
We feel like we've got two to three years of runway to create those gains to apply against those losses.
We continue this program without any interruption.
Great. Thanks, guys appreciate it.
Yep.
There are no further questions like to turn the call back over to Bowen Diehl for any closing remarks.
Well, thanks, everybody for joining us we appreciate your support and we'll continue to work hard for you all and we look forward to keep you posted next quarter on the on updating us on our business.
Ladies and gentlemen. This concludes today's conference call. Thank you for participating you may now disconnect everyone have a great day.
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