Q3 2020 Owl Rock Capital Corp Earnings Call
[music].
Good morning.
And welcome to Oh, Roth capital corporations third quarter 2020 earnings call I.
I would like to remind our listeners that remarks made during the call may contain forward looking statements.
Forward looking statements are not guarantees of future performance or results and involve a number of risks and uncertainties.
That are outside the company's control.
I will start today's call by briefly discussing our financial highlights for the third quarter before providing an update on our portfolio and deal activity in the quarter.
Then after Alan covers our financial results I will discuss our outlook and make some closing remarks.
Getting into the third quarter financial highlights net investment income per share was 33 cents we.
We ended the quarter with net asset value per share of $14.67.
Up 15 cents from the second quarter.
We are pleased to report the second consecutive quarterly increase in the fare value of the portfolio since the end of March.
Looking forward for the fourth quarter. Our board has declared a dividend of 31 cents per share. The same amount we have paid each quarter since our I T O and which is in addition to the previously declared special dividend of eight cents per share.
It's planned the fourth quarter special dividend will be the final of our previously declared special dividends that were put in place as part of our I P. O in 2019.
Regarding our balance sheet, we remained very well capitalized with 1.8 billion of liquidity.
We ended this quarter with leverage a 0.72 times, reflecting in increased the pace of originations in the quarter.
We are seeing improving levels of deal activity and continue to expect to achieve leverage within our targeted range of 0.9 to one and a quarter times by the second half of 2021.
Has announced in our earnings release yesterday, our board has authorized a new share repurchase program for up to $100 billion of our stock over the next 12 months.
Which we may purchase in the open market on an opportunistic basis we.
We believe this is a valuable tool for us to have going forward.
Turning to the portfolio, we are pleased with the overall credit performance to date.
Which by and large has come in towards the higher end of potential outcomes, we could've hope for given the economic environment.
This quarter many of our borrowers saw improved operating metrics and revenues in line with the broader economic reopening.
They also implemented cost savings measures, which improve profitability.
Broadly speaking, we are seeing economic activity returned to a more normalized pace approaching pre covid levels.
Our internal credit ratings metrics are consistent with last quarter names.
Names and are one or two rating categories, which are names performing in line with or exceeding our expectations at the time of underwriting continue to comprise approximately 88% of the fair value of the portfolio.
The vast majority of our portfolio continues to demonstrate solid financial performance has proved to be resilient in the face of a challenging economy.
The percentage of of our lower rated names right at three four or five which are underperforming expectations is 12% of fair value largely unchanged from last quarter.
While there's always some natural movement between ratings categories. We are pleased that the number of underperforming credits has stabilized.
Most of our credits are seeing improving results and many are exceeding their revised covid budgets.
While they're certainly there are certainly a few which will have a longer road to recovery.
As a quarter and 109 of our 110 portfolio companies where current on their interest.
We currently have two names on nonaccrual status Swipe acquisition Corp, which we added to nonaccrual status. This quarter is not current on its interests. We're finalizing discussions with swipe regarding a long term solution, which if completed would include al rock, becoming the controlling shareholder and providing the.
Accompany within necessary support to execute its operational plan and growth strategy.
She I B T global which was added in the second quarter for me. It's current on its interest.
With a portion paid in cash and a portion and pick.
These two investments represent less than 1.5% of the total fair value of the portfolio, which is consistent with our nonaccrual last quarter.
One name I'd like to spend a minute on his national Dentex, which was placed on nodical status in the second quarter, but was placed back on a cruel status. This quarter. As this is one of the first challenge credits we've had in our portfolio I'd like to walk through the situation and ultimate outcome.
National Dentex, which shows at G O Dime Corporation on a schedule of investments as a leading dental lab business that serves dentist across the U S.
No additional borrowers were moved to pick interest in the quarter and Pik interest continues to represent less than 5% of total investment income.
Looking forward, we may see some amendment request from additional borrowers, but largely we feel that we have addressed those situations in which borrowers were most impacted by the economic shutdown and that we provided we have provided sufficient runway for those businesses to operate and recover.
While we remain cautious given the broader economic uncertainty we have been pleased with the pace of recovery and our borrower our borrowers have experienced to date.
Moving on to investment activity, we entered the quarter with a very cautious posture that as the period. We're on we saw both an economic rebound and an increase in deal activity.
We were able to capitalize on this activity and we are pleased to close on a number of attractive new investments gross originations for the quarter were $844 million with net funded originations of $599 million, which was up from net funded activity of $142 million in the second quarter.
We had $48 million of repayments, noting there were no full repayments. This quarter, we do expect to see an increase in repayments over time, certainly co bid and the economic disruption has impacted repayment catalysts for the near term.
Overall, we added eight new portfolio companies and serve as the administrative agent on the majority of the origination volume this quarter.
Currently all of our origination volume was for new borrowers as we saw less add on volume for existing portfolio companies.
We do expect to see add on volumes increase in the next few quarters. As we are seeing many of our portfolio companies returned to more normal operating levels and strategic discussions are picking back up.
We are pleased with the investments we closed this quarter, which we believe offer compelling economic and structural terms for businesses, which have proven to be resilient in the current economic climate.
I'd note that the weighted average spread of new investments this quarter was roughly 720 basis points.
I'd like to highlight two of the investments which closed this quarter.
Across the aisle rock platform, we committed as the sole lender to a $410 million first lien facility to support the acquisition of Sonny's enterprises by Genstar capital.
Sonys is a leading provider of equipment and supplies to conveyor carwash operators in the US a sector, which has continued to demonstrate strong performance during the cobot crisis.
The facilities are attractively priced at L. Plus 700, with a 1% LIBOR floor and benefit from strong call protection.
We are pleased to once again demonstrate our ability to provide sizable commitments and serve as a one stop financing provider.
Another name worth highlighting was our investment in the in the $250 million second lien term loan for Shearers Foods, The company, which is owned by the Ontario Teachers' pension plan is a leading contract manufacturer of snack foods in the U.S.
Consistent with our approach to second lien investments, we believe shares was an attractive investment due to significant EBITDA and low loan to values.
While second liens have been a more modest portion of our portfolio to date and the current market. We are seeing increased demand from private equity firms directly placing second liens. We believe these opportunities were done for the right credit profile can offer attractive risk adjusted returns.
Our portfolio at quarter end now stands at $9.9 billion across 110 portfolio companies.
We feel that the performance of the portfolio. During cobot has validated where we have focused primarily first lien investments in upper middle market recession resistant sponsor backed businesses.
Now I will turn it over to Alan to discuss our financial results in more detail.
Thank you Craig good morning, everyone. It's great to be speaking with everyone again, and I would like to wish everyone. The best and these can continue to unusual times. Thank you very much for your partnership and support of our business the.
To start off I'll refer to our earnings presentation, starting with slide seven you can see that we ended the third quarter with total portfolio investments of 9.9 billion outstanding debt of $4.3 billion and total net assets of 5.7 billion, our net asset value per share increased to $14.67.
As of September Thirtyth compared to $14.52 as of June Thirtyth.
We ended the quarter with leverage of 0.72 times debt to equity and $1.8 billion and liquidity.
Our dividend for the third quarter was 31 cents per share.
Plus an eight cents per share special dividends and our net investment income was 33 cents per share.
On the next slide slide eight I'm going to talk through in a bit of detail the results of our revenues and expenses for the third quarter.
You can see total investment income for the third quarter was $187 million down slightly from $190 million last quarter. This.
This $3 million decline was driven by three items, we saw a 4 million dollar decline in other income and other fees during the third quarter, largely driven by fewer amendments and repayments as Craig touched on earlier.
The next item is in connection with us putting swipe acquisition corp. on non accrual this quarter.
As of June Thirtyth swipe was operating in forbearance as we were in constructive negotiations with the sponsor on a comprehensive amendment, we had swipe on accrual status as of June Thirtyth as we were awaiting the receipt of our interest payments because this was on accrual we recognized income in the second quarter.
As of September Thirtyth, the amendment had not closed and as a result, we placed swipe on non accrual status.
Due to this we did not recognize any income associated with this portfolio company in the third quarter and in addition, we reversed the income we had recognized in the second quarter.
The income for each quarter represented a little over three and a half million dollars, where one penny per share per quarter. So this reduced third quarter Eni by a little over $7 million or approximately two cents per share.
Lastly, we only saw an increase of approximately $8 million in interest income from our investments.
Although our portfolio increased in size this quarter almost half of our originations were towards the end of September so not driving interest income up as much as if the originations were weighted throughout the quarter in Fourq you will see a pickup of interest income driven in part by now having a full quarter of interest income for our Threeq originations.
So as you can see the net of all this is the $3 million decline in investment income this quarter.
To hit the expense side briefly net expenses were roughly flat quarter over quarter into Q, we had a onetime noncash item net increased interest expense shipping that out interest expenses up quarter over quarter, driven by increasing leverage in the third quarter. These two items basically net out hence expenses are roughly flat quarter over quarter.
So pulling the lens back a bit we continued to make good progress towards earning our dividend and are on track to achieve our target leverage by the second half of 2021, we.
We expect to continue to pay our regular dividend of 31 cents per share and would anticipate returning a modest amount of capital in the interim.
So to wrap up our financial results discussion I'll mention a few other quick items as a result of the fair value of our portfolio, increasing from 95.1% to 96% we had $88 million of net unrealized gains during the third quarter.
Our other operating expense ratio continues to be among the lowest in the industry at 22 basis points on a trailing 12 month basis, and our undistributed distributions as of September Thirtyth is five cents per share.
A few final closing comments before handing back over to Craig we continue to be well positioned in the industry and given the strength of our balance sheet. Our three structural pillars of low leverage significant liquidity and unsecured debt continue to provide us and our stakeholders comfort in the strength of our balance sheet.
We very intentionally have built a well diversified financing landscape diversifying the number of facilities. We have the types of facilities and number of lenders, we partner with matching duration between the left and right sides of our balance sheet is another important aspect of our landscape of our weighted average debt maturity is over six years and we do not have any debt.
Maturities until June of 2023.
We continue to have one of the lowest leverage levels in the industry at 0.72 times debt to equity as of September Thirtyth, We had $1.8 billion of liquidity in total now we have issued $2 billion of unsecured debt, which brings us to a current funding mix of 45% unsecured debt because of this week.
Continue to have a meaningful amount of excess collateral for our secured facilities and we continue to have a significant cushion to our new regulatory asset coverage of 150%.
As we have previously mentioned our updated target leverage ratio is 0.9 to 1.25 times debt to equity.
Overall, our funding profile continues to be very sound and we continue to be in a very good position.
Thank you all very much for your support and for joining us on todays call Craig back to you.
Thanks, Alan I will close with some thoughts on the current market and competitive landscape and touch on some of the earnings levers we have in the business.
The increased level of deal activity, we experienced in the third quarter has carried into the fourth quarter. So far.
Improving economic conditions and strong markets have stimulated M&A activity for private equity firms.
We are seeing private equity firms commenced sale processes for portfolio companies presume acquisition plans and seek financing solutions for refinancings and liquidity needs.
As a result, we are pleased with the current opportunity set on our having significant dialogue around new lending opportunities.
We believe borrowers and sponsors continue to appreciate the value of execution certainty, which was provided by your direct lending solution, especially with the continued economic uncertainty in.
In particular, our ability to provide large scale and flexible solutions is a significant competitive advantage.
Our strong balance sheet and liquidity make us a preferred lending partner.
Certainly over the last several months syndicated market conditions have strengthened as a result of the fed monetary stimulus, which can impact terms for larger companies.
The terms, we are seeing on new opportunities are more attractive than those of the pre cobot market. However.
However, we have seen some spread compression from the widest levels, we saw during the height of cobot.
We remain disciplined and are excited by the pipeline of opportunities were seeing which we believe will allow us to prudently deploy capital into compelling opportunities at attractive yields.
Before I close I wanted to discuss some of the levers we have to drive higher earnings over the next several quarters.
Many of these were on display this quarter.
The biggest driver is the continued growth in our portfolio.
This quarter, we again demonstrated our origination strength and continued portfolio growth will allow us to achieve our target leverage by the second half of 2021.
We were able to originate loans at higher spreads over the past two quarters and hope to continue to lift our overall portfolio spread as we continue to deploy capital into new investments.
As existing higher quality, but lower yielding investments get repaid we expect to redeploy that capital into higher yields also increasing the portfolio spread.
As we amend loans, we typically receive additional economics, often from increased spread on the loans last.
Lastly, as the markets recover we expect to have increased repayments, resulting in increased income and prepayment fees.
Taking all these factors into consideration we feel confident that there are a number of levers in our portfolio that will allow us to achieve our full earnings potential in 2021.
Of course, along with that our core focus remains on the credit quality of our portfolio, which remains quite strong.
We're very pleased with where our portfolio sits at this point in the economic recovery, which is at the upper end of what we could have hoped for.
We believe we are well positioned to be a direct lender of choice and to continue to deliver attractive risk adjusted returns to our investors.
In closing thank you for joining us today. We appreciate your continued interest and support and look forward to keeping you apprised of our progress on behalf of the entire al Rock team. We hope each of you and your families remain safe and well.
Operator, please open the line for questions.
Thank you Sir at this time, if you would like to ask a question simply press Star then the number one on your telephone keypad now we will pause for just a moment to compile the culinary roster.
Your first question comes from the line of Robert Dodd of way.
Raymond James.
Hi, Hi, guys I'm just looking at those drivers you talked about correct can you give us obviously, you've given us an outlook on on portfolio growth. When you can get to target leverage and the capacity to to cover the dividend since she relies on on that plus basically prepayment activity. Obviously it was a.
She negligible this quarter.
Typically you know if M&A is picking up and there's a lot of private equity activity somebody's origination is somebody else's repayment.
And what's your outlook for <unk>.
Oh, we payment actually I mean, how fast can that Matt back up to kind of a normalized level because obviously thats.
That's a significant delta in earnings power from quarter to quarter.
And to the point, where you can cover the dividend is largely contingent on repayment activity just.
Sure Robert I'll try to hit a few things you said in their just in terms of generally what are we seeing in terms of repayments. We've commented on this pretty consistently over the last few quarters that we've been surprised.
At a low level of repayments that Weve had you know even even pre co bid and certainly cobot the press them further I.
Some of that too just that the.
The <unk> the realm.
Relative use of our portfolio and it's going to pick up I mean, it's just it just is we given how long some of these investments have been in the sponsors portfolio. It.
It typically will pick up when a sponsor cells accompany I would quibble a little bit with your comments someone's repayment. It's someone else's origination I think you know often the case is that the incumbent lender is oftentimes financing the new buyer because we have an advantage in doing so that was that was that an advantage we didnt have.
For the first couple of years of Al Rock and it's an advantage. We do have now so with our large portfolio. What I would expect to happen is we will have companies get sold on we will get a repayment and we will have the opportunity to finance the new buyers.
We are seeing dialogue right now that that could very well results and repayment activity picking up on as soon as this quarter or next quarter, but it's hard to know for sure if it will consummate and what the timing will.
It will be but you know as you know and we've talked about we assume a three year life. We've got about a $10 billion portfolio that should average 750 million of repayments a year excuse me a quarter 250 million a quarter and the last couple of quarters. We've had as you said almost almost minimal.
Even a modest pickup in repayments will will enhance our earnings the way I would think about it I just I tend to think about it in that obviously this is not something we can easily model its idiosyncratic to individual credits, but if you think we're sitting at about a $10 billion portfolio a fully a full year.
Levered portfolio for US is about 11.4 billion, that's about a billion four of growth.
So if you think a 400 million net originations a quarter, that's about three and a half quarters to get to target leverage So that's where you get the.
You know the middle or the back half of next year comments that we made it could be a little faster could be a little slower. We've been we were pleased with the origination of peer activity. This quarter I do think we'll see a pickup this was unusually light quarter just code that I think kept some of the repayments way when they come they are chunky we up.
Position our position sizes are on average 100 million Bucks, so two or three repayments could could easily.
Increased prepayments to two or $300 million in the quarter. So hopefully I covered the gist of what you're asking.
You did I appreciate that and I recognize the income.
Necessarily mean payments and that and yeah et cetera, just one more follow on if I can be quick on swipe, you know you're going to be shortened the control equity holder. This would be the first kind of.
Equity position for.
But this this company that came from a.
From a restructuring can you give us any color on kind of.
How long you would expect to hold on.
On equity type position that fall potentially slipping isn't the last word, but turning it back into a and income producing.
Piece of capital is often the equity piece of capital.
Sure. So as we as we commented we are finalizing discussions with swipe. So we were not an equity holder yet, but we clearly are clearly are signaling that if we consummate the discussions that what would become one.
I just want to go back to dentists. So before we talk about flight because I really want to make sure. We're clear on this yes, we could have if things have played out differently, we could have wound up being an equity holder dentists, but instead, we work cooperatively with existing sponsor to convince us to commence a sale of the company whereby we got our entire.
Got repaid and so I just want to emphasize how proactive we are managing these situations. It's that's a tricky balance to strike and and I think it worked out well for the company and the and the previous sponsored the new sponsor at US. We're really pleased with that in the case of POI, We don't anticipate the kind of timing, but then.
Tax had impart because as I mentioned in my comments Gentex was a business that was particularly impacted by co bid and as as the economy opened back up that business snapped back quickly in the case of POI to manufacture of gift cards and hotel key cards and so the end markets they serve.
For our call are going to have a longer road back and so we go into it I'm expecting a longer timeframe I don't want to speculate how long that could be but its we don't anticipate.
Media term immediate sell the company and the case, we had with with dentists I will say, we have tremendous resources, we're very supportive of POI working very closely with our management team and the existing sponsor to make sure. It's a smooth transition and we have balance sheet to support their growth we believe in their business and in terms of how long it.
It really just depends on on 'em, although logical factors you would expect us how the company's doing what's going on in the market and and what we think is best for our shareholders. We generally would prefer generally I don't think we view our equity positions is something that we want to hold you know longer than needed. If there's an opportunity in the company does.
Better theres opportunity to exit the position of course, we'll we'll actively look for that but but I would imagine it's going to take a little while for that for POI to be in a position where thats. The case, but we'll have to we'll have to see.
Got it got it. Thank you I appreciate the investment management.
Great. Thanks, Robert.
Your next question comes from the line of Ryan Lynch.
Hey, good morning, Thanks for taking my questions just a.
A quick follow up on your discussions with with Swiper POI you know as you guys are looking to do our restructuring or take over part of this business EPS controlling shareholder is it the anticipation that you guys will as part of that restructuring inject additional capital into that business.
Yes.
We are we are.
We're providing additional capital now I mean, we're supporting the company.
And you know, we I would expect if they if they need it we worked very closely with the management team to make sure. The business is well positioned to be successful the amount of capital that that swipe might need in the context of our $1.8 billion of liquidity is quite quite modest and but we are absolutely.
You know we feel it's incumbent upon us if we do wind up taking ownership of the company to make sure. It has the capital it needs to to thrive and so we will do that working closely with the with the company.
Okay, and then you mentioned your prepared comments that you guys are seeing some some increased demand for second lien debt out there.
You guys would only look to do so.
It's really the right credit profile.
I guess, how does the Bahar Lou.
For your guys underwriting process. When you guys are looking to restructure persuading versus second lien debt. What do you see in that borrower profile that would get you guys comfortable with.
With bidding or subordinated debt position.
Sure we.
For obvious reasons, if we're going to be a second lien lender. The bar is that much higher in terms of the risk the.
The risk profile, we're willing to take on for our secondly businesses they tend to be materially bigger probably double the amount of EBITDA at our typical borrower we want to see a very substantial equity cushion from from a very strong financial sponsor and most importantly, we want to do second liens and companies that we think are very stable.
And won't be cyclical won't be volatile won't have concentrations that could result in our second lien loan potentially being at risk.
We think our second liens are oftentimes the very best companies in our portfolio, we do them extremely extremely limited amounts, it's been about 20% and a pretty consistent basis, but the companies themselves or upper middle market businesses, I think on average directionally EBITDA of close to $200 million, but.
Loan to value is actually very comparable to our first lien so very significant equity checks and the performance has been quite strong and our second liens does nothing I've said there is different than what we've said for the last four and a half years, we've been very disciplined we get shown given our scale and our ability to do second liens, which not all lenders will do we get shown.
Most opportunities in the market and we are incredibly selective I would say most selective on our second lien opportunities. We're not trying to do more mezzanine like loans, we will not trade off juice. Your second lien you know if it entails more credit risk I'm really trying to do very stable upper middle market businesses, where our sponsor values having.
Al rock as a lender and prefer that having a direct lender like us on versus trying to do a deal on the syndicated markets, where they're not sure who are the ones are a little bit.
Okay. That's good color on that and then just one last one if I can.
On the new nearly a true share repurchase program, you know, but that said your yourselves discretion for opportunistic purposes are.
Your guys' stock prices that you know in you know.
It's called right around 80, 85% of book value. The last several months is that a level, where where you guys feel like that that's an opportunistic type of purchase for your guys stock or is this share repurchase more reserved in case. There is more volatility like we saw in the March and April time.
Framework of where your stock price and all Bdcs stock price dropped pretty meaningfully from from these current levels.
Sure look we are you know.
I'm glad you brought this up we're disappointed with where our stock is.
The only thing we can control is our performance, but we believe our performance has been very strong and consistent with what we said we would we do since the beginning the credit performance has been excellent we think amongst the best in the space. We continue to grow the portfolio at attractive terms you can see that this quarter balance sheets been strong we can.
To grow NAV, and I have to say and I'll come back to your question, but it's it's very interesting to US we look at market data since Cove It has hit.
You've seen all the credit markets rallied the high yield markets rallied leverage loan markets rallied.
Any assets in Bdcs have rallied as evidenced by increased NAV pretty much across the board and were seeing most bdcs report that now yet despite all that BDC equities have traded down not up and it's hard for us to reconcile pre coke pre covance, we traded above NAV, we would expect over time for us to get back.
Jack.
II now at or above.
Our portfolio is very visible everything investor can go look at every single investment our schedule of investments.
80% of its first lien, we hire evaluation firm to value every name every quarter.
And we look at the return profile for our BDC.
Just taking our dividends, assuming we continue to pay our dividend, which Weve said, we strongly I intend to do and are going to be able to do at current levels. It's an 11.5% cash on cash return at the current stock price. The stock gets back to now we're trading at 80 as you said you can do the math, if you're getting a lever and a half.
Percent and a 20 points of appreciation, obviously, there's no guarantees to any of that.
But clearly the return opportunity is there we would hope if.
If we continue to perform the market will recognize that in light of where the stock was trading we thought we talk to our board and we thought it was appropriate and important for us to have a stock buyback.
I am not going to share exactly how we think about where we would purchase but we're clearly disappointed with where the stock is trading today.
We're going to watch it very carefully and decide how we deploy that capital, but we think the stock comp clearly warrants consideration.
For trading where it is and certainly for the trade off you know all the more so.
[laughter].
That's good color Craig on those are all my questions I appreciate the fact that act.
Great. Thanks, Ryan Thanks, Ryan.
Your next question comes from the line of Mickey Schleien of Ladenburg.
Yes, good morning, everyone.
Craig I wanted to follow up a little bit on the prepayment expectations given that you operate at the very high end of the middle market I'm curious as to your opinion about how much competition, you're seeing from from banks, you know I have seen banks.
Starting to take out some of the more attractive deals and other bdcs and obviously their cost of funds is extremely low. So are you seeing them as being more aggressive.
Well I'm I'm not sure I'm, well when you say banks, taking it out in their cost of funds, you're all you're almost describing something where a commercial bank a regional bank might be taking out I'm, a very low levered company in a term loan a type financing.
Where where we typically compete the size of companies, we lend to oftentimes they were too were too big and the companies have little more leverage and what a regional bank would be comfortable doing alone on their balance sheet too we tend to compete more with the syndicated market. So it's less a regional bank doing a refinancing it.
At a low rate, although that's certainly possible, but more than that the banks might try to do a syndicated term loan and distribute that to the market on that potentially better pricing and the answer is I know, we're not seeing although it's possible and maybe we'll have a couple I'm not seeing any.
And uptick in companies talking to regional banks or even the investment banks about refinancing just for cost of capital purposes companies choose direct lending solutions for a lot of reasons not just pure rate they like having a lender they know under that can grow with them.
The flexibility that we can offer so it's not simply trying to say 25 basis points on the biggest driver for us on when we get refinanced as the company gets sold occasionally will lead to a more modest sized business and it will it will grow through acquisition and that will be a catalyst for refinancing into the syndicated market. We may see some of that.
That but look as I as I commented a couple of minutes ago discussions are picking up so we will see 'em will cease and I expect we will see increased repayments I mean, while it's it's as part of the model, we're going to see it we've seen really very little and even with an increase it'll still be.
It's sort of an average amount amount of what we would expect but I don't see any regional banks coming in any material way and refinancing our debt more sponsors typically are not not working with the regional banks leverage profiles, a little a little too high the bite size is frankly way too big So that's that's really helpful. Craig Let me fall.
Although up by asking about portfolio.
Portfolio allocation, you know I think part of the investment thesis for Al Rock is over the medium term a rotation from you know pure first liens to more a unitranche and I'd like to understand are you trying to do that proactively into what is currently a pretty healthy market.
Or are you just going to wait to let you know the portfolio run its course and rotate yeah repayments into unitranches they come.
So as we as we're looking at new opportunities now new deals you know, we we very much would like to find more unitranches and I would say.
Have have pretty limited appetite for additional first lien traditional first lien high quality, but lower spreads so for new deals we are absolutely preferring unit tranche versus the.
The lower spread and we have the luxury and flexibility to be able to do that now now that were.
Closing in on our target leverage you know we have of capital working and the marginal deal absolutely. We prefer unittranche carries higher spread and you saw that this quarter because our average spread on new investments was 720 basis points, where given an opportunity in the portfolio. If it presents itself for whatever.
The reason, where we can you know get refinanced or or sell down a little piece of a first lien that has lower spread 'em, we will we will come.
Consider that strongly and do it and doing it do it you know if it's appropriate in other words, we would like to migrate the portfolio. There's we you know we can't control that.
It's not something that's easily control you can't turn on a dime, but but over the course of a quarter over the course of the year, you're going to find opportunities, where maybe there is a refinancing and we declined to participate or we do participate on a smaller amount and migrate that first lien into something with a little bit higher return, we're going to be judicious about it we're not.
To do anything to undermine the overall quality of the portfolio, but you know we try to balance getting invested with with risk and and picking our spots on unitranches and that's played well for us and we're going to do it but I would say going forward really focused on additional higher spread opportunities versus the high quality lower spread opportunities.
Please.
And in terms of higher spread opportunities you touched a bit on on second liens, they're about 700 basis points wider first lien notwithstanding.
Andrew underwriting requirements for individual investments do you think that's a good risk adjusted return today on average in the market for second liens or your preference would be unitranche deals.
Well I'm, not sure, where you're where you're getting the 700, but I'll tell you where I think you know secondly, it second liens today, depending upon the credit are clustered around L. <unk> 880, 25, a couple of syndicated ones have gone in the high held 750 775 or a few except.
Yeah, but that's about that's about where it is but let's call. It l.
25 for the purpose of this discussion.
With a LIBOR floor and some fees its about a 10% return opportunity.
Unit tranche today is around L. 650 to 700. So you know that's only 150 basis points inside of that.
So you know not true first lien today in the syndicated market is all 400 in that and that said code. So there's about typically about a 400 basis point relative value between first lien and second lien and the syndicated markets. When we do a secondly, we will typically insist on having at least 400.
Basis points of spread on the second lien versus the personally I.
No I'm throwing a lot of statistics that you have so stop me. If this is a but this is not helpful. Do we find second liens attractive for the right situations I think there are attractive risk reward for the right situations. The hardest part is just fine and credits that were willing to be a second lien lender on if we chose to.
We could do a lot more second liens, but we really are quite disciplined about it and we say no to most of them, but where we where we see ones. We like you know we're you know, we'll do them and we think they enhance the yield on the portfolio and they're just they're good credits and a good risk reward but.
But.
We've been running at this 20% for what for a long time, you know I wouldn't.
It'd be averse to taking that up modestly depending upon the opportunity set but but it has on its own natural flows bin bin bin at about 20% and if we see some good ones than we'd consider taking it higher.
I understand.
My last question on a different note I noticed the unsecured.
Facility to HKG Genesis and curious whether that's to support sort of an overall relationship with that sponsor.
Or was that just an interesting investment opportunity for you and sort of a one off.
I don't want to go into too much detail on that on that facility. We don't extend I'm as much as we have wonderful relationships with financial sponsors and are incredible part of our business. We were not in the business of extending a relationship loans to support the relationship that's not the nature of what we do and certainly not you know what.
It's all our shareholders would want us to do so any investment we're going to put on our portfolio, it's going to be a one that we think is an attractive on a risk risk adjusted return on that that was a bit of an unusual structure and that it was being done at a fund level, but it had a very high quality assets are very attractive spread to very attractive.
Loan to value. It was a sponsor that does a lot in the technology Arena, which is obviously one of our sweet spots and so it checked all the boxes of everything were like in an investment. It's it was a bit of a complicated structure, which I'm not going to I'm not going to go into because its private but it's an absolutely.
Attractive loans, just like every other loan on our books.
I understand that's really helpful. Those are all my questions for this morning I appreciate your time as always.
Great. Thank you.
Thanks Mickey.
Your next question comes from the line of Casey Alexander of Compass point.
Yes. Good morning, my questions have been asked and answered so I'll step back out. Thank you.
Thanks Stacy.
Your next question comes from the line of Devin Ryan of JMP Securities.
Good morning, this is Kevin faults on through Devon.
First you scaled the portfolio at a strong pace over the last few years. Currently stands at 7 billion can you discuss the portfolio size that you think the platform can support.
Both in terms of dollar value and the number for those companies and also has that changed at all after the endemic to the challenges that you have to navigate this year.
Sure our our equity is about 5.7 billion today, we've put out a target leverage profile about 0.9 to one a quarter times.
Keep them out of simple it system call that one times debt to equity and so that would imply about $11.4 billion portfolio versus where it stands today about about about 10 billion.
In terms of number of names you know today were at 110 names. So it's about $90 million per name I don't see that that average bite sized changing and so you know me well rounded up to 100 just to keep the math.
Simple so probably for another billion for you know, it's a it's probably another 14 and yourselves. So call. It 124 I'm. We don't we don't it's not program that way, but that's what it's been running out and that's it I think a reasonable assumption.
Last question was was this just cobot impact that I believe it was that the last part of your question.
That's correct.
No no change to that portfolio construction for coated I would say just generally we think our models were quite well I think for those of you who have followed us since the beginning.
It may sound a bit redundant because we've been saying the same thing for for four and a half years upper middle market sponsor backed first lien you know I I, we've been very consistent in what we like and we have been executing on that we're really pleased with the portfolio build and the credit performance I really really just the credit performance has been quite strong and I know one of the questions that.
We've been asked.
As we've been investing over the last few years as you're investing a lot what about credit about credit quality and here, we are and our non accruals are amongst the lowest in the space and half many of the peers. We just had one of our first two non accruals get repaid at par or NAV is growing the portfolios in quite good shape. So.
There is no no no not only no reason to change our strategy, but we feel very validated by our strategy.
But it started that's very helpful. And then looking at a portfolio the fair value of mind body first thing loan I was March is not just about 91 this quarter I know in the past you've mentioned that the sponsor is very supportive of the business can you give a high level overview of how the company has been performing recently.
Given the rest of the current environment poses to its business.
You know, there's probably not a lot of money go in detail on mind body mind body is software sold to Jims and spas. Obviously, that's a business that was impacted by by co vid given shutdowns. It was a take private by Vista one of the Premier.
Our technology sponsors technologies, the sweet spot for us and as we've commented in the past.
You know we were very confident in the MINDBODY credit Vista is very confident MINDBODY credit. We've worked very closely with them to continue to support the business, obviously without getting into into non public information regarding the company, obviously as the economy reopens and Jim's reopen that's obviously positive for mind body.
They've also adjusted EPS.
As you would expect to remote remote fitness and there and.
Their software help helps with that so we market appropriately it's.
Not anything that I have an undue level of concern about but but certainly you know was impacted by cogan.
Okay. Thank you that's helpful. And then lastly, with the expectation that the low interest rate environment will persist for quite some time, how has that changed how you view your liability structure.
I apologize Kevin I heard the last part the liability structure. It was the first part.
Yeah, I said with the expectation that the low interest rate environment will persist for quite some time, how has that changed how you view your liability structure going forward.
Yeah look we've you know I guess the sound like a broken record similar similar to Craig. We've we've been I think really consistent in the roadmap that we followed here from the beginning.
We've built a very diverse funding landscape, we're going to continue to build out and you see a low financing we're going to continue to do unsecured financing and we have a very big senior secured revolver. So overtime I I've mentioned in the past overtime, we will.
Pay down the dropdown financing facilities, we have and turn those into either again, CLL financing or unsecured unsecured notes, but we have a significant amount of liquidity sitting here today. So we're sitting in a very good position so not not nothing's changed from our perspective.
Okay. That's helpful and that's it for me. Thank you for taking my questions.
Of course, thank you Kevin.
Your next question comes from the line of Kenneth Lee of RBC capital.
Hi, Thanks for taking my question.
I'm wondering if you could just provide a little bit more color on the outlook for originations I think in the past.
You mentioned that origination volumes could skew towards existing borrowers versus new borrowers, but wondering with the pickup in sponsor activity, whether you could see a lot more origination on that new borrower front. Thanks.
Sure. So this quarter was really mostly new new new names and we had very little add ons for existing portfolios, this quarter, which which I think reflected.
Sponsors looking to do new buyouts, and sort of being cautious before they turned on the acquisition spigot for their existing portfolio companies.
That since evolved since this quarter has ended and we are seeing now sponsors resume their acquisition plans for their portfolio companies and I think many of them view the economic climate in the uncertainty as potentially being conducive to I'm doing buy and Bill you know acquisitions.
So that will be a benefit we hope to get you know in terms of 'em we.
Financing or is this new portfolio company, obviously, that's the easiest to underwrite we do is when we're extending capital it's a company, where a large investor too and so I think that will will help us grow our up a portfolio growth over the next this fourth quarter and into early early next year.
So I've got third quarter, mostly new investments fourth quarter, I expect more of a mix between add ons.
New investments I'm, the new investments tend to be chunky or because it's a new buy out, whereas the add ons tend to be little more modest in terms of the of their size.
So I don't know if that if that helps give us a little bit of color around it.
Great that was very helpful. Thats all I have thank you very much.
Thanks, Ken.
Your next question comes from the line of Derek Hewett of Bank of America.
Good morning, everyone, Hey, Craig assuming that unitranche opportunities kind of more emerge over the next few quarters or so are there opportunities to maybe migrate some of that first lien into the JV to to manage overall capital and optimize the portfolio yield.
We.
How many oh I'm going to give you a short answer but it's a more complicated question. You know we have a we have them as a BDC you know there are we have strict limitations on.
How we manage our funds we don't manage the JV, the JV, where an investor in the JV, we have a partner in that JV and so you know under our Exemptive relief orders and the rules on whats. The JV is governed there are limitations in and what we can do well I'm not going to go into all the detail, but but it's definitely not as.
Simple as us quote us just moving moving it in there or not so I don't I don't want to set your expectation that that's something that we would do although I do appreciate why you're asking the question, it's sort of a logical question.
But its there given the way the joint venture set up and the partnership that we have all the University of California, which is incredibly warm and constructive partnership but the way it set up it doesn't allow for easy a movement of assets from an al locked managed fund into a joint venture that we're investor and so.
Don't don't expect that in any meaningful way.
Okay. Thank.
Thank you and then kind of circling back to an earlier question in terms of leverage you were using the kind of the simple math of one times or not 11, then roughly 11 and a half billion dollar optimal portfolio that being said what would it take.
For you to want to go towards the upper end of the the leverage target what would you need to see.
Well, it's refreshing to be asked that question, we've been really focused on just getting through our one times and we're not quite there yet and I hope were there we expect to be there by the second half of the year I think that that's it that's where you know we use we you should expect us to be I don't think we expect to be in it.
Yes of that we have a we have we try to be very balanced in the use of leverage we care deeply about our lenders and our bond holders and the rating agencies and they obviously want to make sure we're being prudent with leverage obviously, there's a trade off on on those considerations versus returns.
We feel really good that at one times leverage with the type of return profile that we're seeing with investments that can be a really good place in terms of balancing returns.
But in coverage returned to our shareholders as well as maintaining a very strong balance sheet and cost of capital and obviously that gives us a tremendous amount of cushion versus a regulatory cap.
Okay, great. Thanks, that's all for me.
Great. Thank you. Thank you Derek.
At this time I'm showing no further questions I will now turn the call over to Craig Packer.
Great well thanks, everyone. Thanks for the questions appreciate.
Interest I'm really pleased with the quarter look forward to catching up with many of you individually I'm really hope everybody's families stay safe and well and we will talk with you again very soon.
Thank you.
This concludes today's conference call you may now disconnect.
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