Q2 2021 Capital Southwest Corp Earnings Call
Ladies and gentlemen, please standby your conference call will begin momentarily once again, ladies and gentlemen, thank you for calling fishermen are your was your conference call will begin momentarily. Thank you for your patience.
[music].
Thank you for joining today's capital southwest second quarter fiscal year 2021 earnings call participating on the call today are but one deal.
Oh, Michael Sarner, CFO, and Chris Reed Berger VP Finance I will now turn the call over to Chris re Berger.
Thank you I'd like to remind everyone that in the course of this call we will be making certain forward looking statements. These.
These statements are based on current conditions currently available information and management's expectations assumptions and beliefs. They are not guarantees of future results are subject to numerous risks uncertainties and assumptions that could cause actual results could differ materially from such statements for.
Nation concerning these risks and uncertainties see capital southwest publicly available filings with the FCC.
The company does not undertake any obligation to update or revise any forward looking statements whether as a result of new information future events changing circumstances or any other reason after the date of this press release, except as required by law I will now hand, the call off to our President and Chief Executive Officer Bowen Diehl.
Thanks, Chris.
Thank you everyone for joining us for our second quarter fiscal year 2021 earnings call.
For our prepared remarks, we will refer to various slides in our earnings presentation, which can be found on our website at www Dot capital southwest Dot com.
We are pleased to be with you. This morning to announce our results for our second fiscal quarter ended September 32020, I want to first say that I hope everyone their families and their employees continue to be safe and well.
Your capital Southwest, we have continued to prioritize the health and safety of our employees and all the employees of our portfolio companies.
We remain in regular dialogue with our portfolio company financial sponsors and management teams and have been pleased with the overall performance of the portfolio.
We have been most impressed with the management teams and financial sponsors ability to manage all aspects of Kati company performance, including protecting our employees, while increasing operating efficiencies during these unprecedented times.
Well the pandemic is not yet behind us as we look back to where we were in March 2020, with so much uncertainty and market volatility.
We are very grateful for all the work done by the team here at capital southwest and the teams at both our portfolio companies and financial sponsor clients.
We're also extremely pleased with the performance of our portfolio.
And we remain highly competent in the quality of the assets and its earnings power.
During the quarter, our portfolio performance continue to improve as evidenced by 8.4 million of net appreciation across the portfolio.
For the quarter, we had two loans, which had investment rating upgrades.
We had no investment rating downgrades, and we had no new loans placed on non accrual.
It's a well capitalized first lien lender with ample liquidity capital southwest continues to be in a favorable position to think attract seek attractive financing opportunities and to provide financial support to help our company's growth.
Executing our investment strategy under our shareholder friendly internally managed structure closely aligns the interests of our board and management team with that of our fellow shareholders and generating sustainable long term value for 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 pretax net investment income of 44 cents per share, which more than earned our regular dividend paid for the quarter, a 41 cents per share.
We also continue to our supplemental dividend program paying out an additional 10 cents per share funded by our sizeable undistributed taxable income balance.
Total dividends for the quarter of 51 cents per share represented an annualized dividend yield on the quarter end on the quarter and stock price per share of 14.5% and an annualized yield on net asset value per share of 13.3%.
I'm also pleased to announce that our board has declared total dividends of 51 cents per share again for that for the quarter ended December 31 2020.
Consisting of a regular dividend of 41 cents per share in a supplemental dividend of 10 cents per share.
During the quarter, we grew our investment portfolio by over 7% to 631 million as of September 32020.
Portfolio growth during the quarter was driven primarily by 66.3 million in total new commitments to four new portfolio companies and six existing portfolio company offset by 21 million in prepayments from two loans, which I will review in a bit more detail in a moment.
Additionally, on the capitalization front, we successfully raised 50 million in proceeds at par on our existing five and three eights institutional unsecured bonds, bringing the total principal outstanding of this bond issuance to 125 million.
Finally, as we mentioned last quarter we.
We continue to work with the U.S. small business administration towards becoming officially licenses and FDIC.
We are pleased to report that we completed our final license of metal during the quarter and look forward to reporting developments on the status of our pending license application to our shareholders as warranted.
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 million in debt.
Financing to be drawn to fund investments in our lower middle market strategy.
We estimate that the vast majority of the deals we have reviewed over the past five years would qualify for Sps refinancing giving.
Giving us a high level of confidence that we will be able to invest this capital in our existing strategy and continue to support growth and employment and small businesses across the country.
As a reminder, each draw from the FDIC debenture program separately represent a new debt security and our capital structure with a 10 year maturity from the date of draw making this capital truly long term in nature.
From a cost perspective, if treasury rates remain close todays level. The all in cost of the FDIC debentures would be less than 3%.
This program is clearly a perfect fit for our lower middle market focus and we look forward to continuing to work with the FDA and completing the application process.
In in successfully executing the Sps Mitch mission of supporting growth and employment and U.S. small businesses.
Turning to slide seven and eight.
We illustrate our track record of producing a strong dividend yield consistent dividend coverage and value creation since the launch of our credit strategy.
We strongly believe that the maintenance and growth of both in 80 per share and dividends paid per share are paramount to creating long term value for our shareholders.
Turning to slide nine as a reminder, our investment strategy has remained consistent since its launch in January of 2015, we.
We continue to focus on our core lower middle market.
While also maintaining the ability to invest in the upper middle market when attractive risk adjusted returns exist.
In the lower middle market, we directly originated opportunities consisting of debt investments in equity co investments.
Building out a well performing and granular portfolio of equity co investments is important to driving NPV per share.
Growth as well as aiding in them in the 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 over time.
It isn't as it 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 through any economic cycle.
Though we continue to take a cautious in extremely selective approach towards deploying new capital taken.
Taking into account the new normal of potential pandemics. Among other risks, we're pleased to have the capital to invest to support acquisitions and growth across our markets.
That said, we continue to find superior risk adjusted return opportunities in 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 on balance sheet credit portfolio, excluding I 45 groups.
Grew 7% during the quarter to 521 million as compared to 487 million as of the end of the prior quarter.
Our credit portfolio is currently weighted 82% to the lower middle market to lower middle market loans down slightly from 85% last quarter. As a result of two loan prepayments in the lower middle market and to originations in the upper middle market during the quarter.
We continue to heavily emphasize first lien senior secured debt lending with a 100% of the debt originations this quarter being first lien senior secured.
As a result as of the end of the quarter, 91% of the credit portfolio was in first lien senior secured debt.
On slide 11, we lay out the $56.3 million of capital invested in and committed to portfolio companies during the quarter.
This included $42.2 million in first lien senior secured debt committed to four new portfolio companies and $20.9 million in additional first lien senior secured debt committed to six existing portfolio companies.
Turning to slide 12, as I previously lead to alluded to we had to lower middle market exits this quarter Danforth advisors and Trinity three.
Our debt at Dan fourth was refinanced by a traditional bank repaying our loan in full generating proceeds of 6.7 million and an hour of 12.4%.
We continue to hold equity and Dan fourth alongside the sponsor and we are excited to watch this management team and sponsor continue its stellar performance.
In the case of Trinity three which also appears on the new deal fundings for the quarter.
We were able to participate in a much larger club deal, which refinanced our original loan and.
And financed a large strategic acquisition fraternity three.
We also hold an equity interest in this company and are very excited about its continued growth prospects going forward.
This continues our track record of successful exits to date, we have generated a cumulative weighted average RMR of 14.7% on 33 portfolio exits generate.
Generating approximately 308 million in proceeds.
On slide 13, we breakout our on balance sheet portfolio as of the end of the quarter between the lower middle market and the upper middle market, Excluding I 45.
As of the ended the quarter, the total portfolio, including equity co investments was weighted approximately 84% to the lower middle market and 16% to the upper middle market on a fair value basis.
We had 39 lower middle market portfolio companies with a weighted average leverage ratio measured as debt to EBITDA through our security of 3.9 times.
Down from 4.1 times weighted average leverage in the prior quarter.
This reduction in leverage was primarily driven by EBITDA outperformance across the lower middle market portfolio during the quarter.
Within our lower middle market portfolio as of the end of 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 12 companies with an average leverage ratio through our security of 3.7 times down meaningfully from the 4.4 times weighted average leverage for the prior quarter. This.
This decrease was also driven by primarily by EBITDA improvement quarter over quarter across the portfolio.
Turning to slide 14, we have laid out the rating migration within our portfolio for the quarter.
During the quarter, we had two loans upgraded while having no loans downgraded.
As a reminder, all loans upon origination are initially assigned investment rating of two on a four point scale with one being the highest rating and for being the lowest rating.
The upgrades consisted of two loans to one portfolio company previously rated a three.
Which were upgraded to a two rating based on much improved performance.
As of the end of the quarter, 88% of our investment portfolio at fair value was rated one of the top two categories, a one or two.
We had seven loans, representing 10% of the portfolio at fair value rated a three and only two loans representing 2% of the portfolio at fair value rated a four.
As illustrated on Slide 15, we have established a portfolio well diversified across industries with an asset mix, which provides 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 and only 2% of the portfolio and one remaining subordinated debt investment.
Turning to slide 16, the I 45 portfolio showed meaningful improvement during the quarter.
As our investment in I 45 appreciated by 4.7 million or 8%.
Leverage at the I 45 fund level is now 1.39 times debt to equity at fair value.
Which is substantially approved improved from the March 31 quarter leverage of 2.51 times.
As we ended the quarter, 96% of the eye Port I 45 portfolio was invested in first lien senior secured debt.
With diversity among industries at an average whole size of 2.4% of the portfolio.
I will now hand, the call over to Michael to review the specifics of our financial performance for the quarter.
Thanks, Don specific to our performance for the September quarter as summarized on Slide 17, we earned pre tax net investment income of $8.1 million or 44 cents per share.
This was a 13% increase from the $7.2 million or 40 cents per share earned during the prior quarter.
Hey to 41 cents per share 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 December quarter.
In the near and long term, we have built a consistent track record of meeting to meaningfully covering our regular dividend with pre tax net investment income as demonstrated by our 103% 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 has also declared a further 10 cents per share supplemental dividend to be paid out during the December quarter.
As a reminder, the supplemental dividend program allows our shareholders to meaningfully participate in the successful exit of our investment portfolio through distributions from our Yutai balance.
As of September 32020, our estimated you CCI balance was a $1.19 per share.
Our investment portfolio produced $16.7 million of investment income this quarter with a weighted average yield on all investments of 10.4%.
This represents an increase of approximately $1.5 million from the previous quarter.
As Bowen mentioned, we had no new non accruals as of the ended the quarter currently three assets remain on non accrual with a fair value of $10.9 million, representing 1.7% of our total investment portfolio at fair value.
The weighted average yield on our credit portfolio was 10.3% for the quarter.
On slide 18, we lay out our operating leverage for the quarter, which was up slightly quarter over quarter.
Operating expenses were slightly elevated this quarter due mainly to a true up to our annual bonus accrual based on improvement in our overall portfolio performance as well as an increase in share based compensation expenses relating to the annual grants to employees on a run rate basis, we expect operating leverage will be well within our sub 2.5% target.
But going forward.
Turning to slide 20, the Companys NPV per share as of September 32020 was $15.36 as compared to 14 95 cents as at June 32020.
The main driver of the any NPV per share increase was $8.4 million of appreciation in the investment portfolio much of which was in the upper middle market portfolio.
On slide 21, we lay out our multiple pockets of capital as we have mentioned on prior calls a strategic priority for our company is to continually evaluate approaches to de risk the liability structure of the company.
Ensuring that we have adequate investable capital throughout the economic cycle.
During the quarter, we raised an additional $50 million on our 5.375% unsecured notes due 2024, and subsequently paid down $20 million on our 5.95% baby bond due 2022.
We will continue to be after opportunistic and paying down higher price debt to optimize optimized net investment income, while also being mindful of maintaining appropriate flexibility in our liability structure.
Net capitalization today include the $325 million on balance sheet revolving line of credit with 11 syndicate banks maturing in 2023.
The $57 million publicly traded baby bond maturing in 2022.
$825 million institutional bond with over 25 institutional investors maturing in 2024, as well as a $150 million revolving credit facility at I 45 for syndicate banks maturing in 2024.
We're pleased to report that our liquidity is strong with approximately $151 million in cash and undrawn commitments as of the end for us with ample borrowing base capacity and covenant cushions on our senior secured revolving credit facility.
Approximately 49% of our current capital structure led the liabilities are unsecured with the earliest debt maturity at December 2022.
Our balance sheet leverage as seen on slide 19 ended the quarter at a debt to equity ratio of 1.28 to one.
Finally, as Bowen mentioned, we continue to work actively with the FDA toward an FDIC license, which would allow us in time to access up to $175 million in attractively priced debt at our FDIC. We believe we are in the final stages of the licensing process and are hopeful with receiving our license by the end of the calendar year. We're.
I need to integrate the FDIC license into our capitalization strategy as the flexibility and low cost of FDIC debentures should be highly accretive to our net investment income per share while also allowing us to continue to provide important growth and acquisition capital to use small businesses.
I will now hand, the call back to Bowen for some final comments.
Thanks, Michael and thank you everyone for joining us today capital southwest has grown in the business and portfolio of developed consistent with the vision and strategy, we communicated to our shareholders almost six 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 difficult environments like the one we have experienced over the past several months.
In fact difficult environments like this demonstrate the investment acumen of our team at capital southwest and the merits of our first lien senior secured debt strategy.
While we are not immune to the challenges the economy faces today, we feel good about the health of our company and the opportunities that the environment will present us as we consider places to invest capital.
Everyone here 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 even in challenging times such as these.
This concludes our prepared remarks, operator, we are ready to open the lines for Q and a.
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Our first question or comment comes from the line of Mike Smith from B. Riley. Your line is open.
Hey, guys. Congrats on a very strong quarter. So I guess my first question would be you had a very good quarter of origination activity. Despite.
Despite some of the cobot headwinds. So I was wondering if you could maybe size the pipeline and just talk a little bit about the quality of deals you're seeing now just in terms of pricing covenants attachment points et cetera.
Yeah sure. Thanks for the question.
You know.
We thought the quarter originations very strong income.
It included both new portfolio companies as well as for add on acquisitions in our portfolio companies.
And so right now I'd say the pipeline is a bout average so it still is still solid but it's about average.
You know as far as what we're seeing in the market.
We do think that the most most all if not all of the pre co bid.
Premium if you will on a yield basis or spread basis is disappeared there might be slight in certain deals, but certainly a lot of cases, the premium the free covert or the cobot premium as decreased.
With respect to leverage attachment points I think we're still we're still seeing leverage attachment point slightly below pre cobot levels.
And and covenants are still strong and you know.
The EBITDA adjustments and those types of things that you see in credit Docs are still are still really strong in the lenders favor I should say.
And as far as quality deals you know weve. We definitely are seeing you know quality deals certainly seeing low quality deals too low quality being defined as companies that we still can't underwrite coded performance.
But we're seeing.
Fair amount of quality deals and if you look across the the business descriptions of the company's we originated this quarter.
Yes, I mean software government services cyber cyber security Internet marketing, you know type companies, Mitch really interesting business models, especially in this environment. So you.
Our team has done an excellent job they've got a very wide array of network a network of relationships and they've done a fantastic job.
Monetizing those those relationships through the form of originating quality deal flow.
Got you that's helpful. That's very helpful color. So another question would be on leverage you're currently sitting at 1.28 times and if I'm not mistaken I think the previous target was one to two I'm just wondering how do you kind of thinking about leverage moving forward here and are you comfortable with that be slightly above your target.
Yes, sure so I'll make a macro comment and that is just with respect to leverage as it relates to economic cycles. I mean, you know it.
Got it.
In a recessionary challenging environment, you might be willing to go to one leverage level and in a peak everything's wonderful marching forward like we were a year ago.
You want to be at another leverage level and so you know.
You want it you don't want to maximize leverage at the high end of the cycle and you might be willing to.
Have leverage increase at the low end of the cycle.
Nick you want to go into the cycle with leverage low. So you can manage leverage down in the cycle. So what all that means if you think about.
Leverage of 1.28 answer is yes, we're comfortable with where we are.
It is higher than our 1.11 to 1.2 kind of target range, we gave pre cove it.
If you look at if you just take a high level look at the depreciation in the portfolio.
During cobot retracing that kind of the cobot effect on the portfolio, we're basically back to the top end of our leverage range and so you have to kind of keep in mind that as the portfolio re appreciates that leverage all else equal come down. So that's one kind of point and why so why I can say were come.
For winter, where we are.
The next thing is you know we've got visibility on.
$30 million to $35 million of prepayments coming in from portfolio companies that are performing very well and and we and are being sold or refinanced or what have you. So so you kind of think about leverage we have visibility on cash coming in.
So, we'll obviously be redeploying that cash in originations, but thats another point in.
And the third thing I would say is if you think about.
We traded well above book for almost two years pre covance. So I believe that weve proven that our business model and our strategy in a more and more in a more normal market should trade above anything okay. So if its trades above the navy as you guys know we've got an ATM program that we are diligent about accessing at very low spreads dita.
Trade in so that's obviously a function in our yield on in aby today is 13.5% or so and on the stock price, it's north of 14%.
The market will figure out the risk premium on our stock over time. So we're.
We're comfortable that just letting the market play out but those yield levels.
I mean based on our strategy and track record really you know aren't are not where we believe those yield levels will will normalize out overtime, which we believe will trade above NAV and we'll be able to raise equity. So those are kind of all the points for that.
Hi, there my head as I look at the leverage at 1.28 and go my comfort with that or not yeah. I was asking to say just from a company profile perspective, our asset mix is a little different now than it was a year ago, we were probably in the mid eighties on first lien and our 91% first lien we had a few probably two to three sub debt investments and today, we have one sub debt investment.
And our equity percentage of the portfolio was probably.
Probably in the low 20% now it's sub 10%. So our overall profile is a lot stronger than it was then so you could probably take on a little more leverage.
Based on that profile at good point.
So thats good color.
Yes, Thats all very helpful. And then one more kind of just high level question for me.
Not mistaken I think $631 million is a record portfolio size. So just given your outlook for the origination environment and kind of the potential for an SPD license I'm wondering what kind of portfolio size can you support with your current infrastructure.
Yeah, So we've kind of manage costs we.
We look at operating leverage and so.
We think you know as the portfolio grows we're looking at the operating leverage number so as our portfolio grows we can invest in staff and resources right. So.
And so are our dollar costs will go up over time, but that's what we look at as a percentage of our assets and so you know as.
As we layer in the FDIC as we grow continue to grow the portfolio, we will add people.
But we manage it to that operating leverage number because that's really what the shareholders should care about is that that percentage drag. If you will on the income on the portfolio from overhead that we're spending. So so we look at that metric and we absolutely add to resources as we as we grow the assets.
Got you well thanks for taking my questions I will I'll, let somebody else ask a few thanks bye.
Thank you. Our next question or comment comes from the line of Mickey Schleien from Ladenburg. Your line is open.
Morning, Bill and then Mike.
To hear from you.
I wanted to follow up on the prepayment risk I sort of think we're living in a world obviously of haves and have nots in terms of the portfolio companies and.
As a lot of private capital out there chasing what I would say is still limited deal pipeline. When you consider the constraints everyone has on underwriting.
Meanwhile, theres potential changes in tax rates and that could catalyze some business owners to sell now this quarter. So with those trends in mind, how high do you feel prepayment risk is in your portfolio.
Given the strength of some of your investments besides the two that you've already mentioned in the prepared remarks.
Yes. Thank you. Thanks for the question I mean again, if we if we.
Just a quick to quantify the number of units $30 million to $35 million of prepayments that we have some visibility on.
With respect to the environment and tax regime changes.
Theoretically.
As we move into the end of the year because of potential pending capital gains treatment changes that could could definitely influence deal flow.
I would say that I don't I'm not.
Im not as certain that that people are going to make especially with the aging entrepreneurial population that are monetizing their their retirement in these businesses is what is generating a lot of the sales across the lower middle market.
I don't know that founder owned business makes a rash lifetime decision.
30 days here or there based on a tax change if they were already thinking about selling their business it could absolutely accelerate it so and push it into this this year.
But and I would also say that we will I guess, we won't know till tomorrow or or hopefully soon after the election change and you would have more visible or more visibility on a theory on tax change it'd be hard to launch a sale process right now and get installed by the end of year, So long way of saying I don't know.
The tax changes necessarily we're going to dramatically change or certainly our prepayment risk.
But look as you know.
And the lender the strongest performers get prepaid get refinanced, especially in the lower middle market, where you know traditional banks, maybe aren't willing to lend to some of these companies. We are and then the traditional banks in the case of Dan fourth Refinances out I mean, that's a that's a process.
And so you know there.
There is a vast majority of the majority your portfolio companies you just kind of.
Going along growing and we end up holding loans for a couple of years. You know that you have the star performers and of course, you have a small universe of guys to underperform. So if that makes sense and also say that some of the deals that are set to repay were on our list of deals.
Could occur so thats kind of being taken off the.
All the register so what we're left with is a lot of companies that weve refinanced over the last two years. So we actually feel like we have a good sense that you're not going to be another $30 million to $50 million in the next quarter. After that so I feel like that Weve a lot of the stuff is happening right now.
That's helpful.
Appreciate that.
And I wanted to touch on the nonperforming loans, if I'm not mistaken.
They're all in certain stages of bankruptcy and I think there has been some movement since our last call.
Starting with.
American addiction.
From what I've read and you know the information's little sparse it looks like you're going to be repaid in cash on that from asset sales is that correct and when will that be.
So based on you know based on what's public.
You know, it's a it's going to emerge from bankruptcy very relatively soon.
It will be restructured so the the lender group first lien lender group, which we are a part of we'll end up holding a debt security first lien debt security in the new restructured company and then ownership of the equity in the company. So it will be restructured it will be emerged from bankruptcy and capital.
Well actually we will have a board seat.
So.
That's adding a lot of yours was all relatively soon I mean, it's not in our control, but it's but it's you know it's it's basically got to work through taxes and various things structuring the recap so.
The restructuring so that's that's a C.
Hey, you want to talk about kings and Cpk as well well before we go into those just so.
So you will end up with a performing piece of debt and a c. at some point maybe next quarter. That's correct, yes, okay thats the expectation.
So cpk it looks like similarly are going to get equity and debt is that correct and when when is that going to happen.
So similar similar store.
The story as a C as far as what will happen from the bankruptcies for bankruptcy perspective, So we'll end up where they perform.
Performing first lien note and equity in the in the company, we will not have a board seat in that instance.
Okay, and we think thats going to happen and that should help.
I think may be announced that it will be it will be it will be relatively soon.
And what's the game plan for CP, Chem, and I've been reading headlines where lenders.
I guess surprising we are taking over some of these restaurant businesses. Despite everything that's going on in the world, obviously thinking that long term there must be value there.
I think you mentioned in the past the Cpk was doing pretty well prior to the pandemic, but looking ahead.
Or any major changes you expect to implement with the other owners at Cpk or you're just going to wait for covert to run its course and hope for things to improve okay.
Okay, well, yes appreciate the question and obviously.
I'll give you my a couple of points my view, but obviously want to be very careful as competent shouty around that company I think I understand that but I will say that this management team seems to be doing a really good job with the business and that's one thing and then the other thing is that the restaurants that have opened.
People come eat there and so you know and so its tells me that the brand is relevant and its desired and there is a demand for that brand and that concept in the market. So that's encouraging.
Clearly cove it is a bunch of noise out there it's affecting all the restaurants.
You know the major teams doing some interesting creative things around that with respect to CDK.
The election, and any kind of unrest that may result, unrest in an area thats all the retailers all the all the places restaurants included in those areas. So there's clearly noise out there, but the things I grab onto his maiden team seems to be doing a great job we have weekly calls.
And the restaurants that are opened people want to eat there and so base.
Based on those two things that gives me a lot of encouragement as to the future of that concept once all the market noise cobot pandemic noise. So.
Fades away, which look this too shall pass.
And so still challenges, but good team and there are some definitely some signs of relevance of that concept and brand.
I understand that that's great. Thanks for that and then Agee Kings. Obviously, there was a stalking horse bid I haven't seen another bit come through unless I'm mistaken.
Is that correct or are.
Are there other folks you know sort of snooping around and potentially going to offer yes.
Yes, so, making so thats actually been announced and they signed a purchase agreement to sell the albertsons.
That's in a in process.
Of closing slash documentation process.
And that's pretty much all I should really say about it but but our valuation is is the best guest a best guess on waterfall analysis around the proceeds on a on a sale.
I didn't see that Albertsons announcement, thanks for that and finally sort of just a balance sheet question is there any restriction on.
Using the remaining borrowing base in the credit facility to help fund the SP I see once you get the license and.
At the same time can you contribute at least part of your positions in your existing lower middle market portfolio to to capitalize it.
Yes, so yes, we're able to draw on the revolver to fund the equity.
So and the plan going forward, we expect to get the license as we said earlier by the end of the year and then we'll start originating assets and the collateral and get allocated between the revolver and the FDIC and we think thats important from a capital flexibility standpoint, I think you've seen other bdcs that are solely focused on FDIC and when.
Things go bad they don't have enough collateral in the revolver to be able to draw on that that's obviously a cash flow issue. So we will be ramping up our revolver in fact to bulk pay down some of the 5.95% bonds.
As well as to accommodate.
Originations that are not in the FDIC going forward.
I understand and Michael can you sort of warehouses lower middle market deals now and contributing to the SP I see once you get the license to move things along.
The answer is you can but the answer is there is a process you go through we're not going to do that we actually expect that were weeks away from actually having that application, we don't wanna be presumptive, but that's the kind of the guidance. We've been given so we're going to just wait until probably December men likely start allocating those assets to the FDIC probably in January.
Larry as you originate them and just Directionally how.
How much I guess, you're not going to start out at two to one leverage in the US guys see off on day one.
Hi, good leverage in the EPS basis subsidiary going to progress sure. So essentially get one turn of leverage.
Out of the gate and based on to detect notes related the FDIC. So essentially the first $40 million of capital will be funded by us and as equity and then we'll be drawing from the FDIC thereafter.
You will get you had access immediately to 40 million of debentures.
Yes, Okay. That's it for me. This morning appreciate your patience and your time. Thank you.
Thanks Mindy.
Thank you. Our next question or comment comes from the line of Kyle Joseph from Jefferies. Your line is open.
Hey, good morning, guys. Thanks for taking my questions any ECA finance on a on a nice quarter there.
Just most of my questions have been answered.
Answered, but just given that the balance shifts between the lower and upper middle market in the quarter. I think you know upper grew a little bit as a percentage of the portfolio was that was that a one off is that something we could look forward to continuing are you seeing any differences in between risk risk adjusted returns between those two markets.
Yeah, no we still as a macro statement as I try to put my per prepared remarks, we do think of a macro statement, we see a more attractive risk adjusted returns in the lower middle market and Thats why.
Really our that's our core to our strategy.
In any one quarter that can you know that we will look at upper middle market deals and there are upper middle market deals that are attractive.
We funded the I guess Trinity three technically its an upper middle market deal now because it's so much larger.
And and then what we have one other funding on the upper middle market. So we'll fund up in middle market deals. We also had a fair amount of appreciation.
In the upper middle market too, so thats, a factor as well because our metrics are all in fair value. So generally you know that.
Our position is still the same we have macro from macro we like the lower middle market risk adjusted returns better as a general comment.
But we certainly are actively looking at upper middle market deals.
I got it and then in terms of the portfolio yield I think that the consolidated portfolio yielding increased in the quarter, but can you just give us that refresh us on the outlook you know given where rates are floors on your port in your portfolio as well as spread you're seeing on new investments versus repayments.
Yes, I would tell you it's going to be stable I mean, obviously.
Over at our floors, and that's not going to change for the next 18.
18 months to two years or longer.
There are some step ups for pricing grid that that's that might be something you might see it go up 0.1 or down 0.1 based upon company performance then ill then move those grid.
Other than that I would expect it's pretty stable, where it is and in most instances the pre cobot post co bid world. We are theres definitely competition out in the market.
While attachment points are I would say generally are a little bit lower than they were pre cobot spreads in most cases are kind of back to or close to pre covered levels.
Got it one last one from me just in terms of quarter to date origination activity have you seen any sort of disruption given the the election or people kind of on hold until the election or air has.
Origination activity remains strong.
Yes, I'd say origination activity is a remains strong as far as deal looks.
You know, we've got a handful of deals that we've lost on pricing.
But that's just part of the World. We live in there are definitely some people out there you know certain instances for certain companies being pretty aggressive and so.
As far as the elections concern I wouldn't it doesn't feel like people have shut off.
Deals waiting for what happens tomorrow, I mean certain business models might have.
Or industries might have react differently to Democratic.
Legislator versus a Republican.
But but as a general I wouldn't say that.
In a lot of instances, we've seen things like halting pending the election.
Got it thats. It from me thanks, very much for answering my questions and congrats again on a good quarter. Thanks.
Thanks.
Thank you. Our next question or comment comes from the line of Bryce Rowe from National Securities. Your line is open.
Thanks, Good morning.
Morning, Brian.
Got to go in and Michael just wanted to kind of follow up on a comment you made a couple of question to go.
Around using the revolver to continue to redeem that the baby bonds are publicly traded baby bonds that are out there.
So curious if you will you will continue to grow.
Redeem those at a at a measured pace is 20 $25 million measured pace, we sell here this quarter.
And are you are you, giving any thought to possibly extending out.
The unsecured bucket.
And doing another maybe another five year.
Institutional issuance.
Sure, Yes, I would tell you that we plan to increase the size of the revolver in the near term and then probably pay off the bonds over the next two to three quarters and then we'll have to do with the pace of repayments. It will have to do that whether we're able to raise equity or not but I would tell you that when we look at it the shift between six.
Percent bond and the revolver that 3% that's an uplift of when it's done at 2.2 cents per quarter in Eni, We think that's pretty powerful ominous risk free to the extent, we control that pay down.
So we will definitely look to do that in the near term.
And your other question on the unsecured I think our strategy over the next few years is going to be to grow this revolver as I said.
We're going to utilize the FDIC and quite frankly, we're hopeful over the next year to two years as we grow our balance sheet and we get closer to investment grade we.
We would look to go back to the unsecured bond market and tap that market at the 4% rate or thereabouts.
If there is a need for liquidity.
During this coming year 2021, we would hit that the baby bond market, perhaps but that's at this moment, that's not our that's not our baseline assumption.
Okay, that's fair.
And Michael you mentioned the.
The compensation true true up for that for the bonus accrual just curious if you could quantify that for us. So we have a good run rate going forward sure sure. So last quarter, we actually brought down the bonus accrual by $200000 based on the uncertainty in the market with Covance. So this quarter, we essentially retrenched that to hunt.
1000 into the bonus pool to bring it back to full bonus and so the run rate you should be looking at it's usually about on the cash compensation line. It's around 1.8, so thats going to be the run rate going forward you should expect the next few quarters okay.
Okay.
And then last last me another one on the income statement.
You all in the press release talked about a nonrecurring amendment type of fees.
You saw in the in the third quarter. So I was curious if.
If you could quantify that and then number two with the visibility you mentioned into Prepays.
In this fourth quarter do you expect any any prepayment fees to come along with that.
Yes, so total fees for the quarter I, probably break it down like this so we generally have recurring fees that are ad men.
And agent fees on our debt of about $250000 a quarter. So that every quarter. We typically have between 200 and $300000 in re occurring with a portfolio of 50 companies. We tend to have fees. So with this quarter, we had probably about 400000 ish of onetime fees that are above our.
Normal expectation or run rate.
Okay, and then just in terms of this quarter.
Repayments I don't right now I think the one to three prepayments one of them does not have a.
They call and I think that there's maybe just one small one.
Between the other two so I would tell you it's like 50000 ish in it but having said that there is always something that comes up so there that.
That number could be validated by the end of the quarter Yep Yep. Okay.
I think thats all I had thanks.
Right.
Oh. Thanks. Thanks Bye. Thank you our next question or comment comes from the line of.
Robert Dodd from Raymond James Your line is open.
Hi, guys first a housekeeping one kind of follow on to do but was there anything in terms of anything material in terms of accelerated amortization.
Amortization in the interest income line, rather than the fee income line I mean, it seems to me that roughly like 250 Grand something like that from the to come.
From Trinity and data.
Now all of that was shut up and fee line. There was not all the interest income had to do with the 66 million of originations this quarter with a lot of them were early on in the quarter as well as some of the pickup in income from originations that were late stage in the previous quarter.
Got it got it.
Then just on the kind of the pipeline.
You described as average I mean.
How much I mean, this quarter a number of add on acquisitions, obviously in the existing portfolio.
For that Trinity was effectively come I you described it.
Thank God, we fight out clauses and major add on acquisition.
Can you give us any color on how much.
What's the what's the level of oversight coal closed cycle for an add on acquisition versus.
Normal kind of new portfolio company I can add on acquisitions happen.
A a much faster pace.
And all those acquisitions in the appetite in the market out there right now I mean is there.
More of that given them.
Then our troubled companies that might be available buyout.
Before so can you give us any any color there on on the outlook for more add ons and how quick second half.
Yeah. So I mean generally speaking as you can imagine you know if we're.
There's two ways to look at that the portfolio company financial sponsor pace and then our pace. We clearly it can offer an add on acquisition. It's in the same space same industry more times than not the management team knows the other manager team and they're just numbers of way reasons, why though they tend to come together faster.
To your point I think when you're behind your question yes.
And clearly we have to do less.
You know figuring out the industry in the business model right. It's more focused on it's more focused on what are these companies going to do together synergies.
Integration risk those types of things, which generally speaking or don't take you as much time to generate the work and do the work to figure those things out so.
And so so it's a general statement add on acquisitions are in some sense easier to get done and happened faster than a new platform, where both the financial sponsor or and or us are trying to figure out and verify the core business model as opposed to some of the other thing.
And so so they do generally happen faster.
I would say that that's one of the great things about our portfolio and other BDC portfolios to which is we do have we do back companies and we provide a capital weve capital source to help them make acquisitions and so not every company in our portfolio every company out there.
Have acquisitions as a strategy.
But but many of them do and so and so thats a name that's the nature of of a portfolio like ours or other bdcs as well.
That you had this kind of natural home in the background of potential add ons and so in the current environment. Yeah. I mean, I think there are companies that.
No that that are maybe underperforming, but I think it's more often the case, where it's like okay. Operating efficiencies are really important in our industry said portfolio companies industry and we've seen the value of that managing things like co bid and that kind of thing and so you know to it.
All else equal two businesses appreciate maybe more the efficiency of combining after an event like we've seen maybe than they did a year ago at the margin. So does that make does that mean deal flow tripled. The result, you know probably not but but it's definitely a positive tailwind to deal deal activity on the add on front.
Got it got I appreciate and congrats on the quarter guys. Thanks. Thank you.
Thank you. Our next question or comment comes from the line of Chris Mccampbell from Hilltop Securities. Your line is open.
Hi, guys just quickly.
I don't think we're getting to a place where factors that drove net asset value grows or part of the trend.
And yes visibility into beginning to grow the dividend again.
Yes, so as far as in Avi I think.
I think a big uplift in Navy for many bdcs, including US will be just re appreciation of the noise that that's been created by the current market environment. So.
And so.
So I think what we we certainly expect to see that and then we have you know we have a a nice equity portfolio with some companies that are are growing.
A couple of companies that we've had to decrease the appreciation to write it down based on coated which we certainly expect that to the re appreciate so.
I think that I think that clearly there are from where we sit today there are definitely tailwinds that should support the navy growth going forward.
And with respect to I don't Mike you want to talk about the Eni effect of the FDIC and some other things Weve talked about yes, I think that limits. Your direct question I think we do have an eye on growing the dividend the regular dividend.
Overtime.
Based upon our originations to date and some of this transition to the five point getting away from those unsecured bonds and we think our run rate in the next quarter or two is going to be in the 42 to 43 cents in terms of Eni and.
And when we feel comfortable there, we'll probably end up at the dividend in turn when we make the full transition out of those notes and we start drawing on the revolver next year, we see quite a bit of.
If an increase in Miami to quantify it long term I think I said this on the last call and once we have fully immersed in the FDIC fully deployed we see it that's a 20% to 25% increase.
Relative to using bonds.
In the next two to three years. So we're definitely looking ahead towards increasing that dividend slowly and steadily.
Fantastic great job guys.
Thank you.
Thank you our next question or comment comes from the line of David.
My name is Aki from confluence investment your line is open.
Hi, good morning, guys.
A couple of.
Observations in questions. It seems like you know where the outsize returns you get made tend to be where people won't go or they can't go on I think you guys have done a really good job of being fully engaged in underwriting and managing your portfolio to the cobot crisis, thus far which is kind of how you've been able to grow the portfolio. So nice.
But I'm wondering along those lines when when you talk about Dan what's getting refinanced by the banks.
Obviously, there is a point in time when they were not willing to make that loan and then something happened where they were interested in taking you guys out. So can you guys talk about it if not specifically the danforth, but just generally what happens with the banks that makes them change their mind that they would come into your companies and refinance them.
Yeah, Hi, David subsidy.
Thats good question I would say.
Two things one is just the banks the banks appetite for risk and I'm, not really here to sort of quantify that but with respect to certain bank at a certain company and its performance one of the things that banks will look at is the is the performance of the company. Obviously, so so as these companies as part of the size of the company as it grows.
Gets to an EBITDA level that the banks would consider it.
Others are just the bank in a particular, it's not a macro market comment, but with a particular company in a particular industry.
With that particular financial sponsor, who clearly we'd rather.
In time bring banks in because it's cheaper capital. It just the whole story evolves and so you know as as it again at some market appetite bank appetite for that particular company in that particular industry part of its.
The financial sponsors that are courting those relationships and ultimately wanting to get to a point where they can.
Graduate from a non bank lender to a bank lender.
So it's part of the natural.
Dynamic within the lower middle market is that evolution.
Non bank to bank financing.
And is that part of your strategic positioning is that your exit strategy would be to have the company grow to a point, where it can be taken up by banks.
So definitely in certain situations, but it's but it's it's not a macro strategy necessarily it is a dynamic as I described that does exist.
Some companies as we're underwriting that might be more of a discussion than other companies.
But there's other things that banks need like amortization scheduled amortization. They you know things like that that we don't necessarily need on every business that also goes into where our capital is more expensive than a bank, but it can be more flexible and especially sponsors are trying to drive growth. These companies. The next 5000 based.
As points of leverage financing is not what moves there are our needle what moves there are needle as the operating changes in the in acquisitions and various things and they need a capital provider that is you know.
Really diving into the enterprise value of the business and the cash flows of the business, which generally speaking is not what banks necessarily are looking at as much as non bank lenders that makes sense. So every deal and industries different so it's hard to say.
Macro were sitting around saying, okay. Corporate strategy is we want to do deals that we think within a couple of years are going to be taken out by banks.
It's not quite that definitive but it off it can be a part of the conversation in certain situations.
Okay, great. Thanks.
If I could just shift gears and ask there's been a lot of great discussion about the FDIC and I don't want to kind of chickens before they hatch, but congratulations on the progress thus far.
I'm not sure if you talked about your targeted leverage on an economic basis versus a statutory leverage basis and should you get the ability to.
Participate in Espeed debentures.
Can you talk a little bit about the ranges that you might work with and.
Host hosts that FDIC.
Yes, I think overall I would tell you in this environment, where were may or may not be able to raise equity in the short term and we we still point you to the 1.5 times board mandated leverage that would be you would say that probably the Max leverage that we feel comfortable with.
Economic or statutory that would be economic.
Okay.
But in time, when we've actually we look at what will look like I tell you that we probably will be more focused somewhere in the one three to one for maybe economic.
With a regulatory leverage in the one to 1.1 would probably be where we'd be living as a target going forward.
Okay, Okay, great that's very helpful.
Well I appreciate your comments and congratulations and I will step out of the kina. Thank you.
Okay.
Thank you very much our next question or comment comes from the line of Devin Ryan from JMP Securities. Your line is open.
Hi, This is kevin's bolt on for Devon, and I just have one more outstanding question most of mine if that answered already.
What is the weighted average LIBOR floor for the portfolio and what percent of floating rate investments workforce.
So the weighted average LIBOR on the asset portfolio is 1.4%.
We'll give you maybe a little bit lower than that because we are new originations have lower 20, 135, yeah and what was the other question sorry.
What percentage of floating rate investments have LIBOR floors.
Yeah pretty much all of them.
Okay, Great and Thats all my questions Congrats on a strong quarter.
Thank you thanks.
Thank you I'm showing no additional questions in the queue at this time I would like to turn the conference back over to Mr. Bowen Diehl for any closing remarks.
Great. Thanks, operator, and again, thanks, everybody for the call. Thanks for all the robust questions. We appreciate it.
And we look forward to keeping you guys posted.
On our progress animal rule.
If not before well be talking next quarter.
Ladies and gentlemen, thank you for participating in today's conference. This concludes the program you may now disconnect everyone have a wonderful day.
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