Apollo Investment Corporation
Q1 2021 Earnings Call Transcript

Published: 7 Aug 2020

[Operator:]

Good morning and welcome to Apollo Investment Corporation's Earnings Conference Call for the period ended June 30th, 2020. At this time, all participants are in a listen-only mode. The call will be open for question-and-answer session following the speakers' prepared remarks. [Operator Instructions] I will now turn the call over to Elizabeth Besen, Investor Relations Manager for Apollo Investment Corporation.

[Elizabeth Besen:]

Thank you, operator and thank you for everyone for joining us today. Speaking on today's call are Howard Widra, Chief Executive Officer; Tanner Powell, President and Chief Investment Officer; and Greg Hunt, Chief Financial Officer. I'd like to advise everyone that today's call and webcast are being recorded. Please note that they are the property of Apollo Investment Corporation and that any unauthorized broadcast in any form is strictly prohibited. Information about the audio replay of this call is available in our earnings press release. I'd also like to call your attention to the customary Safe Harbor disclosure in our press release regarding forward-looking information. Today's conference call and webcast may include forward-looking statements. Forward-looking statements involve risks and uncertainties, including, but not limited to statements as to our future results, our business prospects, and the prospects of our portfolio companies. You should refer to our most recent filings with the SEC for risks that apply to our business and that may adversely affect any forward-looking statements we make. We do not undertake to update our forward-looking statements or projections unless required by law. To obtain copies of our SEC filings, please visit our website at www.apolloic.com. I'd also like to remind everyone that we posted a supplemental financial information package on our website, which contains information about the portfolio, as well as the company's financial performance. At this time, I'd like to turn the call over to Chief Executive Officer, Howard Widra.

[Howard Widra:]

Thanks Elizabeth. Good afternoon and thank you for joining us today. Before we began, I'd like to say we hope everyone is healthy and doing well. I'll begin today's call with an overview of our portfolio and a review of our financial results for the June quarter. I will also discuss today's distribution announcement. Following my remarks, Tanner will review our investment activity for the quarter, and will discuss the impact of the COVID-19 pandemic and economic shutdown on our portfolio in greater detail. Ray will then review our financial results and provide an update on liquidity. We will then open call to questions. During today's call, we will be referring to some of the slides in our investor presentation which is posted on our website. As we all know the COVID-19 pandemic has been an unprecedented shock to the global economy. We believe our portfolio repositioning over the last several years has allowed us to enter this challenging period with a well-diversified senior corporate lending portfolio invested in less cyclical industries with granular position sizes. Despite the significant economic headwinds through the pandemic, our corporate lending portfolio continues to perform well as evidenced by a net gain during the quarter. We believe the performance of our corporate lending portfolio during this challenging period demonstrates its resiliency in quality. No investments within our corporate lending portfolio replaced non-accrual status during the quarter. The corporate lending portfolio, which represents 79% of the total portfolio is 85% first lien, 100% floating rate, and 86% sponsor-backed. We continue to work closely with our sponsor clients and portfolio companies and we have generally been pleased with how sponsors and borrowers have been managing through the current environment. Away from corporate lending, results for the quarter were negatively impacted by non-core and legacy investments. On our last call, we said that our intention to -- it was our intention to reduce the funds leverage over the coming quarters. During the June quarter, we made considerable progress deleveraging the balance sheet by exiting approximately $233 million of assets on a gross basis, or $95 million on a net basis, which reduced our leverage to 1.66 times down from 1.71 times. Since the end of the quarter, we have received net pay downs of approximately $50 million, including one loan with documents in escrow. Pro forma for these additional pay downs and assuming no changes to fair value up or down, net leverage is currently approximately 1.61 times. We have visibility into meaningful additional repayments in the remainder of the September quarter and for the December quarter. We may focus on further deleveraging to within our target range of 1.4 to 1.6 times over the coming quarters. As the pandemic began, many of our portfolio companies join the revolvers during the March quarter to shore up liquidity. Many of the drawdowns were repaid in the June quarter. In cap [ph] of the agent for nearly all of our revolver and delayed draw term commitments and is actively monitoring every commitment. For context as midcap, leveraged loan revolvers were 23% utilized before the pandemic. Revolver utilization peaked at 70% in mid-April and has since declined to 48% today. Greg will discuss our liquidity and unfunded commitment exposure in greater detail later in the call. Moving to our financial results, net investment income for the quarter was $0.43 per share, reflecting a smaller portfolio given the reduction in our leverage and a lower contribution from Merx, which Tanner will discuss later. In addition, given the total returns feature in our incentive fee structure, no incentive fees were accrued during the quarter. The portfolio had a net loss of $25.2 million or $0.39 per share, driven by a net loss on non-core and legacy assets, partially offset by a net gain on corporate lending. Slide 16 in our investor presentation shows a net loss for the quarter broken out by strategy. Net assets per value -- net asset value per share at the end of June was $15.29 cents, a 2.6% decline quarter-over-quarter. Turning to our distribution, in light of the challenges and uncertainty created by the COVID-19 pandemic and our plans to further reduce the funds leverage, we have reassessed the long-term earning power of the portfolio and included that as a prudent to adjust the distribution at this time. We believe that distribution level should reflect the prevailing market environment and be aligned with the long-term earnings power of the portfolio. Going forward in addition to a quarterly based distribution, the company's Board expects to also declare supplemental distribution and an amount to be determined each quarter. We believe a $0.31 distribution reflects the long-term earning power of the core portfolio including Merx. We believe there are several sources of earnings which will allow us to pay an ongoing supplemental distribution, including the redeployment of non-earning or lower yielding assets from our non-core and legacy portfolio, the recovery of earnings from Merx, and the rebound of fee income to historic levels. The base supplemental distribution construct is intended to provide shareholders with a minimum annualized yield on NAV of 8%, a level which is consistent with some of our peers and allows for some upside via a supplemental distribution. To that end, the Board has declared a base distribution of $0.31 per share payable on October 7th, 2020 to shareholders as of record on September 21st, 2020. The Board has also declared a supplemental distribution of $0.05 per share payable on October 7th, 2020 to shareholders of record as of September 21st, 2020. Again, the Board expects to declare quarterly supplemental distribution in the amount to be determined each quarter. With that, I will turn the call over to Tanner to discuss our investment activity and our portfolio.

[Tanner Powell:]

Thanks Howard. Starting with the market environment, since the March lows, leveraged loan prices have recovered and loan spreads have tightened significantly, which had a positive impact on the fair value of our corporate lending portfolio. Given the economic backdrop middle market loan volumes during the period were light in both the syndicated market and the private credit market. Activity in the middle market remains slow as sponsor and lenders -- as sponsors and lenders continue to struggle to evaluate how to price risk. While deal activity has been light, we do see that price in terms have shifted in favor of lenders. In addition, borrowers are increasingly seeking asset-backed lending solutions, an area where we the mid-cap have expertise in significant market share. Given the composition of our corporate lending portfolio, which is primarily first lien loans to less cyclical businesses, we believe that the credit quality of our corporate lending portfolio is held up relatively well during this period. However, we have seen an increase in requests for loan amendments. Today, AINV has completed or is in the process of completing 23 amendments across the portfolio, representing 15% of portfolio companies. Most of these amendments have been for covenant waivers or resets, generally in exchange for a new covenant. To-date, only four amendments have impacted interest rates or principal payments. Given the lack of investment activity in the overall market and our focus on reducing leverage, new investment activity was limited during the quarter. New corporate lending commitments for the quarter were only $17 million across two companies. Sales were $68 million, repayments were $49 million, and revolver pay downs were $116 million for total exits of $233 million. These sales were executed at prices around our marks at the end of March. Net repayments for the quarter were $95 million including $31 million of net revolver pay downs. Going forward, given our visibility into upcoming repayments, we expect to be in a position to make new commitments as market activity resumes. Moving to Merx, our aircraft leasing portfolio company, -- as discussed on our last call, the pandemic has caused an unprecedented decline in global air traffic, which has led to a widespread lease deferrals throughout the industry. Although aircraft -- air traffic trends have improved slightly more recently, it remains significantly below pre-pandemic levels. Merx has been working with its lessees to provide the necessary flexibility during these unprecedented times. During the June quarter, AINV converted $105 million of Merx revolver into equity and reduce the interest rate on the revolver from 12% to 10%. Accordingly, at the end of June, our investment in Merx totaled $329 million at fair value, consisting of a $200 million revolver at 10% and $125 million of equity, which also reflects a $4.3 million write-down during the period. This partial equitization will reduce the interest Merx pays to AINV from $36 million per year, or $9 million per quarter to $20 million per year or $5 million per quarter. We believe this reduced debt burden will provide Merx with the cash flow relief needed to navigate this challenging period. We expect Merx will be able to make dividend payments on our equity investment, improving AINC's return on its overall investment when the industry recovers. We believe Merx's portfolio compares favorably with other lessors in terms of asset, geography, age, maturity, and lessee diversification. Merx's portfolio is skewed towards the most widely used types of aircraft, which means demand for Merx's fleets should be somewhat more resilient. Merx's fleet predominantly consists of narrowbody aircraft serving both the U.S. and international markets. At the end of June, Merx's own portfolio consists of 81 aircraft, 10 aircraft types, 40 lessees in 26 countries with an average age of 9.5 years. Merx's fleet includes 75 narrowbody aircraft, two widebody aircraft, and one freighter. As mentioned last quarter, the majority of rents deferrals impacted cash flow in the June quarter. We expect to recover in lease payments going forward given the significant amount of capital that has been raised by airlines in the public markets and the level of government support around the world. So far for the month of July, cash flows are at or above expected levels. Merx's continues to diversify its revenue sources beyond aircraft leasing. Merx has built a best-in-class servicing platform which generates income from aircraft manage on behalf of other Apollo-affiliated capital. As you may have seen during the quarter, Apollo Global's dedicated aircraft leasing fund, Navigator, entered into a sale leaseback transaction with Delta Airlines for 10 aircraft. As Navigator acquires additional aircraft, Merx will generate incremental income from servicing fees. Across Merx and PK AirFinance, the aircraft lending platform which was acquired by Apollo Global, Apollo's aviation platform has 45 professionals dedicated solely to aviation look located across North America, Europe, and Asia and providing an expert in-house support to the platform's various aviation strategies. The aviation team has the experience to skillfully navigate this period of market stress and the requisite capabilities to mitigate potential adverse outcomes. In addition, the Apollo Aviation platform will seek to opportunistically deploy capital in the face of widespread uncertainty and marked disruption. To be clear Merx is focused on the existing portfolio and is not seeking new investing opportunities. However, growth in the overall Apollo Aviation platform will inure to the benefit of Merx as the exclusive servicer for aircraft owned by other Apollo Funds. Moving to overall credit quality during the quarter, our two first lien depositions in carbon-free chemicals were placed on non-accrual status. The company has been facing earnings headwinds, due to an unprecedent slowdown for the demand for one of its project -- products, hydrochloric acid or HCl which is used in the fracking process. Due to the decline in oil prices and production, the company's profitability has been negatively impacted by the lack of HCl offtake. At the end of June, investments on non-accrual status represented $182 million or 6.1% of portfolio cost and 47 million, 1.7% at fair value. Looking ahead, we anticipated the continued need for covenant relief in our portfolio over the next few quarters. We believe these amendments will provide our portfolio companies with the flexibility needed to operate in the economic downturn. We can use such amendments to reprice our risk, tighten loan documentation, add covenants, and secure additional equity capital. With that, I will turn the call over to Greg who will discuss financial performance for the quarter.

[Greg Hunt:]

Thank you, Tanner. Beginning with the statement of operations, total investment income is $56.7 million for the quarter as interested income declined due to the reduction in income from Merx, non-accrual investments and the decline in LIBOR. The decline in LIBOR was primarily offset by corresponding decline in AINV's interest expense for the quarter. The remainder of the decline was primarily as a result of muted origination and prepayment activity during the quarter. Approximately 97% for contractual interest payments for the quarter were collected and the weighted average yield at cost on our corporate lending portfolio was 8.1% versus 8.5% last quarter, reflecting somewhat the decline in LIBOR to floor levels. Expenses for the quarter were $28.4 million, down $4.4 million quarter-over-quarter, primarily due to lower interest expense and lower management fees. Interest expense declined due to the decline in the average portfolio and the decline in LIBOR. The average weighted average cost declined 81 basis points from 3.93% to 3.12%. Management fees declined due to the decline in the average portfolio and there were not any incentive fees paid during the quarter. Net investment income per share for the quarter was $0.43. As Howard mentioned, that leverage at the end of the quarter was 1.66 times, down from 1.71 times at the end of March due to $95 million of net pay downs, partially offset by the net write-down on the portfolio. The net loss on the portfolio for the quarter totaled $25.2 million or $0.39 per share. On page 16 in the earning supplement, we've broken out the net loss by strategy. Spreads in the syndicated market tightened meaningfully since the end since the peak decline in March, and as a result, we saw several reversals of unrealized losses from last quarter. Our corporate lending portfolio had a net gain of $4.7 million or $0.07 a share during the quarter. Merx had a loss of $4.3 million or $0.07 a share, reflecting the continued stress in the aviation industry. Non-core and legacy assets had a net loss of $25.6 million or $0.39 per share due to carbon-free legacy position in our shipping and oil investments. The loss and shipping primarily reflect did the decrease in the residual value of the underlying assets in our dynamic shipping investment. The loss in oil -- in our oil investments was primarily due to the weakness in the forward oil curve. NAV per share at the end of June was $15.29, a 2.6% decline quarter-over-quarter. Moving to liquidity and capital, at the end of June, we had $1.7 6 billion of debt outstanding, down $40 million from the prior quarter. Adjusting for settlements at quarter end, we had $243 million of immediately available liquidity, up from $224 million at the end of March and we had $205 million of additional capacity under the credit facility, up from $131 million at the end of March. The net effect of the quarterly activity improved our available borrowing capacity from $350 million to $450 million. And as Howard mentioned, the activity post quarter end has added to our overall borrowing capacity for this quarter. Moving to -- and lastly, we were pleased to Kroll affirmed our investment-grade rating in July. Moving to our unfunded commitments, on page 18 in our earnings supplement, we have laid out the outstanding commitments at the end of June. During the quarter, we experienced meaningful revolver pay downs from our portfolio of companies, because many of them chose to pay down the revolvers because they had better visibility regarding the impact of the pandemic on their respective businesses. Of the $275 million of unfunded revolver commitments outstanding at the end of June $180 million are available to borrowers and $95 million are not available to borrowers. Availability is based on borrowing base limitations and other covenants. There were no significant drawdowns on delayed draws term loans commitments during the quarter, which are generally used to support portfolio of company acquisitions and have in current covenants. As noted, a significant portion of our unfunded commitments are not available to borrowers. Most of our revolver commitments are subject to borrowing dates, and many of the companies do not have the requisite collateral. Delayed draw term loans are typically used to support portfolio of company acquisitions and have encouraged covenants and therefore, we do not expect these facilities to have any material utilization in the current environment. Turning to the portfolio composition, our investment portfolio had a fair value of $2.67 billion at the end of June, across 149 companies in 29 different industries. We ended the quarter with core assets representing 90%, 91% of the portfolio. Non-core assets decreased to 9% of the portfolio at the end of June, down from 10% at the end of March. First lien assets can for 85% of the corporate lien lending portfolio. The weighted average attachment point decreased 2.8 times. Investments made pursuant to our co-investment order were 77% at the end of the quarter, we continue to remain focused on preserving liquidity and accordingly, no stock repurchases were made during the quarter. As our leverage and liquidity continue to improve, we will continue to evaluate repurchasing our securities as appropriate. This concludes our prepared remarks and we would like to open the call up to questions.

[Operator:]

Thank you. The floor is now open for questions. [Operator Instructions] Our first question comes from the line of Kenneth Lee of RBC Capital.

[Kenneth Lee:]

Hi, thanks for taking my question. Just one following upon on, what was mentioned during the prepared remarks you said that you have some visibility into investment repayments over the next few quarters. Just wondering if you could just expand upon that and what gives you some comfort around that visibility? Thanks.

[Howard Widra:]

Yes, well, it's -- this is Howard. We have a -- we go through the portfolio, there's a number of companies that are basically in our strategic transactions, you know for sale that are either pending or are committed. So they're like they're pending closing. So we're talking about things that are in a number of cases already under contract. So that, can't be broken up or just waiting for some regulatory approval. And, and in other cases are in you know, are being auctioned are valuable sort of platforms and won't get executed. So, it's and it's also it's a -- it's sort of a granular list. So, you know, we would expect that to happen over sort of, continually over the next few quarters over the next quarters.

[Kenneth Lee:]

Got you. Very helpful. And just one follow-up by, if I may. In regards to the new distribution policy, you mentioned that the supplemental dividend, couple drivers that could help that including, non-core migration as well as recovering Merx wondering for outside observers, what's the best way to think about how the supplemental dividend? Is there a better way for us to -- when supplemental dividend? Could be in 10 days? Any kind of guidance on that? Thanks.

[Howard Widra:]

Yes, so I'll take a crack at it first. So, we set -- we tried to set the, the base dividend based on what sort of corporate portfolio was earning, or will earn at the at the size it's expected to be at, plus what we expect Merx to produce, currently, with, relatively sort of moderated assumptions in terms of sort of fee income there, and that -- will enable us to sort of pay that base dividend. We do you know, in addition to that, we would expect to generate income from a number of different items. One is returns off our noncore portfolio, which we get some today. What we said in the prepared remarks, were repositioning that non-core portfolio and earning even more off of those, but even offer, you know, the sort of a moderate amount of cash that's produced off that that is incremental Merx basically, picking back up to a level of distributions above where we model that, which could still be below where it was historically, and there's room for upside there. In the interim, there's also sort of upside, or it's not really upside, there's also further earnings coming over the next few quarters because, we won't be paying an incentive fee for a little while, because of the total return feature. And then lastly, that base dividend was set on a fee level that is relatively conservative based on, historical levels over the past four or five years, and that was with a smaller portfolio. So, our view is that, we can support that base dividend with just the you know, the very basics of basics of the business. And there should be -- there should be meaningful opportunities to produce each quarter income above that, which we will then be distributed based on sort of what the board decides each quarter meaning, the expectation was, is we would declare some each quarter and, potentially retain sound to drive, NAV up and leverage down each quarter as well.

[Kenneth Lee:]

Great, very helpful. Thank you.

[Operator:]

Our next question comes from one of college Kyle Joseph of Jefferies.

[Kyle Joseph:]

Hey, good afternoon, guys. Thanks a lot for taking my questions. Just you know, in terms of capital allocation going forward, the key focus here is, is delivering, but in terms of new investment opportunities, would we expect those to be primarily focused on the existing portfolio or, you know, subject to market conditions would you look to kind of rotate some of your portfolio into new investments.

[Howard Widra:]

Yes, I mean, you know, Tanner had said, as we get our leverage into sort of the range right now, we're at the sort of very top end of the range. But as we get payments, we would expect to sort of deploy back into opportunities, we think that are sort of, effectively cherry picked for risk return off the top of what's coming through the platform. Those may be in existing portfolio companies, if those opportunities are good, and we understand they may be in other opportunities, we have a couple sort of in the pipeline, we expect to fund right now in the quarter that's in one of each of those. So disproportionately high return for the risk That we -- that given sort of our visibility into pay downs, we believe we can find and then continue to sort of our path to delivering so the answer is it's going to be both it will for sure, though, being the strategy that we have sort of articulated now for extended period of time, first lien floating rate, you know, it'll all in those categories, our ability to deploy obviously will be dictated some by the cash that we're able to sort of, bring in but we do expect sort of normal course, churning up the portfolio to enable us to invest in sort of, you know, cherry pick off the best of what's coming through the platform.

[Kyle Joseph:]

Got it. And one follow-up from me. So given that sort of investment considerations, and then in light of the rate environment, the LIBOR floor you have on your portfolio, do you think the first quarter could reflect kind of the nature for and for yields or in any sort of outlook in terms of the yield on the portfolio?

[Howard Widra:]

So, it should, right because LIBOR won't go and won't, I mean, LIBOR can't go much lower, but it doesn't matter. We have the floor so that our yield won't go lower and we would expect to be deploying at high rate, just because, we're just like I said, we're just going to be very selective of what we pick off. The issue is, though, obviously, we're not going to be, turning 20% of the portfolio every quarter. So it doesn't, it's not going to move 50 basis points per quarter up, but I do think that that's the right assumption that we know -- of the speed.

[Kyle Joseph:]

Understood. Yes. No. That makes sense. Thanks very much for answering my questions.

[Operator:]

Our next question comes from Finian O'Shea of Wells Fargo Securities.

[Finian O'Shea:]

Hi, good afternoon. Hope everyone's doing well. First question on Merx you gave a lot of input there. I apologize, if I missed this, it did was reorg on your provided capital structure. Was that just the more conservative play on what cash for according to what cash comes in, or is was there a -- was there any form of test trips underneath on the securitization there?

[Tanner Powell:]

Yes, I'm having -- yes.

[Howard Widra:]

You go ahead.

[Tanner Powell:]

Yes. So, hey, Finian. So, the change was, as Howard alluded to, to more appropriately reflect the earnings power that we anticipate from Merx and no was not was not driven by as you referred to issues in the underlying financings, we remain to be in good covenant compliance in those facilities. There is some cash not only unrestricted cash that's trapped in those facilities, but also restricted cash that sits in those facilities and an unrestricted cash that that sits at Merx, to help defer cash needs going forward.

[Finian O'Shea:]

Okay. Thank you. That's helpful. And just a follow-on perhaps for Howard. Reading and listening a bit to the Apollo parent call, it looks like Apollo starting a new private credit platform strategic opportunities. How did you describe this as it compares to mid-cap and the private credit group? Is it a different part of the house or to what extent are you integrated and how can we -- how should we think about this as it as it impacts your current group today?

[Howard Widra:]

Okay. Well first, let me answer it for sort of the BDC. From the BDCs perspective, it doesn't -- it's just another product offering, which is available for the BDC, if it decides to opt into those financings surrounding the exemptive order it has a right to. From the perspective of where it sits, it's effectively an adjacent product. If you're thinking -- it's basically large market origination. So take deals in the billion dollar range, which historically had not really been done in the private market. And so, effectively what it does is, it allows us to offer at scale to underwrite deals privately, and take them down in sort of capital market solutions for providers. So, if you looked at the universe of borrowers that mostly would -- that would be availing themselves of that they would be ones that would have been BSL borrowers previously, not mid-cap borrowers. And so the original for those companies, they tend to be sort of large corporates or sponsors that are more diversified than middle market sponsors. So like more like Apollo than they would be the core sponsors we cover at mid-cap in the basic way. So, in that way, it's sort of an adjacent product offering, it's basically how do we make sure that we are able to offer sort of scaled solutions in sort of lower BSL market, upper middle market, so stop there. Separately, though, however, the coverage, the origination of that product will be is an Apollo effort across the board. So it includes the origination resources that we have at mid-cap and at Apollo is sort of in our direct origination team, as well as sort of the originating we do and the relationships we have in the BSL market with issuers that are there now because one of the biggest holders of those market. So the sponsor origination of those transactions will be led by our team, at mid- cap in Apollo combined, but when they reach the size that they would have gone to the DSL market, they'll instead use this solution as opposed to sort of being funded primarily on mid-caps balance sheet, if that makes sense. From the BDCs perspective, and the people on this call, who aren't sort of, as plugged into Apollo, generally, the BDC has a right to sort of take its portion of whatever transactions it likes. It is less likely to do those transactions, both because of yield and structure. And then especially when it's only picking off the highest yielding stories. But that are asset secured, if you will or first lien, but that's not definitive they could do something. Does that make sense?

[Finian O'Shea:]

Yes, that's a lot of color. Thank you. And third, if I can do that. On the amendments that you said 23 have been done are in the works, is this mostly -- I assume these are mostly within the core mid-cap originated book not nothing legacy. And just a question on any color you can provide, are these companies tripping covenants? If so, are they maintenance covenants on EBITDA? Or are they getting ahead of a covenant that they my trip later this year is it proactive or reactive? Any context you can provide there?

[Howard Widra:]

Both. It depends on the company. It is generally -- there is almost never a time where they trip a covenant we get their numbers and it's tripped. They're going to call in advance and we're going to solve it in many cases, that tripping of the covenant or expectation is coming multiple quarters down the line, which is really what you're asking. So they're saying, okay, we're working through this over the next, two, three quarters or whatever, we want to come up with a solution that we know enables us to work our way through it. And so it has been both as Tanner said, there's 23 and only four of them were really sort of major, I don't know, what we would call it would be Sacred Rites types amendments. So they tend to be like yes, covenants relief like that's anticipatory, or even something more innocuous than that. So Tanner, I don't know, would you add to that.

[Tanner Powell:]

Yes. That's spot on. And then we're very sensitive not to be subjective in the aggregate of data. And so a much smaller subset of that 23 would actually even be more benign, as in certain of the borrowers that had access to the PPP program and would need relief there. And so we didn't want to -- we didn't obviously want to cherry pick, give a more comprehensive proposal. But other than that comment, would echo or corroborate as Howard described.

[Finian O'Shea:]

Okay. Thank you, everybody.

[Operator:]

Our next question comes from line of Ryan Lynch of KBW.

[Ryan Lynch:]

Hey, good afternoon. Thanks for taking my questions. Just had a follow-up question on the supplemental dividend. I just wanted to clarify that, that supplemental dividends expected to oscillate on a quarter-by-quarter basis as well as your expectation is that that will not necessarily 100% payout net operating earnings that there will actually be supplemental dividend that will actually probably come under net operating earnings and you will actually use some to build up book value is that correct?

[Howard Widra:]

Yes.

[Ryan Lynch:]

Okay. And then as far as your guys, right side your balance sheet, your capital position today, I've been a little bit surprised that you guys haven't made any material changes really, to the right side of your balance sheet as we've entered into this downturn. Do you foresee the need to making meaningful changes to the right side of your balance sheet or are you pretty happy with how it sits today managing through this downturn?

[Howard Widra:]

Greg, you want to go first?

[Greg Hunt:]

Yes, And I think currently I mean, I think we continue to look at it and when one I think it was really important for us to, update our crawl rating, which we were able to accomplish in July and also create our own liquidity on -- within the portfolio. And I think our next step will be to look at maturities. One of the things we haven't wanted to do was ladder another five-year maturity and top of the five-year maturity we have with the 350s. So we are looking at that from a ladder point of view. And on then we're also looking at spreads. We know that there's been for $1.8 billion issued on. And on -- so we are looking at our cost of capital overall. So I think it's something we continue to look at on and may or may not act in the next few quarters.

[Howard Widra:]

But I will say Ryan, like -- we do feel like our funding situation is stable, we have ample liquidity, we have good relations with the bank, we sort of shown them our capabilities of sort of operating in this environment. And so our decision on what to do is going to be driven by opportunity, as opposed to sort of a real immediate need, which I think is helpful because some of the things that were done immediately by some people were fairly costly. And so, I would, as Greg said, we'll continue to evaluate it. We would expect to sort of diversify and make some choices over the next couple quarters, but we want to do it in the -- in sort of at the time of our choosing because we think that will be much more cost effective.

[Ryan Lynch:]

Okay. Got it. Howard, in your prepared remarks, you kind of commented on said your corporate lending portfolio continues to perform pretty well. My question is if you look at slide number 16, you guys had about 7% increase per share in your corporate lending portfolio right up in the quarter. When you compare that to the $0.97 [ph] decline in that same category to corporate lending portfolio in prior quarter, I was a little bit surprised just given the recovery and loan prices, tighter credit spreads, we've seen several other BDCs, you market portfolio up a bit higher, given just the improving market condition. So, can you comment on why your portfolio didn't really seem to recover very much of the decline and I’m talking about specifically your corporate funding portfolio?

[Howard Widra:]

Yes. Well, I think first of all, I think last quarter as a percentage basis, we didn't go down quite as much. So our sort of our pickup would not have been quite as much from like on a -- on sort of on a gross basis. So I think that's the first thing. And I think the second thing is that we -- frankly, probably have a little bit more pent up upside than some of the other people who reported have down the road. I mean, I think we have we -- our approach to this has been to try -- to make sure that the valuations are driven by fundamentals as well as sort of the market flows, because that's more relevant. And so the recovery of a lot of these companies happens over the course of June and July. And so, we were not as forward-looking as maybe I think some of our competitors might have been.

[Ryan Lynch:]

Okay. Understood. I appreciate the time this evening.

[Operator:]

[Operator Instructions] Our next question comes from lien of Matt Jayden [ph] of Raymond James.

[Unidentified Analyst:]

Hey, everyone, afternoon and thanks for taking my questions. Just a quick one on Merx if I can. That new $5 million interest expense, was Merx able to cover that through cash flow? And then as a follow-up to that, if not, is there any risk of that toggling to pick? Thanks.

[Greg Hunt:]

Yes, sure. Thanks for the question. So, a couple of notes here. The first would be and I alluded to this in my prepared remarks, the experience in July as a number of the previously agreed to deferrals were expiring has been above our expectations. But I would caution everyone that there's still more deferrals to expire. And how many of those lessees, ultimately come back online will have a lot to do over the next three to six months with where things correct or how air traffic recovers. And so, we endeavored in that $5 million appreciating that there might be a need for capital at some point in the future as its path dependent to reflect a more steady state supportable earnings number. It's not our expectation right now that it would go pick. But I would imagine, as you can probably well appreciate, it will be a little bit past dependent, and again distress. While we don't want to extrapolate too far the early experience with lessees coming back online has been positive and exceeded expectations. And really two sources of strength there, again alluded to this in our -- in my prepared remarks, but the amount of government funding particularly in the U.S. has helped buoy lessees and their cash flow profiles. And then also in China and Asia more broadly things are close to 90% of pre-COVID levels, and the cash flows associated with lessees, the leases to those particular counterparties have held up really well and would expect to buttress earnings going forward. And so those are the drivers for the performance to-date. But again distress will be path dependent.

[Unidentified Analyst:]

That's it for me. Appreciate the color.

[Operator:]

And that was our final question. I'd like to turn the floor back over to Mr. Howard Widra for any additional or closing remarks.

[Howard Widra:]

Thank you. And thanks for everybody for listening to today's call. We all thank you for your continued support and interest in this environment. And obviously, please feel free to reach out and call any of us if you have any other questions. We hope everybody stays healthy and safe. Have a good day. Bye.

[Operator:]

Thank you, ladies and gentlemen, this does conclude today's conference call. You may now disconnect.