Apollo Investment Corporation
Q1 2014 Earnings Call Transcript

Published: 8 Aug 2013

[Operator:]

Good afternoon, and welcome to Apollo Investment Corporation's Earnings Conference Call for the period ending June 30, 2013. [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, everyone, for joining us today. With me today are Jim Zelter, Chief Executive Officer; Ted Goldthorpe, 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 of companies. You should refer to our registration statement and our shareholder reports for risks that apply to our business and 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've 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 Jim Zelter.

[James Charles Zelter:]

Thank you, Elizabeth. This morning, we issued our earnings press release and filed our quarterly report on Form 10-Q. I'll begin my remarks with some financial highlights for the quarter, followed by some other recent business highlights. Following my remarks, Ted will provide an overview of the market environment, and we'll review our investment portfolio activity for the quarter. And finally, Greg will discuss our financial results in much greater detail. We will then open the call to questions. Starting with the financial highlights, we reported net investment income per share of $0.25 for the June quarter. Our results were driven by stable recurring interest income, strong dividend income and a high level of prepayment income. While we are pleased with our quarter, Greg will provide detail regarding the recurring and nonrecurring portions of our results. Net asset value per share was $8.16 at the end of June compared to $8.27 at the end of March, a 1% decrease. As we stand here today, we estimate that our NAV has increased since quarter end, given the rally in the credit markets. On the asset side of our balance sheet, we continue to focus on secured investments, which we believe represent the best risk-reward opportunity in the marketplace today, and we are pleased with the current composition of our portfolio. During the June quarter, we invested $788 million, driven in part by strong activity in our specialty industry verticals. In addition, market volatility in late June -- in late May and in June allowed us to make opportunistic investments in the secondary market. Repayments and sales totaled $475 million and $105 million, respectively, for total exits of $580 million. The relatively high level of repayments was driven by opportunistic refinancings by several of our portfolio of companies. Accordingly, net investment activity for the quarter was $208 million. With respect to the portfolio's credit quality, investments on non-accrual status at the end of June were 1.1% of the portfolio on a cost basis and 0.3% on a fair value basis, down from 4.9% on a cost basis and 0.8% on a fair value basis at the end of March, as we exited several investments. Moving to some other recent highlights. The company held its Annual Meeting of Stockholders in a special meeting this past Tuesday. At these meetings, the company stockholders approved all 3 proposals. We greatly appreciate the support of our shareholders on these matters. Turning our discussion to the dividend. The Board of Directors approved a $0.20 dividend for shareholders of record as of September 20, 2013. Based on our closing share price yesterday and annualizing the dividend, our stock currently offers a dividend yield of approximately 10%. With that, I will turn the call over to Ted to discuss the current market environment and our investment portfolio.

[Edward J. Goldthorpe:]

Thank you, Jim. During the first half of the quarter, the credit markets remained firm, but beginning in mid-May, the markets became volatile due to comments made by the Federal Reserve. The market response to the potential stimulus tapering was significant, as treasury yields climbed, interest rate volatility increased, credit spreads widened and record bond outflows put additional pressure on prices. The bank loan market was less affected by the volatility, as investors began to divert money into floating rate bank debt. Common bond markets, favorable economic data and additional commentary from the Fed about their commitment to monetary accommodation helped markets recover and normalize by the end of the quarter. The mezzanine market remained very quiet throughout the quarter due to robust activity in the second-lien bank debt market and high-yield bond markets. Apart from the period of volatility during the quarter, we continued to see a mispricing of risk in secondary markets throughout the quarter. Volatility in June did provide an attractive opportunity for purchases in the secondary market. As a result, gross investment activity was more balanced between primary and secondary activity compared to recent quarters, which have been more heavily weighted towards primary origination. Given this market backdrop, we remain focused on direct origination opportunities within our specialty verticals during the quarter. During the June quarter, we invested $788 million in 23 new and 23 existing portfolio companies. This represents our second highest quarterly level of gross investment activity since inception, as we continue to focus on investing in secured debt, which accounted for 55% of the investments made during the period. Consequently, secured debt investments accounted for 48% of the portfolio at the end of June, up from 44% last quarter and 30% a year ago. We also received $105 million of proceeds from selected sales and $475 million from repayments. From a yield standpoint, the yield on our debt portfolio declined approximately 30 basis points to 11.6% at the end of June, down from 11.9% at the end of March. The decline in yield of our debt portfolio reflects the exit or repayment of some of our higher-yielding investments, partially offset by our ability to capture illiquidity premiums, as we continue to redeploy capital into less liquid assets. For the June quarter, the yield on debt investments made was 10.5% while the yield on debt investments sold was 10%, and the yield on debt repayments was 12.3%. I will now discuss some specific portfolio activity for the quarter. Beginning with our specialty verticals, our energy team invested approximately $220 million during the quarter, representing 28% of our gross investment activity. We invested $20 million in a first-lien term loan in equity to Caza Petroleum, an independent oil and gas company focused on onshore exploration, development and production in New Mexico, Louisiana and Texas, to fund its drilling program. Caza may draw an additional $30 million, the majority of which is subject to specified performance and financial requirements. We also invested $24 million in the unsecured debt and equity of Energy & Exploration Partners, a private oil and gas company, to support acreage acquisition and a development drilling program. In addition, we made investments into several of our existing energy portfolio companies. Merx Aviation, our aircraft leasing subsidiary, purchased 2 aircraft for $41 million and a sale-leaseback transaction. At the end of June, aircraft-related investments accounted for 6% of the fair value of the portfolio. In addition, during the quarter, we invested $60 million in secured debt of Skyonic, or Maxus Capital Carbon as shown on our financial statements, to support the development and construction of a chemical plant. As mentioned earlier, volatility in the quarter provided us with interesting opportunities in the secondary markets. Secondary market purchases accounted for 50% of gross investment activity. We invested $80 million in several mining companies, mostly in the secondary market, as we were able to leverage Apollo Global Management's expertise in natural resources. Notable investments that were sold during the period included our investments in the debt of Penton Media and our remaining position in Cengage Learning. The exit of our position in Cengage had a de minimis impact to NAV during the June quarter. Notable investments that were repaid in whole or in part during the period included our 2 secured debt investments at Ranpak, our unsecured investment in Advantage Sales & Marketing, our unsecured investments in Intelstat and one of our unsecured debt positions in Ceridian. With respect to Ceridian and Ranpak, we know these companies well and reinvested in both of them. As you may recall, we made a $67.5 million investment in Ceridian in the March quarter in anticipation of this repayment. With respect to Ranpak, we reinvested $22 million in a new secured term loan during the June quarter. As mentioned earlier, the high level of repayments generated significant prepayment income during the period. I will now review some general portfolio statistics as of June 30. We continue to be diversified by issuer and industry, with 94 portfolio companies invested in 31 different industries. The company's investment portfolio had a fair market value of $3 billion with 48% in secured debt, 39% in unsecured debt, 6% in structured products and 7% in preferred equity, common equity and warrants. Lastly, with respect to credit quality, we believe that the repositioning of the portfolio of the last 18 months into more secured debt has made the portfolio better able to withstand market and economic volatility, as evidenced by the decline in attachment points and improving interest coverage. To illustrate this point, let me provide you with some credit statistics. Based on our portfolio at the end of June, the weighted average net leverage of investments made through the first half of calendar year 2013 was approximately 4x compared to 6x for investments made in 2010. The weighted average cash interest coverage was approximately 3x for investments made in the first half of 2013, up from 2x in 2010. In addition, the weighted average risk rating of our portfolio measured at cost was 2.3 at the end of June, unchanged from the end of March. The weighted average risk rating of our total portfolio measured at fair value was 2.2 at the end of June, up from 2.1 at the end of March. And lastly, given our exits in Cengage Learning and ATI Acquisition, investments on non-accrual status declined to 1.1% of the portfolio on a cost basis at the end of June. With that, I will now turn the call over to Greg, who will discuss our financial performance for the fiscal first quarter.

[Gregory W. Hunt:]

Thank you, Ted. I'd like to remind everyone that in addition to our 10-Q, we have posted a financial supplemental presentation on our website. I will now discuss Apollo Investment Corporation's financial performance for the quarter ended June 30, 2013. Beginning with operating results. Total investment income for the June quarter totaled $96.7 million, a 14% increase from the March quarter and a 20% increase from the June 2012 quarter. The sequential increase is attributable to higher interest, dividend and other income. The increase in interest income is attributable to prepayment fees, and the higher dividend income is mostly attributable to dividend from structured products, a dividend from Ranpak and our investment in AIC Credit Opportunity Fund. With respect to AIC Credit Opportunity Fund, we wound down the First Data portion, which contributed additional dividend income during the period. As you may recall, the Credit Opportunity Fund dividend, relative to First Data, was historically recorded on an every-other-quarter basis. We now hold the remainder of our First Data bond directly on our balance sheet. Other income rose due to strong structuring and other fee-related income. Expenses for the quarter totaled $44.3 million. This compares to $42.6 million for the March quarter and $41.6 million for the June 2012 quarter. The sequential increase in expenses was mainly due to higher incentive fees due to the increased investment income generated during the period, as well as higher interest expense from a higher average outstanding debt balance. Net investment income totaled $52.4 million or $0.25 per share for the June quarter. This compares to $42.1 million or $0.21 per share for the March quarter and $39.8 million or $0.20 per share for the June 2012 quarter. Included in interest income for the quarter is $7.8 million of prepayment fees. Approximately $0.04 to $0.05 of our NII for the June quarter is attributable to these prepayment fees into other income. This compares to approximately $0.02 last quarter and $0.015 in the year-ago quarter. While early repayment impacts future interest income, we endeavor, where appropriate, to structure most of our investments with call protection, which generates income in periods of elevated prepayment activity. For the quarter, the net loss in the portfolio totaled $33.6 million or $0.16 per share compared to a net gain of $23.8 million or $0.12 per share in the March quarter and a net loss of $50 million or $0.24 per share for the year-ago quarter. The net loss for the quarter was mostly driven by unrealized losses on liquid positions due to the selloff in the high-yield market, partially offset by gains on a handful of investments. In total, our quarterly operating result increased net assets by $19 million or $0.09 per share compared to an increase of $66 million or $0.32 per share for the March quarter and a decrease of $11 million or $0.05 per share for the June 2012 quarter. Our total investment portfolio had a fair value of $3 billion at the end of June compared to $2.85 billion at the end of March. The increase was driven by positive net investment activity, partially offset by a slight portfolio depreciation. Net assets totaled $1.8 billion with a net asset per share value of $8.16 at the end of June. This compares to a net asset totaling $1.7 billion or a total net asset value of $8.27 at the end of March. On the funding side of the balance sheet, we continue to focus on improving our capital structure. The continued strength in the credit and equity markets during the first period of the quarter allowed us to improve our capital structure. In May, we raised $182 million of common equity, which was fully deployed during the June quarter. And in June, we issued $150 million of 30-year senior unsecured debt in the form of retail notes with a coupon of 7 -- 6 7/8%. We are also currently working on an improved credit facility. At the end of June, we had $1.1 billion of total debt outstanding, down from $1.2 billion at the end of March. The company's debt-to-equity was 0.61, down from 0.69 at the end of March. Our net leverage ratio, which includes the impact of cash and unsettled transactions, was 0.66 at the end of June, down from 0.7 at the end of March. The decline in leverage was attributable to our equity offering in May, partially offset by positive net investment activity during the quarter. In the June quarter, no investments were placed on non-accrual. As a result, at the end of June, the portfolio included 2 investments in one company that are on non-accrual status, representing approximately 1.1% of the portfolio on a cost basis and 0.3% on a fair value basis. We also, during the quarter, received an affirmation from S&P on our credit rating. Before opening the call to questions, I'd like to discuss our interest rate exposure, which we now -- which we know many of you have been focused on in the current environment. We have taken several steps to prepare our balance sheet for higher interest rates, including investing in floating-rate assets and issuing fixed-rate debt. As of June 30, 32% of our debt investments on a cost basis were floating rate, and only 12% of our funding sources were directly sensitive to interest rates. Approximately 91% of our floating rate debt assets include floors, with the vast majority of floors between 125 and 175 basis points. Given the impact of the floors, the first 100-basis-point increase in base rate decreased net investment income. But for every 100 basis points thereafter, the incremental net investment income is positive. For additional disclosure regarding the impact from interest rates, please see the financial supplement in today's quarterly report. With that, operator, please open the call up to questions.

[Operator:]

[Operator Instructions] Your first question comes from the line of Rick Shane with JPMorgan.

[Richard B. Shane:]

This quarter, in terms of the portfolio turnover, is the first time we've seen you guys experience what's been a broader industry trend, in terms of yield on new investments is lower than the stuff that's paying off. And I think we all understand the market dynamics that are driving that, and I think we also understand the condition of your balance sheet that gave you an opportunity to sort of offset that trend. Should we see this as the inflection point that the portfolio rotation is now largely played out? And we should think of your profile going forward is more consistent with what's going to happen over the -- with the overall market?

[James Charles Zelter:]

Well, first of all, Rick, thanks for following up with this question. I think that -- a few things. One is, as we sit here today, 1-year-plus after the new team, the new strategy was really put in place, we feel like we've accomplished a lot of goals on the investment side, and certainly, the portfolios in our hands today really reflects a lot of the success of that strategy. And you are correct, this was the first time that we've really seen a little bit of compression. But I think that we have a view right now of prudent optimism. We don't see the world melting in front of us. But as we get longer and longer in this credit cycle, we want to make sure we maintain our secured position to the degree we have. And if there is a pressure on new assets coming in, in terms of overall rate, that's okay because we feel we've got the portfolio on better shape. But I know that's -- listen, we see what's going on in the market. We see what's going on with our peers, and I think that, as Ted and Greg pointed out, some of our older positions got called out north of 12%. So I think -- I don't want to say we're at an inflection point, but I certainly feel like we have a handle on what we've done historically with our book, and we have a handle on where we're trying to take the book.

[Edward J. Goldthorpe:]

So I'll say a couple of things just to follow-up to that. I think it's going to be hard -- as we sit here today, if nothing changes in terms of the environment, yes, it's going to be hard to maintain the overall yield of our portfolio where it is, just given that we've done a lot of the high-grading of our portfolio and capturing the illiquidity premium. That being said, the magnitude of the spread decompression between our repayments and our purchases, we don't think this magnitude -- the magnitude of that difference is indicative of a trend. We don't think that size of a spread differential's going to continue, but I think at the end of the day, I think that the priority #1 of the management teams we're not going to stretch credit risk in order to maintain yields. And so from our perspective, the most important thing is being disciplined on the underwriting side, and so we're willing to sacrifice some yields in order to kind of protect our capital.

[Operator:]

Your next question comes from the line of Arren Cyganovich with Evercore.

[Arren Cyganovich:]

I just want to touch on the higher proportion of secondary purchases in the quarter versus primary originations. What exactly was driving that? And what comfort do you have in terms of the volatility of the more liquid assets that you had in the quarter?

[Edward J. Goldthorpe:]

Yes, I mean, again, I think this last quarter was a -- when the Fed made their comments and there's a lot of volatility in the market, we spent a lot of time with the broader Apollo platform taking advantage of the volatility. And so in this quarter, now that credit markets have settled down, we don't again -- some other comment I made before, we don't think the amount of secondary purchases we did this past quarter is indicative of a broader trend. I think it was us trying to take advantage of our low leverage and take advantage of what we thought was a temporary market correction to generate NAV for our shareholders. So I don't think -- on a go-forward basis, I think that the mix between primary and secondary is going to be consistent with previous quarters. I think this past quarter was really an aberration, just given the real downdraft in the credit markets post Bernanke's comments.

[Arren Cyganovich:]

Do you have an estimate or a number of what your quotable liquid securities are relative to your total portfolio?

[Edward J. Goldthorpe:]

Yes, it's about half.

[Arren Cyganovich:]

About half? Would you expect to...

[Edward J. Goldthorpe:]

Most people -- sorry, go ahead.

[Arren Cyganovich:]

I was just going to say, would you expect that to trend lower over time? I guess just been thinking about the rate environment, while you benefit from the -- obviously benefit from the interest side of when rates rights on a short-term basis when you have a steep in earned[ph] and credit spreads widened, I think the secondary stuff is going to be a little bit more difficult to deal with from an NAV perspective.

[Edward J. Goldthorpe:]

I mean, I think we're -- I think our stated strategy is to take advantage of the illiquidity premium in the market, and so I think what you'll see us continue to do is I think you'll see the proportion of our book that's quoted over the long term to go down. And number two is, to the extent that credit markets rally back, you would have to think that we would be taking advantage of that liquidity to kind of sell down certain sort of our liquid positions that we think have hit our price targets. So I think both those factors together would indicate, longer term, the amount of quoted securities in our portfolio should decline as a percentage of the overall portfolio.

[Arren Cyganovich:]

Okay. That's fair enough. And then on the dividend income side, I think you had in your Q that was $3 million was what you would refer to as nonrecurring, but the dividend was still relatively large on a quarterly basis. What else was driving that dividend income?

[Gregory W. Hunt:]

We also had the dividend from First Data, which was brought forward. So that also drove it. On a recurring basis, our dividend income is $3 million to $4 million.

[Edward J. Goldthorpe:]

I think -- I was going to say, I think, the reason dividend like recurring -- it's not -- it's a predictable dividend income, has gone up over the past 12 months, because clearly there's things in their like our Kirkwood investments and some of our structured products investment. So that is -- I think you have to bifurcate dividend income between what we view as relatively recurring, it changes a little bit from quarter-to-quarter, and relatively nonrecurring like special dividends.

[Arren Cyganovich:]

Understood. And the FTC back on the balance sheet, will that change the timing pattern of the dividends that you receive from them or will that still be a September, March kind of heavy dividend?

[Edward J. Goldthorpe:]

Yes, it's just going to be a reclassification. So if you remember in the Cotfunds [ph], every second quarter we would get a dividend from the Cotfunds. Now that it's brought back on balance sheet, it'll flow through on yield, and it'll flow through every quarter versus every second quarter on dividend income.

[Operator:]

Your next question comes from the line of Troy Ward with KBW.

[Troy L. Ward:]

Just real quick, talking around the same kind of questions that I have, to follow up on Rick's question on the portfolio yields. In the quarter, with the secondary purchases on Slide 8, it looks like in your deck, you talk about 10.5% on new investments. What was -- do you have the bifurcation of the secondary market purchases versus the primary market purchases? What's the different yields on the cost?

[James Charles Zelter:]

We do, we're just pulling it up for you now.

[Troy L. Ward:]

Okay, I'll go on and come back to you.

[Edward J. Goldthorpe:]

I'll just make a statement about it, which is a lot of the stuff that we bought in the secondary markets was lower yielding, because again, we wanted to take advantage of the volatility in the market, but again, we didn't want to take a lot of credit risk. So we bought a lot of things that we viewed as not high in credit risk but it had obviously, corrections due to the Fed comments.

[Troy L. Ward:]

Right, and that actually leads into my second question for a name like new publishing holdings, I see you bought it at like 92, maybe at 93, it looks like a percent of par. Would you use the snapback in the credit environments to maybe even move that out and lock in a higher gain? Obviously, your yields are on an annualized basis. If you could turn that into par in a quicker time frame, would you be looking to do that in the next -- this quarter? Or is it something you want to hold on to, do you think? Not that one in particular, but I'm thinking in general.

[Edward J. Goldthorpe:]

I think it's a great question. I mean, it's position by position, but I think that's right. I mean, our underwritten yield at maturity is oftentimes different than what our realized returns are. And so if you buy a position south of par, which trades up through our price target and through our yield target, I mean, this quarter we've been selling a lot of that stuff and monetizing our gains.

[Troy L. Ward:]

Great. And that kind of leads into my last question. We have seen that others -- obviously, we're talking maybe a little bit more lower and middle market things, but other managers have used this environment to move out of considerable amounts where they're getting good bids, in particular equity. And when and if you choose to do that, where do you think the next best opportunity is if happier credit, happier portfolio has a quoted mark, what if that environment is no longer conducive to new investments, how will you turn -- where will you turn to put those proceeds to work?

[James Charles Zelter:]

Well, I guess, and I think you're really homing in on a good topic. About a year ago, when we talked about a year, 1.5 year ago, like April of '12, we really talked about using the permanent nature of our capital to do a variety of illiquid strategies that we thought were a better risk-reward. And we've done that, whether it's in energy or aircraft. But we always maintained that in periods of dislocation, we wanted to be less levered to be more opportunistic, and I think what you saw in the June quarter was a period where our primary origination kept on going along, but we also saw market dislocation. And as Ted said, when we were able to buy high quality names at discounts to par, we did that opportunistically, and so as we see the market recover, because there was quite a bit of volatility, you should expect us, if things we don't believe are really accretive to our overall portfolio, on a name-by-name basis, we'll be monetizing those. But we don't want our primary objective to be diminished about trying to use our specialty origination to really continue to plow ahead. So it really is like -- what I'm trying to say is we want to have our cake and eat it, too. We want to be able to use our specialty silos to originate product, but because of our platform when we see dislocations we want to take advantage of them, which we did and we don't -- we're not afraid to monetize those in short order if they snap back past what we think is relatively good value.

[Edward J. Goldthorpe:]

The second thing I'd say is, and we've talked about this the last 12 months, we're really trying to use this environment to monetize or sell down positions that we think have material credit risk. And so this past quarter, we used the environment to monetize some of our more challenged investments, and I think on a go-forward basis, even though we think -- even if we think something is ultimately covered, if they've heightened credit risk, and we can do a proprietary origination, something we feel really, really good about, we'll sell that position.

[Gregory W. Hunt:]

Troy, just a follow-up on your first question. When you look at the composition of the yield on our originations for the quarter, 11.8%, was our primary origination yield, and our secondaries were 9.2%.

[Edward J. Goldthorpe:]

So that should just highlight what we talked about earlier it, which is we think maintaining yield in the book is obviously challenging given the environment, but this quarter was a bit of an aberration. A lot of our secondary purchases were lower yielding.

[Operator:]

Your next question comes from the line of Doug Mewhirter with SunTrust Robinson Humphrey.

[Douglas Mewhirter:]

Most of my questions have been answered. I just have a question might have -- you may have covered actually in the conference call, maybe I just misinterpreted it. The net realized loss in the quarter, was that from exit of a particular investment or is that more of the accounting treatment of the fluctuation in your portfolio?

[Gregory W. Hunt:]

It was principally, I mean, you did it from a -- on the realized side, okay, you had the realized losses on Cengage and ATI, although the marks were originally marked to that at the end of the March quarter. So it didn't have an impact on NAV, okay? The others were unrealized losses on our more liquid portfolio.

[Douglas Mewhirter:]

Okay, that clears it up. That's actually what I suspected, and that is all my questions.

[Operator:]

Your next question comes from the line of Chris York with JMP Securities.

[Christopher York:]

Following up on your discussions with Rick and Troy, was curious how you guys are thinking about leverage in the current environment given the rotation of your portfolio.

[James Charles Zelter:]

I think that we, again, going back to about last year, we always talked about trying to operate between 0.5 and 0.7. During the quarter, we are right in the middle of that in terms of like 0.61. So I think that we, as I said before, I think we're operating with a prudent optimism. I mean, we see a slow grinding positive economy, but yet we want to make sure we maintain the right liquidity, and we're really happy with the terming out of our -- we thought we'd be -- we're not market timers but between our debt and equity, between Greg and Ted really leading that charge, really, really very happy with what we did. So I think our -- we're comfortable with where we're operating right now and to Ted's comment about monetizing a few things, I think we're -- and when things rallied up, we're not afraid to sell those assets, which would take our leverage down.

[Christopher York:]

Okay. And then how are you guys thinking about allocation of investment capital going forward within your specialty verticals?

[Edward J. Goldthorpe:]

I think -- listen, at the end of the day, we're just looking for good risk-reward opportunities, first and foremost. And I think what we said previously is certain of our specialty verticals, we don't foresee -- today, we don't foresee a situation where any one of our verticals would represent more than 10% of our overall portfolio. But we continue to see our best opportunities out of our proprietary source channels versus secondary.

[Christopher York:]

Okay. That's helpful, and then lastly, it looks like you put some swaps on during the quarter. Can you talk about your hedging strategy?

[Gregory W. Hunt:]

Yes, well, the swaps are related to an investment we made in a student loan portfolio, which had a variable rate infrastructure inside of it. So we hedged that interest risk for the majority of the duration of the investment.

[James Charles Zelter:]

Yes. So the swap was not a portfolio hedge. It was really a package based on the overall specific investment we made. So we should -- don't read anything into our view on rates overall. Although we've always been wanting to fix long-term liabilities, but that was just a package really attached, if you would, to the individual investment itself.

[Operator:]

Your next question comes from the line of Robert Dodd with Raymond James.

[Robert J. Dodd:]

All mine have been answered.

[Operator:]

Your next question comes from the line of Matthew Howlett with UBS.

[Matthew Howlett:]

Just to follow on that, the student loan investment, did you buy it in a pool of student loans, like a mezzanine type investments?

[Edward J. Goldthorpe:]

So, yes, to get more specific, we leveraged off the overall Apollo platforms, an area we spent a lot of time on, to buy a portfolio of SELF[ph] loans, which are effectively government-guaranteed SELF[ph] loans, whereby, as Greg said, they do have an interest rate variability component to them. So we hedged out the interest rate risk associated with that.

[Matthew Howlett:]

Got you. And okay, great. Just on the liability side, you guys have done a great job basically on long-duration debt, 30-year paper. You have some stuff coming due, I think, in '15. How do you feel about drawing the bank line down? And then on that front, could you even -- we've seen some of the BDCs come back with a lower pricing on that. I mean, given you've been there a year, you've turned the portfolio around, you termed out some debt, would you feel more comfortable drawing on the bank line at some point in time? And wouldn't that go to improve your margin? It seems like your liability costs are -- while you're lying[ph] out on the curve, it seems that they could come down, so there could be just more work done on that side over time.

[James Charles Zelter:]

Yes, I think we want to be balanced in our approach. And certainly -- if we had a view that rates were not going to go up for a long period of time, we'd be using a lot of our revolver and wouldn't pay the incremental liability cost, but there's a bit of a balance. So I think -- we have some upcoming maturities. We're very comfortable. We have access to the market. But certainly, we want to balance the short-term benefit of having lower cost of funding and having a long term robust capital structure. So we're -- but to your last point, Greg alluded to it, we feel very comfortable that the marketplace is affording us some very interesting opportunity with our revolver group. We have a great group of banks, and I would suspect that, as Greg mentioned, that there's some progress being made on that front to benefit us, as a company, and our shareholders in that regard.

[Matthew Howlett:]

Okay, great. We look forward to that. You've done a nice job of the past year, on the liability side certainly. And then just on origination fees, I mean upfront fees you take, I mean, and if you look[ph] at them all for every BDC, but what can you tell us about how we should look at that for next year?

[Edward J. Goldthorpe:]

Yes, I think, maybe back past our fees over time, you have to break them out between fees from repayments and fees from origination. And fees from repayments are very volatile. So those have -- in some quarters, have been 0, and this current quarter, they're between $0.03 and $0.04. So the -- by and large, our origination-related fees are really consistent. Quarter in, quarter out, they're somewhere between $0.01 and $0.02, and it's just the nature of charging upfront fees in our investments. So the prepayment fees, I mean it's not going to be any surprise to anybody in the call, are much more volatile and we obviously, had a strong repayment income quarter this quarter, but origination-related is very, very consistent between $0.01, $0.015 and $0.02.

[Matthew Howlett:]

Right, and I know that people tend to look at prepayment fees and backed out but I mean, that is, to a certain extent, a recurring part of the business model. I mean, is it not? I mean, in the sense that you put those in the structure then you sort of -- you collect them sort of when things come -- the way you get called upon, is that sort of a recurring view? Should we take a view on that?

[Edward J. Goldthorpe:]

Yes, it's almost like, I mean, the way I think about it, it's a recurring, nonrecurring revenue. So we don't know where it's going to come from, but it just seems like pretty consistently -- we've done a lot of studies on this, obviously, and especially after our peers have all reported. We back test our fees over time. There's a relatively consistent stream of fee income that comes into this vehicle, and the one part of it that is a little bit more volatile, as I said before, is the prepayment side of it.

[Operator:]

Your next question comes from the line of Mark DeVries with Barclays.

[Mark C. DeVries:]

First question just had a follow-up on the SELF[ph] residual investment. Did you comment on what the yield is on that investment?

[Edward J. Goldthorpe:]

I don't think we commented on it but you can expect it to be north of 10%.

[Mark C. DeVries:]

Okay. And I'm assuming, while you didn't comment on it, this is from one Sallie Mae's recent sales. I know they'd commented that pricing has improved on those sales. But also it's still not even at levels where they view it as economic to do many more of them. Should we assume that, that opportunity is not something you'd expect to be able to follow up on?

[Edward J. Goldthorpe:]

I mean, I think, yes, I think the transaction we did was one of the first ones they did, and I think subsequent to that, they have come out publicly and said that yields have been coming down. So again, we don't think we're going to be a large student lending investor. We think it's a relatively opportunistic investment for us that we felt was very favorable risk-reward.

[Mark C. DeVries:]

Okay, got it. And just one question on the Ceridian investment. Was your interest in that supported just by the in-place cash flows to support the leverage there or is it all kind of dependent on some of their plans to unlock value there, like some of the IT investments they've been making and thoughts on splitting the payroll and payment processing side of the business?

[Edward J. Goldthorpe:]

I think that there's 2 parts to the Ceridian business, and we feel really, really good about both of them. One of them is obviously very subject to float income, which has suffered in the low interest rate environment. So as interest rates go up, that side of the business should actually benefit. The other side of their business is doing very well. They just came out with earnings so we feel very good about our investment there.

[Operator:]

The next question comes from line of Jon Bock with Wells Fargo Securities.

[Jonathan Bock:]

One item, guys, as it relates to the risk of a syndicated, more opportunistic investment strategy. Can you walk through what the downside scenario is to the extent that one is long, highly-liquid leveraged securities at a point when the Fed perhaps in September is going to startle the market again with Fed tapering comments.

[Edward J. Goldthorpe:]

I think the way I'll answer that question is indicative of the yields where we bought the secondary purchases, we think that we are buying things that we thought had very minimal credit risk. It's 9% versus much higher than that on the rest of our portfolio. Number two, we want to be very clear we are not a market timing vehicle. We are not trying to trade the markets, we just saw a lot of value created in the month of June, July that -- sorry, May and June, that we thought we could buy things that we thought were very safe, had reasonable yield attached to them, that we felt good about holding them through the cycle. So that was kind of our perspective.

[Jonathan Bock:]

Appreciate that. Then I guess another question is, is to the extent that this is a kind of a question that would just sit in the mind of today's investors as they kind of look at fees or the management structure, and you guys have been favorable on several items. But to the extent that a good amount of syndicated debt doesn't enter in the model from time-to-time, as you're opportunistic, is 2 and 20 the correct fee structure on those types of assets?

[James Charles Zelter:]

Well, Jon, I think that -- we take a step back. I don't want to -- I think the last 1.5 years, we have shown that the platform AGM has -- between our origination, between what we've done with the portfolio, the aircraft, the energy, the student loan, we bring a lot to the table on broad origination, and those, in and of themselves, merit the structure of the fee structure along with many of our peers. So we believe that we have -- our investors actually benefit from having an additional ability, being part of a $60-billion-plus credit platform, where we're also able to add the ability to have a view on a variety of market credits. So I don't want you or the other analysts or shareholders to be -- to take the view that we are a liquid portfolio. We are not. We are primarily a portfolio trying to take advantage of our permanent capital with a variety of proprietary origination. But when we can add to that appropriately, with the right risks, understanding the impact of volatility -- and the message you should be getting here is we bought some stuff that we thought was attractive in a vacuum, and we are not going to hold that to duration. Those are assets that, if they go up a variety of points past what we think is fair value, we are not afraid to sell those and monetize them. But again, I go back to the initial premise. There's a long-standing convention about structure and fees in this business. And if anything, we are very comfortable that our recent experience, especially in the last 1.5 years, has shown the breadth of the value that the franchise brings to be an appropriate counterparty in those fees.

[Jonathan Bock:]

Appreciate the color. And then in terms of leverage, talking about leverage in new deals, you mentioned a desire to -- Ted, to kind of maintain a yield spread as best as one can. And if I look through new investments, Deltec [ph] or others, at what point does leverage get to be a bit too high in what you're finding in your nonproprietary vertical, leaving energy and aircraft aside, at what point do you find leverage to get too high relative to the spreads that one is getting today in a hyper-competitive environment?

[James Charles Zelter:]

I guess, I would say -- how I think about that philosophically is, if we are in a environment where we're continually booking lower yields on our portfolio, that would merit to me a lower leverage number in the historic range and we've -- if we've operated historically, 0.5 to 0.7, but we find we're going into a new zip code of origination, that we believe is indeed the case for a while longer, we would probably be operating in the lower end of that, i.e. 0.5 to 0.6 or maybe even lower, if yields went lower on our front book. So I think yield and your leverage go a bit hand-in-hand. And if you're able to -- depending on how you think about the overall leverage of the book, I mean, we just want to be -- as I said, there's -- we operate right now with what I'd call a prudent optimism. Do we think that the credit markets are going to have a meltdown anytime soon and there's lots of pockets of distress? We don't. But at the same token, we want to be very thoughtful about adding incremental credit risk in a declining yield opportunity.

[Jonathan Bock:]

I appreciate that, and maybe I can rephrase a bit. Leverage levels on new investments at which you're entering in at? So let's say, for example...

[James Charles Zelter:]

I'm sorry. Let me -- I thought you meant the overall, I'm sorry.

[Edward J. Goldthorpe:]

So by and large, Jonathan, your comments are accurate, which is, by and large, we feel like the syndicated markets are taking up leverage to areas that we don't feel comfortable with, and pricing them in a way that we also don't feel comfortable. But I think we've been able to find pockets of the market where we think it's not the case. But as I mentioned in my prepared comments, the average leverage of our investments in 2010 was 6x on new originations. Year-to-date, it's at 4x. So it's 2 turns less leverage what we were originating in 2010. Our interest coverage has gone from 2x to 3x. So although the overall market, we think, has gotten to levels that we feel relatively uncomfortable with on a broad-based -- on a broad basis, I think we're still finding one-off opportunities to originate assets at what, we think, are low leverage levels with continued high yields.

[Jonathan Bock:]

Appreciate that. And as you are focusing in on those high quality, let's say, lower leveraged or lower leverage level per unit of return-type investments, which lots of people are looking for in this environment, how should we look at repayment velocity over the next several quarters, particularly for your portfolio of existing assets that are performing and do have, in some cases, higher yields. Is that a trend you would expect to persist, particularly what happened this last quarter, for the remainder of 2013?

[Edward J. Goldthorpe:]

The answer is -- I think some of our peers have made a similar comment. The first 6 months of this year a lot of the activity that was going on with -- in the sponsor -- in our sponsor business or on our -- any kind of primary deals, a lot of it was repricing activity not net new activity. I think what we've seen the last -- at least the last couple of weeks, is we're seeing a lot of the repricing has kind of flowed through the system. We think a lot of the activity we're seeing today is actually new activity. So a lot of our pipeline today is not repricing the new activity, and what that means is I think the mix between repayments and sales on a go-forward basis is probably going to skew a little bit towards -- and then this ties into the comments we're talking about before. I think you'll see, of our exits, a higher percentage of our exits on a go -- this quarter, are going to be from sale activity is our desk[ph] versus payments.

[Operator:]

Your next question comes from the line of David Chiaverini with BMO Capital Markets.

[David J. Chiaverini:]

A couple of questions. The first -- so you spoke about being better positioned for rising interest rates, but your percentage of floating-rate investments decreased to 32% from 35% in the quarter on a cost basis. Now was that more a function of the opportunistic purchases you discussed, and it's more transient or is there anything else behind that?

[Edward J. Goldthorpe:]

I think, I mean, listen, again, I wouldn't read into it too much. I think, I see 2 things. One is I think a lot of people that focus on floating-rate exposure, for you to get the benefit of -- and this is all disclosed in our 10-Q, but to get the benefit of floating-rate, short-term rates not long-term rates, but short-term rates have to rise pretty materially, 100 basis points. So with that comment in mind, I think #1 is I think this quarter, I wouldn't read too much into what happened this past quarter. We exited some very large investments that were floating and there was a -- certain of our purchases were in fixed-rate assets, but I don't -- I think, over time, as we shift more towards bank debt, senior secured, I think you'll see the trend of our assets moving more towards floating continue over time.

[David J. Chiaverini:]

Okay, got it. And then, so you made a decent amount of energy investments in the quarter. Could you talk about the opportunities and in the risk-reward you're seeing in that vertical on a go-forward basis?

[Edward J. Goldthorpe:]

Yes, I mean, I think the trends continue. I mean, just a voracious demand for capital. Where oil prices are today, there is the economics of individual wells is just so massive that we're finding that the -- a lot of energy companies prefer to take on extensive debt capital than issue equity. And so I think what you'll see over the next -- I think the trend will continue. I think -- we continue to see just great value in that vertical, where we feel really, really good about downside protection. So first-lien senior-secured risk. The underlying borrower is hedged. So we don't feel like we're taking a lot of commodity risk. And a lot our recent investments have been yielding 12% to 15%. So we don't know how long it's continue for, but as we sit here today, the opportunities for energy continues to be very positive.

[Operator:]

Your final question comes from the line of Troy Ward with KBW.

[Troy L. Ward:]

Yes, Jonathan Gerald Bock answered -- asked most of my questions, but one I had left was kind of the 30% bucket. We're seeing a lot of BDCs actively use that, and is there anything that you're looking at in the market that maybe would go into the 30% bucket? And then secondarily, how much is already in your 30% nonqualified bucket?

[Edward J. Goldthorpe:]

So when -- as Jim mentioned earlier, when we set all of our goals 18 months ago, we feel like we've done a really good job of achieving most of them. The one big opportunity in our business that we continue to have is to continue to better optimize our 30% bucket. Greg will go through with you the exact numbers. We continue to have a lot of capacity within the 30% basket. And number two, within our 30% basket, there are a number of securities in there that are liquid. So to the point -- to the extent that we find very, very, very high quality 30% opportunities and to the extent we get capacity constrained, we feel like there's other assets in there that we can sell down to make room.

[Gregory W. Hunt:]

Right, and I think when you look at our capacity, we're -- we have over 10%. We are about 20 -- a little bit under 20%. So we have another 10%, so over $300 million of capacity at the current time.

[James Charles Zelter:]

And that doesn't -- as Ted pointed out, Troy, we got 10% on face and then there's a fairly strong liquid portion of our 30% bucket. So we can certainly reallocate for higher, more efficient yields to our book if we need to.

[Operator:]

I would like to turn the call back over...

[James Charles Zelter:]

Great. Thank you, operator. Again, we appreciate the support. This is another quarter where we really believe we've really executed on the plans we laid out in the middle of -- the beginning and the middle of '12. We appreciate the support from all of our constituents, our shareholders and our analysts. And, as usual, we're all always open for dialogue and inquiry. Thank you for your time.

[Operator:]

This concludes Apollo Investment Corporation's Earnings Conference Call for the period ending June 30, 2013. You may now disconnect.