Capital Southwest Corporation
Q2 2021 Earnings Call Transcript

Published: 2 Nov 2020

[Operator:]

Thank you for joining today's Capital Southwest Second Quarter Fiscal Year 2021 Earnings Call. Participating on the call today are Bowen Diehl, CEO; Michael Sarner, CFO; and Chris Rehberger, VP Finance. I will now turn the call over to Chris Rehberger.

[Chris Rehberger:]

Thank you. I'd like to remind everyone that in the course of this call, we will be making certain forward-looking statements. These statements are based on current conditions, currently available information and management's expectations, assumptions and beliefs. They're not guarantees of future results and are subject to numerous risks, uncertainties and assumptions that could cause actual results to differ materially from such statements. For information concerning these risks and uncertainties, see Capital Southwest's publicly available filings with the SEC. The company does not undertake any obligation to update or revise any forward-looking statements, whether as a result of new information, future events, changing circumstances, or any other reason after the date of this press release, except as required by law.

[Bowen Diehl:]

Thanks, Chris. And thank you everyone for joining us for our second quarter of fiscal year 2021 earnings call. Throughout our prepared remarks we will refer to various slides in our earnings presentation, which can be found on our website at www.capitalsouthwest.com. We are pleased to be with you this morning to announce our results for our second fiscal quarter ended September 30, 2020. I want to first say that I hope everyone, their families and their employees continue to be safe and well. Here at Capital Southwest, we have continued to prioritize the health and safety of our employees and the employees of our portfolio companies. We remain in regular dialogue with our portfolio company financial sponsors and management teams and have been pleased with the overall performance of the portfolio. We have been most impressed with the management teams and financial sponsors' ability to manage all aspects of company performance, including protecting our employees, while increasing operating efficiencies during these unprecedented times. While the pandemic is not yet behind us, as we look back to where we were in March 2020 with so much uncertainty and market volatility, we are very grateful for all the work done by the team here at Capital Southwest and the teams at both our portfolio companies and financial sponsor clients. We're also extremely pleased with the performance of our portfolio and we remain highly confident in the quality of the assets and its earnings power. During the quarter, our portfolio performance continued to improve as evidenced by $8.4 million of net appreciation across the portfolio. For the quarter we had two loans which had investment rating upgrades. We had no investment rating downgrades and we had no new loans placed on non-accrual. As a well-capitalized first lien lender with ample liquidity, Capital Southwest continues to be in a favorable position to seek attractive financing opportunities and to provide financial support to help our companies grow. Executing our investment strategy under our shareholder-friendly internally managed structure closely aligns the interests of our board and management team with that of our fellow shareholders in generating sustainable long term value through recurring dividends, capital preservation and operating cost efficiency. On Slide 6 of the earnings presentation, we have summarized some of the key performance highlights for the quarter. During the quarter we generated pre-tax net investment income of $0.44 per share, which more than earned our regular dividend paid for the quarter of $0.41 per share. We also continued our supplemental dividend program paying out an additional $0.10 per share, funded by our sizable undistributed taxable income balance. Total dividends for the quarter of $0.51 per share represented an annualized dividend yield on the quarter stock price per share of 14.5% and an annualized yield on net asset value per share of 13.3%. I'm also pleased to announce that our board has declared total dividends of $0.51 per share again for the quarter ended December 31, 2020, consisting of a regular dividend of $0.41 per share and a supplemental dividend of $0.10 per share.

[Michael Sarner:]

Thanks, Bowen. Specific to our performance for the September quarter as summarized on Slide 17, we are in pre-tax net investment income of $8.1 million or $0.44 per share. This was a 13% increase from the $7.2 million or $0.40 per share earned during the prior quarter. We paid out $0.41 per share regular dividends for the quarter flat from the $0.41 regular dividend per share paid out in the prior quarter. As mentioned earlier, our board has also declared a further $0.41 regular dividend per share to be paid out during the December quarter. In the near and long term, we have built a consistent track record of meaningfully covering our regular dividend with pre-tax net investment income, as demonstrated by our 103% regular dividend coverage over the last 12 months and 106% cumulative regular dividend coverage since the launch of our credit strategy. During the quarter, we maintained our supplemental dividend at $0.10 per share and again, our board has also declared a further $0.10 per share supplemental dividend to be paid out during the December quarter. As a reminder, the supplemental dividend program allows our shareholders to meaningfully participate in the successful exits of our investment portfolio through distributions from our UTI balance. As of September 30, 2020, our estimated UTI balance was $1 19 per share. Our investment portfolio produced $16.7 million of investment income this quarter, with a weighted average yield on all investments of 10.4%. This represents an increase of approximately $1.5 million from the previous quarter. As Bowen mentioned, we had no new non-accruals as of the end of the quarter. Currently, three assets remain on nonaccrual with a fair value of $10.9 million, representing 1.7% of our total investment portfolio at fair value. The weighted average yield on our credit portfolio was 10.3% for the quarter.

[Bowen Diehl:]

Thanks, Michael. And thank you everyone for joining us today. Capital Southwest has grown and the business and portfolio have developed consistent with the vision and strategy we communicated to our shareholders almost six years ago. Our team has done an excellent job building both a robust asset base as well as a flexible capital structure that prepares us for difficult environments, like the one we have experienced over the past several months. In fact, difficult environments like this demonstrate the investment acumen of our team at Capital Southwest and the merits of our first lien senior secured debt strategy. While we are not immune to the challenges the economy faces today, we feel good about the health of our company, and the opportunities that the environment will present to us, as we consider places to invest capital. Everyone here at Capital Southwest is totally dedicated to being good stewards of our shareholders' capital by continuing to deliver strong performance and creating long term sustainable value, even in challenging times such as these. This concludes our prepared remarks. Operator, we are ready to open the lines for Q&A.

[Operator:]

Yes, sir. Our first question or comment comes from the line of Michael Smith from B. Riley. Your line is open.

[Michael Smith:]

Hey, congrats on a very strong quarter. So my first question would be, you had a very good quarter of origination activity despite some of the COVID headwinds, so I was wondering if you can maybe size the pipeline, and just talk a little bit about the quality of deals you're seeing now, just in terms of pricing covenants, attachment points, etcetera?

[Bowen Diehl:]

Sure, thanks for the question. We thought the quarter origination was very strong, it included both new portfolio companies, as well as four add-on acquisitions at our portfolio companies. And right now, I'd say the pipeline is about average. So it's still solid, but it's about average. As far as what we're seeing in the market, we do think that the most all -- if not all of the pre-COVID premium, if you will, on a yield basis or spread basis is disappeared. There might be slight in certain deals, but certainly a lot of cases, the premium, the pre-COVID, or the COVID premium has decreased. With respect to leverage attach points, I think we're still seeing leverage attachment points slightly below pre-COVID levels. And covenants are still strong, and the EBITDA adjustments, and those types of things that you see in credit docs are still really strong in the lenders favor, I should say. And as far as quality deals, we definitely are seeing quality deals, certainly seeing low quality deals too, low quality being defined as companies that we still can't underwrite COVID performance. But we're seeing a fair amount of quality deals. And if you look across the business descriptions of the companies we originated this quarter, I mean, software, government services, cyber security, internet marketing-type companies, there's really interesting business models, especially in this environment. So, our team has done an excellent job, they've got a very wide array of network -- a network of relationships, and they've done a fantastic job monetizing those relationships through the form of originating quality deal flow.

[Michael Smith:]

That's very helpful color. So another question would be on leverage, you're currently sitting at 1.28 times and, if I'm not mistaken, I think the previous target was one to two. So I'm just wondering, how are you thinking about leverage moving forward here? And are you comfortable with it being slightly above your target?

[Bowen Diehl:]

Sure. I'll make a macro comment just with respect to leverage as it relates to economic cycles. In a recessionary challenging environment, you might be willing to go to one leverage level and in a peak, everything's wonderful marching forward like we were a year ago, you want to be in another leverage level. And so you don't want to maximize leverage at the high end of the cycle. And you might be willing to have leverage increase at the low end of the cycle. And you want to go into the cycle with leverage low, so that you can manage leverage down in the cycle. So what all that means, if you think about leverage up to 1.28, the answer is, yes, we're comfortable with where we are. It is higher than our 1.1 to 1.2 target range we gave pre-COVID. If you look at -- if you just take a high level, look at the depreciation in the portfolio during COVID, retracing that COVID effect on the portfolio, we're basically back to the top end of our leverage range and so, you have to keep in mind that as the portfolio re-appreciate that leverage, all else equal will come down. So that's one point and why I can say we're comfortable with where we are. The next thing is we've got visibility on $30 million to $35 million of pre-payments coming in from portfolio companies that are performing very well and are being sold or refinanced or what have you. So if you of think about leverage, we have visibility on cash coming in. So we'll obviously be redeploying that cash in originations. But that's another point. And the third thing I would say is, if you think about -- we traded well above book for almost two years pre-COVID. So I believe that we've proven that our business model and our strategy in a more normal market should trade above NAV. So if it's trades above NAV, as you know, we've got an ATM program that we're diligent about accessing at very low spreads to trade. So that's obviously a function and our yield on NAV today is 13.5% or so. And on the stock price, it's north of 14%. The market will figure out the risk premium on our stock over time. So we're comfortable and just letting the market play out. But those yield levels, based on our strategy and track record, really are not where we believe those yield levels will normalize out over time, which we believe will trade above NAV and we'll be able to raise equity. So, those are all the points that are in my head, as I look at the leverage of 1.28 and go, am I comfortable with that or not?

[Michael Sarner:]

Yes, I was just going to say, just from a company profile perspective, our asset mix is a little different now than it was a year ago, we were probably in the mid-80s on first lane and our 91% first lien, we had a few -- probably two to three sub debt investments send today, we have one sub debt investment. And our equity percentage of the portfolio was probably in the low 20% and now it's sub 10%. So our overall profile is a lot stronger than it was then. So you could probably take on a little more leverage based on that profile.

[Michael Smith:]

Yes, that's all very helpful. And then one more high level question for me, if I'm not mistaken, I think $631 million is a record portfolio size. So just given your outlook for the origination environment, and the potential for an SBA license, I'm wondering what kind of portfolio size can you support with your current infrastructure?

[Bower Diehl:]

Yes, so we've managed costs, we look at operating leverage, and so we think as the portfolio grows, we're looking at the operating leverage number. So as our portfolio grows, we can invest in staff and resources. So our dollar costs will go up over time, but that's what we look at as a percentage of our assets. And so, as we layer in the FDIC, as we continue to grow the portfolio, we will add people, but we manage it to that operating leverage number, because that's really what the shareholders should care about is that that percentage drag, if you will, on the income and the portfolio from overhead that we're spending. So we look at that metric and we absolutely add to resources as we grow the assets.

[Michael Smith:]

Got it. Well, thanks for taking my questions. I'll let somebody else ask a few. Thanks.

[Operator:]

Thank you. Our next question or comment comes from the line of Mickey Schleien from Ladenburg. Your line is open.

[Mickey Schleien:]

Good morning, Bowen and Michael, nice to hear from you. I wanted to follow up on the prepayment risk. I think we're living in a world of haves and have-nots in terms of the portfolio companies. And there's a lot of private debt capital out there chasing, what I would say, still a limited deal pipeline, when you consider the constraints everyone has on underwriting. Meanwhile, there is potential changes in tax rates, and that could catalyze some business orders to sell now this quarter. So, with those trends in mind, how high do you feel prepayment risk is in your portfolio, given the strength of some of your investments, besides the two that you've already mentioned in the prepared remarks?

[Bowen Diehl:]

Thanks for the question. I mean, to the quantify the number, it's $30 million to $35 million of prepayment, so we have some visibility on. With respect to the environment and tax regime changes, theoretically as we move into the end of the year, because of potential pending capital gains, treatment changes that could definitely influence deal flow. I would say that I I'm not as certain that people are going to make, especially with the aging entrepreneurial population that are monetizing their retirement in these businesses is what's generating a lot of sales across the lower middle market. I don't know that founder of own business makes a rash lifetime decision, 30 days here or there based on a tax change. If they were already thinking about selling their business, it could absolutely accelerate it and push it into this this year. I would also say that we won't know until tomorrow or hopefully soon after the election change, and you would have more visibility on a theory on tax change, it'd be hard to launch a sale process right now and get it sold by the end of the year. So long way of saying, I don't know that the tax changes necessarily were going to dramatically change, there certainly are prepayment risks. But look, as a lender, the strongest performers get pre-paid refinance, especially in the lower middle market ,where traditional banks maybe aren't willing to lend to some of these companies we are. And then, the traditional banks in the case of Danforth refinances out. I mean, that's a process. And so, there's a vast majority of portfolio companies are just going along, growing, and we end up holding loans for a couple years, then you have the star performers, and of course, you have a small universe of guys that underperform, if that makes sense.

[Michael Sarner:]

Yes. And also to say, some of the deals that are set to repay were on our list of deals that could occur. So that's being taken off the register. So what we're left with is a lot of companies that we've refinanced over the last two years. So, we actually feel like we have a good sense that there's not going to be another $30 million to $50 million in the next quarter after that. So I feel like a lot of the stuff that's happening right now.

[Mickey Schleien:]

That's helpful. I appreciate that. And Bowen, I wanted to touch on the non-performing loans, if I'm not mistaken, they're all in certain stages of bankruptcy. And I think there's been some movements since our last call. So starting with American Addiction, from what I've read, the information is a little sparse, it looks like you're going to be repaid in cash on that from asset sales. Is that correct? And when will that be?

[Bowen Diehl:]

So based on what's public, it's going to emerge from bankruptcy relatively soon. It'll be restructured. So the lender group, personally lender group, which we are a part of, will end up holding a debt security, first lien debt security in the new restructured company, and then ownership of the equity in the company. So it'll be restructured, it will emerge from bankruptcy and Capital Southwest actually will have a board seat. And so, that's that, it will all be resolved relatively soon. I mean, it's not in our control, but it's basically got to work through taxes and various things, structuring the recap, the restructuring, so that's AC. Anyway, you want to talk about Kings and CPK, as well?

[Mickey Schleien:]

Well, before we go into those, you will end up with a performing piece of debt in AAC at some point, maybe next quarter?

[Bowen Diehl:]

That's correct; that's the expectation.

[Mickey Schleien:]

So CPK, it looks like similarly you're going to get equity and debt. Is that correct? And when is that going to happen?

[Bowen Diehl:]

Similar story as AC as far as what will happen from the bankruptcy perspective. So we'll end up with a performing, firs lean note and equity in the company, we will not have a board seat in that instance. We think that's going to happen -- I think it may be announced, but it'll be relatively soon.

[Mickey Schleien:]

Right. And what's the game plan for CPK? I mean, I've been reading headlines where lenders, surprisingly, are taking over some of these restaurant businesses despite everything that's going on in the world, obviously thinking that in the long term there must be value there. I think you've mentioned in the past that CPK was doing pretty well prior to the pandemic, but looking ahead, are there any major changes you expect to implement with the other owners at CPK? Or you're just going to wait for COVID to run its course and hope for things to improve?

[Bowen Diehl:]

I appreciate the question. And obviously, I'll give you my couple of points of my view, but want to be very careful of the confidentiality around that company, I think everybody understands that. But I will say that this manager team seems to be doing a really good job with the business. And it's one thing, and then the other thing is that the restaurants that have opened, people come eat there, and so it tells me that the brand is relevant, and it's desired, and there's a demand for that brand and that concept in the market. So that's encouraging. Clearly COVID is a bunch of noise out there. It's affecting all the restaurants, the management team is doing some interesting creative things around that, with respect to CPK. The election and any kind of unrest that may result -- unrest in an area affects all the retailers, all the places, restaurants included in those areas. So there's clearly noise out there. But the thing I grab on to is manager team is seem to be doing a great job, we have weekly calls, and the restaurants that are open, people want to eat there. And so, based on those two things, that gives me a lot of encouragement as to the future of that concept once all the market noise, COVID pandemic noise sort of fades away, which will, this too shall pass. And so, still challenges, but good team, and there's some definitely some signs of relevance of that concept and brand.

[Mickey Schleien:]

I understand that. That's great. Thanks for that. And on AG Kings, obviously there was a stalking-horse bid. I haven't seen another bid come through unless I'm mistaken. Is that correct? Or are there other folks snooping around and potentially going to offer?

[Bowen Diehl:]

Yes, so that's actually been announced, and they signed a purchase agreement to sell the Albertsons . That's in a process of closing/documentation process. And it's pretty much all I should really say about it, but our evaluation is the best guess on waterfall analysis around the proceeds on a sale.

[Mickey Schleien:]

Okay, I didn't see that Albertson announcement. Thanks for that. And finally, just a balance sheet question. Is there any restriction on using the remaining borrowing base in the credit facility to help fund the SBIC once you get the license? And at the same time, can you contribute at least part of your positions in your existing lower middle market portfolio to capitalize it?

[Michael Sarner:]

Yes. We're able to draw on the revolver to fund the equity. And in the plan going forward, we expect to get the license, as we said earlier, by the end of the year, and then we'll start originating assets, and the collateral will get allocated between the revolver and the FDIC. And we think that's important from a capital flexibility standpoint, I think you've seen other BDCs that are solely focused on FDIC, and when things go bad, they don't have enough collateral in a revolver to be able to draw. And that's obviously a cash flow issue. So we will be ramping up our revolver, in fact, to both pay down some of the 5.95% bonds, as well as to accommodate originations that are not in the FDIC going forward.

[Mickey Schleien:]

I understand, and Michael, can you sort of warehouse lower middle market deals now and contributing to the SBIC once you get the license to move things along?

[Michael Sarner:]

The answer is you can, but the answer is there's a process you go through, we're not going to do that. We actually expect that we're weeks away from actually having that application. We don't want to be presumptive, but that's the kind of the guidance we've been given. So we're going to just wait until probably December and likely start allocating those assets to the FDIC, probably in January.

[Mickey Schleien:]

And just directionally, how much -- I guess you're not going to start out at two to one leverage in the SBIC on day one. How has leverage in the SBIC subsidiary going to progress?

[Michael Sarner:]

Sure. So you essentially get one term of leverage out of the gate, and it's based on the tech notes related the FDIC. So essentially, the first $40 million of capital will be funded by us as equity, and then we'll be drawing from the FDIC thereafter,

[Mickey Schleien:]

You have access immediately to $40 million of debentures then?

[Michael Sarner:]

Yes.

[Mickey Schleien:]

Okay. That's it for me this morning. I appreciate your patience and your time. Thank you.

[Operator:]

Thank you. Our next question or comment comes from the line of Kyle Joseph from Jefferies. Your line is open.

[Kyle Joseph:]

Hey, good morning. Thanks for taking my questions on the on a nice quarter there. Most of my questions have been answered. But given the balance shift between the lower and upper middle market in the quarter, I think upper grew a little bit as a percentage of the portfolio. Was that a one off, is that something we could look forward to continue? Are you seeing any differences in between risk adjusted returns between those two markets?

[Bowen Diehl:]

No, we still, as a macro statement, as I tried to put my prepared remarks, we do think as a macro statement we see more attractive risk adjusted returns in the lower middle market. And that's why, for really, that's the core of our strategy, anyone quarter that can -- we will look at upper middle market deals and there are upper middle market deals that are attractive. We funded a -- I guess Trinity 3 technically is an upper middle market deal now, because it's so much larger. And then, we have one other funding on the upper middle market. So we'll find upper middle market deals, we also had a fair amount of appreciation in the upper market too, so that that's a factor as well, because our metrics are all on fair value. So generally know that our position is still the same. We know macro, for macro we like the lower middle market risk adjusted return is better as a general comment. But we certainly are actively looking at upper middle market deals.

[Kyle Joseph:]

I got it. And then, in terms of the portfolio yield, I think that the consolidated portfolio yielding increased in the quarter, but can you just give us refreshes on the outlook given where rates are, floors in your portfolio, as well as spreads you're seeing on new investments versus repayments?

[Michael Sarner:]

Yes, I would tell you, it's going to be stable. I mean, obviously, we're at our floors. And that's not going to change for the next, what, 18 months to two years or longer. There are some step ups for pricing grids, that might be some -- but you might see it go up 0.1 or down 0.1 based upon company performance that'll move those grids. But other than that, I would expect it's pretty stable where it is.

[Bowen Diehl:]

And in most instances, the pre-COVID, post-COVID world there's definitely competition out in the market. While attachment points are, I would say, generally a little bit lower than they were pre-COVID spreads in most cases are kind of back to or close to pre-COVID level.

[Kyle Joseph:]

Got it. One last one for me, just in terms of quarter-to-date origination activity. Have you seen any sort of disruption given the election or people on hold until the election or has origination activity remained strong?

[Bowen Diehl:]

Yes, I'd say origination activity remains strong as far as deal looks. We've had a handful of deals that we've lost on pricing. But that's just part of the world we live in. There are definitely some people out there in certain instances for certain companies being pretty aggressive. And as far as the elections concerned, it doesn't feel like people have shut off deals waiting for what happens tomorrow. Certain business models might have or industries might have reacted differently to a Democratic legislator versus a Republican. But as a gentleman, I wouldn't say that in a lot of instances, we've seen things like halting, pending the election.

[Kyle Joseph:]

Got it. That's it for me. Thanks very much for answering my questions and congrats again on a good quarter.

[Operator:]

Our next question or comment comes from the line of Bryce Row from National Securities. Your line is open.

[Bryce Rowe:]

Thanks. Good morning, Bowen and Michael, just wanted to follow-up on a comment you made a couple questions ago around using the revolver to continue to redeem the baby bonds, the publicly traded baby bonds that are out there. So curious if you'll continue to redeem those at a measured pace, this $20 million, $25 million measured pace we saw here this quarter? And are you are you giving any thought to possibly extending out the unsecured bucket and doing maybe another five-year institutional issuance?

[Michael Sarner:]

I would tell you that we plan to increase the size of the revolver in the near term, and then probably pay off the bonds over the next two to three quarters. And that'll have to do with the pace of repayments. It'll have to do with whether we're able to raise equity or not. But I would tell you that when we look at it, the shift between 6% bond and the revolver that 3%, that's an uplift of -- when it's done, $0.02 per quarter in NII, we think that's pretty powerful. And it's risk-free to the extent we control that pay down. So we'll definitely look to do that in the near term. And your other question about the unsecured, I think our strategy over the next few years is going to be to grow this revolver. As I said, we're going to utilize the FDIC and quite frankly, we're hopeful over the next year to two years, as we grow our balance sheet, we get closer to investment grade, we would look to go back to the unsecured bond market and cap that market at the 4% rate or thereabouts. If there's a need for liquidity during this coming year 2021, we would hit the baby bond market perhaps. But at this moment, that's not our baseline assumption.

[Bryce Rowe:]

Okay, that's fair. Then, Michael, you mentioned the compensation true-up for the bonus accruals. Just curious if you could quantify that for us so we have a good run rate going forward.

[Michael Sarner:]

Sure. So last quarter, we actually brought down the bonus accrual by $200,000 based on the uncertainty in the market with COVID. So this quarter, we essentially retrenched that $200,000 into the bonus pool to bring it back to full bonus and so the run rate you should be looking at is usually about on the cash compensation line is around 1.8. That's going to be the run rate going forward you should expect in the next few quarters.

[Bryce Rowe:]

Okay. Then last for me. Another one on the income statement. You all in the press release talked about nonrecurring amendment type of fees that you saw in the third quarter. So I was curious if you could quantify that. Then number 2, with the visibility you mentioned into prepays in this fourth quarter, do you expect any prepayment fees to come along with that?

[Michael Sarner:]

Yes, so total fees for the quarter -- I'll probably break it down like this. So we generally have recurring fees or admin, and agencies on our debt of about $250,000 a quarter. So that's every quarter. We typically have between $200,000 and $300,000 in reoccurring with a portfolio of 50 companies, we tend to have fees. So with this quarter, we had probably about $400,000-ish of one-time fees that are above our normal expectation or run rate. Then in terms of this quarter repayments -- right now I think of the one to three prepayments, one of them does not have a , and I think that there's maybe one small one between the other two. So I would tell you, it's like $50,000-ish but having said that, there's always something that comes up so that number could be elevated by the end of the quarter.

[Bryce Rowe:]

Okay. I think that's all I had. Thanks.

[Michael Sarner:]

Thanks, Bryce.

[Operator:]

Thank you. Our next question or comment comes from the line of Robert Dodd from Raymond James. Your line is open.

[Robert Dodd:]

Hi, guys. First, a housekeeping one to kind of follow on to Bryce. Was there anything in terms of -- anything material in terms of accelerated amortization in the interest income line rather than the fee income line? It seems to me that roughly like $250,000 something like that, from Trinity and Danforth.

[Michael Sarner:]

Now all of that was showed up in fee line. All the interest income had to do with the $66 million of origination this quarter. A lot of them were early on in the quarter, as well as some of the pickup in income from originations that were late stage in the previous quarter.

[Robert Dodd:]

Got it. Then just on the kind of the pipeline. You describe it as average. This quarter, a number of add on acquisitions, obviously, in the existing portfolio. I think four there. Trinity was effectively from how you described and got refinanced out because of a major add-on acquisition. Can you give us any color of how much -- what's the length of a closed cycle for an add on acquisition versus a normal kind of new portfolio company? Can add on acquisitions happen at a much faster pace? Of those acquisitions again, the appetite in the market out there right now, is there more of that given there are troubled companies that might be available to buy out but that weren't before. Can you give us any color there on the outlook for more add-ons and how quick that can happen?

[Bowen Diehl:]

Yes, so generally speaking, as you can imagine, if we're -- well, there's two ways to look at that. The portfolio company, the financial sponsor pace, and then our pace. Clearly, it can offer an add-on acquisition. It's in the same space, same industry, more times than not the management team knows the other management team. They're just numbers of reasons why they tend to come together faster to your point, I think, behind your question. Clearly, we have to do less figuring out the industry and the business model. It's more focused on what are these companies going to do together, synergies, integration risk, those types of things, which generally speaking don't take you as much time to generate the work and do the work to figure those things out. So the gentlemen statements add on acquisitions are in some sense easier to get done and happen faster than a new platform, where both the financial sponsor and/or us are trying to figure out and verify the core business model as opposed to some of the other things and so they do generally happen faster. I would say that that's one of the great things about our portfolio and other BDC portfolios too, which is we do back companies and we provide a capital source to help them make acquisitions. So not every company in our portfolio or every company out there have acquisitions as our strategy but many of them do. That's the nature of a portfolio like ours or other BDCs as well, that you have this kind of natural hum in the background and potential add-ons. In the current environment, I think there are companies that are maybe underperforming, but I think it's more often the case where it's like, okay, operating efficiencies are really important in our industry, said portfolio companies industry. We've seen the value of that, managing things like COVID, and that kind of thing. All else equal, two businesses appreciate maybe more the efficiency of combining after an event like we've seen, maybe than they did a year ago, at the margin. So does that mean deal flow triples as the result? Probably not but it's definitely a positive tailwind to deal activity on the add on front.

[Robert Dodd:]

Got it. I appreciate that and congrats on the quarter, guys. Thanks.

[Bowen Diehl:]

Thank you.

[Operator:]

Thank you. Our next question or comment comes from the line of Chris McCampbell from HilltopSecurities. Your line is open.

[Chris McCampbell:]

Morning, guys. Just quickly, do y'all think we're getting to a place where factors that drove net asset value growth are part of a trend and do you have visibility into getting to grow the dividend again?

[Bowen Diehl:]

Yes, so as far as NAV I think a big uplift in NAV for many BDCs including us will be just re-appreciation of the noise that's been created by the current market environment. I think we certainly expect to see that. Then we have a nice equity portfolio with some companies that are growing, a couple of companies that we've had to decrease the appreciation to write it down based on COVID, which we certainly expect that to re-appreciate. So I think that clearly there are -- from where we sit today, there are definitely tailwinds that should support NAV growth going forward. With respect to I don't know if Mike wants to talk about the NII effect of the FDIC and some other things we've talked about.

[Michael Sarner:]

Yes, I think that the mature direct question, I think we do have an eye on growing the regular dividend over time, based on origination to date and sort of this transition to the five points -- getting away from those unsecured bonds, we think our run rate in the next quarter or two is going to be in the $0.42 to $0.43 in terms of NII. When we feel comfortable there, we'll probably inch up the dividend in turn. When we make the full transition out of those notes, and we start drawing on the revolver next year, we see quite a bit of an increase in NII. To quantify it long term, I think I've said this on the last call and once we have fully immersed in the FDIC, fully deployed, we see that's a 20% to 25% increase relative to using bonds in the next two to three years. So we're definitely looking ahead towards increasing that dividend slowly and steadily.

[Chris McCampbell:]

Fantastic. Great job, guys.

[Michael Sarner:]

Thank you.

[Operator:]

Thank you. Our next question or comment comes from the line of David Miyazaki from Confluence Investment. Your line is open.

[David Miyazaki:]

Hi, good morning, guys. Just a couple of observations and questions. It seems like where the outsized returns get made, tend to be where people won't go or they can't go and I think you guys have done a really good job of being fully engaged in underwriting and managing your portfolio through the COVID crisis thus far, which is kind of how you've been able to grow the portfolio so nicely. I'm wondering along those lines when you talk about Danforth getting refinanced by the banks, obviously, there's a point in time when they were not willing to make that loan, and then something happened where they were interested in taking you guys out. So can you guys talk about it, if not specifically to Danforth, but just generally what happens with the banks that make them change their mind that they would come into your companies and refinance them?

[Bowen Diehl:]

Yes. Hey, David, that's a good question. I would say two things. One is just the bank's appetite for risk and I'm not really here necessarily to quantify that, but with respect to a certain bank and a certain company, and its performance, one of the things that banks will look at is the performance of the company, obviously. So as these companies -- part of it is size. The company as it grows gets to an EBITDA level that the banks would consider it. Others are just the bank. In a particular, it's not a macro market comment, but with a particular company in a particular industry, with that particular financial sponsor, who clearly would rather in time bring banks in because it's cheaper capital, just the whole story evolves. Again, it's some market appetite, bank appetite for that particular company in that particular industry, part of it's the financial sponsors that are courting those relationships, and ultimately wanting to get to a point where they can graduate from non-bank lending to a bank lender. So it's part of the natural dynamic within the lower middle market, is that evolution of non-bank to bank financing.

[David Miyazaki:]

Is that part of your strategic positioning? Is that your exit strategy would be to have the company grow to a point where it can be taken out by banks?

[Bowen Diehl:]

So definitely, in certain situations, but it's not a macro strategy, necessarily. It is a dynamic, as I described, it does exist. Some companies, as we're underwriting, that might be more of a discussion than other companies. But there is other things that banks need like amortization, scheduled amortization. Things like that that we don't necessarily need on every business. That also goes into -- our capital is more expensive than a bank, but it can be more flexible and especially sponsors are trying to drive growth of these companies, the next 50, 100 basis points of leverage financing is not what moves the RR needle, what moves the RR needle is the operating changes and acquisitions and various things, and they need a capital provider, that is really diving into the enterprise value of the business and the cash flows of the business, which generally speaking is not what banks necessarily are looking at as much as non-bank lenders. Does that make sense? So every deal in the industry is different. So it's hard to say, macro, we're sitting around saying, okay, corporate strategy is we want to do deals that we think within a couple of years are going to be taken out by banks. It's not quite that definitive, but it can be a part of the conversation in certain situations.

[David Miyazaki:]

Okay, great. Thanks. If I could just shift gears and ask, there's been a lot of great discussion about the FDIC, and I don't want to count chickens before they hatch but congratulations on the progress thus far. I'm not sure if you talked about your targeted leverage on an economic basis versus a statutory leverage basis and should you get the ability to participate in SBA debentures. How can you talk a little bit about the ranges that you might work within post that FDIC?

[Bowen Diehl:]

I think overall, I would tell you in this environment where we may or may not be able to raise equity in the short term. We were still pointing to the 1.5x board mandated leverage that would be we say that beats probably the max leverage that we feel comfortable with.

[David Miyazaki:]

Is that economic or statutory?

[Bowen Diehl:]

That will be economic. But in time, we actually look at what we'll look like. I tell you that we probably wouldn't be more focused somewhere in the 1.3x to 1.4x maybe economic with a regulatory leverage in the 1 to 1.1 would probably be where we be living as a target going forward.

[David Miyazaki:]

Okay, great. That's very helpful. Well, I appreciate your comments and congratulations, and I will step out of the queue now. Thank you.

[Bowen Diehl:]

Thanks, David.

[Operator:]

Thank you very much. Our next question or comment from the line of Devin Ryan from JMP Securities. Your line is open.

[Kevin Fulton:]

Hi, this is Kevin Fulton for Devin. I just have one more outstanding question. Most of mine have been answered already. What is the weighted average LIBOR floor for the debt portfolio and what percent of floating-rate investment have LIBOR floors?

[Bowen Diehl:]

The weighted average LIBOR on the asset portfolio is 1.4x.

[Michael Sarner:]

Maybe a little bit lower than that because the new originations have a lower floor.

[Bowen Diehl:]

Yes, maybe 1.35. What was the other question?

[Kevin Fulton:]

What percent of floating-rate investments have LIBOR floors?

[Bowen Diehl:]

Yes, pretty much all of them.

[Kevin Fulton:]

Okay, great. That's the only question. Congrats on a strong quarter.

[Bowen Diehl:]

Thank you.

[Operator:]

Thank you. I'm showing no additional questions in the queue. At this time, I would like to turn the conference back over to Mr. Bowen Diehl for any closing remarks.

[Bowen Diehl:]

Great. Thanks, operator. Again, thanks, everybody for the call. Thanks for all the robust questions. We appreciate it and we look forward to keeping you guys posted on our progress and will not before we'll be talking next quarter.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Everyone, have a wonderful day.