Saratoga Investment Corp.
Q1 2016 Earnings Call Transcript

Published: 15 Jul 2015

[Operator:]

Good morning, ladies and gentlemen, thank you for standing by. Welcome to Saratoga Investment Corporations Fiscal First Quarter 2016 Financial Results Conference Call. Please note that today's call is being recorded. During today's presentation all parties will be in a listen-only mode. Following Management's prepared remarks, we will open the line for questions. At this time, I would like to turn the call over to Saratoga Investment Corp's Chief Financial Officer, Mr. Henri Steenkamp. Sir, please go ahead.

[Henri Steenkamp:]

Thank you. I would like to welcome everyone to Saratoga Investment Corp's fiscal first quarter 2016 earnings conference call. Today's conference call includes forward-looking statements and projections. We ask you to refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these forward-looking statements and projections. We do not undertake to update our forward-looking statements unless required to do so by law. Today, we will be referencing a presentation during our call. You can find our fiscal first quarter 2016 shareholder presentation in the Events & Presentation Section of our Investor Relations website. A link to our IR page is in the earnings press release distributed last night. A replay of this conference call will also be available from 1

[Christian Oberbeck:]

Thank you, Henri and welcome everyone. Since we acquired Saratoga Investment Corp, we've been singularly focused on our long-term objective of increasing the quality and size of our asset base with the ultimate purpose of building Saratoga Investment Corp into a best-in-class BDC. As highlighted on Slide 2, during the first quarter of 2016 we continued the momentum gained during the first -- during the fiscal year 2015 towards realizing our long-term objectives. To briefly recap, first we've continued to steadily build and improve our asset base, yield and return on equity. Each metric saw an important increase on a quarter-over-quarter basis that we'll discuss in further detail shortly. Second, the overall strengthening of our financial foundation has enabled our regular quarterly cash dividends policy. We will pay a quarterly dividend of $0.33 per share for the first fiscal quarter of 2016 payable on August 31, 2015, for all stockholders of record on August 3, 2015. This is the third quarterly increase of 22% to our regular quarterly cash dividend and shareholders continue to be able to participate in our dividend reinvestment plan if they prefer. During the quarter, we also paid a special dividend of $1 per share. Third, our base of liquidity remained strong and promises to improve. On April 2, 2015, we received a green light and go-forth letter from the SBA for a second SBI fee license, which if approved will allow us to grow our assets by an additional $112.5 million. And effective May 29, 2015, we entered into a debt distribution agreement with Ladenburg Thalmann through which we offer from sale from time to time up to $20 million in aggregate principal amount of our existing Baby Bonds issuance through an aftermarket offering. As of yesterday we sold bonds with a principal of $5.7 million at an average premium of 1.3% and finally, we continue to see an expansion and diversification in our shareholder base, including additional analysts coverage recently added to our stock. In addition to these corporate milestones, during this quarter we continued on our path of further strengthening our financial foundation and building scale by expanding our assets under management to $263 million, a 9% increase from $241 million at the end of last quarter, improving our investment quality and credit with over 95% of our loan investments now having our highest rating and increasing performance with our key performance indicators for fiscal quarter 2016 as compared to last year's first quarter. Our adjusted net investment income is up 33% to $2.9 million. Adjusted NII on net asset value increased to 9.3%, up 180 basis points from 7.5%. Adjusted NII per share of $0.53 up 33% from $0.40 and our return on equity is up 1,780 basis points to 24%. We're very excited about these accomplishments and we'll go into greater detail on each one on today's call. As I mentioned, we remain committed to further advancing the overall size and quality of our asset base. As you can see on Slide 3, our upward trend of quality and quantity of assets has continued with $263 million in assets under management in our BDC as of May 31, 2015, we've seen a 9% increase in assets since last quarter and 176% increase since fiscal year '12 with over 95% of our loan investments currently holding the highest internal rating that we award. Thus our overall loan quality continues to increase while we continue to grow assets in a very measured way. With that, I would like to now turn the call back over to Henri to review in greater detail our full financial results as well as the composition and performance of our portfolio.

[Henri Steenkamp:]

Thank you, Chris. Before starting to go through our financial results, I would like to highlight again the importance of assessing our net investment I income metric on an adjusted basis. This quarter is a good example of where our significant unrealized capital gain impacts net investment income. As we will discuss later, we had a very strong capital gains quarter of more than $5 million, which is highly accretive to net asset value. However, these capital gains are not included in net investment income while the second incentive fee expense related to this gain does reduce net investment income. Therefore we provide adjusted NII metrics by adjusting for the incentive fee accrual to thereby eliminate the one sided impact of capital gains in assessing our NII financial results. Now moving on and looking at our quarterly key performance metrics on Slide 4, we see that for the quarter ended May 31, 2015, our net investment income was $1.8 million or $0.53 on a weighted average per share basis. Adjusted for the incentive fee accrual related to net unrealized capital gains in the second incentive fee calculation that I mentioned earlier, our net investment income was $2.9 million or $0.53 per share. This represented an increase of $0.7 million as compared to the same period last year and $0.2 million compared to the quarter ended February 28, 2015. In the first quarter of fiscal '16, we experienced a net gain on investments of $5.6 million or $1.03 on a weighted average per share basis, resulting in a total increase in net assets from operations of $7.4 million or $1.56 per share. The $5.6 million net gain on investments was largely comprised of $5.5 million net unrealized depreciation on investments including a significant unrealized gain of $4.2 million relating to one specific legacy investment, which has actually been realized since quarter end. Net investment income yield as a percentage of average net asset value was 5.8% for the quarter ended May 31. Adjusted for the incentive fee accrual related to net unrealized capital gain, the net investment income yield was 9.3%, up from 7.5% last year and up from 8.8% last quarter. Return on equity was 24.0% for this quarter. These are all performance metrics that we feel are important indicators or our success in pursuing our strategy of growing the asset base, building scale and generating competitive yields, while continuing to focus on the quality of our portfolio. As these metrics improve quarter-over-quarter, it continues to highlight the following two important points about the value of our asset growth. Virtually as our SBIC assets continue to grow as compared to our overall assets under management, the greater net investment income on these investments finance through lower cost SBI debentures contributes more to our bottom line. This is demonstrated again with SBIC assets increasing this quarter to 58% of our investment and secondly, we see the benefit of scale becoming more visible as our operating expense stabilize and reduce as a percentage of our total assets. Our total investment income was $7.6 million for the fiscal first quarter of '16. Total investment increased $1.4 million or 23.1% compared to the first fiscal quarter last year. Our total investment income for the quarter was comprised primarily of $6.9 million of interest income, $0.4 million of management fee income associated with the investment in our CLO and $0.3 million of other income. As a reminder, other income includes dividends received from portfolio companies, as well as origination, structuring and advisory fees. Our total operating expenses were $5.8 million for the fiscal first quarter and consisted of $2 million in interest and debt financing expenses, $2.9 million in base and incentive management fees, $0.6 million in professional fees and administrator expenses and $0.3 million in insurance expenses, directed fees and general administrative and other expenses. For this fiscal first quarter, total operating expenses as presented increased by $1.9 million as compared to the same period last year. This increase in total operating expenses was primarily attributable to higher interest and credit facility financing expenses supporting the growth of our asset base, as well as increased management and incentive fees. These increased incentive fees reflect the outperformance of our growing asset base, but this quarter also includes a $0.9 million incentive fee accrual related to one specific legacy investment for which a $4.2 million unrealized gain was recognized during the quarter. Mike will elaborate on this later in further detail. Total expenses excluding interest and debt financing expenses, base management fees and incentive management fees, actually offset this increase slightly and decreased by $42,000 as compared to last year's first quarter or from 1.8% on average assets under management for the same period last year to 1.4% for this quarter. This demonstrates the benefit of scale as our assets continue to increase, while our cost structure remains consistent. NAV was $123.5 million as of May 31, 2015, a $0.9 million increase from an NAV of $122.6 million as of February 28. NAV per share was $22.75 as of May 31, 2015, compared to $22.70 as of yearend. During these three months and despite a significant dividend being declared this quarter NAV per share actually increased by $0.05 per share primarily reflecting $1.36 of earning offset by the $1.27 dividend declared during the quarter. As you might have noted our prior period numbers for May 31, 2014, have been revived to reflect adjustments outlined in our notes to the financial statements included in our Form 10-K, including the early adoption of a new accounting standard. Slide five outlines the dry powder available to us as of May 31, 2015. As of the end of the fiscal first quarter, we had $11.8 million outstanding in borrowings under our revolving credit facility with Madison Capital Funding and $79 million in outstanding SBA debentures. Our Baby Bonds had a carrying amount and fair value of $48.5 million and $49.7 million respectively. With the $33.71 million additional borrowing capacity at our SBIC subsidiary and $6.6 million in cash and cash equivalents, we had a total of $110.8 million of available liquidity at our disposal as of May 31. This available liquidity equates to approximately 42% of the value of our investments, meaning we can grow our assets under management by a further 42% without any additional external financing. We remain pleased with our liquidity position; especially taking into account the conservative composition of our balance sheet and the ability we have to substantially grow our assets without the need for external financing. We also continue to assess all our various capital and liquidity sources and will manage our sources and uses on a real time basis to ensure optimization. In fact effective on May 29, 2015, we entered into a Debt Distribution Agreement with Ladenburg Thalmann through which we may offer for sale from time to time up to $20 million in aggregate principal amount of our existing Baby Bonds issuance through an At-the-Market offering. This is a benefit of having our N-2 shelf registration statement allowing us to capitalize from market opportunity. As of yesterday, we had sold bonds with principal of $5.7 million at an average premium of 1.3% enabling us to further enhance our liquidity and plan ahead for future capital needs such as the remainder of our first SBIC licence and the funding of our second SBIC licence. These new issuances are under the exact same term as the original Baby Bond offering in 2013. Now I’d like to move on to Slide 6 through 8 and review the composition and performance of our investment portfolio. Slide 6 highlights the portfolio composition and yield of our portfolio at the end of the quarter. As of May 31, the fair value of the company’s investment portfolio was $263 million, principally invested in 35 portfolio companies and one CLO fund. Our portfolio was composed of 59.8% of first lien term loans, 15.4% of second lien loans, 6.8% of syndicated loans, 2.2% of unsecured notes, 6.4% of subordinated notes of the Saratoga CLO and 9.4% of common equity. The weighted average current yield on the portfolio for the three months ended May 31, 2015 was 12.0%, which was comprised of a weighted average current yield of 11.2% on first lien term loans, 11.0% on second lien term loans, 6.3% on syndicated loans, 10.8% on unsecured notes and 28.8% on our CLO subordinated notes. Despite downward pressure on yields due to continued competition, our yields have remained strong as compared to the previous fiscal quarters. To further illustrate this point, Slide 7 demonstrates again how the yield on our core BDC assets, excluding our CLO and syndicated loan has remained consistently above 11%, while our asset base has continued to grow. Subsequent to the decrease in our CLO assets under management and higher refinancing costs related to this, the CLO’s yield has also remained strong and in fact increased. Syndicated yields have remained largely stable. Moving on to Slide 8, during this fiscal first '16, we invested $23.2 million in new and existing portfolio of companies and had $7.3 million in exits and repayments, resulting in net investments of $15.9 million for the quarter at our BDC. As you can see on Slight 8, our investments continue to be highly diversified by type as well as in terms of geography and industry, with a large focus on business, consumer and healthcare services, as well as software as a service while spread over 15 distinct industries. It is worth noting that we have no significant exposure to the oil and gas industry. Of our total investment portfolio, 9.4% consists of equity interests. Equity investments are and will continue to be an important part of our overall investment strategy. Slide 9 demonstrates how realized gains from the sale of equity investments, combined with other investments has helped enhance shareholders capital. For the past three years, we have had a combined $5.2 million of net realized gains from the sale of equity interest or sale or early redemption of other investments. This consistent performance continues to be a good indicator of our portfolio credit quality. That concludes my financial and portfolio review. I will now turn the call over to Michael Grisius, our President and Chief Investment Officer for an overview of the investment market.

[Mike Grisius:]

Thank you, Henry. I’d like to take a couple of minutes to update everyone on the current market as we see it. Then I’ll discuss our strategy and performances we operate in this environment. The market’s extremely competitive conditions persist as there remains an abundance of capital chasing a historically low volume of new investment opportunities. As you can see in the chart on Slide 10, middle market leverage has surpassed pre-crises levels and is still continuing its upper trajectory. Excess liquidity within the private equity community, as well as an increase in the number of middle market lenders relative to the quantity of new deal opportunities have helped drive debt and purchase multiple expansion. In addition several data sources and our own experience indicate that gross investment yields have remained tight and are accompanied by wider leverage levels and narrower equity cushions. Despite the NII pressure facing many BDCs, we have not seen a widening of yields. The general sentiment is that standard deals remain in high demand while more aggressive deals have seen investor scrutiny. As mentioned earlier, the lower middle market's increased leverage is very much being driven by fewer investment opportunities. Slide 11 is quite remarkable and demonstrates how the number of transactions per deal sizes in the U.S. below $25 million year-to-date in 2015 were down 49% from year-to-date 2014. Calendar year 2015 is off to a very slow start with 432 private equity deals closing to date compared to 843 for the same period last year. Despite this trend we remain optimistic of our own pipeline and originations. With regards to our own pipeline and originations, we have made great strides in expanding our relationships and are confident these relationships will create higher origination activity in the future. We're now dedicating additional resources to our origination effort, which we believe will allow us to accelerate our growth while maintaining our disciplined approach. We also continue to believe that the lower middle market is the most attractive market segment to deploy capital and the fundamentals here remain strong leading to the best risk adjusted returns in our view. Additionally, the sheer quantity of businesses at this end of the market make is less efficient and less competitive. Despite the rise of market-wide leverage, we’ve been able to invest in deals with relatively low multiples. In the chart on Slide 12, you can see that 56% of the market’s debt-to-EBITDA multiples were 4.1 times or higher. Historically, the majority of our closed yields are beneath that level, with the average SAR leverage for the last two years still below four times even though our average SAR leverage for the three deals closed in Q1 was 4.5 times. We're very careful to exercise extraordinary investment discipline in investing only credits with attractive risk return profiles. As we had noted before, deals are not necessarily low risk and they have low leverage and high risk and have leverage. We declined plenty of low leverage loans to weak credits and frequently pursue higher leverage loans to strong companies. The most important thing for us is that we remain thorough and disciplined in assessing the risk profile of each underlying business and that we craft the capital structure to mask the relative strength of each portfolio of companies. Slide 12 also demonstrates the growth we've had in a number of executed investments. With the strong execution track for the past couple of quarters as well as year-over-year growth, our executed investments doubled from seven in 2013 to 14 in calendar year 2014. In the first half of calendar year 2015 we saw seven deals closed number on pace with 2014's performance, despite the pressures of the aforementioned comparative market differences. We achieved this growth in an extremely competitive market that speaks to our strength in the origination efforts and as overall portfolio of quality is improved to the risk profile of our investment portfolio and the investment philosophy of the firm. Along those lines, some of you may have noticed the favorable realization on network communications or NCI. NCI was a legacy investment that existed before Saratoga took over management of the BDC and was in an old media print company focused on real estate end markets, the combination that saw our performance deteriorate substantially in 2009. We worked with NCI to restructure its debt around a new operating environment, permitting the borrower time and run rate to introduce digital products. When the company was sold this quarter, we received full recover on its restructured notes including PIK interest and a meaningful return on equity, which combined amounted to $6.5 million. We believe our experience with NCI illustrates again the sound judgment and experience of the investment team that is growing Saratoga's investment portfolio. Our objective is to maximize our risk adjusted returns in a manner that utilizes our low cost of capital and the two to one leverage advantage we possess through the SBIC license. By focusing on the smaller less competitive event in the market, we were able to reduce the risk profile of our portfolio while delivering highly accretive returns to our investors. As you can see on Slide 13, as of May 31, 2015, over 74% of our SBIC investments are in senior debt securities, which is relatively unchanged from last quarter. The leverage profile of these investments is very low, especially compared to market leverage. Because of the leverage in low cost of capital advantages inherent in the SBIC program, we can achieve strong returns for our shareholders without moving far out on our risk factor. Therefore and as demonstrated this past quarter, we intend to grow our net investment income by continuing to dedicate the majority of our effort and resources to growing that portion of our portfolio. Now moving on to Slide 14, you can see our SBIC assets increase to $151.5 million as of May 31, 2015 from $135.8 million last quarter. As a percentage of our total portfolio, SBIC assets have grown from 0% of our total portfolio as of fiscal yearend 2012 to 58% this quarter. This growth in SBIC assets is an important part of our continued increase in net investment income as the lower financing cost help grow our NII yield at a healthy pace. Also it is important to note that as of the fiscal quarter ended May 31, 2015, we had $85.6 million of total available SBIC investment capacity of which $70 million is leverage capacity within our current SBIC license. Now if we were to obtain a second license, our leverage capacity would increase by another $75 million with the ability to increase assets by an addition $112.5 million. Fundamentally, our strategy in this market is to focus on our core strengths; our origination platform, our experienced and disciplined underwriting and our SBIC funding capacity. In our view, our origination platform is among the very best at our end of the market and we are dedicating more resources toward it. We're seeing a steady flow of SBIC eligible investments and are optimistic about our ability to grow that portfolio at a health rate, while remaining extremely diligent in our underwriting and due diligence procedures. This concludes my review of the market and I would like to turn the call back over to our CEO, Chris.

[Christian Oberbeck:]

Thank you, Mike. This past year we met an important milestone that has been an important goal for us since our inception namely to commence the payment of regular, quarterly cash dividends. From the start, we set our expectation was that this dividend would continue to increase, which it has by 22% per quarter over the last three quarters. As outlined on Slide 15, over the past 12 months Saratoga has paid quarterly dividends of $0.18 per share for the quarter ended August 31, 2014, $0.22 per share for the quarter ended November 30, 2014 and $0.27 per share for the quarter ended February 28, 2015. Saratoga also paid a special dividend of $1 per share on June 5, 2015. July 8, 2015, Saratoga Investment announced that its Board of Directors has declared a dividend to shareholders of $0.33 per share for the quarter ended May 31, 2015, payable on August 31, 2015 to all stockholders of record at the close of business on August 3, 2015. Consistent with our new policy, shareholders will have the option to receive payment of the dividend in cash or receive shares of common stock pursuant to the company's dividend reinvestment plan or DRIP plan, which Saratoga adopted in conjunction with the new dividend policy and provides for the reinvestment of dividends on behalf of its stockholders. Our goal with this policy remains to allow stockholders who want cash to receive their dividends in cash; however also provides the opportunity from any stockholders we've spoken to who are interested in reinvesting their dividends to receive addition shares of common stock. Experience has shown that those stockholders who hold their shares with the broker mush have affirmative instructed their brokers prior to the record date if they prefer to receive this dividend and future dividends in common stock. The number of shares of common stock to be delivered shall be determined by dividing the total dollar amount by 95% of the average of the market prices per share at the close of trading in the 10 trading days immediately preceding and including the payment date. For more information see the Stock Information section of the company's Investor Relations website. Moving on to Slide 16, all of our initiatives are designed to make Saratoga Investment a highly competitive BDC that is attractive to the capital markets community. We hope to drive the size and quality of our investor base while continuing to add institutions to the roster. During this past quarter, we added further analysts coverage and hope to continue to expand that as well. We've spoken today about many of the components of our competitiveness that is highlighted on Slide 16. Earnings yield of more than 9%, dividend yield of approximately 7.7% and growing, ample low cash cost liquidity, strong earnings per share and expansion of assets under management. Addition, we've had only limited exposure to the oil and gas industry and had no realized right down as many other BDCs have experienced. Believe that Saratoga Investment is on the path of being a premier BDC in the marketplace and we feel we've already demonstrated superior shareholder returns. We've achieved annualized rates of return in excess of 18% for the past one, three and five-year periods, positioning the company as one of the top four or better performing BDCs for each period. Moving on to Slide 17, our objectives are simple to continue to execute our long-term strategy, to expand our asset base without sacrificing credit quality while benefiting from scale. We also continue to increase our capacity to source, analyze, close and manage our investments by addition to our management team and capabilities. Our primary focus remains on maximizing the potential high teen returns on the equity invested in our SBIC and utilizing the two for one leverage that it provides. This is the optimal means to increase our assets under management and net investment income yield, enabling us to increase returns to shareholders and achieve growth in our net asset and stock values. Closing, I would again like to thank all of our shareholders for their ongoing support. We're excited for the growth and profitability that lies ahead for Saratoga Investment Corp and I would now like to open the call for questions.

[Operator:]

Thank you. [Operator Instructions] And our first question comes from the line of Casey Alexander from Gilford Securities. Your line is open.

[Casey Alexander:]

Yes. Good morning. Mike, my first question is for you. Looking at Slide 11, normally elevated leverage levels are also associated with extremely elevated deal activity such as the pre-crises levels. What do you think it means that we were experiencing elevated deal leverage multiples at a point in time where we were having a decrease in deal activity?

[Mike Grisius:]

I wish I had a crystal ball to give you a perfect answer on that, but the perspective I had shared with you is my experience is that elevated leverage levels are more correlated to a benign credit environment where people feel like they can do [on their own] [ph] by investing capital that often works in conjunction with a very robust deal environment. In this case, deal flow is down, but it is still a benign credit environment and there is a lot of capital out there. So when we see a transaction, it is often the case that many other people are competing for that deal and we're seeing that even more so at the lower end of the middle market. I think the competition there is less as we've referenced in the prepared remarks, but still very competitive simply because there is a lot of capital out there and fewer deals and what happens in that environment is the buyers of those companies can push leverage and create a sort of an auction environment at times as well and of course the private equity firms are also paying really hefty prices for companies in this environment as well. Some of that has to do with just a very low interest rate environment too. So there is a lot of factors that are at play here. I think what we try to do is just stick to our guns, do very thorough due diligence and make sure that we're populating our portfolio with deals that have a very good risk adjusted return and with the cost of capital that we have in the SBIC, we can do that and still make it very accretive for our shareholders and be aggressive in the right circumstances.

[Casey Alexander:]

You've been doing this through multiple cycles and I am sure you remember how you felt when you were doing deals in 2007 and 2008 and 2006. How does your spider sense so to speak tell you about the environment now versus then and are you trying to gear yourself towards different types of deals to prepare the portfolio in any way for the future?

[Mike Grisius:]

That's a good question. I think the thing that you should know is that when we underwrite a credit, we're always thinking about how it may perform in a downturn, but it would be really hard for us to say the sky is falling, let's prepare ourselves for six months from now when the market is going to turn, etcetera, etcetera. We're really -- we're not trying to time the market by any stretch. Instead we're really just looking at every credit with the mindset that -- to make sure that if it goes through a down cycle and economic down cycle that the company will perform well in our principal V shape and we've spend a lot of time doing analysis around for every credit that we invest in. Really hard to sort of compare market to market and how this one feels like versus prior ones. The one thing I do know is that we remain disciplined and continue to find the right credits will be fine even if there is a downturn.

[Henri Steenkamp:]

And Casey to add to that, I think what we talked about in our presentation, what we've sought to do is increase the credit quality of what we're investing in and being much more senior loans, much more dollar type of loans and those type of credit positions on the balance sheet being at the top of the balance sheet are like a bull work against a potential future downturn. But I think as Mike said, we're not predicting any downturn. In fact, U.S. economy seems to be okay. It's not -- I think people are more complaining about it being not as robust it's like to be, but not necessarily thinking there is an eminent decline in it. So again we can't -- we're not economists. We're not trying to predict the future here, but we're trying to structure ourselves soundly in what we're doing now so that we can handle what may come or may not come.

[Casey Alexander:]

Okay. Thank you for that. Look I have one more question. When Saratoga originally did the Baby Bond deal, you took a certain amount of the proceeds and put it into broadly syndicated loans that were lower yielding until you had a deal home for those assets. I can’t understand the calculus involved in selling more of the Baby Bonds as opposed to you still have not sold all of this syndicated loans you still have $16 million of syndicated loans on the books that can be used. You still have the lower cost SBIC facility substantial amount of SBIC’s subsidiary still at your disposal. I struggle to understand the calculus for why distributing more Baby Bonds versus those other alternatives, which would be more accretive to shareholders?

[Christian Oberbeck:]

Well look, Casey I think a part of the answer is corporate financial management and it’s very important for any company and certainly a company like ourselves to have multiple sources of liquidity and the Baby Bonds and the appetite for that community to own Saratoga Investment Securities right now specifically in Baby Bonds and ultimately helping to increase the awareness and the presence of Saratoga in the capital markets is an important strategic element. We don’t want to rely on too narrow series of sources of capital. So part of it is diversification of our capital source. Secondly, the precise use of proceeds on the most recent issuance of these Baby Bond has been to repay our line of credit and our line of credit has a -- is a three-year revolver and the Baby Bond still have five plus years of term to them. So we’re getting a security that might be marginally a little more expensive today; however, it has a much longer duration and are much more stable source of capital and also frees up our SBIC -- our line of credit from Madison for other potential uses. And we have a lot of different types of deal opportunities, which have come to fruition where we need to be able to deploy the Madison Facility and we want to make sure we keep that as liquid as we can for whatever circumstances. With regards to the SBIC capital and availability, I think it’s fair to say that we are doing our best to add to that portfolio as rapidly while being as prudent as we can and so we continue to do that. We would be -- that is really a function of the deals that we approve to do in that portfolio there and the debt available at the SBIC is only available for SBIC type of investments. And so we are -- inside our firm we're maximizing what we're doing in that direction and we've been showing a lot of growth and we will continue to show growth there, but that’s where that capital is. And with regards to the remaining bonds I think the average yield on those is not terrible. What is that?

[Henri Steenkamp:]

The yield to maturity is around 7% on that because we're issuing at other premium.

[Christian Oberbeck:]

The deals on our existing $18 million syndicated market.

[Henri Steenkamp:]

Oh! I am sorry. It’s about 6.4% on the syndicate.

[Mike Grisius:]

So those are actually earning more than our Madison facility for example. So I think in a very short run like this month or something, yes, there are some marginal capital differences, but in terms of the capital structure and the corporate financial structure and our access to different sources of financing we believe we continue to create a foundation that’s very sound for Saratoga. And in the grand scheme of our total capital structure the amount of Baby Bonds we’re selling is actually quite small.

[Casey Alexander:]

All right. Thank you for taking my questions.

[Operator:]

Thank you. Our next question comes from the line of David Chiaverini from Cantor Fitzgerald. Your line is open

[David Chiaverini:]

Thanks. Good morning and excellent quarter you guys. I have a follow-up question on the capital structure theme. Why issue and I am mostly interested in the drip program. Why issue share at a discount to book through the drip when it’s dilutive to shareholders and book value?

[Mike Grisius:]

Well, historically I think there is a long line of companies that have issued a discount -- issued shares at a discount including AT&T even historically. So that is not our unusual feature necessarily for a DRIP program. With regards to the DRIP program in particular, clearly we're trading at a discount to NAV, but we do have a lot of growth and we do need to support the financing of our growth and we do have shareholders that are interested in acquiring more stock and we do have shareholders that have approached us and are having a difficulty acquiring more stock because of the flow in the overall stock of Saratoga. And so we're very interested in allowing our shareholders to invest further in the company. I think the structure of the DRIP is such that all shareholders are treated equally. In other words any shareholder that wants to participate in a DRIP can participate. So it’s really a voluntary exercise to either participate or not participate. So all shareholders have an equal opportunity there. The other thing I would add to the DRIP, I think again if we focus on precise delusion around the DRIP, that’s one thing, but I think on a broader picture if you look at our overall strategy I think as we said in our presentation, our stock appreciation and for someone who ones a share of our stock five years ago, three years ago, a year ago, we’re talking about 18% compound annual rates of return on our shares. And so the ownership of our stock all things considered, all strategies employed has been very rewarding, has been in the top four BDC stocks in every period. So we’re trying to take all of that into consideration as we pursue our strategy to grow and improve our stock price.

[David Chiaverini:]

Okay. And a follow-up to that given the growth objectives and the opportunities is a buyback kind of off the table.

[Mike Grisius:]

I am sorry is the buyback?

[David Chiaverini:]

Is doing some share repurchases up the table.

[Mike Grisius:]

No not at all. We authorized a share buyback program and we have it in place and we have a certain amount of authorization and yes we -- that is a facility that we have available to deploy. Yes.

[David Chiaverini:]

And what valuation given that the stock is trading around 75% of book value, what would be a good value to start implementing that buyback?

[Mike Grisius:]

We don’t have a specific metric in terms of specific price point that we have determined and it is something that we would evaluate sort of on a day-by-day, week-by-week, month-by-month basis. As I mentioned earlier, our stock has been appreciating. I think we had some recent gains right now in terms of our capital gain etcetera. So I think our NAV has probably the announcement last night of our earnings and this call, I don’t think a lot of market place was expecting the improvement in the NAV just because it wasn’t public now it is public. And we would want to let the market digest the fact that this new information of our improvement in NAV, despite paying out a lot of dividends our NAV actually increased. So we would like to see the market digest that and respond to that. Again we believe our stock is very attractive relative to the other BDC’s based on our performance. But again yes, we have the stock buyback program available and we're prepared to use it when we see a moment to use it. But no, we have not put specific stock price target on that.

[David Chiaverini:]

Got it. And then a separate question on the SBIC and I see that you increased the outstandings, the loans outstandings by about $15 million in the quarter, but I noticed that the SBI debentures has been flat now for three quarters in a row at $79 million. I was just curious can you talk about the expected ramp of getting more SBI debentures and the timing of that and when you could actually kind of dip into that second license once its approved.

[Mike Grisius:]

Two things on that front. Number one, part of that has to do with -- ultimately we're permitted to get to a two to one leverage point in the SBIC. However, we need to put the equity in first and then increase the debt subsequently to that. And so we have invested sufficient equity to create an allowance for certain amount of leverage and what we've been dealing with is redemptions. We had a fair number of redemptions and we've also had a fair number of redeployments and so that's part of the reason why that number has stayed at that level. With regards to the second license, once we hopefully successfully receive the full license, we are able to commence investing in that SBIC immediately and we would intend to do so.

[Henri Steenkamp:]

And Mike actually made I think the comment in his remarks David that, so we have access to $85 million more through the SBIC currently for which we would only need to put in the $15 million as Chris said. So it's big availability there without even putting in more money as we speak at the moment.

[David Chiaverini:]

And you wouldn't start investing in the second license until you've fully utilized leverage in the first place, that's right?

[Henri Steenkamp:]

Not necessarily.

[Christian Oberbeck:]

Not necessarily, but the idea would be to take full advantage of the first license as well, but there is not a restriction on our capacity to also invest through that second license, but we certainly would want to optimize the first license and try to get that to the fully two to one leverage level. And in terms of how fast we can deploy that, I think in the prepared remarks we talked about the difficulty in the marketplace that's a very competitive marketplace with not as much deal flow. The vast majority of our efforts are really concentrated on trying to deploy capital within that SBIC given the value proposition if offers to our shareholders and we're continuing to do that. I think the pace at which we've invested historically is a pace that feels good. Now it's probably a good indication of how we're feeling today. We're making -- putting a lot of effort into increasing that pace. For us fortunately despite the market being difficult and transaction volume being down we started when we took over management of this company and got our SBIC license, we really came out into the marketplace for the first time. So as much as overall deal flow is down, we're growing our relationships and seeing more and more opportunities to invest capital. So that gives us some confidence that we can accelerate our pace of investment over time. Can't tell you exactly what that pace is going to be, but we tend to look at it over not so much quarter to quarter, but really are we developing more good relationships that will lead to good opportunities to deploy capital and that's kind of how we evaluate ourselves in that respect.

[Henri Steenkamp:]

And one further specific response to your question on SBIC fund versus SBIC fund two, I think as you can appreciate there is quite a lot of rules, regulations, procedures etcetera around these SBIC funds in terms of sequencing of funding etcetera. And so at the time at which we receive our, hopefully receive our second SBIC license, we will be required to make an equity investment in that fund and then that fund and that equity investment can then be levered two to one. So it will be in our interest to deploy capital to get that fund up to its two to one leverage even though we might have capacity in fund one. And so this is -- inside of the overall SBIC equation and licenses one and licenses two etcetera, there is a bunch of little procedures and step functions if you will that make it the sequencing, maybe not as smooth as the ultimate endpoint would be.

[David Chiaverini:]

Got it. That's very helpful. Thank you.

[Operator:]

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

[Mickey Schleien:]

Yes, good morning, everyone. Just wanted to make sure I understand Page 5 of the Investor Presentation, it would seem to imply and given that this is pre the ATM facility, it would seem to imply that you could use the collateral already existing in the credit facility and the advance rates project the addition equity in the SBIC to gain access to the full 150 of debentures. Is that correct or am I misinterpreting that?

[Henri Steenkamp:]

Yes, that's correct.

[Christian Oberbeck:]

Practically yes.

[Mickey Schleien:]

Okay. And now given that you have the ATM facility in place and are starting to raise some capital, that would also obviously be a way you could fully fund the SBIC correct?

[Henri Steenkamp:]

That's correct.

[Christian Oberbeck:]

Correct, yes.

[Mickey Schleien:]

All right. Thank you. I also wanted to make sure I understood Page 12, so this is the -- specifically in terms of leverage, the 4.5 that refers to deals you closed during the quarter, that's not the average for the portfolio. Is that right?

[Henri Steenkamp:]

That's right. The whole portfolio didn't rise to 4.5. It's…

[Mickey Schleien:]

So what is the average? Can you tell us?

[Christian Oberbeck:]

I think we've remarked. Do you have that number handy?

[Henri Steenkamp:]

Yes it's under 4, it's probably like 3.7, 3.8 I believe yes.

[Mickey Schleien:]

And that must be up just a little bit then versus the previous quarter?

[Henri Steenkamp:]

Yes I mean marginally the sort of the net amount of this quarter's increase is obviously from a weighting perspective is very marginal impact to the overall.

[Mickey Schleien:]

And on that chart the bar that shows deals closed that includes follow-on offerings correct? I only saw one new actual portfolio investment.

[Henri Steenkamp:]

That does include follow-on investments to existing portfolio of companies and we do measure it that way because we think it's -- as we build our portfolio, it's indicative of or I guess it's a better way to say is that it gives us another avenue to deploy capital. We like nothing better than to find a business that we underwrite and is doing well and we can support that management team and that business model with more capital. It's a good way to enhance our growth, but yes it does include follow-on investments as well.

[Mickey Schleien:]

Okay. And switching gears to another topic. The reinvestment period for the CLO ends in a little bit over a year. I've seen a lot of noise in results once we go post reinvestment period, which tends to cause a lot of ingestion and doesn’t really help stock prices. I am just curious what you can tell us about the plans for that CLO post the reinvestment period?

[Henri Steenkamp:]

Well I think it's -- I mean it's fair to say that we're quite a long ways from that period of time, but I guess what we would point out is that the last time we came into a reinvestment period, what we did was we refinanced the CLO and so that is certainly an option to be pursued at that point in time. I think when you look at the return on our investment in CLO, it's very favorable and it makes sense to at this point in time if it were now, we would certainly be pursuing a refinancing of it. Now exactly what we will do at that point in the future, we just don't know all the market dynamics that will be at work, but again the last time we were faced with this type of scenario, which was post investment period, what we did was refinance it to be able to continue the very high returns on that investment.

[Mickey Schleien:]

Right. I understand, but like you said who knows where the market dynamics will be a year from now. In what position are you in terms of an equity holder to call that deal? Can you do that by yourself or do you need to work with the other equity owners or can you…

[Henri Steenkamp:]

We own a 100% of the equity and we can call it at any time.

[Mickey Schleien:]

You could call, okay. My last question is just sort of modeling question. It seems that a PIK interest income rose, it's not a large number in and of itself, but on a relative basis it increased to some extent. Is that idiosyncratic or was there something, what drove that?

[Christian Oberbeck:]

Do you mean gross interest income of the income statement?

[Mickey Schleien:]

No PIK income, Payment In Kind income increased fairly meaningfully quarter-to-quarter. I just was wondering if that was idiosyncratic just some particular deal or are you looking to do more PIK deals or just what happened and if you don't have that in front of you, we can do that offline.

[Christian Oberbeck:]

No, we actually -- there was a -- because of the network realization that we had and the redemption was with par and PIK, we had been reserving a portion of the PIK historically and so included in the PIK income is a reversal of some of the reserve that we had placed on it previously.

[Mickey Schleien:]

Okay. I understand. Those are all my questions for today. Thanks for your time.

[Christian Oberbeck:]

Thank you.

[Henri Steenkamp:]

Thanks.

[Operator:]

Thank you. Our next question comes from the line of Andrew Kerai from BDC Income Fund. Your line is open.

[Andrew Kerai:]

Yes, hi. Good morning. Thank you for taking my questions and congrats on a very strong quarter again. The first is just a housekeeping item on network communication. So if I understood you correctly, you said that you had been realized that post quarter end. So if I am running the math correctly, it looks like there is about a $3.5 million gain combined on the equity and the PIK notes, which would be then required for distribution. Is your plan to basically distribute that out as another special dividend sometime as the fiscal year kind of moves along here?

[Christian Oberbeck:]

Well look clearly that's an important and substantial gain for us. We haven't made a determination specifically of what to do at that particular gain at this particular moment in time. Again our distribution policy is driven very much by the regulations around the BDC and our tax returns and our taxable requirements to distribute income and we evaluate that periodically and very substantially at every yearend. And so the exact treatment of how that gain would fit into our overall gains and our overall regular dividend policy is part of an ongoing consideration, but it's not a -- we haven't concluded yet if we are going to do something specifically relative to that gain.

[Andrew Kerai:]

Great. No, certainly makes sense. And then I noticed on prepaid legal, it looks like you guys dropped out of about $2 million or I should say, sold about $2 million of the first lien debt went into increased your exposure to the second lien debt increased by about $5 million. Just maybe if you could give some comments on kind of this particular credit why you felt like moving down in the capital structure made sense given that the 25 basis points pick up in yield on what I'll call basically an increased overall exposure, but also obviously going down the capital structure for that particular name?

[Christian Oberbeck:]

Yes like all of the deals in our portfolio, we're constantly monitoring the performance of the company. In this case, we were monitoring their portfolio performance and had an opportunity to upsize our position in the second lien and became quite comfortable with that. And as part of that in evaluating our overall exposure to the credit, we decided that it made sense and it would benefit their shareholders to downsize our position in the first lien given the rate of interest that it offered. So it's a good opportunity for us to enhance the yield and take more exposure in the credit that we have a lot of comfort with.

[Andrew Kerai:]

Great. No, certainly makes sense. And then just for HMN Holdco, notice you took off the PIK component on your first lien and you wrote up the equity if you look at the warrants by about $0.5 million. Just wondered one what was the logic of taking off the PIK piece and was the equity appreciation just reflective of sort of the decrease in the value of debt, was that basically the swap from the sort of the debt valuation to the equity side, given that there is not that 2% PIK component that's going to come due and accrued here in about four years?

[Christian Oberbeck:]

That company is performing very well. So the write up in the equity and warrants is reflective of the performance of the company. I have to look at and get back to you precisely on the PIK component.

[Andrew Kerai:]

Okay.

[Christian Oberbeck:]

That deal is structured so that as the performance of the business improves, there is a grid that we negotiated with the majority owner such that their interest rate comes down over time as the risk profile reduces. So that maybe what you're seeing in the numbers I would have to check.

[Andrew Kerai:]

Okay. Great. No, thank you. I appreciate that. And then a leery of foundry noticed the mark stayed the same this quarter, just given that it's a couple quarters out here on the restructuring, any update you can give on that business would certainly be helpful.

[Christian Oberbeck:]

We continue to monitor that company carefully. I think it's fair to say that the business has still a lot of challenges ahead of it. Many of their customers are in end markets that are difficult. So the new ownership is focused on that and I think one of the offsets to the challenges that the company is currently is facing and working through is that they have practically no debt. The only debt they had on the balance sheet is the first lien. So the company is producing a lot more cash flow then its fixed charges are. So it's building up and accumulating cash as well, which is somewhat of an offset to some of the challenges they're facing and help improve the enterprise value from that standpoint. We continue to watch that one closely.

[Andrew Kerai:]

Great. No, certainly appreciate the color. Thank you for taking my questions and congrats on a great quarter again.

[Christian Oberbeck:]

Thank you.

[Henri Steenkamp:]

Thanks Andrew.

[Operator:]

Thank you. Our next question comes from the line of Joshua Horowitz from Palm Global Small CA. Your line is open.

[Joshua Horowitz:]

Hi. Thank you. What a tremendous job everyone has been doing. I just wanted to say congratulations and great job. Once again I feel like I am repeating myself every quarter, but everything the company says and the management says ends up getting done exactly as you describe it. So thanks for that. All of my questions have been answered. It's been a pretty thorough call and I am glad to see there is a lot of investor interest. So I guess at this point I would just say we hope that you continue to work to shrink the discount to net asset value and continue to execute as you have been.

[Christian Oberbeck:]

Thank you for that.

[Henri Steenkamp:]

Thanks Josh.

[Joshua Horowitz:]

Thanks.

[Operator:]

Thank you. Our next question comes from the line of Keith Dalrymple from Dalrymple Finance. Your line is open.

[Keith Dalrymple:]

Great. Hi. Thank you. I have a question about the general environment, if you guys could comment a little more on that. If I take your comments thus far, they're basically that there is more lenders and more capital and cheaper capital but few transactions, when I look at that, I would say that that imply that companies didn't have a great need for capital which in turn would imply that it's a lower no growth environment. Does that jibe with what you're seeing out there or is there something I am missing here?

[Christian Oberbeck:]

No, that's interesting. I think there are a lot of factors at play. Generally we're seeing solid performance from our portfolio of companies and just the deals with companies that we're looking at, but overall in the middle market, we're not seeing businesses growing at a really rapid rate. So that may corroborate with your statement as well. I think another factor at play is that the price -- the private equity firm, people that are buying these companies are facing some of the same dynamics that we are. In this low interest rate environment, prices are really high and there is a lot of capital out there and not as many assets that are changing hands and so that's making it difficult as we'll. I think a lot of the private equity firms are looking at the prices of the things that are coming for and having a challenge to pull the trigger on deals, the deal flow in general is down.

[Keith Dalrymple:]

Great. Thank you.

[Operator:]

Thank you. [Operator instructions] And that looks like all the questions that we have for today. So I would like to turn the call back over to management for closing remarks.

[Christian Oberbeck:]

Okay, well again would like to thank everyone for joining us today. We appreciate your support and we look forward to speaking with you next quarter.

[Operator:]

Ladies and gentlemen, thank you again for your participating in today’s conference. This now concludes the program and you may all disconnect your telephone lines. Everyone have a great day.