Saratoga Investment Corp 6.00% Q4 FY2025 earnings call

• Announced transition to a monthly dividend structure, increasing the quarterly base dividend to $0.25 per share per month, with an annualized first quarter dividend of $0.75 per share implying a 12.1% dividend yield. - Q4 adjusted NII was $0.56 per share, adjusted for excise tax was $0.69 per share, impacted by decreasing short-term interest rates and spreads on floating rate assets. - Assets under management had Q4 originations putting it back on the growth trajectory despite Q3 decline. - Portfolio quality was strong with only two restructured non-accrual credits. - Expanded business development efforts, added personnel in portfolio management and business development, and saw positive results in the pipeline. - Portfolio companies mostly in SaaS or domestic services sectors, relatively well positioned regarding tariffs.

The core BDC portfolio had a fair value 1.6% above cost. The CLO and JV were marked down by $2.7 million, and the core non-CLO portfolio was marked down by $3.4 million. The overall portfolio at fair value was 2.2% below cost. In Q4, adjusted NII was $0.56 per share, adjusted for an annual excise tax expense of $0.13 per share was $0.69 per share. Assets under management saw net positive originations in Q4, with $41.8 million originated from one new portfolio company and six follow-ons, and $7.2 million realized gains from three equity realizations.

• Continue to steadily increase the portfolio size, quality, and investment performance over the long-term. - Deploy $205 million of cash available at year-end accretively in investments or to repay existing debt. - Confident in navigating current challenges and uncovering opportunities in the future environment.

• Volatility in the broader macro environment. - Uncertainty from tariff discussions. - Potential impact on portfolio companies due to macroeconomic and tariff-related factors.

Q: Curious if you can maybe add a little color in terms of what that mix looks like in terms of new versus add-on opportunities as well as any particular industries where you're seeing strength at this point?

A: That's a difficult question to answer, mostly because there's so much going on in the marketplace, particularly some of the uncertainty that's being driven by the tariff environment. I think that plus the low volume of deals in the marketplace makes it a bit challenging to look out at the pipeline with any real level of certainty. I would say that we feel very confident in the initiatives that we're undertaking to reinforce our business development efforts and that in the space that we occupy in the lower middle market, there's an enormous number of businesses and deal sources there and that over time, our asset deployment will exceed the payoffs that we experienced in the marketplace. A little bit hard to say, too much about where our pipeline is right now. It's kind of reflective of what you've seen in the last couple of quarters would be the best way to characterize it?

Q: Just the -- like if there's a specific yield or structure that you guys are looking for the new dealers?

A: Generally, the way we're looking at the market and any deals that we do is we're looking at our all-in cost of capital and making sure that we're pricing deals cognizant of what our all-in cost of capital is, so that we can make sure that as we're deploying our capital that it's accretive to our shareholders. Now where we occupy in the lower end of the middle market, we've seen that generally, over time, the spreads that we can achieve are a bit higher than where they are in the upper market. That's not always the case at every moment. But by and large, we end up -- we tend to operate in a wider spread in market -- spread environment than the upper market. This market is a little bit volatile. So it's hard to tell, but we're finding deals and certainly the deals that we're investing in right now, we're looking at them from a standpoint of what's our cost of capital and making sure they're accretive from that standpoint?

Q: Did you repay some of the debentures on SBIC II during the quarter?

A: We did. Absolutely. Yeah, we repaid $44 million of SBIC II debentures because we're at the end of our reinvestment period in SBIC II. So when it makes sense, we'll start using available cash that is in SBIC II, III pay debentures, and we did that in February, end of February?

Q: What was the cost on those that you repaid? What was the interest rate?

A: I think on average, they were about $6 million or so -- sorry, 6% or so?

Q: 6%. What's the rate on the new SBA debentures when you take them down right now?

A: Yeah. The most recent ones were priced around about the high 4s. I think all in is probably like 5.25%?

Q: Have you considered moving to recognizing the excise tax quarterly as opposed to annually, and kind of removing some of the distortion that such a large excise tax creates on your results?

A: Yeah. We actually did. And we actually walked through all the accounting with our accountants, but the way the accounting works is you only recognize that when you know it's definitive. And if you can -- depending upon when you pay your spillover, you have until the end of December to pay it. So if, for example, you paid on December 30, you won't have any excise tax. So it's a point in time. So only once you hit January 1, is the expense definitive and do you pay it? Is it an obligation in it?

Q: Just to go back to the spillover question. I mean, it looks to me like you've got about $3.30 per current share, obviously, second contract. I mean, that's more than four quarters of current run rate dividend. So is there -- I mean, is the spillover balance too high is what it boils down to. Because I mean, is there an issue that you're sort of almost mandated to grow the dividend or pay out special distributions again as you did in the third quarter. Even if our base rates go down and earnings go down, with the spillover level that high, there's now an emerging disconnect between what your dividend must do to meet the BDC distribution requirements versus what earnings might do. So I mean, is there a case to be made that like lowering it more than the $0.35 special. Should you do more than that to lower it so that you can reconnect dividend trends to potential earnings trends, if that makes sense?

A: Well, I think there's been a lot of change in the marketplace. And I think, for example, we talked about at length, sort of outsized redemptions affecting our earnings level. The good news is those were redemptions of very successful investments, some of them dating back five and more years. And so on the one hand, we had realized equity gains and things like that. So it's reflective of a solid portfolio with strong underwriting. But nonetheless, it does reduce our earnings relative to our dividends. But we do have a dividend level, and we do have the spillover, as you remarked, but a lot of things remain to be seen. I mean there may be some opportunities to substantially deploy capital and pay out sufficiently. And then further, as Henry mentioned in answering the question, the -- earlier about the accounting for the spillover, we do have until the 30th of December, to decide what to do. And if -- as you laid out, things sort of continue on the path they're continuing, yes, there would be a special dividend to be paid. But to reduce the spillover and the excise tax and things like that. But again, I think a lot of it is going to be conditioned on our relative performance over the balance of the year?

Q: I noticed that the portfolio yield did not change quarter-to-quarter, at the same time, the portfolio's allocation by security didn't change, but SOFR -- or average SOFR went down about 50 basis points. So I was hoping you could triangulate how portfolio yield was stable in that environment?

A: No. Actually, Mickey, our portfolio did go down 30 basis points. If you look at slide 12, you'll see it's important to differentiate the CLO and the joint venture out of the sort of the overall interest and portfolio. So what we call the core portfolio went down from $11.8 million to $11.5 million, that was 30 basis points and about two-thirds of that was SOFR, which changed by about 20 basis points during the quarter. And then the other thirds was just sort of the -- like you said, the mix in some of the new -- the impact of the new deals that we've done over the last couple of quarters versus the repayments?

Q: Was there any sort of reversal of interest income during the quarter?

A: No?

Q: Did the external manager subsidize some of the common share issuance during the quarter?

A: Yes. Yes, we did, consistent with what we've done in other quarters as well. And so all the issuances were done at NAV or even slightly above while we're trading anything from like 3% to 7%, 3% to 8% below NAV?

Q: On the balance sheet leverage question, maybe a question for Chris, just thinking long term, I do understand, obviously, that you have a series of unsecured notes outstanding, and that gives you flexibility that's superior to having secured debt. But the leverage ratio is quite high and the regulatory coverage ratio is quite low. At the same time, that economic risk is increasing. So just thinking broadly and longer term, would you like to see balance sheet leverage perhaps trend down some more. You specifically talked about issuing equity last quarter to help that along the way. Is that the long-term goal of management?

A: Well, that's a very good and complex question that we wrestle with ourselves and with our Board quite a bit, like what is the right leverage level at a given point in time. I think as we mentioned earlier, the issuance of equity something that's kind of opportunistic because certainly, BDCs our size don't have the opportunity to do that on a regular basis. There's only certain times in places where you can do that, and we think you have to do that. And our intent and our history has been one of significant long-term growth and the cornerstone of that long-term growth is equity. You have to have more equity to grow and there's different ways to get that equity. One is by selling it in the open market. Others has been realizations on capital gains, which has been an important source because we do get equity in our investments often. And we did have $7 million of realized gains this past quarter. So all that contributes to the cornerstone building of it. Now in terms of our view of leverage. I think, we've talked about that many times over the years, we feel that if you have long-term covenant-free fixed rate financing, with a maturity structure 2 to 10 years out, that is -- that leverage is very different than asset-based leverage, which is have got mark-to-market risks and things like that. I mean we don't have mark-to-market risks. And if -- but a lot of people -- a lot of entities that have the asset-based lending, if there's some event like happened in 2008 or COVID or something like that, mark-to-market risks have to be addressed immediately or else there's a foreclosure kind of action that takes place. But we don't have that risk, really at all. So we think we've got a very -- that's sort of like sort of a huge risk factor that's really not present for us. So that gives us the confidence to run with a higher leverage rate because over time, we feel confident in the US economy. We're confident in our underwriting, our underlying companies and all that. So we think there may be dislocations in short periods of time, but over long periods of time, we think we're going to be all right with everything. And so that kind of governs a lot of how we look at that. And so we don't feel that we're over leveraged right now. And I think also, I think if you go back to the comments, that Mike was making about our portfolio and Henry. Our portfolio right now is in very good shape. I don't know what all the other portfolios you cover look like. But our we have our problems are very, very minor. We have some very solid companies very well underwritten. So we feel like we've got a very solid portfolio. And so that gives us also more confidence that the leverage level that we're at right now is certainly not too high relative to all those things that we've just mentioned?

Q: If I could just follow up, Chris. I hear what you're saying, but you do have mark-to-market risk on your assets, right? And if we were to -- God-forbid we had an 2008, 2009 sort of environment, I could paint a picture where you would trip your regulatory asset coverage ratio and you'd have to spend the dividend. Are you saying that you're willing to take that risk at this point in time?

A: I think what I'm saying is that I don't foresee given the nature of our portfolio, very substantial mark-to-market risk in the type of businesses that we're financing?