Prepared remarks
Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Saratoga Investment Corp.'s 2025 Fiscal Third Quarter Financial Results Conference Call. Please note that today's call is being recorded. At this time, I would like to turn the call over to Saratoga Investment Corp.'s Chief Financial and Chief Compliance Officer, Mr. Henri Steenkamp. Please go ahead, sir.
Thank you. I would like to welcome everyone to Saratoga Investment Corp.'s 2025 Fiscal Third Quarter 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 third quarter 2025 shareholder presentation in the Events and Presentations 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. Please refer to our earnings press release for details. I would now like to turn the call over to our Chairman and Chief Executive Officer, Christian Oberbeck, who will be making a few introductory remarks.
Thank you, Henri, and welcome, everyone. Saratoga Investment Corp. highlights this quarter include a sequential quarterly increase of adjusted NII, excluding the effect of one-time Knowland interest reserve reversal, improved latest 12 months return on equity of 9.2%, reflecting the solid high-quality nature of our existing portfolio. Another increase in total NAV and steady NAV per share, healthy originations in both new and existing portfolio companies, while also experiencing outsized redemptions of successful investments and continued over-earning of our dividends. The substantial over-earning of the dividend this quarter continues to support the current level of dividends, increases NAV, supports increased portfolio growth and provides a cushion against adverse events. This quarter's earnings reflect the impact of the past 6-month trend of decreasing levels of interest rates and spreads on Saratoga Investment's largely floating rate assets, while not yet recognizing the full-time impact of the recent outsized repayments seen this quarter.
The cost of most long-term balance sheet liabilities is largely fixed though callable either now or in the near future, in the context of the significant level of available cash currently creating a negative arbitrage, management is evaluating the use of such calls prospectively to reduce current debt. From an overall investment value and current yield perspective, our annualized third quarter dividend of $0.74 per share implies a 12.2% dividend yield based on the stock price of $24.21 per share on January 7, 2025, or 90% of our third quarter's NAV. During the quarter, we began to see the early stages of a potential increase in M&A in the lower middle market, reflecting in multiple repayments during the quarter in addition to significant new originations. As was the case in previous quarters, our strong reputation and differentiated market positioning, combined with our ongoing development of sponsor relationships, continues to create attractive investment opportunities from high-quality sponsors despite lower overall mergers and acquisitions volumes and elevated interest rate levels.
We believe Saratoga continues to be favorably situated for potential future economic opportunities as well as challenges. At the foundation of our strong operating performance is the high-quality nature, resilience, and balance of our $960 million portfolio in the current environment. Where we have encountered significant challenges in four of our portfolio companies over the past year, we've completed decisive action and resolved all four of these companies' challenges through two sales and two restructurings. Our current core non-CLO portfolio was marked down slightly by $1.4 million this quarter, and the CLO and JV were marked down by $4 million. This was offset by net realized gains of $1.2 million this quarter on various repayments, most notably the Invita investment and $0.7 million of escrow realized gains, mainly from the former Netreo investment resulting in $3.5 million of total net reduction in portfolio value during the quarter.
Our total portfolio fair value is now 0.7% below cost while our core non-CLO portfolio is 3% above cost. Our originations this quarter were elevated as we began to see the effect of declining interest rates and increased M&A activity in the market. Deployments during the quarter included $85 million in 2 new portfolio company investments and 8 follow-on investments in existing portfolio companies that we know well, all with sound business models and strong balance sheets. Our quarter-end cash position grew to $250 million, largely due to an outsized $160 million of repayments of successful investments in 5 portfolio companies and amortizations, exceeding the substantial $85 million of originations. The repayments include the recognition of a $4.8 million realized gain along with $67 million of debt repayments from our successful 5-year Invita investment. This increase in our cash position improved our effective leverage from 160.1% regulatory leverage to 183.2% net leverage, netting available cash against outstanding debt.
Our overall credit quality for this quarter remained steady with 99.7% of credits rated in our highest category, with the two investments currently still on nonaccrual status being Zollege and Pepper Palace both of which have been successfully restructured, each representing only 0.3% of both fair value and cost. With 86.8% of our investments at quarter end in first lien debt, our overall portfolio is generally supported by strong enterprise values and balance sheets in industries that have historically performed well in stress situations. We believe our portfolio and leverage are well structured for challenging economic conditions and further changes in interest rates in either direction. As always, and particularly in the current uncertain environment, balance sheet strength, liquidity, and NAV preservation remain paramount for us. At quarter end, we maintained a substantial $474 million of investment capacity to support our portfolio companies with $136 million available through our existing SBIC II license, $87.5 million from our two revolving credit facilities, and $250 million in cash.
Saratoga Investment's third quarter of fiscal 2025 demonstrated a solid level of performance with our key performance indicators as compared to the quarters ended November 30, 2023, and August 31, 2024. Our adjusted NII is $12.4 million this quarter, down 5.3% from last year and 31.7% from last quarter. Our adjusted NII per share is $0.90 this quarter, down 10.9% from $1.01 last year and down 32.3% from $1.33 last quarter. When excluding the $7.6 million, which is equivalent to $0.44 per share, net impact of the nonrecurring Knowland investment interest reserve released in the previous and current quarter from its successful sale, adjusted NII increased $0.01 per share from $0.89 to $0.90 as compared to the previous quarter. Adjusted NII yield is 13.3% this quarter, down from 14.6% last year and from 19.7% last quarter. Latest 12 months return on equity is 9.2%, up from 6.6% last year and up from 5.8% last quarter, and beating the industry average of 8.5%.
Our NAV per share is 26.95, down 1.7% from 27.42 last year and down 0.4% from 27.07 last quarter. And our quarter-end NAV was $374.9 million, up from $359.6 million last year, and up from $372.1 million last quarter. The $2.8 million increase in NAV sequentially resulted primarily from at-the-market sales of 108,000 shares at NAV. In addition, a further 356,000 shares were sold to the market at NAV for $9.6 million subsequent to quarter end, resulting in total sales of $12.6 million. While the past 12 months have seen markdowns to a small number of credits in our core BDC portfolio, Slide 3 illustrates how our recent strong results have delivered a return on equity of 9.2% for the last 12 months above the industry average of 8.5%. Additionally, our long-term average return on equity over the last 10 years of 10.4% remains well above the BDC industry average of 6.9% and has remained consistently strong over the past decade, beating the industry 8 of the past 10 years.
As you can see on Slide 4, our assets under management have steadily and consistently risen since we took over the BDC 14 years ago. Outsized repayments offset strong originations this quarter, resulting in our AUM declining, but this does not impact our expectation of long-term AUM growth. The quality of our credits remains solid, with only the two recently restructured Pepper Palace and Zollege credits on nonaccrual consistent with last quarter. Our management team is working diligently to continue this positive trend as we deploy our significant levels of available capital into our pipeline while at the same time being appropriately cautious in this evolving credit environment. With that, I would like to now turn the call back over to Henri to review our financial results as well as the composition and performance of our portfolio.
Thank you, Chris. Slide 5 highlights our key performance metrics for the fiscal third quarter ended November 30, 2024, most of which Chris already highlighted. Of note, the weighted average common shares outstanding in Q3 of this year was 13.8 million shares, increasing from 13.7 million and 13.1 million as compared to last quarter and last year's third quarter, respectively. Adjusted NII decreased this quarter, down 5.3% from last year and 51.7% from last quarter. This quarter's investment income decreases as compared to last quarter were primarily due to the impact of the nonrecurring Knowland interest reserve reversal of $7.9 million last quarter, following the investments full repayment, including accrued interest, offset by higher prepayment and structuring and advisory fees this quarter, reflective of the high level of both originations and repayments in Q3. Excluding the Knowland interest reserve reversal, adjusted NII per share increased $0.01 per share to $0.90 per share as compared to the previous quarter.
Investment income reflects a weighted average interest rate of 11.8% as compared to 12.5% as of the previous year and 12.6% last quarter. Approximately two-thirds of the interest rate reduction is due to SOFR base rate decreases and one-third due to the higher yields of the recent repayments. The impact of this quarter's outsized repayments is not yet fully reflected in this quarter's results as most repayments occurred in the last month of the quarter. Total expenses for this year's third quarter, excluding interest and debt financing expenses, base management fees, incentive fees, and income and excise taxes increased to $2.8 million as compared to $2.3 million last year and $2.2 million last quarter. This represented 0.9% of average total assets on an annualized basis, up from 0.8% last year and 0.7% last quarter. Also, we have again added the KPI slides 26 through 29 in the appendix at the end of the presentation that shows our income statement and balance sheet metrics for the past 9 quarters and the upward trends we have largely maintained.
Moving on to Slide 6. NAV was $374.9 million as of this quarter end, a $2.8 million increase from last quarter and a $15.3 million increase from the same quarter last year. This chart also includes our historical NAV per share, which highlights how this important metric has increased in 22 of the past 29 quarters and has stabilized over the past couple of quarters since the resolution of the recent discrete nonaccruals. Over the long term, our net asset value has steadily increased since 2011 and grown by 33% over the past 5 years, and this growth has been accretive, as demonstrated by the long-term increase in NAV per share. Over the past 4.5 years, NAV per share is up $1.84 per share or over 7%. We continue to benefit from our history of consistent realized and unrealized gains. On Slide 7, you will see a simple reconciliation of the major changes in adjusted NII and NAV per share on a sequential quarterly basis.
Starting at the top, adjusted NII per share was down $0.43, primarily due to, first, the impact of the nonrecurring Knowland interest reserve reversal last quarter as previously noted. And second, the decrease in non-CLO net interest income reflecting a lower SOFR rate in Q3 and the partial impact of the quarter's repayments. These decreases were partially offset by higher prepayment and structuring and advisory fees this quarter reflective of the high level of originations and repayments. On the lower half of the slide, NAV per share decreased by $0.12, primarily due to the $0.16 overearning of the dividend being more than offset by the $0.25 quarterly net realized gains and unrealized depreciation on investments. Slide 8 outlines the dry powder available to us as of quarter end, which totaled $473.7 million. This was spread between our available cash, undrawn SBA debentures, and undrawn secured credit facility.
This quarter-end level of available liquidity allows us to grow our assets by an additional 49% without the need for external financing, with $250 million of quarter-end cash available and thus fully accretive to NII when deployed, and $136 million of available SBA debentures with its low-cost pricing, also very accretive. We also include a column showing any call options of our debt. This shows that $321 million of baby bond, effectively all of our 6% plus debt is callable, either now or within the next 4 months, creating a natural protection against potential continuing future decreasing interest rates, which should allow us to protect our net interest margin, if needed. These calls are also available to be used prospectively to reduce current debt. We remain pleased with our available liquidity and leverage position, including our access to diverse sources of both public and private liquidity and especially taking into account the overall conservative nature of our balance sheet, the fact that almost all our debt is long-term in nature and with almost no non-SBIC debt maturing within the next 2 years.
Also, our debt is structured in such a way that we have no BDC covenant that can be stressed during such volatile times. Now I would like to move on to Slides 9 through 12 and review the composition and yield of our investment portfolio. Slide 9 highlights that we have $960.1 million of AUM at fair value and this is invested in 48 portfolio companies, 1 CLO fund, and 1 joint venture. Our first lien percentage is 86.8% of our total investments, of which 25.7% is in first lien last out positions. On Slide 10, you can see how the yield on our core BDC assets, excluding our CLO has changed over time, especially this past quarter, reflecting the recent decreases to interest rates. This quarter, our core BDC yield decreased to 11.8% from 12.6% with about two-thirds of the decrease due to core SOFR base rates decreasing during the fiscal quarter. The CLO yield increased to 24.6% from 13.0% last quarter, purely reflecting lower fair value.
The CLO is performing and current. Slide 11 shows how our investments are diversified throughout the U.S. And on Slide 12, you can see the industry breadth and diversity that our portfolio represents, spread over 40 distinct industries in addition to our investments in the CLO and joint venture, which are included as structured finance securities. Moving on to Slide 13. 9.0% of our investment portfolio consists of equity interest, which remain a very important part of our overall investment strategy. This slide shows that for the past 12 fiscal years, we had a combined $32.4 million of net realized gains from the sale of equity interest or sale of early redemption of other investments. This is net of the Zollege, Netreo and Pepper Palace realized losses this year. This long-term realized gain performance highlights our portfolio credit quality, has helped grow our NAV and is reflected in our healthy long-term ROE. That concludes my financial and portfolio review. Our Chief Investment Officer, Michael Grisius, will now provide an overview of the investment market.
Thank you, Henri. Today, I will focus on our perspective on the changes in the market since we last spoke with everyone and then comment on our current portfolio performance and investment strategy. While broader middle market deal volumes are showing signs of improvement, deal activity in the lower middle market where we operate has yet to pick up. Year-to-date deal volumes through calendar Q4 for transactions below $150 million are down significantly over the prior year by more than 34% and down further still as compared to 2021 and 2022. We believe a number of factors are influencing the decline in the lower middle market deal activity, including a disconnect between where buyers and sellers are willing to transact, elevated interest rates making debt financing more expensive and a trend toward private equity firms holding on to assets longer in order to meet their return expectations.
The combination of historically low M&A volume and an abundant supply of capital is causing spreads to tighten and leverage to remain full as lenders compete to win deals, especially premium ones. This was evidenced this past quarter, with outsized repayments being experienced in some cases, due to lenders offering extremely aggressive pricing on some of our low-leverage assets. The historically low deal volume we're experiencing currently has made it more difficult to find quality new platform investments than in prior periods. Now that said, the relationships and overall presence we've built in the marketplace, combined with our ongoing business development initiatives, give us confidence in our ability to achieve healthy portfolio growth in a manner that we expect to be accretive to our shareholders in the long run. This quarter, we closed two new platform investments and our investment pipeline is solid.
I'll also point out that we continue to believe that the lower middle market is the best place to be in terms of capital deployment. As compared to the larger end of the middle market, the due diligence we're able to perform when evaluating an investment is much more robust. The capital structures are generally more conservative with less leverage and more equity. The legal protections and covenant features in our documents are considerably stronger. And our ability to actively manage our portfolio through ongoing interaction with management and ownership is greater. As a result, we continue to believe that the lower middle market offers the best risk-adjusted returns, and our track record of realized returns reflects this. The Saratoga management team has successfully managed through a number of credit cycles, and that experience has made us particularly aware of the importance of first being disciplined when making investment decisions; and second, being proactive in managing our portfolio.
Our underwriting bar remains high as usual, yet we continue to find opportunities to deploy capital. As seen on Slide 14, our more recent performance has been characterized by continued asset deployment to existing portfolio companies, as demonstrated with 40 follow-ons this calendar year versus 2 investments in new platform portfolio companies. During the fiscal quarter, we invested $85 million through a combination of 2 new platform investments and 8 follow-on investments. Overall, our origination platform remains strong and our consistent ability to generate new investments over the long term, despite ever-changing and increasingly competitive market dynamics is a strength of ours. Portfolio management continues to be critically important, and we remain actively engaged with our portfolio companies and in close contact with our management teams. There remain 2 portfolio companies that we are actively managing as discussed in previous quarters, and I will touch on them shortly.
But in general, our portfolio companies are healthy and the fair value of our core BDC portfolio is 3% above its cost. 86.8% of our portfolio is in first lien debt and generally supported by strong enterprise values in industries that have historically performed well in stressed situations. We have no direct energy or commodities exposure. In addition, the majority of our portfolio is comprised of businesses that produce a high degree of recurring revenue and have historically demonstrated strong revenue retention. We have the same 2 investments on nonaccrual, namely Pepper Palace and Zollege consistent with last quarter. We continue to hold them on nonaccrual following their restructurings, but their combined remaining value, including equity, is just $5.8 million or 0.6% of total portfolio fair value, with Zollege's fair value being written up this quarter, reflecting positive company performance.
Looking at leverage on the same slide, you can see that industry debt multiples remain above 5x. Total leverage of our overall portfolio increased to 5.56x, excluding Pepper Palace and Zollege reflecting both the repayment of a handful of low leverage investments as well as follow-on debt this quarter by some of our existing investments. Slide 15 provides more data on our deal flow. As you can see, the top of our deal pipeline is down from last year, in part because we made a conscious effort to improve the quality of our deal pipeline and in part because market activity is down considerably as previously discussed. Despite these macro trends, our investment volume was the highest we've had in the past 6 quarters. Overall, the significant progress we've made in building broader and deeper relationships in the marketplace is noteworthy because it strengthens the dependability of our deal flow and reinforces our ability to remain highly selective as we rigorously screen opportunities to execute on the best investments.
As you can see on Slide 16, our overall portfolio credit quality and returns remain solid. As demonstrated by the actions taken and outcomes achieved on the nonaccrual and watch list credits we had over the past year, our team remains focused on deploying capital in strong business models where we are confident that under all reasonable scenarios, the enterprise value of the businesses will sustainably exceed the last dollar of our investment. Our approach and underwriting strategy has always been focused on being thorough and cautious at the same time. Since our management team began working together a dozen plus years ago, we've invested $2.24 billion in 119 portfolio companies and have had just 3 realized economic losses on these investments. Over that same timeframe, we've successfully exited 78 of those investments, achieving gross unlevered realized returns up 15% on $1.2 billion of realizations.
Even taking into account the recent write-downs of a few discrete credits, our combined realized and unrealized returns on all capital invested equal 13.6%. We think this performance profile is particularly attractive for a portfolio predominantly constructed with first lien senior debt. As was the case in the previous quarter, with Knowland repaid, we have only 2 investments on nonaccrual. Although both Pepper Palace and Zollege have been successfully restructured, we are still classifying Pepper Palace as red, while Zollege has been elevated back to yellow, with a combined fair value of only $5.8 million, including equity. During the previous quarter, the Pepper Palace restructuring was successfully completed with us taking over a majority control of the business. The turnaround specialists we have been working with, who have substantial successful experience in similar situations, have invested significant equity in the business and became the CEO and a Board member.
The total fair value of the remaining investment is $1.6 million. Following the Zollege restructuring of the balance sheet during the first quarter that resulted in us taking over the company and starting to actively manage the investment, the founder and previous owner has invested meaningful dollars in the business and is leading the enterprise and has reassembled some of the former senior leadership. He and the management team are working in partnership with us with the immediate goal of returning the business to its former profitability levels and the ultimate objective of exceeding those levels. We still have equity in a first lien term loan in the company with a current fair value of $4.2 million, with the equity marked up this quarter to reflect the recent positive financial performance of the company. In addition, we recognized a $4.8 million realized gain on our Invita equity resulting from the sale of the company and recognized $0.7 million of realized gain on a Netreo escrow payment, further improving the overall positive outcome of that investment sold earlier this year.
The CLO and JV had $4 million of unrealized depreciation this quarter, reflecting primarily markdowns due to individual credits, most notably in the first CLO. Our overall investment approach has yielded exceptional realized returns and recovery of our invested capital and our long-term performance remains strong as seen by our track record on this slide. Moving on to Slide 17. You can see our second SBIC license is fully funded and deployed, although there is cash available there to invest in follow-ons, and we are currently ramping up our new SBIC III license with $136 million of lower cost, undrawn debentures available, allowing us to continue to support U.S. small businesses, both new and existing. This concludes my review of the market, and I'd like to turn the call back over to our CEO. Chris?
Thank you, Mike. As outlined on Slide 18, our latest dividend of $0.74 per share for the quarter ended November 30, 2024, was paid on December 19, 2024. Though unchanged from last quarter, this reflects a 3% and a 9% increase over the past 1 and 2 years, respectively. Additionally, we paid a special dividend of $0.35 per share concurrently with $1.09 per share of total distribution fulfilling our fiscal 2024 requirements. The Board of Directors will continue to evaluate the dividend level on at least a quarterly basis, considering both company and general economic factors, including the current interest rate environment's impact on our earnings. Moving to Slide 19. Our total return for the last 12 months, which includes both capital appreciation and dividends, has generated total returns of 4%, which is uncharacteristically low and underperforms the BDC index of 13% for the same period. Our longer-term performance is outlined on our next Slide 20.
Our 5-year return places us in line with the BDC index while our 3-year performance is slightly below the index, reflecting the impact of the recent latest 12 months' performance and discrete credit issues. Since Saratoga took over management of the BDC in 2010, our total return has been 740% versus the industry's 284%. On Slide 21, you can further see our differentiated performance placed in the context of the broader industry and specific to certain key performance metrics. We continue to focus on our long-term metrics such as return on equity, NAV per share, NII yield, and dividend growth and coverage, all five of which are above industry averages, reflecting the growing value our shareholders are receiving. The negative NAV per share metric this past year is primarily due to the two discrete nonaccruals, Zollege and Pepper Palace previously discussed. Yet we continue to be 3x better than the industry average at negative 0.4% versus negative 1.2% for the industry.
Our dividend coverage and dividend growth has been one of the strongest in the industry. We also continue to be one of the few BDCs to have grown NAV over the long term, and we have done it accretively, and our long-term return on equity is 1.5x the long-term industry average. Moving on to Slide 22. All of our initiatives discussed on this call are designed to make Saratoga Investment a leading BDC that is attractive to the capital markets community. We believe that our differentiated performance characteristics outlined on this slide will help drive the size and quality of our investor base, including adding more institutions. Looking ahead on Slide 23, as we navigate through a reshaped yield curve environment, with decreasing short-term and increasing long-term rates and an uncertain economic outlook, we remain confident that our reputation, experienced management team, robust pipeline, and historically strong underwriting standards and time and market tested investment strategy will serve us well to continue to steadily increase our portfolio size, quality, and investment performance over the long term.
This will allow us to deliver exceptional risk-adjusted returns to shareholders and to navigate through the current challenges in the market and uncover opportunities in the current and future environment. We also believe that our strong balance sheet, capital structure, and liquidity will benefit Saratoga's shareholders in the near and long term. In closing, I would like to again thank all of our shareholders for their ongoing support. I would like to now open the call for questions.
Questions and answers
Operator Instructions. Our first question will come from Eric Zwick of Lucid Capital Markets.
So I wanted to start first and just looking at Slide 23. Since we kind of just wrapped up there. You remain committed to expanding the asset base and growing the investment portfolio. You made comments during the call that the pipeline remains solid and then you had a pretty good quarter. Here the one that just wrapped up. So I guess maybe the harder part for me and maybe for you guys as well to have a longer-term view, and it's just the pace of repayments, which was obviously strong in the most recent quarter. So to the degree that you have some sort of sightline, at least over the next maybe 3 to 6 months. What are your expectations there, just given that some of it seemed to be the repayments in this most recent quarter were driven by the pickup in the M&A market and you expect that to continue as well. So just trying to kind of balance the outlook for new growth versus repayments as well.
I will begin and then Mike can provide additional comments. In the last quarter, we achieved $85 million in originations, which is a solid amount. Additionally, our Invita investment, which is a 5-year commitment, accounted for around half of the $160 million in redemptions. If you overlook that specific case, we were essentially neutral. Such occurrences are normal as investments and redemptions go through various cycles, making it challenging to predict exactly when that investment will yield returns over the 5-year span. Mike, wasn’t the initial amount of that investment around $6 million?
Yes. It represents a significant investment for us in many ways regarding our operations and market involvement. Initially, it was a $6 million debt deal, paired with $2 million in equity. We held this investment for about 5 years, during which we were able to support the company's growth, and the debt position increased considerably as the company expanded. Ultimately, we achieved a $4.8 million gain on our equity investment. The overall return for our shareholders on this deal was quite significant over the five years. One of the challenges we face with this model is that when we bring in new portfolio companies, they are typically smaller and more granular. However, the successful ones in our portfolio have allowed us to support them with growth over time. When they eventually pay off, those returns can be somewhat unpredictable. It requires more platform companies to balance out those variable payoffs. In this quarter, we experienced a couple of unusually large payoffs that were not typical, as Chris noted.
It's difficult to accurately predict our origination. We have a strong and sizable portfolio, and we receive inquiries from our portfolio companies wanting to make large acquisitions, which could lead to significant follow-on investments. Therefore, it's not something we can forecast neatly. While we do have substantial cash available and our historical pipeline data, the specifics concerning redemptions and origination remain unpredictable, and it may not be wise for us to attempt making predictions about those metrics.
And Eric, we often talk about how quarters can be lumpy, right, either that you have a lot of originations and repayments in one quarter or even none. And Slide 4 is the best slide to sort of illustrate how we think of things, which is long term and being able to grow on a long-term basis rather than quarterly that could be a lot more volatile.
I want to emphasize that this is a key focus for our management team. The market is currently experiencing significant add-on activity, particularly in the lower end of the middle market, where new M&A activity has notably declined and continues to do so. We are optimistic that the factors contributing to this decline in M&A volume might start to improve as interest rates potentially decrease and other conditions align in our favor. We believe that a new equilibrium will be achieved, leading to an increase in M&A activity that we can take advantage of. Currently, our portfolio origination pace is not as strong as it was a couple of years ago. However, interestingly, the decrease in M&A activity has also resulted in lower repayment levels. In fact, over several recent quarters, we managed to grow despite lower origination activity due to reduced repayment. In the latest quarter, although we experienced robust production, we also had some significant repayments. Looking ahead, we are confident that our origination efforts and expanding market relationships will ensure our deployment pace surpasses any repayment fluctuations over time.
That's helpful. I appreciate all the information provided. You have effectively shown your capability as mentioned. Regarding Slide 8, Henri, you discussed the potential opportunities with the publicly traded notes, noting that SAT is around 6% and JY is above 8%. There is a chance to achieve some savings if those are paid down or refinanced. As for the SBIC ventures, I have noticed that the call period has calmed down, but I'm interested in understanding how the process of potentially calling those or attempting to reprice them would work, considering they are tied to specific assets. Perhaps I should start by asking what the current average cost of those debentures is, though that may not even be relevant for us.
Yes, I believe the key factor when dealing with a license is whether you are still within the reinvestment period. For instance, SBIC III is a newer license. If we receive a repayment, we will use that cash to invest in new assets rather than repaying debentures. Once we are outside the reinvestment period, as we are with SBIC II, any cash from repayments can only be used for additional investments in existing assets to provide support. This creates a decision point when cash is available in a license outside its reinvestment period, where you must choose whether to hold onto the cash for potential follow-on needs or use it to repay existing SBIC debentures. The process is quite simple, with two opportunities each year, at the end of August and February, to decide on repaying the debentures. If, for instance, we opt not to repay in August, we must hold the debentures until the next six-month period. So, at the upcoming February meeting, we will need to decide whether to apply some of the cash from SBIC II toward repaying some of the existing debenture. Many of those debentures were issued when interest rates were low, creating a consideration for us on whether to keep earning cash for potential follow-on investments or to pay down the debentures, and we will revisit that decision in mid-February.
Got it. And then last one for me. You noted your success in the past with realizing some equity gains with your investments there. Remind me just how you think about the potential to realize future gains? Is it really just tied to if the company sells in those transactions? Or do you typically sometimes proactively go out and seek to commoditize where a fair value might be well above kind of your holding.
On the equity side, we usually act as a minority investor. We believe that enhancing our debt returns through equity co-investments is a crucial part of our investment strategy. Our relationships with private equity sponsors and management teams often appreciate the alignment of interests that comes from co-investing in equity. However, as a minority investor, we don't usually control the exit; instead, we have the right to exit when the company is sold or when there is some realization, which is typically when we see a return on equity. From a strategic perspective, we conduct thorough evaluations of these businesses, making us confident in assessing whether co-investment in equity is a good opportunity. Our experience shows a substantial overlap between what constitutes a solid credit and what makes for a strong equity investment. Businesses that stand out typically operate in markets with strong dynamics, excellent management, and high free cash flow characteristics. The criteria we use to evaluate businesses are often the same factors that make them viable equity investments. This approach has enabled us to achieve 15% unlevered returns on our portfolio over time, mainly driven by debt returns but also benefiting significantly from successful equity co-investments. We continue to see this as a fundamental aspect of our strategy.
And our next question will be coming from the line of Casey Alexander of Compass Point Research & Trading.
I do find it interesting when we all sound sort of disappointed when you get large repayments because that's kind of the goal, right? And I get you're a platform that originates small and repays big. I get that. But one question I would ask is that you discussed kind of the reduction in weighted average yields as being 2/3 rate and 1/3 higher-yielding loans paying off. Looking at the quarter-over-quarter, it looks like your portfolio yields declined by about 80 basis points. So would it be fair to say that you're only about halfway through the resetting function of the 100 rates that base rates have gone down, you still have about half way to go. I mean, that seems like reasonable math to me.
It's a little more than half. I would estimate that around two-thirds of it is being shown in the way our loans reset, and when they reset, I believe about two-thirds of the decrease has been reflected. There has been a sort of reset on our end since September already, so I would say about two-thirds. Additionally, since the end of the quarter, there has been a slight decline in SOFR as well.
So right. Well, that's what I mean. I mean, when I look at it across the entire 100 basis points of what the Fed has done, it would seem to me that you've reflected about 50 basis points in your results as of the end of November and maybe there's another 50 bps to go counting what the Fed has done subsequent to the end of your quarter.
Yes. I haven't done like the exact count, but I would guess it's again, slightly more than that, probably in the low 60s.
Okay. When I think in terms of decline in rates, higher yielding loans paying off, clearly a reduced portfolio balance that's going to take some time to build up. Do you still feel comfortable? Or is there maybe a quarter or two here where maybe it might seem reasonable to actually under-earn the dividend a little bit until you can build the portfolio back up?
I don't believe we've ever under-earned our dividend, and that's not something we would like to do. There are factors beyond our control, such as the rate of repayments and deployments. However, we do have a solid pipeline. As Mike mentioned earlier, there has been a significant slowdown in M&A activity. Many private equity firms are holding onto assets that aren't meeting their expectations, but there's considerable pressure within the market. With the new administration and potential changes in antitrust policies, we might see a resurgence in deal activity soon, as many have been waiting. Some deals, projected to be worth around $8 billion, were surprisingly turned down by the Justice Department, which raises questions about those decisions. On a broader scale, many participants are prepared to engage in business as we move forward. While we cannot predict the timing or pace of this activity, we believe there will be a significant amount of it in the future. How this will affect us on a quarter-by-quarter basis is uncertain, but we do not expect to under-earn our dividend, although that's not entirely in our hands.
Okay. Looking at Slide 17, with $77 million of cash in SBIC II and as Henri said, you're no longer in the reinvestment period there. Is it reasonable to think that there could be that much follow-on activity? Or does it make sense to at least start paying down some of those? And when do you start dusting off the paperwork on SBIC IV?
First of all, Casey, I believe it’s fair to say that the current cash rate is higher than the cost of the debentures in SBIC II. Therefore, there is a positive arbitrage in not paying off the debt in that situation. If it were the opposite, we would likely reduce it. We are monitoring this situation closely. If it shifts to a negative arbitrage, it would make sense to pay it off. Additionally, we need to carefully consider the type of acquisition activity we expect from those companies. Regarding SBIC IV, you might have noticed Henri's reaction; it's a significant paperwork task, but we still have much to accomplish with SBIC III. We have had a successful program there, and we do not expect any issues in obtaining the next license; it's primarily a timing concern. There are also some metrics related to investment levels that need to be met before we initiate that process.
There is definitely a new process in licensing for repeat issuers that has streamlined things significantly, which is great. I know Casey is also very familiar with it. However, we still have $136 million of debentures, and we haven't seen much realization in SBIC III yet. Actual realizations in the fund are something I monitor closely as part of my assessment.
My last question is about the repayment situation you were aware of at the end of the quarter. Selling equity when you have $250 million in cash seems illogical, especially since that occurred right at the end of the quarter and at the start of the next one. Can you clarify the reasoning behind that decision? It appears irrational given the cash balance and the implications of paying down some of your debt.
Sure, that's a good question, Casey. We've discussed this extensively internally. If you look at BDCs in general and our BDC specifically, the ability to raise equity depends largely on whether we can sell stock at net asset value. In this case, we were very close, and the manager supported the sales to reach that NAV. Opportunities to sell significant amounts do not arise frequently. There's a common saying on Wall Street that it's difficult to raise money when you need it and easier when you don't. Equity is a permanent form of capital, and when the chance to raise it arises, it's important to seize that opportunity. We have also talked about our leverage levels in previous calls, and there are different ways to manage leverage, such as repaying debt or increasing equity. Our preferred method of boosting equity is through capital gains, which we have successfully achieved, but we also periodically sell new equity.
We view equity sales as a long-term strategic decision rather than being influenced by our current cash balance. While we have $250 million in cash right now, there have been times when cash was limited, and we faced challenges in finding liquidity for our investments. Therefore, we see cash as a short-term concern and equity as a long-term strategy crucial for the growth of our BDC. We don't anticipate a slowdown in our investment opportunities; in fact, we see considerable growth ahead. All of these factors contributed to our decision.
And our next question will be coming from the line of Mickey Schleien of Ladenburg.
First question I'd like to ask is, could you give us a sense of how much more refinancing risk you believe exists in the portfolio given the current terms available in the market?
That's a good question, Mickey, just in terms of what we could see in terms of pace of repayments. Hard to answer it candidly. You could see for several quarters, we were getting almost no repayments, and a lot of that was just due to the fact that there wasn't much M&A activity. We have seen some deals that have exited our portfolio because somebody approached the owner with terms that were just way below kind of the rates that we play in, in the marketplace. But we don't see generally, when we look at our portfolio now, a lot of exposure to that dynamic. It doesn't mean it doesn't exist, but I don't think we're highly vulnerable to that. Our expectation is that when M&A activity picks up, our origination pipeline will pick up in earnest, and that will probably be the same time that we'll start to see payoffs kind of resume to their normal pace. And we think that this last quarter was a bit of an anomaly, just having some pretty chunky payoffs all at once.
Okay. That's helpful. And a question for Henri. Could you give us a sense of where your spillover taxable income stands net of the special, and are you envisioning more special dividends to get that number down a little bit and reduce some of the drag from the excise tax?
Sure, Mickey. So the most recent dividend that included the special dividend covered our fiscal 2024. So February '24 tax year, and so it's cleaned out our spillover fully. We're now in our February '25, fiscal '25 tax year. And so we're effectively about 3 quarters in, which means it's just over the $3 in spillover at the moment, reflecting the taxable income of the last 3 quarters.
And that's still relatively high, Henri, and there is an excise tax that you pay on that. Is the Board thinking about distributing some more of that to shareholders?
I believe, Mickey, regarding the excise tax, as interest rates have changed, the excise tax, which is 4%, is currently one of the least expensive financing options available. Therefore, if we were to repay and aim to reduce our liabilities, it would be more economically sensible to redeem some of our higher-interest bonds, such as those at 8.7%, which are more than double the marginal cost of issuing baby bonds today, estimated at around 7% to 8%. The cost of financing through those means is significantly higher than the excise tax, making the excise tax a very advantageous financing source.
And in addition, Mickey, excise tax is a point in time tax; it's not an accrual. So in other words, you get no credit for, for example, distributing something today versus like December 30.
Yes, I agree. I understand. I'm just curious how the Board is thinking about it. And Chris, I completely agree with you on the debt. I mean, to me, it seems like at least some of your debt, it's a no-brainer to call that given where you could probably deploy that capital. But those are all my questions this morning. Thank you for your time.
Well, Mick, I have a slight disagreement with your view. If you examine the yield curve, the increase at the 10-year rate has matched the decrease at the short end. Additionally, the cost of selling 5-year debentures might rise in the coming years. Therefore, there are numerous factors to consider regarding the overall cost of debt. As you mentioned, relative to our origination pace, it's important to note that it's a new year, a new administration, and a new perspective on various issues. Consequently, we plan to be cautious about making any significant changes until we have more clarity on the forthcoming environment.
Yes, I understand your point, Chris, but you have the highest leverage among all listed BDCs, so I was considering that as well. I appreciate your time this morning.
And our next question will be coming from the line of Bryce Rowe of B. Riley.
Most of my questions have already been addressed. I wanted to get a sense of the changes we observed quarter-over-quarter. The debt portfolio remains valued at very high levels, with only a few items recorded below cost. However, from an equity standpoint, we did see some consumer-facing investments decrease in value, while there were offsets from other businesses that increased. I just wanted to understand the overall health of the consumer-related businesses in your portfolio.
That's a good question. I think the marks that you saw go down in a handful of our portfolio investments were reflective of a bit softer performance generally. And of course, equity is going to be more whippy as a result of an underperformance than debt will be. I don't know that I would tie that to some broader perspective we have on the consumer; while it's a good question, we wouldn't necessarily draw that conclusion to the extent that there's a handful of modest write-downs in some of our portfolio companies, a little bit more specific to just the dynamics of those particular businesses and less, in our view, less a result of macro trends that we're seeing, at least from our vantage point.
Okay. Okay. That's helpful, Mike. And then maybe a different topic. You all are talking about a solid pipeline. From an origination perspective, did that refer to pipeline of new opportunities for both new and existing?
Yes, that's a really good question. We have certainly enjoyed the ability to continue growing at a healthy pace by supporting our existing portfolio companies. We expect to maintain that pace moving forward, similar to what we've done in the past. We're not seeing as many new platforms, but at times like this, it's common to reflect on our portfolio and pipeline. Currently, many of the new opportunities we're pursuing are not actually new for the sponsors; they are upsizing opportunities where sponsors have either outgrown their current lender or there are changes in the capital structure that allow us to step in. This suggests that owners are holding onto their businesses longer and focusing on driving value within their existing portfolios, rather than seeing an increase in M&A activity. More than half of what we're currently looking at, where we have term sheets out and are excited about, involves upsizing rather than new M&A deals.
Okay. One more question from me regarding leverage, which has been discussed in previous calls. We have observed a significant reduction in net debt to equity, particularly this quarter due to strong repayment activity. Looking back 2 or 3 years, our ratio was certainly higher than in 2022, but it has decreased compared to what we experienced in 2023 and 2024. Do you have any additional insights on how you plan to manage balance sheet leverage in the future, especially considering that you have historically maintained more leverage than most BDCs?
Sure. We invest a lot of time considering this issue. There are some specific elements of Saratoga that aren’t typically found in the broader BDC landscape, such as our significant SBIC portfolio and the related investments. The leverage in these isn't treated the same way as baby bond leverage under regulatory standards. While regulatory leverage focuses on one aspect, total leverage provides a different perspective. The nature of the debt is crucial. We've discussed this in our quarterly calls. With short-term, asset-based leverage, reaching the maximum limits set by asset formulas can lead to foreclosure risks if something goes wrong. For instance, if a temporary event like COVID occurs, this could have serious implications. In contrast, SBIC debt leverage consists of long-term, interest-only instruments with no covenants, providing significant flexibility over a decade. The requirement to only repay interest means that this type of debt poses minimal risk to the company’s overall health. Similarly, baby bonds are also long-term, featuring bullet maturities and no covenants. Most of our debt lacks covenants, and the interest is minimal compared to our liquidity and earnings. Thus, our overall debt structure is exceptionally safe relative to its amount. That's the liability side. Then the assets...
Even our asset-based loan that we have, although they're lowly drawn, so they also have no recourse to the BDC and no BDC covenants in them either, which is different than the BDC...
Our leverage is compartmentalized and structured in a low-impact way, resulting in a slightly higher cost of capital compared to some other BDCs, but it's much safer. We have a solid and safe long-term debt structure with maturities ranging from a small amount in the next year to largely 2- to 10-year maturities. It has taken significant effort on our part to establish this debt structure, and it’s important to be cautious about making changes to it. On the asset side, our portfolio currently consists of over 85% senior debt and senior secured loans, putting us in a strong position as the most senior lender involved in decision-making close to the companies. The credit quality and performance of our portfolio are robust, leading us to consider our leverage as a significant asset rather than high or dangerous. Our average cost of this leverage structure is considerably lower than our dividend yield, which stands at around 12%, while our average cost is approximately 5% or 6%.
This debt cost positively contributes to our equity. For instance, during COVID, while some BDCs faced difficulties with their short-term asset-based credit facilities, we managed to operate effectively thanks to our debt structure. After COVID, we deployed significant capital, leading to a period of high-quality growth and investment opportunities, and strengthened our relationships by supporting our sponsors during critical times. We are confident that our debt structure is advantageous and well-suited for the current environment.
Thank you. That does conclude today's Q&A session. I would now like to turn the call back over to Christian for closing remarks. Please go ahead.
Okay. We'd like to thank everyone for joining us today, and we look forward to speaking with you next quarter. Thank you.
Thank you all for joining today's conference call. You may now disconnect.