Prepared remarks
Good morning, ladies and gentlemen. Thank you for standing by. And welcome to Saratoga Investment Corporation’s Fiscal Year End and Fourth Quarter 2025 Financial Results Conference Call. Please note that today's call is being recorded. During today's presentation, all parties will be in listen-only mode. Following management’s prepared remarks we will open the line for questions. At this time I'd like to turn the call over to Saratoga Investment Corporation’s Chief Financial Officer and Chief Compliance Officer, Mr. Henri Steenkamp. Sir, please go ahead.
Thank you. I would like to welcome everyone to Saratoga Investment Corp's 2025 fiscal full year and fourth 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 full year and fourth 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 includes net positive originations generated from our pipeline including one new portfolio company originated in the quarter and two new companies since quarter end, an increase in AUM on a fair value basis following significant repayments, lower statutory and absolute leverage from an increase in NAV and importantly, the core BDC portfolio, demonstrating solid performance in a volatile macro environment. Building on our strong dividend distribution history with a base quarterly dividend of $0.74 per share declared and distributed for the fiscal fourth quarter, we announced the transition to a monthly dividend structure, increasing our quarterly base dividend by $0.01 per share to $0.25 per share per month or $0.75 per share in aggregate for the first quarter of fiscal 2026. From an overall investment value and current yield perspective, our annualized first quarter dividend of $0.75 per share implies a 12.1% dividend yield based on the stock price of 24.86 per share on May 6, 2025.
Our Q4 adjusted NII of $0.56 per share, further adjusted for a $0.13 per share annual excise tax expense is $0.69 per share and reflects the impact of the past nine months trend of decreasing levels of short-term interest rates and spreads on Saratoga's investments largely floating rate assets, and the full period impact of the recent outsized repayments. This has resulted in $205 million of cash available at year-end to be deployed accretively in investments or to repay existing debt. During the quarter, we continued to see the early stages of a potential increase in M&A in the lower middle market reflected in multiple equity realizations in Q4, in addition to significant new originations. The three equity realizations generated $7.2 million of realized gains, while we originated $41.8 million from a combination of one new portfolio company and six follow-ons. 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.
These trends have continued since quarter end with $45.5 million of originations, including two new portfolio companies and six follow-ons, and $24.5 million of partial or full repayments of investments. We continue to remain prudent and discerning in terms of new commitments in the current volatile environment. 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 $978 million portfolio in the current environment. Where we have encountered significant challenges in four of our portfolio companies over the past year, we have 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 by $3.4 million this quarter.
The CLO and JV were marked down by $2.7 million, and an unrealized depreciation charge of $1.5 million resulted in an overall reduction of $7.6 million in portfolio value. We had three equity realizations generating overall realized gains of $7.2 million. The $1.5 million unrealized depreciation charge resulted from late changes in the pricing of one of the realizations. Our total portfolio at fair value is now 2.2% below cost, while our core non-CLO portfolio is 1.6% above cost. The overall financial performance and solid earnings power of our current portfolio reflects strong underwriting in our growing portfolio of companies and sponsors in well-selected industry segments. Our overall credit quality for this quarter remains steady, at 99.7% of credits rated in our highest category, with two investments remaining on non-accrual status being Zollege and Pepper Palace, both of which have been restructured, representing only 0.3% and 0.5% of fair value and cost, respectively.
With 88.7% of our investments at quarter end in first-lien debt and generally supported by strong enterprise values and balance sheets in industries that have historically performed well in stress situations, we believe our portfolio and company leverage is well-structured for future economic conditions and uncertainty. Recognizing the challenges posed by the current tariff discussions, and the volatility seen in the broader macro environment, we remain confident in our experienced management team, solid pipeline, strong leverage structure, and high underwriting standards to continue to steadily increase our portfolio size, quality, and investment performance over the long-term, to deliver exceptional risk-adjusted returns to shareholders. Mike, will touch more on the impact of tariffs on our portfolio companies. 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 $428 million of investment capacity to support our portfolio companies, with $136 million available through our existing SBIC III license, $87.5 million from our two revolving credit facilities, and $205 million in cash. This level of cash improves our current regulatory leverage of 162.9% to 186.2% net leverage, netting available cash against outstanding debt. Saratoga Investment's fourth quarter of fiscal 2025 key performance indicators as compared to the quarters ended February 29, 2024, and November 30, 2024, are as follows. Our quarter end NAV was $329.7 million up 6.1% from $370.2 million last year and up 4.7% from $374.9 million last quarter. The $17.8 million increase in NAV sequentially resulted from ATM sales of 1.2 million shares at NAV for net proceeds of $32.4 million, partially offset by net realized gains and unrealized depreciation.
Our adjusted NII is $8 million this quarter, down 37.2% from last year and 35.4% from last quarter. And our adjusted NII per share is $0.56 this quarter, down 35.4% from $0.94 last year and down 37.8% from $0.90 last quarter, netting the annual excise tax of $2.4 million, or $0.13 results in an adjusted NII of $0.69 in Q4. Adjusted NII yield is 8.4% this quarter, down from 14% last year and from 13.3% last quarter. Latest 12 months return on equity is 7.5%, up from 2.5% last year and down from 9.2% last quarter, slightly below the industry average of 8.9%. And our NAV per share is $25.86 down from $27.12 last year and down from $26.95 last quarter. While these past 12 months have seen markdowns to a small number of credits in our core BDC portfolio, resulting in a latest 12-month return on equity of 7.5%, which is below the industry average of 8.9%, Slide 3 illustrates how our long-term average return on equity over the last 11 years is well above the BDC industry average of 10.3% versus the industry's 7%.
Our long-term return on equity has remained strong over the past decade, beating the industry 8 of the past 11 years and consistently positive every year. 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. Outside repayments offset healthy originations this year resulting in our AUM declining, yet a solid Q4 originations quarter put us back on the AUM growth trajectory. One quarter of AUM decline in Q3 does not detract from our expectation of long-term AUM growth. The quality of our credit it remains strong with only two recently restructured Pepper Palace and Zollege credits on non-accrual 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 and volatile economic environment. With that, I would like to turn the call 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 fourth quarter ended February 28, 2025, most of which Chris already highlighted. Of note, the weighted average common shares outstanding in Q4 was 14.5 million, increasing from 13.8 million and 13.6 million shares for last quarter and last year's fourth quarter, respectively. Adjusted NII decreased this quarter, down 37.2% from last year and 55.4% from last quarter. This quarter's adjusted investment income decreases were primarily due to two reasons: First, this quarter included $2.4 million of an annual excise tax expense due to the spillover amount as of end of December 2024 versus $1.8 million last year. The impact to NII per share from this excise tax is $0.13, which means that adjusted NII per share is $0.69 for Q4 when adding this annual expense back. Second, there was lower total investment income resulting from both lower base interest rates this year and lower AUM levels these past two quarters.
The weighted average interest rate on the core BDC portfolio of 11.5% this quarter compares to 12.6% as of the previous year and 11.8% in Q3. The yield reduction primarily reflects the SOFR base rate decreases over the past year. AUM is down primarily due to the impact of the significant repayments experienced in Q3 with part of that offset by this quarter's net positive originations not yet fully reflected. Total expenses for this fourth fiscal quarter, excluding interest and debt financing expenses, base management fees and incentive fees and income and excise taxes decreased $0.5 million to $1.4 million as compared to $1.9 million last year and decreased $1.4 million from $2.8 million last quarter. This represented 0.8% of average total assets for fiscal 2025, up from 0.7% last year. Also, we have again added the KPI slides 28 through 31 in the appendix at the end of the presentation that shows our income statement and balance sheet metrics for the past two years.
And slide 6 highlights the same key performance metrics for the full fiscal year as compared to the previous two years. Of note is that the adjusted NII per share for fiscal 2025 is $3.81 per share, which is net of $0.57 of dilution resulting from increased net share count from the DRIP and ATM during the year. Moving on to slide 7. NAV was $392.7 million as of fiscal year end, a $17.8 million increase from last quarter and a $22.5 million increase from the same quarter last year. During this year, $55.4 million of new equity was raised at or above net asset value through our ATM program, of which $52.4 million was this quarter. This chart also includes our historical NAV per share, which highlights how this metric has increased 22 of the past 30 quarters, seeing a recent decrease due to the special dividend declared in the third quarter and write-downs this year in discrete assets being Pepper Palace, Zollege and our CLO and JV investments.
Over the long-term, our net asset value has steadily increased since 2011 and grown by $2.90 or 12% over the past 7 years. Our history of consistent realized gains also continued this quarter with $7.2 million of realized gains recognized on the three equity realizations this quarter. On slide 8, 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 $0.34 in Q4 primarily due to, first, the annual excise tax, which was $0.13 this quarter related to unpaid spillover, as previously mentioned, and second, a decrease of $0.22 in non-CLO net interest income due to both lower base rates and AUM. Lower other income from lower originations and repayments and dilution from the increased net ATM and DRIP share count reduced earnings by an additional $0.03 each. This was offset by a $0.06 increase from lower operating expenses.
On the lower half of the slide, NAV per share decreased by $1.09 primarily due to the Q3 special dividends declared in the fourth quarter, outweighing net investment income as well as net realized gains and unrealized depreciation on investments of $0.53 per share. On slide 9, you will see the same reconciliation but now on a sequential annual basis. Starting at the top, adjusted NII per share decreased from $4.10 per share last year to $3.81 per share, mainly due to the increased net share count from the DRIP and ATM programs resulting in a $0.57 per share decrease and a $0.10 decrease from increased operating expenses and excise taxes. On the lower half of the slide, this reconciles the $1.26 NAV per share decrease for the year. $3.81 of GAAP NII was more than offset by $1.66 of net realized losses and unrealized depreciation and $3.31 of dividends paid during the year. There was a $0.04 net accretion from the ATM and DRIP plan issuances during the year.
Slide 10 outlines the dry powder available to us as of quarter end, which totaled $428.2 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 44% without the need for external financing, with $204.7 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. In addition, all $321 million of our baby bonds, effectively all our 6% plus debt is callable now, 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 and the fact that almost all our debt is long-term in nature.
Also, our debt is structured in such a way that we have no BDC covenants that can be stressed during volatile times, especially important in the current economic environment. Now, I would like to move on to slides 11 through 14 and review the composition and yield of our investment portfolio. Slide 11 highlights that we have $978 million of AUM at fair value, and this is invested in 48 portfolio companies, one CLO fund and one at JV. Our first lien percentage is 88.7% of our total investments, of which 25% is in first lien last out positions. On slide 12, you can see how the yield on our core BDC assets, excluding our CLO has changed over time, especially this past year, reflecting the recent decreases to interest rates. This quarter, our core BDC yield decreased to 11.5% from 11.8% last quarter with two-thirds of the decrease due to the impact of decreasing core SOFR base rates. The CLO yield decreased to 16.4% from 24.6% last quarter, reflecting continued lower portfolio performance.
Slide 13 shows how our investments are diversified through the US. And on slide 14, 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 JV, which are included as structured finance securities. And moving on to slide 15. 7.4% of our investment portfolio consists of equity interest, which remain an important part of our overall investment strategy. This slide shows that for the past 13 fiscal years, we had a combined $59.6 million of net realized gains from the sale of equity interest or sale or early redemption of other investments. This is net of the Zollege, Netreo and Pepper Palace realized losses this year, slightly offset by the realized gains on our Invita investment in Q3 and our Nauticon, Vector and Modern Campus investments in Q4. This long-term realized game 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'll focus on our perspective on the changes in the market since we last spoke with everyone in January and then comment on our current portfolio performance and investment strategy. Broader middle market deal volumes were showing signs of improvement until the recent tariff developments, which initially widened loan spreads and had a stifling effect on new debt issuances. Characteristic of the volatility resident in the larger loan markets, we've more recently observed spreads tightening again and new issuances picking up as concerns about the potential economic impact of tariffs have somewhat abated, at least for the time being. It's important to point out that the lower middle market in which we operate is generally not subject to such immediate volatility and tends to move in sync with medium-term macroeconomic variables. Thus, our market has remained relatively unchanged throughout this economic turmoil and we haven't experienced the roller coaster ride of the larger markets.
Deal volumes in our market have remained down significantly over 2024 and down further still as compared to 2021 to 2023. We believe a number of factors are influencing the decline in 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 the trend toward PE 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. We have experienced this over the course of this past year, with a little over half of our repayment activity resulting from loans being refinanced on more favorable terms. Notably, in about two-thirds of these cases, we had the opportunity to stay in the investments.
Price alone was less of a determining factor. Rather, we weren't comfortable with either the new leverage profile or the structural features of the loan agreements. Despite the volatility in the broader macro environment, loan terms in our market remain stubbornly borrower-friendly, and we have not seen lenders revising their underwriting criteria, hiking spreads or cutting leverage. These dynamics could, of course, change if the macroeconomic outlook changes materially. The historically low deal volumes we're experiencing has made it more difficult to find quality new platform investments than in prior periods. This may naturally prompt the question of what is our approach to operating in this difficult asset deployment climate? First, the Saratoga management team has successfully managed through a number of credit cycles over many years, and that experience has made us particularly aware of being disciplined when making investment decisions and being proactive in managing our portfolio.
We'll continue to invest in high-quality assets and will not lower our investment standards and take on more risk than we feel is prudent just because the market is presently difficult. We believe our shareholders will appreciate this approach in the long run. Second, we're greatly expanding our business development efforts and are investing in resources to provide greater bandwidth for our professionals to dedicate themselves to this effort. While we have developed a strong presence in the lower end of the middle market, the number of companies in our marketplace is vast compared to the traditional middle market and is occupied with hundreds of thousands of businesses. We believe the number of deal sources in our market that we have yet to build relationships with far exceeds the number that we have built relationships with. Further, our market benefits from a natural underpinning of deal flow, driven by business owners seeking to transition ownership as they age.
We're in the early stages of our expanded business development initiatives but have already seen some positive results in our current pipeline and in the most recent portfolio company we closed in April. Third, our existing portfolio serves as a healthy source of deal flow. Our payoffs tend to be lumpy as our portfolio investments reach scale and maturity, while our new portfolio companies tend to be small initially and provide an embedded resource for asset deployment as we support their growth. Because of the nature of the way we invest our capital in this manner follow-on activity has exceeded our new portfolio company deployment in each of our past five fiscal years. In summary, the way we're approaching the currently challenging environment is to first stay disciplined on our asset selection, second, invest in and greatly expand our business development efforts in a market that is still largely under penetrated by us; and third, continue to support our existing healthy portfolio companies as they pursue growth.
The relationships and overall presence we've built in the middle market in the marketplace, combined with our ramped up 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. In the midst of these market conditions, we had $42 million gross and $26 million net asset growth this quarter. Before leaving this topic, I'll also point out that we continue to believe that the lower middle market is the best place 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.
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. Now, I'll move on to the subject of tariffs more directly. Although there natural remains much uncertainty around tariffs and the potential impact on small businesses, we believe we are relatively well positioned if tariffs conditions persist. A large majority of our portfolio companies are SaaS businesses or businesses that operate in the domestic services sector with direct cost structures that should largely not be affected by tariffs. While we're still actively working with the management teams and ownership of each of our portfolio companies to fully assess the potential exposure, it appears that for the handful of companies with more direct tariff exposure, only a portion of their input costs would potentially be affected.
Our underwriting bar remains high as usual, yet we continue to find opportunities to deploy capital. As seen on Slide 16, our more recent performance has been characterized by continued asset deployment to existing portfolio companies as demonstrated with 40 follow-ons in calendar year 2024. While we invested in two new platform investments last calendar year, we focus much of our time and resources towards supporting our portfolio and managing a discrete few challenged credits. More recently, during calendar Q1, we have closed two new platform companies and a third one in April as our business development efforts continue to ramp up despite these low volume markets. Overall, our deal flow remains steady 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 two 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. Notably, the fair value of our core BDC portfolio is 1.6% above its cost. 88% 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 two investments on non-accrual namely Pepper Palace and Zollege consistent with last quarter. We continue to hold them on non-accrual following their restructurings, but their combined remaining fair value, including equity is just $5.5 million.
Looking at leverage on the same slide, you can see that industry debt multiples increased slightly for senior debt. Total leverage for our overall portfolio decreased slightly to 5.35x excluding Pepper Palace and Zollege, reflecting lower leverage across our several portfolio companies. Slide 17 provides more data on our deal flow. As you can see, the top of our deal pipeline is up from the end of the year despite the current M&A activity in the lower middle market remaining low. This recent increase is as a result of recent business development initiatives. 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 18, our overall portfolio credit quality and returns remain solid.
As demonstrated by the actions taken and outcomes achieved on the non-accrual and watch list credits we had over the past year, our team remains focused on deploying capital and 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 investments. 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 almost 15 years ago, we've invested $2.28 billion in 120 portfolio companies and have had just three realized economic losses on these investments. Over that same time frame, we've successfully exited 78 of those investments, achieving gross unlevered realized returns of 15.1% 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 equals 13.5%.
We think this performance profile is particularly attractive for a portfolio predominantly constructed with first lien senior debt. Consistent with the previous couple of quarters, we have only two investments on non-accrual. Although Pepper Palace and Zollege have been restructured, we are still classifying Pepper Palace is red and Zollege as yellow with a combined fair value of $5.5 million, including equity. We continue to have majority control over Pepper Palace with the turnaround specialist we have been working with in the role of CEO and owning significant equity in the business. Management of the company by us continues as we explore avenues to expand the business. The total fair value of the remaining investment is $1.5 million. Zollege continues to show positive signs of improvement and profitability. The previous owner has invested meaningful dollars in the business, 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. Many of the initiatives management has undertaken have resulted in improved key performance indicators for the business. We have equity in a first lien term loan in the company with a current fair value of $3.9 million with the equity marked up this quarter to reflect the recent positive financial performance of the company. In addition, during the year, we recognized $3.4 million net realized depreciation in our core non-CLO portfolio, including Pepper Palace and Zollege. About half of this depreciation represents adjustments to market multiples and prepayment premiums, while the other half is a $1.5 million markdown to our stretch on investment, reflecting slower than projected sales growth combined with increased investment in corporate management team.
Company management and ownership are undertaking initiatives to address these trends and the sponsor has provided meaningful credit support to the business. The CLO and JV had $2.7 million of unrealized depreciation this quarter, reflecting primarily markdowns due to individual credits in these vehicles, most notably in the investment in the first CLO's note. And importantly, we recognized net realized gains of $7.2 million on the equity sales of our modern campus, Norcon, and Vector investments this quarter, continuing our history of healthy realized gains. 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. Now, moving on to slide 19. 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 3 license with $136 million of lower cost, undrawn debentures available, allowing us to continue to support US 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 20, our latest dividend of $0.74 per share for the quarter ended February 28, 2025, was paid on March 25, 2025. Additionally, as previously discussed, building on our strong distribution history, we announced the transition to a monthly dividend structure, increasing our quarterly base dividend by $0.01 per share to $0.25 per share per month or $0.75 per share in aggregate for the first quarter of fiscal 2026. This reflects a 1% increase over the past year and 7% increase over the past two years. 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 and macro environments impact on our earnings. Moving to slide 21. Our total return for the last 12 months, which includes both capital appreciation and dividends, has generated total returns of 26%, outperforming and doubling the BDC index's 13% for the same period.
Our longer-term performance is outlined on our next slide 22. Our five-year return places us well above the BDC index while our three-year performance is in line with the index. Of note, the five-year performance of the BDC industry is uncharacteristically high due to the five-year period starting during the COVID-19 market crash. Since Saratoga took over management of the BDC in 2010, our total return has been 831% versus the industry's 308%. On slide 23, you can further see our last 12 months' 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 of which reflect the value our shareholders are receiving. While return on equity, NAV per share growth and dividend coverage are lagging this past year, this is largely due to the two discrete non-accrual investments previously discussed as well as the impact of recent lower base interest rates and AUM levels, reflecting the full period impact of recent third-quarter debt repayments.
In this volatile macro environment, we will be prudent in deploying our significant available capital into strong credit opportunities that meet our high underwriting standards. We also continue to be one of the few BDCs to have grown NAV accretively over the long term with our long-term return on equity at 1.5 times the industry average. Moving on to slide 24. 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. These differentiating characteristics, many previously discussed, include maintaining one of the highest levels of management ownership in the industry at 11.2%, ensuring we are strongly aligned with our shareholders.
Looking ahead on slide 25, as we navigate through a reshaped yield curve environment with decreasing short-term and increasing long-term rates and an uncertain economic outlook in the face of an ever-evolving geopolitical landscape, we remain confident that our reputation, experienced management team, robust pipeline, and historically strong underwriting standards and time-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 the shareholders and to navigate through the current challenges in the market and uncover opportunities in the current and future environment. Recognizing the challenges posed by the current tariff discussions and the volatility seen in the broader macro environment, we also believe that our strong balance sheet, capital structure and liquidity places us in a strong position to successfully address these types of uncertainties. In closing, I would again like to thank all of our shareholders for their ongoing support. I would like to now open the call for questions.
Questions and answers
Our first question comes from Erik Zwick from Lucid Capital Markets. Please go ahead with your question.
Thanks. Good afternoon, everyone. It was encouraging to hear your comments on the pipeline strengthening. I'm 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.
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?
Thanks. And maybe just a bit of a follow-up. One of the initiatives that you talked about on Slide 24 is the commitment to grow AUM, and I realized to a large degree, that's dependent on market opportunities for new lending as well as paybacks. But just picking a look for maybe a different perspective, just your current kind of personnel and infrastructure capabilities, what is the ideal size for the portfolio from your perspective?
Well, I don't know that we think about it in terms of ideal size. I mean we've certainly grown the business to a point where it's at a decent scale, a scale that works very well in the market that we're in. We do think that there are opportunities for us to grow quite significantly without any change in strategy. In the marketplace that we're in, we could be quite a bit larger but we don't feel like we're under scale and that's a weakness in any respect either. So I don't know if that helps answer your question. I would say this, just to reinforce what I've mentioned on the business development front. I mean we are actively investing in personnel growth. So we've added people on the portfolio management side. We've added people in the business development side. We've invested in other resources to help make our business development efforts that much more efficient and free up our investment professionals to get much more involved in outward-facing activities that should feed our pipeline.
And we're seeing some evidence of that bearing fruit. But it's a little bit early to tell. As you can imagine, by our nature, our DNA is to be cautious, and it's not an easy environment to invest in right now because the deal flows are down. But we feel very good that we can grow our portfolio over time. I would like to discuss the nature of the markets we are focusing on. In the smaller middle market range, we often invest in companies where the founder is still involved and is transitioning their business. The occurrence and volume of these deals are significant due to the number of founders in their mid-60s who are beginning to consider the future of their business and their estate planning. As Mike mentioned, these types of deals are available regardless of the environment, and it is essential for us to locate and pursue them. Therefore, I believe there is an opportunity in the smaller middle market to generate deal flow even in challenging conditions; there are more opportunities available than in larger markets, which are influenced more heavily by broader market trends.
I appreciate the detailed commentary there. Curious, I appreciate the comments you gave regarding potential impact to tariffs. I'm curious if you could kind of address any potential exposure you have to government contracts that could be impacted by the federal agency cuts and reductions.
We don't see anything in our portfolio that makes us feel like we're significantly exposed to that in any way.
All right. That's good to hear. And last one for me and then I'll step aside. I may have missed it in the prepared comments. Could you mention where the spillover level currently stands at this point?
No, we didn't. But it's been disclosed in the 10-Q that we just filed, and it's similar to what we mentioned last quarter; it's just over $3 a share at the moment.
Thank you. And our next question comes from the line of Sean-Paul Adams from B. Riley Securities. Your question please.
Good afternoon. I joined the call a bit late, so I apologize if this has already been addressed. I noticed that there was a noticeable increase in repayments compared to deployments for the quarter. Given the available cash, are there specific yield and structure expectations for new deals where you anticipate deploying capital? Additionally, is the deal flow pipeline consistent with previous quarters?
We're seeing a slight increase in our pipeline in response to your question. However, as I mentioned earlier, the market is challenging. We believe our proactive approach to identify potential deal sources is having some positive impact, but it's difficult to determine the extent of that due to the current marketplace conditions. Could you remind me of the other part of your question?
Is there a specific yield or structure you are looking for in new deals?
Generally, Heath, 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 tend to operate in a wider 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.
Yes. And Sean-Paul, just to clarify, so we actually did grow in AUM in Q4 this quarter. We're actually up about $26 million or so. The big reduction that we referenced the whole time and that you've seen was in Q3. Q3, we had healthy originations, $80-odd million, but we had $160 million of repayments in the one quarter, which probably a record for a quarter for us. And so that obviously resulted in a decline in AUM in Q3 and most of the cash that we have on our balance sheet at the moment, but Q4 was actually growth.
And I would add to that, too. One of the things I should have mentioned, just thinking about our cost of capital. One of the things that we benefit from is that we do have an SBIC license. And that gives us access to very favorable cost of capital for the deals that qualify for SBIC financing, and the vast majority of what we do does qualify for SBIC financing. So it makes it easier for us, even in market conditions like now where pricing is pretty tight because everybody is clamoring for good assets to deploy capital in a way that's still very accretive to our shareholders.
Got it. Appreciate the color. Thank you.
Thank you. And our next question comes from the line of Casey Alexander from Compass Point Research. Your question please.
Yes. First off, Henri, did you repay some of the debentures on SBIC II during the quarter?
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 to pay debentures, and we did that in February, end of February.
And what was the cost on those that you repaid? What was the interest rate?
I think on average, they were about 6% or so.
6%. What's the rate on the new SBA debentures when you take them down right now?
Yeah. The most recent ones were priced around about the high 4s. I think all-in is probably like 5.25%.
5.25%. Okay. 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?
Yes, we did go through all the accounting with our accountants. The accounting rules state that you only recognize the expense when it becomes definitive. Depending on when you pay your spillover, you have until the end of December to make that payment. For instance, if you pay on December 30, you won't incur any excise tax. It is a matter of timing; only after January 1 is the expense definitive and does it become an obligation.
I mean, with $3 a share in spillover, you know you're going to have it. You could accrue for it on a quarterly basis and reduce some of the distortion, can't you?
You have the opportunity. So we'll face a point again come the end of December, where we can pay that $3 and whatever else is built up since then on, like December 30, and then you wouldn't have a liability or obligation.
Thank you. And our next question comes from the line of Robert Dodd from Raymond James. Your question, please.
Hi. Thanks. Regarding the spillover question, it seems you have about $3.30 per current share from the second contract, which is more than four quarters of the current run rate dividend. Is the spillover balance too high? Are you in a situation where you feel pressured to increase the dividend or pay special distributions again, like you did in the third quarter, even if our base rates and earnings decline? With such a high spillover level, there appears to be a disconnect between what your dividend needs to do to satisfy the BDC distribution requirements and what earnings may indicate. Would it be reasonable to consider reducing the special distribution by more than $0.35 to realign dividend trends with potential earnings trends, if that makes sense?
There has been significant change in the marketplace. As we've discussed, we experienced notable redemptions that impacted our earnings. The positive aspect is that these redemptions were from successful investments made five or more years ago. We achieved realized equity gains, highlighting a robust portfolio with strong underwriting. However, this situation does lower our earnings in comparison to our dividends. While we maintain a dividend level and have spillover, many factors are still uncertain. There may be opportunities to effectively deploy capital and make sufficient payouts. Additionally, as Henri mentioned earlier regarding the accounting for the spillover, we have until December 30th to make our decision. If conditions continue as they are, a special dividend could be issued, which would help reduce spillover and excise tax. Ultimately, much of this will depend on our performance for the remainder of the year.
I understand. I appreciate your insights. Regarding the cash, your portfolio is growing again, and the assets under management are also increasing, which suggests that this cash will be utilized over time. When does it make sense to start addressing the higher-cost debt, like the callable baby bonds you mentioned previously? Given your current cash balance, with some of it allocated in semi-restricted areas, how does it make sense to start calling that higher cost debt in the medium term? This could be beneficial for earnings, especially in a market with available deployment opportunities. A cash reserve of over $200 million is significant, so any thoughts on this would be helpful.
If you consider the baby bonds, it's important to assess the remaining time until maturity, the cost of calling them, and the potential costs associated with reissuance if we were to grow after calling them. We previously called a baby bond and regretted it six months later, so we want to be cautious. Baby bonds offer some of the most appealing financing options because they are interest-only, have no covenants, and are callable. They have many attractive features. However, we also need to evaluate the reissuance costs. If our baby bonds were trading significantly higher than what we could reissue at, it would be different, but the reissuance market isn't markedly different from the pricing of our baby bonds. Although there might be a short-term gain for a few quarters, we could face considerable regrets later if we had to reissue and absorb the associated costs. At this point, there isn't enough incentive for us to make a bold move. As Henri mentioned, we have repaid some outstanding debt when the opportunity arose, but currently, we are not actively considering calling the baby bonds.
And Robert, we are currently earning about 4.25% on our cash, so when considering the negative impact, it's more like 2% to 4% instead of 6% to 8%. As Chris mentioned, having a strong capital structure is important, and we view that as a form of deleveraging right now. Additionally, there is a real cost to reinsurance in this market that prevents us from issuing at a lower rate. The bond market hasn’t changed yet, and it might if rates begin to shift, but for now, the breakeven point is quite extended. Therefore, the value of this cash and our capital structure is quite significant.
I understand your point. My point is that you wouldn't need to immediately refinance given the amount of cash you have. I certainly wouldn't encourage refinancing them right now. The question is what lowering cash balances will pay off, but I appreciate your point and thank you for your answer.
Certainly. It's worth noting that the excise tax represents a one-time payment of 4% of the obligation, which could be viewed as relatively low-cost financing in the current environment. In previous years, when we had SBIC debentures below 4%, we didn't experience any spillover. However, this is an important aspect of our capital deployment considerations, and the current cost of the spillover is quite favorable.
Thanks, Robert.
Thank you. Our final question for today comes from the line of Mick Schleien from Ladenburg. Your question please.
Yes, good afternoon everyone. As usual, your prepared remarks were very comprehensive, and many people have already asked great questions. I just have a couple of straightforward questions. I observed that the portfolio yield remained unchanged from quarter to quarter, and although the portfolio's allocation by security stayed the same, average SOFR decreased by about 50 basis points. I was hoping you could clarify why the portfolio yield remained stable in that context.
No, our portfolio did go down 30 basis points. If you look at slide 12, it's important to differentiate the CLO and the joint venture from the overall interest and portfolio. The core portfolio decreased from $11.8 million to $11.5 million, which is a 30 basis point drop, and about two-thirds of that was due to SOFR, which changed by about 20 basis points during the quarter. The remaining third was influenced by the mix of new deals we've completed over the last couple of quarters compared to the repayments.
Okay. That's helpful. And Henri, was there any sort of reversal of interest income during the quarter?
No.
No. And I just want to make sure I understand and following up on Casey's question, did the external manager subsidize some of the common share issuance during the quarter?
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.
Thank you, everyone, for the questions.
Okay. We'd like to thank everyone for joining us today, and we look forward to speaking with you next quarter.
Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.