管理層發言
Good morning, everyone. Thank you for joining us. Welcome to Saratoga Investment Corp.'s conference call for the financial results of the 2025 Fiscal Third Quarter. This call is being recorded. Now, I would like to hand over the call to Mr. Henri Steenkamp, Chief Financial and Chief Compliance Officer of Saratoga Investment Corp. Please proceed, 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 are 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, reflected 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 investment's 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 and 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 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 over-earning 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 bonds, 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 in 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 remains 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 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.
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 become the CEO and a Board member. The total fair value of the remaining investment is $1.6 million. And 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 to achieve 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.
分析師問答
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 add his comments. In the last quarter, we recorded $85 million in originations, which is quite a solid figure. Additionally, our investment in Invita, which is a 5-year commitment, accounted for approximately half of the $160 million in redemptions. If we exclude that, we were essentially neutral. Such fluctuations are normal, as investment redemptions and new investments occur in various cycles. It’s challenging to forecast precisely when that investment will pay off over the 5-year term. Mike, if I recall correctly, that investment began at around $6 million, right?
Yes. This investment has been significant for us in many ways regarding our activities and position in the marketplace. Initially, it was a $6 million debt deal, along with $2 million in equity. We were involved for about 5 years, supporting the company's growth, and the debt position rose to the high 60s as the company prospered. Additionally, we realized a $4.8 million gain on our equity investment, resulting in a substantial gross return for our shareholders over that 5-year period. One challenge with this model is the need for more platform companies to replace the irregular payoffs, which can be quite variable. In this quarter, we experienced a couple of unusually large payoffs that were not typical.
Yes, predicting our origination is challenging. We have a substantial portfolio, and we receive requests from it for large acquisitions and significant follow-on investments. This makes precise forecasting difficult. While we have ample cash reserves and historical data on our pipeline, the future of redemptions and origination remains uncertain, and it may not be wise to attempt making predictions in this area.
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 our management team is very focused on this issue. The market is currently marked by significant add-on activity, especially at the lower end of the middle market, where new M&A activity has drastically declined and continues to do so. We are optimistic that some factors contributing to the drop in M&A volume will change, particularly if interest rates decrease, among other favorable developments. We believe that the market will reach a new balance, leading to a rise in M&A activity that we can take advantage of. Recently, our portfolio has not experienced the same healthy origination pace as it did a couple of years ago. However, with the decrease in M&A activity, our repayments have also been lower. Over the last few quarters, we have managed to grow despite having reduced origination activity and limited repayments. In the latest quarter, although we had robust production, we encountered some uneven repayments. Looking forward, we are confident that our origination efforts, our established relationships in the market, and our commitment to enhancing our business development will ensure that our deployment pace surpasses any repayments over time.
That's helpful. I appreciate the detailed information you've provided. You're correct; the slides illustrate your capabilities well. As for my second question, focusing on Slide 8, Henri mentioned the potential opportunities with the publicly traded notes. I noticed that SAT is around 6%, while JY is above 8%, indicating a chance to gain savings if you decide to pay those down or refinance. Regarding SBIC ventures, I've observed a calm in the call period, but I'm interested in how calling or repricing those would work since they're linked to specific assets. Also, could you remind me of the current average cost of those debentures, or is that not relevant for our discussion?
Yes, the key point regarding a license is whether it is still in the reinvestment period. For instance, SBIC III is a newer license. If we receive a repayment, we will have cash that we can redeploy into new assets instead of repaying debentures. Once you move beyond the reinvestment period, as we have with SBIC II, cash from repayments can only be used for follow-on investments in existing projects to support them. This requires a decision on whether to hold onto the cash, believing the companies may need further investment, or to repay existing SBIC debentures. The process is straightforward: you have two windows each year, at the end of August and February, to decide on repaying the debentures. If you choose not to repay in August, you'll keep those debentures until the next six-month period. That’s why I mention they are callable. For instance, in February, we will need to decide whether to use some cash from SBIC II to repay some existing debentures. It’s worth noting that many of these debentures were issued at lower rates, creating an opportunity to evaluate whether to continue earning cash for potential follow-on investments or to repay them, and we will reevaluate that decision around 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 generally act as a minority investor. This is a crucial part of our investment strategy, as it allows us to enhance our returns on debt through co-investments in equity. Our partners, including private equity sponsors and management teams, appreciate the alignment of interests that co-investing creates. However, as a minority investor, we usually do not control the exit; we can only exit when the company is sold or the investment is realized, which is typically when we see returns on equity. We conduct extensive research on these businesses, equipping us to evaluate whether a co-investment in equity is worthwhile. Our experience has shown that there is significant overlap between what constitutes a solid credit and a promising equity investment. Companies that excel tend to have strong market positions, effective management, and robust free cash flow, which are the same attributes we prioritize in our assessments. This approach has contributed to our achievement of 15% unlevered returns on our portfolio over time, with most of this return originating from debt, although successful equity co-investments have certainly played a role. We believe this strategy remains foundational to our investment approach.
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 the reasonable math to me.
It's just over half. I would estimate that around two-thirds is reflected in how our loans reset, and when they do, approximately two-thirds of the decrease is evident. There was a reset for us in September already. Therefore, I would say about two-thirds, and since the end of the quarter, there has been a slight further 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 like 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?
Well, Casey, I don't think we've ever under-earned our dividend, and that's certainly not something we would want to do. There are factors outside of our control, such as the rates of repayments and deployments. However, we have a solid pipeline, and as Mike mentioned earlier, M&A activity has been sluggish. Many private equity firms are holding on to assets that aren't meeting their expectations, but there's significant pressure in the market. With the new administration, there may be a shift in antitrust approaches that could lead to an increase in deal activity soon, as people have been waiting. Some large deals have been rejected by the Justice Department for reasons that are hard to understand. While I don't want to overemphasize this, on a macro level, there are many players ready to engage in business moving forward. We can't predict the timing or pace of that activity, but we do believe there will be considerable engagement ahead. As for how this will affect us on a quarter-by-quarter basis, we aren't sure. We don't expect to under-earn our dividend, but it's not something we can control.
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, Casey, I believe it's accurate to say that the current cash rate is higher than the cost of the debentures in SBIC II. This creates a favorable situation for not paying off that debt right now. If the situation were reversed, we would likely consider decreasing it. We are monitoring this closely. If we encounter a negative situation, paying it off would be logical. Additionally, we need to carefully evaluate the type of acquisition activity we expect from those companies. Regarding SBIC IV, it involves a significant amount of paperwork, and we still have considerable progress to make with SBIC III. We have had a very successful program there, and we don't foresee any issues with obtaining the next license; the main concern is timing. There are also some metrics to consider related to investment levels before beginning that process.
There is definitely a new process in licensing with a repeat issuer that has streamlined the process, which is wonderful. I know Casey is very familiar with it as well, which has been great. 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 the assessment.
My last question is regarding the knowledge you had at the end of the quarter about the high repayments expected. It seems illogical to sell equity in the market when you already have $250 million in cash. This was done right at the end of the quarter and the beginning of the next one. Can you clarify the reasoning behind this decision? It appears to be unreasonable when considering the cash balance of $250 million and the implications of negative arbitrage as you work on reducing some of your debt.
That's a thoughtful question, Casey. We've had extensive discussions about this internally. If you examine the history of BDCs and ours specifically, raising equity depends on the ability to sell stock at NAV. In this case, we were very close to that, and the manager helped boost the sales to reach NAV. Opportunities to sell in large amounts are rare, and there's a saying on Wall Street that raising money is often easier when you don’t need it. Equity is permanent capital, and when the chance to raise it arises, it's important to seize it. We've previously discussed our leverage levels, and while one way to address leverage is through repaying debt, we also aim to build equity. Our preferred method of increasing equity is through capital gains, which we've achieved successfully, but we've also sold new equity when needed. We consider equity sales as a strategic long-term decision, not just influenced by our current cash balance. Currently, we have $250 million in cash, but in the past, there have been times when our cash was low and we faced challenges finding liquidity for our investments. Therefore, we see cash as a short-term consideration, while equity is essential for our long-term growth. We don't anticipate a slowdown in our investment opportunities, and we are optimistic about future growth, which factored into 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 think regarding the excise tax, since interest rates have changed, the excise tax at 4% is currently one of the cheapest financing options available. If we aim to reduce our liabilities, it would be more economically sensible to call some of our higher-priced bonds, such as those at 8.7%, which is more than double the current marginal cost of financing baby bonds, estimated to be between 7% and 8%. Therefore, the marginal cost of financing is significantly higher than the excise tax, making the excise tax a favorable source of financing.
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 disagree slightly with your assessment of it being a 'no-brainer.' When you examine the yield curve, the increase at the 10-year mark is quite similar; it has risen as much as the shorter-term yields have fallen. Additionally, the cost of issuing 5-year debentures may increase in the upcoming years. Therefore, there are numerous factors to consider regarding the absolute cost of debt, especially in relation to our origination pace. As you mentioned, it’s a new year and new administration, accompanied by a fresh perspective on various issues. We need to be cautious about making significant changes until we have more information on the new environment we are entering.
Yes, I see your point, Chris, but you also have the highest leverage among all listed BDCs. I took that into account 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 been asked and answered. I wanted to understand some of the changes we observed quarter-over-quarter. The debt portfolio remains marked at very high levels, with only a few instances below cost. However, from an equity standpoint, it seems that several consumer-facing investments have been marked down. There were some offsets with other businesses marked up. I just wanted to gauge the overall health of the more consumer-related businesses in your portfolio.
That's a good question. The declines you observed in some of our portfolio investments reflected generally softer performance. Naturally, equity will experience greater fluctuations due to underperformance compared to debt. I wouldn't connect this to a broader view on the consumer; while it is a valid inquiry, we don't necessarily draw that conclusion from the modest write-downs in some of our portfolio companies. These issues are more specific to the dynamics of those particular businesses rather than driven by macro trends from our perspective.
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?
That's a great question. We have definitely appreciated the opportunity to keep growing at a solid pace by supporting our current portfolio companies. We plan to maintain that pace, which is consistent with our historical performance. Currently, we're not identifying as many new platforms. However, in times like this, we tend to reflect on our portfolio and pipeline. Right now, many of the new opportunities we are pursuing are not actually new for the sponsors; they are expansions where we have the chance to step in because the sponsors have either outgrown their current lender or there are changes in the capital structure. This suggests that owners are retaining their businesses longer and focusing on enhancing value in their existing portfolios, rather than seeing a significant increase in M&A activity. More than half of what we are currently evaluating, where we have term sheets out and are excited, are not new M&A transactions, but rather expansions in some form.
Okay. I have one more question related to leverage. This topic has been raised in previous calls. We've observed a significant reduction in our overall net debt to equity, particularly this quarter due to healthy repayment activity. Looking back 2 or 3 years, net debt was higher than it was in 2022 but lower than in 2023 and 2024. Do you have any insights on how you plan to manage balance sheet leverage moving forward, given that historically you've maintained more leverage than nearly all BDCs?
Sure. I have a few thoughts on that, and it's something we consider seriously. There are specific aspects of Saratoga that may not be present in the broader BDC landscape, particularly our significant SBIC portfolio and investments. The leverage from those is treated differently compared to typical baby bond leverage in terms of regulatory requirements. Regulatory leverage represents one aspect, while total leverage is another. Additionally, we have discussed the character of our debt in previous quarterly calls. If you have short-term, asset-based leverage and you reach the limits imposed by your asset base formulas, facing adversity could lead to foreclosure by your banks, resulting in a major setback. This could be something temporary, like the impact of COVID-19. In contrast, with SBIC debt, which consists of 10-year instruments that require only interest payments and have no covenants, the potential risks to the overall health of the company are significantly lower over that timeframe.
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.
All of our leverage is organized within special-purpose vehicles, allowing for a compartmentalized and low-impact structure. While our cost of capital might be slightly higher than other BDCs, this arrangement provides significant safety. We have established a robust long-term debt framework with maturities mainly spanning 2 to 10 years, with some shorter-term obligations coming due in the next year. We've invested considerable effort into developing this debt structure, making any changes to it a careful consideration. On the asset side, our portfolio includes more than 85% in senior secured debt, making us a primary lender involved in critical decision-making with the companies. The credit quality and performance of our asset base are strong. Thus, when discussing leverage in comparison to other BDCs, it's essential to consider both asset and liability characteristics; otherwise, it oversimplifies a complex situation.
We don't see our leverage as excessive or risky, but rather as a significant advantage. Currently, our dividend yield stands around 12%, whereas our average cost of leverage is only 5% or 6%, making our debt very beneficial for our equity. During the COVID period, many BDCs faced difficulties with short-term asset-based credit facilities, but we didn't experience those issues. After COVID, we were able to deploy substantial capital effectively due to our well-structured debt, leading to significant and high-quality growth while strengthening our relationships by supporting our sponsors during challenging times. We are confident in our debt structure, viewing it as a positive attribute.
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.