管理層發言
Good morning, everyone. Thank you for being here. Welcome to Saratoga Investment Corp.'s conference call on the financial results for the third quarter of fiscal year 2025. Today's call is being recorded. I will now hand the call over to Mr. Henri Steenkamp, Chief Financial and Chief Compliance Officer of Saratoga Investment Corp. Please proceed.
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 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 reflects 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, reflecting in multiple repayments during the quarter in addition to significant new originations. As was the case in previous quarters, our strong reputation and differentiated market positioning, combined with our ongoing development of sponsor relationships, continues to create attractive investment opportunities from high-quality sponsors despite lower overall mergers and acquisitions volumes and elevated interest rate levels.
We believe Saratoga continues to be favorably situated for potential future economic opportunities as well as challenges. At the foundation of our strong operating performance is the high-quality nature, resilience, and balance of our $960 million portfolio in the current environment. Where we have encountered significant challenges in four of our portfolio companies over the past year, we've completed decisive action and resolved all four of these companies' challenges through two sales and two restructurings. Our current core non-CLO portfolio was marked down slightly by $1.4 million this quarter, and the CLO and JV were marked down by $4 million. This was offset by net realized gains of $1.2 million this quarter on various repayments, most notably the Invita investment and $0.7 million of escrow realized gains, mainly from the former Netreo investment resulting in $3.5 million of total net reduction in portfolio value during the quarter.
Our total portfolio fair value is now 0.7% below cost while our core non-CLO portfolio is 3% above cost. Our originations this quarter were elevated as we began to see the effect of declining interest rates and increased M&A activity in the market. Deployments during the quarter included $85 million in 2 new portfolio company investments and 8 follow-on investments in existing portfolio companies that we know well, all with sound business models and strong balance sheets. Our quarter end cash position grew to $250 million, largely due to an outsized $160 million of repayments of successful investments in 5 portfolio companies and amortizations, exceeding the substantial $85 million of originations. The repayments include the recognition of a $4.8 million realized gain along with $67 million of debt repayments from our successful 5-year Invita investment. This increase in our cash position improved our effective leverage from 160.1% regulatory leverage to 183.2% net leverage, netting available cash against outstanding debt.
Our overall credit quality for this quarter remained steady with 99.7% of credits rated in our highest category with the two investments currently still on nonaccrual status being Zollege and Pepper Palace both of which have been successfully restructured, each representing only 0.3% of both fair value and cost. With 86.8% of our investments at quarter end and 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. 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 2/3 of the interest rate reduction is due to SOFR base rate decreases and 1/3 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 bond, effectively all of our 6% plus debt is callable, either now or within the next 4 months, creating a natural protection against potential continuing future decreasing interest rates, which should allow us to protect our net interest margin, if needed. These calls are also available to be used prospectively to reduce current debt. We remain pleased with our available liquidity and leverage position, including our access to diverse sources of both public and private liquidity and especially taking into account the overall conservative nature of our balance sheet, the fact that almost all our debt is long-term in nature and with almost no non-SBIC debt maturing within the next 2 years.
Also, our debt is structured in such a way that we have no BDC covenant that can be stressed during such volatile times. Now I would like to move on to Slides 9 through 12 and review the composition and yield of our investment portfolio. Slide 9 highlights that we have $960.1 million of AUM at fair value and this is invested in 48 portfolio companies, 1 CLO fund, and 1 joint venture. Our first lien percentage is 86.8% of our total investments, of which 25.7% is in first lien last out positions. On Slide 10, you can see how the yield on our core BDC assets, excluding our CLO has changed over time, especially this past quarter, reflecting the recent decreases to interest rates. This quarter, our core BDC yield decreased to 11.8% from 12.6% with about 2/3 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 discuss our view on changes in the market since our last conversation, as well as provide an update on our current portfolio performance and investment strategy. Although overall middle market deal volumes are showing some improvement, activity in the lower middle market where we operate has not yet increased. Year-to-date deal volumes for transactions below $150 million are significantly down compared to the previous year, falling by more than 34%, and they are also lower than in 2021 and 2022. We believe several factors are contributing to this decline in lower middle market activity, such as a disconnect between buyer and seller expectations, high interest rates making debt financing more costly, and a trend among private equity firms to hold onto assets longer to achieve their return expectations. The combination of historically low M&A volume and abundant capital is leading to tighter spreads and full leverage as lenders compete for deals, especially premium ones.
This trend was evident in the last quarter, where we saw substantial repayments in some cases due to lenders providing very aggressive pricing on our low-leverage assets. The currently low deal volume has made it tougher to identify quality new investments compared to earlier periods. However, the relationships and presence we have established in the marketplace, along with ongoing business development efforts, bolster our confidence in achieving healthy portfolio growth that we anticipate will benefit our shareholders in the long run. This quarter, we completed two new platform investments, and we have a solid investment pipeline. I want to emphasize that we still believe the lower middle market is the prime area for capital deployment. Compared to the larger middle market, the due diligence we conduct when evaluating an investment is much more thorough. The capital structures tend to be more conservative, featuring less leverage and more equity.
The legal protections and covenant terms in our agreements are much stronger. Furthermore, our ability to actively manage our portfolio through continuous interaction with management and ownership is enhanced. Thus, we maintain that the lower middle market provides the best risk-adjusted returns, and our track record of realized returns supports this belief. The Saratoga management team has successfully navigated numerous credit cycles, making us particularly aware of the need for discipline in investment decisions and proactivity in managing our portfolio. Our underwriting standards remain high, yet we are still uncovering opportunities to deploy capital. As illustrated, our recent performance has been marked by continued asset deployment to existing portfolio companies, as evidenced by 40 follow-on investments this year against just two new platform investments. In this fiscal quarter, we invested $85 million across two new platform investments and eight follow-on investments.
Overall, our origination platform remains robust, and our consistent ability to generate new investments over the long term, despite shifting and increasingly competitive market dynamics, is one of our strengths. Portfolio management is critically important, and we remain actively engaged with our portfolio companies, keeping close contact with their management teams. There are still two portfolio companies that we actively manage, as mentioned in previous quarters, and I will address them shortly. Generally, our portfolio companies are performing well, with the fair value of our core BDC portfolio 3% above its cost. 86.8% of our portfolio consists of first lien debt, generally supported by strong enterprise values in sectors that have historically been resilient in stressed conditions. We have no direct exposure to energy or commodities. Moreover, a large portion of our portfolio comprises businesses that generate a high level of recurring revenue and have shown a strong ability to retain revenue historically.
We currently have two investments on nonaccrual: Pepper Palace and Zollege, similar to last quarter. We continue to hold them on nonaccrual after their restructurings; their combined remaining value, including equity, is just $5.8 million or 0.6% of total portfolio fair value, with Zollege's fair value increasing this quarter due to positive performance. When looking at leverage, industry debt multiples remain above 5x. Total leverage for our overall portfolio has risen to 5.56x, excluding Pepper Palace and Zollege, due to the repayment of a few low-leverage investments and follow-on debt this quarter for some of our existing investments. Our deal flow has shown notable changes, with the top of our deal pipeline lower than last year partly because we made a deliberate effort to enhance the quality of our deal pipeline, and partly because market activity has significantly decreased. Despite these broader trends, our investment volume has reached its highest level in six quarters.
The considerable advancements we've made in forging broader and deeper marketplace relationships are significant as they enhance the reliability of our deal flow and enable us to remain selective while we thoroughly evaluate opportunities for the best investments. Our overall portfolio credit quality and returns remain strong. The actions taken and results achieved regarding the nonaccrual and watch list credits we had over the past year demonstrate our commitment to deploying capital in robust business models where we are confident that the enterprise value will sustain above the last dollar of our investment under reasonable scenarios. Our approach has always combined thoroughness with caution. Since our management team began working together over a decade ago, we've invested $2.24 billion in 119 portfolio companies and have only recorded three realized economic losses on those investments.
During that same period, we have successfully exited 78 of those investments, achieving gross unlevered realized returns of 15% on $1.2 billion of realizations. Even with the recent write-downs in a few credits, our combined realized and unrealized returns on all capital invested stand at 13.6%. We find this performance particularly appealing for a portfolio mostly composed of first lien senior debt. As was the case last quarter, following the repayment of Knowland, we have only two investments on nonaccrual. Although both Pepper Palace and Zollege have been restructured successfully, we continue to classify Pepper Palace as red while Zollege has moved back to yellow, with a combined fair value of just $5.8 million, including equity. Last quarter, we successfully completed the restructuring of Pepper Palace, where we took control of the business. The turnaround specialists we've engaged with, who have significant successful experience with similar cases, have invested substantial equity into the company and have taken on roles as CEO and board member.
The current fair value of our remaining investment is $1.6 million. Following the Zollege restructuring during the first quarter, which resulted in us gaining control and actively managing the investment, the founder and previous owner has invested significant funds in the business, leading the enterprise and reassembling some of the former senior leadership. He and his management team are working collaboratively with us to regain the business's previous profitability levels, aiming ultimately to exceed those levels. We still maintain equity in a first lien term loan in the company, with a current fair value of $4.2 million, and the equity value increased this quarter reflecting the recent positive performance of the company. Additionally, we realized a gain of $4.8 million on our Invita equity from the sale of the company, along with a $0.7 million gain from a Netreo escrow payment, enhancing the overall positive outcome of that investment sold earlier this year.
The CLO and JV experienced $4 million of unrealized depreciation this quarter, primarily due to markdowns among individual credits, particularly in the first CLO. Our overall investment strategy has delivered outstanding realized returns and recovery of our invested capital, and our long-term performance remains solid, as indicated by the track record on this slide. Moving on, our second SBIC license is fully funded and deployed, although there is cash available for follow-on investments, and we are currently ramping up our new SBIC III license, which has $136 million of lower-cost undrawn debentures available, allowing us to continue supporting U.S. small businesses, both new and existing. This wraps up my review of the market, and I would like to hand the call back 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. 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. These differentiating characteristics, many previously discussed, include maintaining one of the highest levels of management ownership in the industry at 12.1%, ensuring we are aligned with our shareholders. 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 just trying to kind of balance the outlook for new growth versus repayments as well.
I will begin, and then Mike will add some insights. Looking at the last quarter, we reported $85 million in originations, which is quite a significant amount. Additionally, our investment in Invita, a 5-year commitment, accounted for roughly half of the $160 million in redemptions. If we exclude that, we were essentially neutral. These situations occur; there are various cycles of investment redemptions and new investments. It's challenging to predict exactly when during that 5-year timeframe the investment will yield returns. Mike, if I recall, that investment began as a $6 million commitment, correct?
Yes, it's a significant investment for us in many aspects regarding our market presence. Initially, it was a $6 million debt deal, along with $2 million in equity. We held it for about 5 years, supporting the company's growth, and ultimately the debt position rose well into the high 60s as the company expanded successfully. 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 of the challenges we face with this model is that, while it's the best way to allocate capital in our market, adding new portfolio companies tends to involve smaller, more granular investments. The successful ones, as demonstrated in our larger positions, allow us to support their growth over time. However, when they do pay off, those returns can be quite uneven, requiring more platform companies to offset the irregular payoffs. In this quarter, we experienced a couple of unusually large payoffs that were not typical.
Yes. It's challenging to accurately predict our origination. We maintain a strong and sizable portfolio, and we receive inquiries from our portfolio companies looking to make large acquisitions, which leads to significant follow-on investments. Therefore, we can't precisely forecast this aspect. Looking ahead, we have substantial cash reserves and a historical overview of our pipeline. However, the specifics regarding redemptions and origination remain unpredictable, and it may not be wise for us to attempt to forecast those variables.
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 topic. The market right now is seeing a lot of add-on activity, especially in the lower end of the middle market where new M&A activity has significantly decreased and continues to do so. We are hopeful that factors contributing to the decline in M&A volume will eventually reverse, particularly if interest rates decrease and other conditions improve. We believe a new equilibrium will be established, leading to an increase in M&A activity that we can take advantage of. Recently, our portfolio has not been originating new business at the same healthy pace as it did a couple of years ago. However, interestingly, due to the decline in M&A activity, our repayments have also decreased. Over the last several quarters, we've managed to grow despite lower origination levels since repayments were also limited. In the most recent quarter, we experienced healthy production, but also faced some irregular repayments. Looking ahead, I'm confident that our ongoing origination efforts, combined with our market relationships, will allow our deployment pace to exceed any repayments over time as we continue to enhance our business development efforts.
That's helpful. I appreciate all the information you provided. You're right; the slides you've shared demonstrate your capability as you mentioned. Regarding Slide 8, Henri, you've pointed out the potential opportunities with the publicly traded notes. It seems that SAT is around 6%, while JY is above 8%, indicating a chance to achieve some savings if those are paid down or refinanced. As for the SBIC ventures, I've noticed that the call period has calmed down, but I'm interested in how the process of calling or repricing those would work since they are tied to specific assets. Perhaps I should first ask what the current average cost of those debentures is, though this may not even be relevant to our discussion.
Yes, I believe the key factor when dealing with a license is whether you are still in the reinvestment period. For instance, SBIC III is a newer license, and if we receive a payment, we will have cash that we would use to invest in new assets rather than repaying debentures. Once you are outside of the reinvestment period, like we are with SBIC II, any cash received from repayments can only be used for follow-on investments to support existing ones. Therefore, you face a choice when you have cash in a license outside the reinvestment period: you can either hold onto the cash for potential follow-on needs or repay existing SBIC debentures. The process is quite simple. You have two opportunities each year, at the end of August and February, to decide on repaying the debentures. If you choose not to do it in August, you will carry those debentures until the next six-month period. That’s why I mentioned they're callable. For us, in February, we will need to decide if we want to use some cash from SBIC II to repay some of the existing debentures. However, many of the debentures in SBIC II were issued when rates were low, and we need to consider whether to continue earning cash for potential follow-on opportunities or repay the debentures. We'll reevaluate this again 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 fair value might be well above kind of your holding?
On the equity side, we usually take a minority stake in the investments. This approach is a vital part of our investment strategy, as it helps enhance our returns on debt through co-investments in equity. Our partners, whether they are private equity sponsors or management teams, appreciate the alignment of interests that co-investing in equity provides. However, as a minority investor, we don’t typically control the exit process. Instead, we have the option to exit when the company is sold or at other realization events, which is usually when we see returns on our equity investments. From a strategic perspective, we conduct extensive due diligence on these businesses, which enables us to assess the co-investment opportunities in equity effectively. We’ve noticed significant overlap between the qualities of solid credits and those of businesses that represent strong equity investments. Companies that excel in markets often have robust dynamics, outstanding management teams, and generate high levels of free cash flow.
Many of the attributes we seek in businesses align with what makes for successful equity investments, which has led us to achieve 15% unlevered returns in our portfolio over time. While most of this return comes from our debt investments, the success of our equity co-investments has certainly contributed to reaching that 15% return, and we believe this strategy remains essential to our 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 halfway to go. I mean, that seems like the reasonable math to me.
It's a little more than half. I'd estimate that about two-thirds of it is reflected in the way our loans reset, and when they reset, around two-thirds of the decrease has been shown. We haven't fully accounted for this yet, as we've already seen a reset in September. I would say it's about two-thirds, and since the end of the quarter, there has been a slight decline in SOFR as well.
So right. Well, that's what I mean. I mean, when I look at it across the entire 100 basis points of what the Fed has done, it would seem to me that you've reflected about 50 basis points in your results as of the end of November and maybe there's another 50 bps to go counting what the Fed has done subsequent to the end of your quarter.
Yes. I haven't done like the exact count, but I would guess it's again, slightly more than that, probably in the 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 believe we have consistently met our dividend obligations, and we certainly do not want to deviate from that. There are some factors beyond our control, such as repayment rates and investment deployments. However, we have a strong pipeline, and as Mike mentioned earlier, there has been a noticeable slowdown in M&A activity. Many private equity firms are retaining assets that are not performing as expected, creating significant pressure in the market. With the new administration, there may be a shift in antitrust policies and other factors that could lead to increased deal activity. Some recent high-value deals have been unexpectedly rejected by the Justice Department, which raises questions about those decisions. On a broader scale, it seems there are many participants in the market who are prepared to engage in more business moving forward. While we cannot predict the timing or pace of this activity, we are confident that there will be a significant amount of movement in the near future. We are not anticipating any underperformance related to our dividend, but again, this is not something we can directly 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 of all, Casey, I believe it’s fair to say that the current rate on cash is higher than the cost of the debentures in SBIC II. Therefore, there is a positive arbitrage in not paying off the debt in that situation. If the situation were reversed, we would likely consider reducing it. We are monitoring this closely, and if it shifts to a negative arbitrage, it would make sense to pay it off. Additionally, we need to carefully consider the type of acquisition activity we expect from those companies. Regarding SBIC IV, it involves a significant amount of paperwork, but we still have considerable progress to make on SBIC III. Our program there has been very successful, and we don't foresee issues in obtaining the next license; the concern is more related to timing. There are also certain metrics regarding investment levels that need to be met before we initiate that process.
There is definitely a new licensing process for repeat issuers that has streamlined things, which is fantastic. I know you're very familiar with it, Casey, and it's been great. However, we still have $136 million in debentures, and we haven't seen much in terms of realizations in SBIC III yet. Actual realizations in the fund are something I monitor closely as part of my assessment.
My last question is about the high repayments you faced at the end of the quarter. It seems questionable to sell equity into the market when you have $250 million in cash, especially since this was done at the quarter's end and the beginning of the next quarter. Could you explain the reasoning behind this? It doesn't appear logical when considering the cash balance and the implications of paying down some of your debt.
Sure, Casey, that's a great question. We've had extensive discussions internally about this. When examining the history of Business Development Companies, especially ours, the ability to raise equity is crucial, as it often depends on whether we can sell stock at net asset value. In this case, we were quite close, and the manager helped subsidize the sales to achieve that NAV. Opportunities to sell in larger amounts are rare. There's a common saying on Wall Street that it can be difficult to raise funds when they're needed, while it tends to be easier when you aren't in urgent need. Equity serves as permanent capital, and when the chance to raise it arises, it's important to seize it. We've talked about our leverage levels in previous discussions. There are multiple strategies to manage leverage, including repaying debt or increasing equity. Our preferred method of growing equity is through capital gains, which we've successfully achieved over time, but we also occasionally issue new equity.
Therefore, we view equity sales as a long-term strategic approach rather than being influenced solely by our current cash balance. Right now, we have $250 million in cash, but there have been instances when our cash was limited, and we faced challenges in finding liquidity for investments. We consider cash to be a short-term matter, while equity represents a long-term strategy, which is essential for the sustained growth of our BDC. We aren't seeing any slowdown in the opportunities available for the types of investments we pursue, and we anticipate significant growth ahead. All of these factors contributed to our decision.
And our next question will be coming from the line of Mickey Schleien of Ladenburg.
First question I'd like to ask is, could you give us a sense of how much more refinancing risk you believe exists in the portfolio given the current terms available in the market?
That's a good question, Mickey, just in terms of what we could see in terms of pace of repayments. Hard to answer it candidly. You could see for several quarters, we were getting almost no repayments, and a lot of that was just due to the fact that there wasn't much M&A activity. We have seen some deals that have exited our portfolio because somebody approached the owner with terms that were just way below kind of the rates that we play in, in the marketplace. But we don't see generally when we look at our portfolio now, a lot of exposure to that dynamic. It doesn't mean it doesn't exist, but I don't think we're highly vulnerable to that. Our expectation is that when M&A activity picks up, our origination pipeline will pick up in earnest, and that will probably be the same time that we'll start to see payoffs kind of resume to their normal pace. And we think that this last quarter was a bit of an anomaly, just having some pretty chunky payoffs all at once.
Okay. That's helpful. And a question for Henri. Could you give us a sense of where your spillover taxable income stands net of the special, and are you envisioning more special dividends to get that number down a little bit and reduce some of the drag from the excise tax?
Sure, Mickey. So the most recent dividend that included the special dividend covered our fiscal 2024. So February '24 tax year, and so it's cleaned out our spillover fully. We're now in our February '25, fiscal '25 tax year. And so we're effectively about 3 quarters in, which means it's just over the $3 in spillover at the moment, reflecting the taxable income of the last 3 quarters.
And that's still relatively high, Henri, and there is an excise tax that you pay on that. Is the Board thinking about distributing some more of that to shareholders?
I believe, Mickey, regarding the excise tax, with the current interest rates and the excise tax being 4%, it's one of the most affordable financing options available right now. Therefore, if we wanted to lower our liabilities, it would be more financially sensible to call some of our higher-priced bonds, such as those at 8.7%, which is more than double the cost. Currently, the marginal cost of financing baby bonds is around 7% to 8%, which is significantly higher than the excise tax. As such, the excise tax serves as a beneficial 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 have a slight disagreement with your perspective. Looking at the yield curve, the increase at the 10-year point is similar as it has risen as much as the short end has decreased. Additionally, the cost of selling 5-year debentures might even rise in the forthcoming years. There are numerous factors to consider regarding the overall cost of debt, especially in relation to our origination pace. As you mentioned, it’s a new year, a new administration, and a fresh outlook on several issues. Therefore, we plan to be cautious about making any significant changes until we gain more clarity on the upcoming environment we are entering.
And our next question will be coming from the line of Bryce Rowe of B. Riley.
Most of my questions have been addressed. I wanted to understand the changes we observed quarter-over-quarter. The debt portfolio remains highly valued, with very few items below cost. From an equity perspective, we noticed some consumer-facing investments marked lower. However, there were offsets from other businesses marked higher. I was hoping to gain insight into the overall health of the consumer-related businesses in your portfolio.
That's a good question. The decline in marks for some of our portfolio investments indicates a slightly weaker performance overall. Equity tends to be more volatile in response to underperformance compared to debt. While it’s a valid inquiry, we wouldn't directly link this to a broader outlook on consumer trends. The modest write-downs in a few portfolio companies are more connected to the specific circumstances of those businesses rather than general macroeconomic trends, at least 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 certainly enjoyed steady growth by supporting our existing portfolio companies. We expect to continue this growth at a rate similar to what we've achieved in the past. We're not seeing as many new platforms currently. It's interesting to note that during times like this, we tend to reflect on our portfolio and pipeline. Right now, our pipeline includes opportunities that are not new for the sponsors; rather, they involve upsizing, where sponsors have outgrown their existing lender or face changes in their capital structure, allowing us to replace that lender. This indicates that owners are holding onto their businesses longer to maximize value in their current portfolios, with a decline in M&A activity. More than half of what we're examining now, for which we have term sheets out and are excited about, are not new M&A deals but rather upsizing opportunities.
One more question from me regarding leverage, which has been discussed in previous calls. We've observed a significant reduction in net debt to equity, particularly this quarter due to strong repayment activity. What are your thoughts on managing balance sheet leverage in the future? If we consider the last few years, it's evident that leverage is lower than in 2023 and 2024, but higher than it was in 2022. How do you plan to address this, especially since you have historically carried more leverage than most BDCs?
Sure. I have a few thoughts on that, and it’s certainly something we take seriously. There are specific aspects of Saratoga that differentiate us from the broader BDC landscape, particularly our sizable SBIC portfolio and investments. The leverage associated with those is treated differently from baby bond leverage in terms of regulatory standards. Regulatory leverage is one thing, but total leverage is another. Also, the nature of the debt is vital, and we’ve discussed this in our quarterly calls. With short-term asset-based leverage, reaching the limits of asset base formulas can lead to significant risks, like foreclosure by banks, especially during temporary situations like the COVID pandemic. However, our SBIC debt leverage consists of 10-year instruments that are interest-only and have no covenants. Many things can happen over ten years, but since our only obligation is to pay interest, the risk associated with this debt's impact on the overall company's health is quite low. Similarly, our baby bonds are long-term instruments with bullet maturities, interest-only payments, and no covenants. Almost all of our debt has no significant covenants. The interest we need to cover is minimal compared to our liquidity and earnings, making our overall debt structure extremely safe relative to its size. This outlines our liability side, and regarding assets...
Even our asset-based loan that we have, although they're lowly drawn, so they also have no recourse to the BDC and no BDC covenants in them either which is different than the BDC...
All of our leverage is organized within special-purpose vehicles, ensuring it's compartmentalized and structured in a low-impact manner. While our cost of capital might be slightly higher compared to some other BDCs, this structure provides a significant safety advantage. We maintain a solid and secure long-term debt structure with maturities ranging from a small amount due in the next year to largely 2- to 10-year maturities. Establishing this debt structure has required considerable effort on our part, so we must handle any changes with care. On the asset side, we've discussed various issues within our portfolio. Two issues resulted in losses, but we've managed to rectify the other two over the past year. Currently, over 85% of our portfolio consists of senior, secured debt, positioning us as the most senior lender closely involved in company decision-making. The credit quality and performance of this portfolio are strong, resulting in a solid asset base.
We believe that discussing leverage in isolation or comparing it to other BDCs without considering both asset and liability factors leads to an incomplete understanding of our situation. We don't perceive our leverage as excessively high or risky; instead, we regard it as a significant asset. The average cost of our leveraged structure is notably lower than our current dividend yield, which stands at around 12%, with our average debt cost between 5% and 6%. This efficiency in debt cost enhances our equity. For instance, during the COVID pandemic, numerous BDCs faced challenges in repaying or funding their short-term asset-based credit facilities, unlike us. After COVID, we deployed substantial capital because our structure was well-suited for turbulent conditions, and we capitalized on this leverage for exceptional growth. This period yielded high-quality investments and strengthened our relationships, as we could support our sponsors during critical times, thanks to our resilient debt structure. Overall, we believe our current debt structure is a distinct advantage.
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.