管理層發言
Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Saratoga Investment Corp.'s 2025 Fiscal Third Quarter Financial Results Conference Call. Please note that today's call is being recorded. At this time, I would like to turn the call over to Saratoga Investment Corp.'s Chief Financial and Chief Compliance Officer, Mr. Henri Steenkamp. Please go ahead, sir.
Thank you. I would like to welcome everyone to Saratoga Investment Corp.'s 2025 Fiscal Third Quarter Earnings Conference Call. Today's conference call includes forward-looking statements and projections. We ask you to refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these forward-looking statements and projections. We do not undertake to update our forward-looking statements unless required to do so by law. Today, we will be referencing a presentation during our call. You can find our fiscal third quarter 2025 shareholder presentation in the Events and Presentations section of our Investor Relations website. A link to our IR page is in the earnings press release distributed last night. A replay of this conference call will also be available. Please refer to our earnings press release for details. I would now like to turn the call over to our Chairman and Chief Executive Officer, Christian Oberbeck, who will be making a few introductory remarks.
Thank you, Henri, and welcome, everyone. Saratoga Investment Corp. highlights this quarter include a sequential quarterly increase of adjusted Net Investment Income (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 Joint Venture (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 a total of $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; however, this does not impact our expectation of long-term AUM growth. The quality of our credits remains solid with only 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, 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 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 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 have 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 has substantial successful experience in similar situations, has invested significant equity in the business and became the CEO and a Board member. The total fair value of the remaining investment is $1.6 million. Following the Zollege restructuring of the balance sheet during the first quarter that resulted in us taking over the company and starting to actively manage the investment, the founder and previous owner has invested meaningful dollars in the business and is leading the enterprise and has reassembled some of the former senior leadership. He and the management team are working in partnership with us with the immediate goal of returning the business to its former profitability levels and the ultimate objective of exceeding those levels.
We still have equity in a first lien term loan in the company with a current fair value of $4.2 million, with the equity marked up this quarter to reflect the recent positive financial performance of the company. In addition, we recognized a $4.8 million realized gain on our Invita equity resulting from the sale of the company and recognized $0.7 million of realized gain on a Netreo escrow payment, further improving the overall positive outcome of that investment sold earlier this year. The CLO and JV had $4 million of unrealized depreciation this quarter, reflecting primarily markdowns due to individual credits, most notably in the first CLO. Our overall investment approach has yielded exceptional realized returns and recovery of our invested capital and our long-term performance remains strong as seen by our track record on this slide. Moving on to Slide 17. You can see our second SBIC license is fully funded and deployed, although there is cash available there to invest in follow-ons, and we are currently ramping up our new SBIC III license with $136 million of lower cost undrawn debentures available, allowing us to continue to support U.S. small businesses, both new and existing. This concludes my review of the market, and I'd like to turn the call back over to our CEO. Chris?
Thank you, Mike. As outlined on Slide 18, our latest dividend of $0.74 per share for the quarter ended November 30, 2024, was paid on December 19, 2024. Though unchanged from last quarter, this reflects a 3% and a 9% increase over the past 1 and 2 years, respectively. Additionally, we paid a special dividend of $0.35 per share concurrently with $1.09 per share of total distribution fulfilling our fiscal 2024 requirements. The Board of Directors will continue to evaluate the dividend level on at least a quarterly basis, considering both company and general economic factors, including the current interest rate environment's impact on our earnings. Moving to Slide 19. Our total return for the last 12 months, which includes both capital appreciation and dividends, has generated total returns of 4%, which is uncharacteristically low and underperforms the BDC index of 13% for the same period. Our longer-term performance is outlined on our next Slide 20.
Our 5-year return places us in line with the BDC index, while our 3-year performance is slightly below the index, reflecting the impact of the recent latest 12 months' performance and discrete credit issues. Since Saratoga took over management of the BDC in 2010, our total return has been 740% versus the industry's 284%. On Slide 21, you can further see our differentiated performance placed in the context of the broader industry and specific to certain key performance metrics. We continue to focus on our long-term metrics such as return on equity, NAV per share, NII yield, 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 have 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 look 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 that you had a pretty good quarter, 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 balance the outlook for new growth versus repayments as well.
I will begin, and then Mike can add his comments. Looking at the last quarter, we achieved $85 million in originations, which is quite a solid amount. Additionally, our investment in Invita, which is a 5-year commitment, accounted for about half of the $160 million in redemptions. If we exclude that, we essentially remained neutral. These fluctuations are typical; investment redemptions and new investments occur in cycles. It's challenging to forecast precisely when the return on that investment will take place during the 5-year span. Mike, if I recall correctly, that investment began at around $6 million, right?
Yes. It's actually a hallmark investment for us in a lot of ways just in terms of what we do and where we play in the marketplace. So that was initially a $6 million debt deal, accompanied with $2 million of equity. We were in it for roughly 5 years and were able to support the company's growth, and I think the debt position got well into the high 60s as the company successfully grew. And then, of course, we realized a $4.8 million gain on our equity investment. So the gross return that our shareholders received on that deal was quite substantial over that 5-year time. One of the challenges that we get when you deploy this model, but we think in the long run, the best way to deploy capital in our market and a really healthy thing is that when you add new portfolio companies, they tend to be on the smaller side, a little bit more granular. And then the really successful ones, and you've seen this in our portfolio for some of our larger positions, we have an opportunity to support them with growth over time. Now ultimately, when they pay off, they can be pretty lumpy. And it takes more platform companies to replace those lumpy payoffs. And in this particular quarter, as Chris was pointing out, we happened to have a couple of pretty sizable lumpy payoffs that were out of the ordinary, if you will, in general.
Yes. It's difficult to accurately predict our origination. We have a substantial portfolio, and we receive inquiries from our portfolio for large acquisitions, which can lead to significant follow-on investments. Therefore, it isn't something we can forecast reliably. While we have plenty of cash available and our historical performance gives some indication of our pipeline, the actual redemptions and origination remain unpredictable, and it may not be wise for us to attempt to estimate those figures.
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 the current market conditions, which are characterized by significant add-on activity, especially in the lower middle market where new M&A activity has significantly decreased. We remain optimistic that some factors contributing to the decline in M&A volume will eventually improve as interest rates may decline and other favorable conditions emerge. We believe that a new equilibrium will be established, leading to an increase in M&A activity, which we intend to leverage. Recently, our portfolio origination pace has not been as robust as it was a couple of years ago. However, since M&A activity has decreased, repayments have also been lower. Consequently, over the last several quarters, we have managed to grow despite the lower origination activity. In the most recent quarter, we experienced healthy production but also had some irregular repayments. Looking ahead, we are confident that our origination efforts, coupled with our strong market relationships and expanded business development activities, will enable our deployment pace to surpass any repayments over time.
That's helpful. I appreciate all the information you've provided. You're right; looking at some of the slides, you've shown your capability to execute on what you mentioned. For my second question, referring to Slide 8, Henri, you pointed out the opportunities with the publicly traded notes; I believe SAT is around 6%, and JY is above 8%, so there is a chance to achieve some savings by paying those down or refinancing. Regarding the SBIC ventures, I've noticed the call period settling down, and I'm curious about how the mechanics of potentially calling those or trying to reprice them would work since they are linked to specific assets. Also, could you remind me of the current average cost of those debentures? That might not even be a relevant topic for us.
Yes, the key factor when holding a license is whether you are still in the reinvestment period. For instance, with SBIC III, which is a newer license, receiving a repayment means we get cash that we can then use to invest in new assets instead of repaying debentures. Once we move beyond the reinvestment period, like we are with SBIC II, any cash we receive from repayments can only be used to support existing investments. This puts us in a position to decide whether to hold onto the cash for potential follow-on needs of the companies we already know or to pay down existing SBIC debentures. The process is clear: we have two chances each year, at the end of August and February, to decide on repaying the debentures. If we choose not to repay in August, we will hold the debentures until the next six-month period. In February, we will need to decide if we want to use some cash from SBIC II to repay some existing debentures. It's worth noting that many of those debentures were issued when interest rates were low, which creates a dilemma about whether to continue earning cash for potential follow-on opportunities or to go ahead and repay, and we will evaluate this again in mid-February.
Got it. And then last one for me. You noted your success in the past with realizing some equity gains with your investments there. Remind me just how you think about the potential to realize future gains? Is it really just tied to if the company sells in those transactions? Or do you typically sometimes proactively go out and seek to commoditize where a fair value might be well above kind of your holding.
On the equity side, we generally act as a minority investor. We believe this is an important aspect of our investment strategy, enhancing our debt returns through co-investments in equity. Our relationships with private equity sponsors and management teams value this alignment of interests that co-investment creates. As a minority investor, we typically do not control the exit; instead, we have the right to exit during a company sale or similar realization, which is when we usually see a return on our equity. Strategically, we conduct thorough research on these businesses, which equips us to assess whether a co-investment opportunity in equity makes sense. Our experience shows that there is a significant overlap between a solid credit and a business likely to be a strong equity investment. We look for companies that distinguish themselves in markets with strong dynamics, excellent management teams, and high free cash flow. Many of the qualities we seek in businesses are the same that indicate they could be good equity investments. This approach has contributed to achieving 15% unlevered returns on our portfolio over time, primarily driven by debt returns, but successful equity co-investments have also played a significant role. We believe this strategy is fundamental to our approach going forward.
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.
Okay. So it's a little more than half. I would say we have about two-thirds of it reflected in the way our loans reset, and when they reset, approximately two-thirds of the decrease has been shown. We haven't fully accounted for the reset we experienced in September. So I would estimate it to be around two-thirds. Additionally, since the end of the quarter, there has also been a slight decline in SOFR.
So right. Well, that's what I mean. I mean, when I look at it across the entire 100 basis points of what the Fed has done, it would seem to me that you've reflected about 50 basis points in your results as of the end of November and maybe there's another 50 bps to go counting what the Fed has done subsequent to the end of your quarter.
Yes. I haven't done like the exact count, but I would guess it's again, slightly more than that, probably in the low 60s.
Okay. When I think in terms of decline in rates, higher yielding loans paying off, clearly a reduced portfolio balance that's going to take some time to build up. Do you still feel comfortable? Or is there maybe a quarter or two here where maybe it might seem reasonable to actually under-earn the dividend a little bit until you can build the portfolio back up?
Well, Casey, I don't think we've ever under-earned our dividend, and that's certainly not something we would welcome. Some factors, like the rate of repayments and deployments, are beyond our control. However, we do have a solid pipeline, and as Mike mentioned earlier, there's been a significant slowdown in M&A activity. Many private equity firms are holding onto assets that aren't meeting their expectations, but there's considerable pressure in the industry. With potential changes under the new administration and different antitrust approaches, we might see a resurgence in deal activity. Some deals have been rejected by the Justice Department, and it's puzzling why they would decline certain $8 billion deals related to antitrust concerns. I believe there's a lot of interest among those waiting on the sidelines to engage in more business moving forward. While we cannot predict the timing or pace of this activity, we feel there will be a significant amount of it in the future. However, we can't say how it will impact us on a quarterly basis, and we aren't anticipating under-earning our dividend, but that is 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 of all, Casey, I think it's fair to say that the current rate on cash is higher than the cost of the debentures in SBIC II. This creates a favorable situation for not paying off the debt. If it were the opposite, we would likely reduce it. We're monitoring this closely. If it turns to a negative situation, it would make sense to pay it off. We also need to consider what type of acquisition activity we expect from those companies. Regarding SBIC IV, you should have seen Henri's reaction; it's a significant paperwork task, but we still have a long way to go with SBIC III. We've had a very successful program there. We don't expect any issues in obtaining the next license; it’s mainly a matter of timing. There are also some investment metrics to consider before starting that process.
There is definitely a new process in licensing with repeat issuers that has streamlined the process, which is wonderful. Casey, you're very familiar with it too, 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 about the decision to sell equity into the market despite having $250 million in cash, especially right at the end of the quarter and at the beginning of the next one. Can you explain the reasoning behind this? It doesn't seem logical when considering the cash balance of $250 million, which suggests a negative arbitrage while paying down debt.
Certainly. Casey, that's a great question. We've had extensive discussions about this internally. When looking at the history of Business Development Companies and specifically ours, the ability to raise equity is highly dependent on whether we can sell stock at net asset value. In this case, we were very close to that value, and the manager supported the sales to help us reach it. Opportunities to sell in larger amounts don't come around often. There's a common saying on Wall Street that many on this call are likely aware of: it's often challenging to raise money when you need it, whereas it's easier when you don't need it. Equity represents permanent capital, and when the chance to raise it arises, it’s important to seize that opportunity. In previous discussions, we have talked about our leverage levels, which can be managed in a few ways. One method is to pay down debt, while another is to increase equity.
Ideally, we prefer to grow equity through capital gains, which we've successfully achieved over time, but we've also periodically issued new equity. We perceive the sale of equity as a strategic decision for the long term, rather than a response to our current cash balance. Currently, we have $250 million in cash, but there have been instances when our cash was much lower, making it difficult to find liquidity for investments. Therefore, we regard cash as a short-term consideration and equity as a key component for the long-term growth of our BDC. Aside from deal volumes, the opportunities for our types of investments remain extensive, and we do not anticipate a slowdown in the long run. We see considerable growth ahead, which influenced 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, interest rates have shifted and the excise tax is currently 4%, making it one of the least expensive financing options available. Therefore, if we aim to lower our liabilities, it would be more economically sensible to pay off some of our higher-interest bonds, which have rates around 8.7%. The marginal cost of issuing baby bonds is now between 7% and 8%, so financing costs are significantly higher than the excise tax. Thus, the excise tax remains 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 would slightly disagree with your perspective. If you examine the yield curve, you'll notice that the rise in the 10-year rate is similar to the decline in the shorter rates. Additionally, the cost of selling 5-year debentures may increase in the upcoming years. There are many factors to consider regarding the overall cost of debt, especially in relation to our origination pace. It's a new year, a new administration, and a fresh outlook on several issues. Therefore, we will exercise caution in making any significant changes until we acquire more information about the new environment we are entering.
Yes, I understand your point, Chris, but you also have the highest leverage among all listed BDCs. I took that into consideration 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 get a sense of some of the movements we observed quarter-over-quarter. The debt portfolio continues to be marked at very high levels, with only a few below cost. However, from an equity perspective, we did notice a few consumer-facing investments marked lower, while some other businesses were marked higher. I just wanted to understand the overall health of the more consumer-related businesses in your portfolio.
That's a good question. The decline in some of our portfolio investments reflects generally softer performance. Equity tends to be more volatile due to underperformance compared to debt. While it's a valid question, we wouldn't necessarily link it to a broader view on the consumer. The modest write-downs in some of our portfolio companies seem more related to the specific dynamics of those businesses rather than macro 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?
Yes, that's a very good question. We have enjoyed the opportunity to continue growing at a healthy pace by supporting our existing portfolio companies. We anticipate being able to maintain this pace consistent with our past performance. We're not encountering as many new platforms currently. It is interesting because at times like this, we tend to reflect on our portfolio and our pipeline. Presently, if you examine our pipeline, many of the new opportunities we are pursuing are actually not new for the sponsors; they are upsizing opportunities where the sponsors either outgrew their current lenders or where changes in the capital structure allow us to step in and replace the existing lenders. This indicates that owners are holding onto their businesses longer and focusing on driving value within their existing portfolios, with less increase in M&A activity. I would say that more than half of what we are currently exploring, for which we have term sheets out and are excited about, are not new M&A deals but rather upsizing opportunities of some kind.
Okay. I have one more question on the topic of leverage. It has definitely been discussed in previous calls. We've noticed a significant decrease in our overall net debt to equity, particularly this quarter due to strong repayment activity. Can you provide your thoughts on how you plan to manage balance sheet leverage going forward? A couple of years ago, the leverage was higher than it was in 2022, but it is lower than what we experienced in 2023 and 2024. I'm curious about your strategy, especially since you have carried more leverage than most BDCs in recent years.
Certainly. I have a few thoughts on that. It's an area we invest considerable time in understanding. There are some distinctive features of Saratoga that differentiate us from the broader BDC landscape, particularly our substantial SBIC portfolio and investments. The leverage associated with these is treated differently than baby bond leverage in terms of regulatory assessments. Therefore, while regulatory leverage is one aspect, total leverage presents a different picture. We've addressed this in our quarterly calls multiple times. When dealing with short-term asset-based leverage, if you reach the limits dictated by asset base formulas and a negative event occurs, you risk foreclosure by your banks, which can lead to significant challenges. Such situations can arise unexpectedly, as seen during events like the COVID pandemic. In contrast, the leverage from SBIC debt, which consists of 10-year instruments that require only interest payments and come with no covenants, poses much less risk to the overall health of the company.
Over a decade, many variables can change; however, with the primary obligation being to service interest, the risk associated with this type of debt is minimal. Similarly, our baby bonds have long-term structures, feature bullet maturities, require only interest payments, and also come with no covenants. As a result, nearly all of our debt lacks significant covenants. Our interest obligations are relatively small compared to our liquidity and earnings. Overall, our debt structure is exceptionally secure considering its magnitude.
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 our leverage is compartmentalized and structured in a low-impact manner through special-purpose vehicles. As a result, our cost of capital might be slightly higher than some other BDCs, but it is significantly safer. We have a robust and secure long-term debt structure with maturities ranging from a small amount due next year to primarily 2- to 10-year maturities. It took considerable effort on our part to establish and maintain this debt structure, so we are cautious about making changes. On the asset side, we have discussed specific portfolio issues, including two losses and two others that have improved over the past year. However, if you look at the portfolio now, it consists of largely over 85% senior secured debt. We are the most senior lender involved in key decision-making processes with the companies. The credit quality and performance of our portfolio are strong, and we view this asset base as solid.
We believe discussing leverage in isolation or comparing it with other BDCs without acknowledging the characteristics of both asset and liability sides presents an incomplete picture. We do not consider our leverage to be high or risky; in fact, we see it as a considerable asset. The average cost of this leverage structure is significantly lower than our current dividend yield, which stands at about 12%, while our average debt cost is around 5% or 6%. The cost of our debt is very beneficial to our equity. For instance, during the COVID period, many BDCs faced challenges with their short-term asset-based credit facilities, but we did not. After COVID, we were able to deploy substantial capital because we were well-positioned for that environment, despite carrying a lot of leverage. This led to significant and high-quality growth for us, and we made excellent investments, strengthening our relationships by supporting our sponsors during critical times. Our debt structure proved resilient in the short term, and we believe we are well-prepared for the current environment. Thus, we view our debt structure as a positive, not a negative.
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.