Capital Southwest - Earnings Call - Q2 2021
November 2, 2020
Transcript
Speaker 0
Thank you for joining today's Capital Southwest Second Quarter Fiscal Year twenty twenty one Earnings Call. Participating on the call today are Bowen Diehl, CEO Michael Sarner, CFO and Chris Reberger, VP Finance. I will now turn the call over to Chris Reberger.
Speaker 1
Thank you. I'd like to remind everyone that in the course of this call, we will be making certain forward looking statements. These statements are based on current conditions, currently available information and management's expectations, assumptions and beliefs. They are not guarantees of future results and are subject to numerous risks, uncertainties and assumptions that could cause actual results to differ materially from such statements. For information concerning these risks and uncertainties, see Capital Southwest's publicly available filings with the SEC.
The company does not undertake any obligation to update or revise any forward looking statements, whether as a result of new information, future events, changing circumstances or any other reason after the date of this press release, except as required by law. I will now hand the call off to our President and Chief Executive Officer, Bowen Diehl.
Speaker 2
Thanks, Chris, and thank you to everyone for joining us for our second quarter fiscal year twenty twenty one earnings call. Throughout our prepared remarks, we will refer to various slides in our earnings presentation, which can be found on our website at www.capitalsouthwest.com. We are pleased to be with you this morning to announce our results for our second fiscal quarter ended 09/30/2020. I wanna first say that I hope everyone, their families, and their employees continue to be safe and well. Here at Capital Southwest, we have continued to prioritize the health and safety of our employees and of the employees of our portfolio companies.
We remain in regular dialogue with our portfolio company financial sponsors and management teams and have been pleased with the overall performance of the portfolio. We have been most impressed with the management teams and financial sponsors' ability to manage all aspects of company performance, including protecting their employees, while increasing operating efficiencies during these unprecedented times. While the pandemic is not yet behind us, as we look back to where we were in March 2020 with so much uncertainty and market volatility, we are very grateful for all the work done by the team here at Capital Southwest and the teams at both our portfolio companies and financial sponsored clients. We're also extremely pleased with the performance of our portfolio, and we remain highly confident in the quality of the assets and its earnings power. During the quarter, our portfolio performance continued to improve as evidenced by 8,400,000 of net appreciation across the portfolio.
For the quarter, we had two loans which had investment rating upgrades. We had no investment rating downgrades, and we had no new loans placed on nonaccrual. As a well capitalized first lien lender with ample liquidity, Capital Southwest continues to be in a favorable position to seek attract seek attractive financing opportunities and to provide financial support to help our companies grow. Executing our investment strategy under our shareholder friendly, internally managed structure closely aligns the interests of our board and management team with that of our fellow shareholders in generating sustainable long term value through recurring dividends, capital preservation and operating cost efficiency. On Slide six of the earnings presentation, we have summarized some of the key performance highlights for the quarter.
During the quarter, we generated pretax net investment income of $0.44 per share, which more than earned our regular dividend paid for the quarter of $0.41 per share. We also continued our supplemental dividend program, paying out an additional $0.10 per share, funded by our sizable undistributed taxable income balance. Total dividends for the quarter of May per share represented an annualized dividend yield on the quarter end stock price per share of 14.5% and an annualized yield on net asset value per share of 13.3%. I'm also pleased to announce that our Board has declared total dividends of $0.51 per share, again, for the quarter ended 12/31/2020, consisting of a regular dividend of $0.41 per share and a supplemental dividend of $0.10 per share. During the quarter, we grew our investment portfolio by over seven percent to $631,000,000 as of 09/30/2020.
Portfolio growth during the quarter was driven primarily by $66,300,000 in total new commitments to four new portfolio companies and six existing portfolio companies, offset by 21,000,000 in prepayments from two loans, which I will review in a bit more detail in a moment. Additionally, on the capitalization front, we successfully raised $50,000,000 in proceeds at par on our existing 5.8% institutional unsecured bonds, bringing the total principal outstanding of this bond issuance to 125,000,000. Finally, as we mentioned last quarter, we continue to work with the US Small Business Administration towards becoming officially licensed as an SBIC. We are pleased to report that we completed our final license submittal during the quarter and look forward to reporting developments on the status of our pending license application to our shareholders as warranted. As a reminder, final approval and issuance to Capital Southwest of an SDIC license would provide a ten year commitment to provide Capital Southwest with up to $175,000,000 in debt financing to be drawn to fund investments in our lower middle market strategy.
We estimate that the vast majority of the deals we have reviewed over the past five years would qualify for SBIC financing, giving us a high level of confidence that we will be able to invest this capital in our existing strategy and continue to support growth and employment in small businesses across the country. As a reminder, each draw from the SBIC debenture program separately represents a new debt security in our capital structure with a ten year maturity from the date of draw, making this capital truly long term in nature. From a cost perspective, if treasury rates remain close to today's level, the all in cost of the SBIC debentures would be less than 3%. This program is clearly a perfect fit for our lower middle market focus, and we look forward to continuing to work with the SBA in completing the application process and in successfully executing the SBA's mission of supporting growth and employment in US small businesses. Turning to slide seven and eight, we illustrate our track record of producing a strong dividend yield, consistent dividend coverage and value creation since the launch of our credit strategy.
We strongly believe that the maintenance and growth of both NAV per share and dividends paid per share are paramount to creating long term value for our shareholders. Turning to Slide nine. As a reminder, our investment strategy has remained consistent since its launch in January. We continue to focus on our core lower middle market while also maintaining the ability to invest in the upper middle market when attractive risk adjusted returns exist. In the lower middle market, we directly originate opportunities consisting of debt investments and equity co investments.
Building out a well performing and granular portfolio of equity co investments is important to driving NAV per share growth as well as aiding in the mitigation of any credit losses over time. Overall, we believe that maximizing the top end of our deal origination funnel in both markets is critical to generating strong credit performance over time as it ensures that we consider a wide array of deals, allowing us to employ our conservative underwriting standards in thoughtfully building a portfolio that will perform through any economic cycle. Though we continue to take a cautious and extremely selective approach towards deploying new capital, taking into account the new normal of potential pandemics among other risks, we are pleased to have the capital to invest to support acquisitions and growth across our markets. That said, we continue to find superior risk adjusted return opportunities in the lower middle market, where we can lend at lower leverage and loan to value levels while maintaining tighter covenants and other terms in the loan documents. As illustrated on Slide 10, our on balance sheet credit portfolio, excluding I-forty five, grew 7% during the quarter to $521,000,000 as compared to $487,000,000 as of the end of the prior quarter.
Our credit portfolio is currently weighted 82% lower middle market loans, down slightly from 85% last quarter as a result of two loan prepayments in the lower middle market and two originations in the upper middle market during the quarter. We continue to heavily emphasize first lien senior secured debt lending with 100% of the debt originations this quarter being first lien senior secured. As a result, as of the end of the quarter, 91% of the credit portfolio was in first lien senior secured debt. On slide 11, we lay out the $66,300,000 of capital invested in and committed to portfolio companies during the quarter. This included 42,200,000.0 in first lien senior secured debt committed to four new portfolio companies and 20,900,000.0 in additional first lien senior secured debt committed to six existing portfolio companies.
Turning to slide 12, as I previously alluded to, we had two lower middle market exits this quarter, Danforth Advisors and Trinity three. Our debt at Danforth was refinanced by a traditional bank, repaying our loan in full, generating proceeds of $6,700,000 and an IRR of 12.4%. We continue to hold equity in Danforth alongside the sponsor, and we are excited to watch this management team and sponsor continue its stellar performance. In the case of Trinity three, which also appears on the new deal fundings for the quarter, we were able to participate in a much larger club deal, which refinanced our original loan and financed a large strategic acquisition for Trinity three. We also hold an equity interest in this company and are very excited about its continued growth prospects going forward.
This continues our track record of successful exits. To date, we have generated a cumulative weighted average IRR of 14.7% on 33 portfolio exits, generating approximately $3.00 $8,000,000 in proceeds. On Slide 13, we break out our on balance sheet portfolio as of the end of the quarter between the lower middle market and the upper middle market, excluding I-forty five. As of the end of the quarter, the total portfolio, including equity co investments, was weighted approximately 84% to the lower middle market and 16% to the upper middle market on a fair value basis. We had 39 lower middle market portfolio companies with a weighted average leverage ratio measured as debt to EBITDA through our security of 3.9 times, down from 4.1 times weighted average leverage in the prior quarter.
This reduction in leverage was primarily driven by EBITDA performance across the lower middle market portfolio during the quarter. Within our lower middle market portfolio, as of the end of the quarter, we held equity ownership in approximately two thirds of our portfolio companies. Our on balance sheet upper middle market portfolio, excluding I-forty five, consisted of 12 companies with an average leverage ratio through our security of 3.7x, down meaningfully from the 4.4x weighted average leverage for the prior quarter. This decrease was also driven primarily by EBITDA improvement quarter over quarter across the portfolio. Turning to Slide 14, we have laid out the rating migration within our portfolio for the quarter.
During the quarter, we had two loans upgraded while having no loans downgraded. As a reminder, all loans upon origination are initially assigned an investment rating of two on a four point scale, with one being the highest rating and four being the lowest rating. The upgrades consisted of two loans to one portfolio company previously rated a three, which were upgraded to a two rating based on much improved performance. As of the end of the quarter, 88 of our investment portfolio at fair value was rated in one of the top two categories, a one or a two. We had seven loans representing 10% of the portfolio at fair value rated a three, and only two loans representing 2% of the portfolio at fair value rated a four.
As illustrated on slide 15, we have established a portfolio well diversified across industries with an asset mix which provides strong security for our shareholders' capital. The portfolio remains heavily weighted towards first lien senior secured debt with only 6% of the portfolio in second lien senior secured debt and only 2% of the portfolio in one remaining subordinated debt investment. Turning to slide 16. The I-forty five portfolio showed meaningful improvement during the quarter, as our investment in I-forty five appreciated by $4,700,000 or 8%. Leverage at the I-forty five fund level is now 1.39 times debt to equity at fair value, which is substantially improved from the March leverage of 2.51 times.
As of the end of the quarter, 96% of the I-forty five portfolio was invested in first lien senior secured debt with diversity among industries and an average hold size of 2.4% of the portfolio. I will now hand the call over to Michael to review the specifics of our financial performance for the quarter.
Speaker 3
Thanks, Bowen. Specific to our performance for the September, as summarized on Slide 17, we earned pretax net investment income of $8,100,000 or $0.44 per share. This was a 13% increase from the $7,200,000 or $0.40 per share earned during the prior quarter. We paid out $0.41 per share on regular dividends for the quarter, flat from the $0.41 regular dividend per share paid out in the prior quarter. As mentioned earlier, our Board has also declared a further $0.41 regular dividend per share to be paid out during the December.
In the near and long term, we have built a consistent track record of meaningfully covering our regular dividend with pretax net investment income, as demonstrated by our 103% regular dividend coverage over the last twelve months and 106% cumulative regular dividend coverage since the launch of our credit strategy. During the quarter, we maintained our supplemental dividend at $0.10 per share and again, our Board has also declared a further $0.10 per share supplemental dividend to be paid out during the December quarter. As a reminder, the supplemental dividend program allows our shareholders to meaningfully participate in the successful exits of our investment portfolio through distributions from our UTI balance. As of 09/30/2020, our estimated UTI balance was 1.19 per share. Our investment portfolio produced $16,700,000 of investment income this quarter, with a weighted average yield on all investments of 10.4%.
This represents an increase of approximately $1,500,000 from the previous quarter. As Bowen mentioned, we had no new non accruals as of the end of the quarter. Currently, three assets remain on non accrual with a fair value of $10,900,000 representing 1.7% of our total investment portfolio at fair value. The weighted average yield on our credit portfolio was 10.3% for the quarter. On Slide 18, we lay out our operating leverage for the quarter, which was up slightly quarter over quarter.
Operating expenses were slightly elevated this quarter due mainly to a true up to our annual bonus accrual based on improvement in our overall portfolio performance as well as an increase in share based compensation expense relating to the annual grant to employees. On a run rate basis, we expect operating leverage will be well within our sub-two point five percent target going forward. Turning to Slide 20. The company's NAV per share as of 09/30/2020, was $15.36 as compared to $14.95 at 06/30/2020. The main driver of the NAV per share increase was $8,400,000 of appreciation in the investment portfolio, much of which was in the upper middle market portfolio.
On Slide 21, we lay out our multiple pockets of capital. As we have mentioned on prior calls, a strategic priority for our company is to continually evaluate approaches to derisk
Speaker 2
the liability
Speaker 3
structure of the company, while ensuring that we have adequate investable capital throughout the economic cycle. During the quarter, we raised an additional $50,000,000 on our 5.375% unsecured notes due 2024 and subsequently paid down $20,000,000 on our 5.95% baby bond due 2022. We will continue to be opportunistic in paying down higher priced debt to optimize net investment income while also being mindful of maintaining appropriate flexibility in our liability structure. Our debt capitalization today includes a $325,000,000 on balance sheet revolving line of credit with 11 syndicate banks maturing in 02/2023, a $57,000,000 publicly traded baby bond maturing in 02/2022, a $125,000,000 institutional bond with over 25 institutional investors maturing in 02/2024, as well as a $150,000,000 revolving credit facility at I 45 with four syndicate banks maturing in 02/2024. We're pleased to report that our liquidity is strong with approximately $151,000,000 in cash and undrawn commitments as of the end of the quarter, with ample borrowing base capacity and covenant cushions on our senior secured revolving credit facility.
Approximately 49% of our current capital structure liabilities are unsecured with the earliest debt maturity at December 2022. Our balance sheet leverage, as seen on Slide 19, ended the quarter at a debt to equity ratio of 1.28:one. Finally, as Bowen mentioned, we continue to work actively with the SBA toward an SBIC license, which would allow us, in time, to access up to $175,000,000 in attractively priced debt at our SBIC. We believe we are in the final stages of the licensing process and are hopeful of receiving our license by the end of the calendar year. We are excited to integrate the SBIC license into our capitalization strategy as the flexibility and low cost of SBIC debentures should be highly accretive to our net investment income per share, while also allowing us to continue to provide important growth and acquisition capital to U.
S. Small businesses. I will now hand the call back to Bowen for some final comments.
Speaker 2
Thanks, Michael. And thank you, everyone, for joining us today. Capital Southwest has grown and the business and portfolio I've developed consistent with the vision and strategy we communicated to our shareholders almost six years ago. Our team has done an excellent job building both a robust asset base as well as a flexible capital structure that prepares us for difficult environments like the one we have experienced over the past several months. In difficult environments like this demonstrate the investment acumen of our team at Capital Southwest and the merits of our first lien senior secured debt strategy.
While we are not immune to the challenges the economy faces today, we feel good about the health of our company and the opportunities that the environment will present us as we consider places to invest capital. Everyone here at Capital Southwest is totally dedicated to being good stewards of our shareholders' capital by continuing to deliver strong performance and creating long term sustainable value even in challenging times such as these. This concludes our prepared remarks. Operator, we are ready to open the lines for Q and A.
Speaker 0
Our first question or comment comes from the line of Mike Smith from B. Riley. Your line is open.
Speaker 4
Hey, guys. Congrats on a very strong quarter. So I guess my first question would be, you had a very good quarter of origination activity despite some of the COVID headwinds. So I was wondering if you can maybe size the pipeline and just talk a little bit about the quality of deals you're seeing now just in terms of pricing, covenants, attachment points, etcetera.
Speaker 2
Yeah. Sure. Thanks for the question. We thought the quarter originations were very strong. It included both new portfolio companies as well as four add on acquisitions at our portfolio companies.
And so right now, I'd say the pipeline is about average. So it's solid, but it's about average. As far as what we're seeing in the market, we do think that the most most all, if not all, of the pre COVID premium, if you will, on a yield basis or a spread basis has has disappeared. There might be slight in certain deals. But certainly, a lot of cases, the the premium, the COVID premium has decreased.
With respect to leverage attachment points, I think we're still seeing leverage attachment points slightly below COVID levels. And and covenants are still strong and, you know, the EBITDA adjustments and those types of things that you see in credit docs are still are still really strong, in the in the lender's favor, I should say. And, you know, as far as quality deals, you know, we we've we definitely are seeing, you know, quality deals. You know, certainly seeing low quality deals too. Low quality being defined as companies that we still can't underwrite COVID performance.
But we're seeing a fair amount of quality deals. And if you look across the business descriptions of the companies we originated this quarter, Yeah. I mean, software, government services, cyber cybersecurity, Internet marketing, you know, companies. There's really interesting business models, especially in this environment. So, you know, our team has done an excellent job.
They've got a very wide array of network a network of relationships, and they've done a fantastic job, you know, monetizing those those relationships through the form of originating quality deal flow.
Speaker 4
Got you. That's helpful. That's very helpful color. So another question would be on leverage. You're currently sitting at 1.28 times.
And if I'm not mistaken, I think the previous target was one to two. So I'm just wondering how you're kind of thinking about leverage moving forward here. And are you comfortable with it being slightly above your target?
Speaker 2
Yes, sure. So I'll make a macro comment, and that's just with respect to leverage as it relates to economic cycles. I mean, recessionary challenging environment, you might be willing to go to one leverage level. And in a peak, everything's wonderful, marching forward like we were a year ago, you want to be at another leverage level. And so, you don't want to maximize leverage at the high end of the cycle, and you might be willing to have leverage increase at the low end of the cycle.
And you want to go into the cycle with leverage low so that you can manage leverage down in the cycle. So what all that means, if you think about leverage of 1.28, the answer is yes, we're comfortable with where we are. It is higher than our one to 1.2 kind of target range we gave pre COVID. If you look at you know, if you just take a high level look at the the depreciation in the portfolio during COVID, retracing that kind of the COVID effect on the portfolio, we're basically back to the top end of our leverage range. And so you have to kind of keep in mind that as the portfolio reappreciates, that leverage all else equal will come down.
So that's one kind of point and why I can say we're comfortable with where we are. The next thing is, you know, we've got visibility on, you know, you know, 30 to $35,000,000 of prepayments coming in from portfolio companies that are performing very well and and and we and are being sold or refinance or what have you. So so if you kinda think about leverage, we we have visibility on cash coming in. So we'll obviously be redeploying that cash in in originations, but that's another point. And the third thing I would say is if you think about, you know, we we traded well above book for almost two years pre COVID.
So I believe that we've proven that our business model and our strategy in a more in a more in a more normal market should trade above NAV. Okay. So if it trades above NAV, as you guys know, we've got an ATM program that we're diligent about accessing at very low spreads to trade. And so that's obviously a function. You know, our yield on NAV today is 13 and a half percent or so.
And on the stock price, it's north of 14 percent. The market will figure out the risk premium on our stock over time. So we're comfortable with just letting the market play out. But those yield levels, based on our strategy and track record, really are not where we believe those yield levels will normalize out over time, which we believe will trade above NAV and we'll be able to raise equity. So those are kind of all the points where I that I that are in my head as I look at the leverage at 1.28 and go, am I comfortable with that
Speaker 3
or not? Yeah. I was also going to say, just from a company profile perspective, our asset mix is a little different now than it was a year ago. We were probably in the mid eighties on first lien, and now we're ninety one percent first lien. We had a few, probably two to three sub debt investments.
And today, we have one sub debt investment. And our equity percentage, of the portfolio was probably in the low 20%, and now it's sub-ten percent. So our overall profile is a lot stronger than it was then. So you could probably take on a little more leverage, based on that profile. That's a good point.
Speaker 5
So I think that was
Speaker 4
really good color. Yeah. That's all very helpful. And then one more kind of just high level question for me. If I'm not mistaken, I I think 631,000,000 is a record portfolio size.
So just given your outlook for the origination environment and kind of the potential for an SBA license, I'm wondering what kind of portfolio size can you support with with your current infrastructure.
Speaker 2
Yeah. So we've kind of managed costs. You know, we look at operating leverage. And so, you know, we think, you know, as the portfolio grows, we're looking at that operating leverage number. So, as our portfolio grows, we can invest in staff and resources, right?
And so, our dollar costs will go up over time, but that's what we look at as a percentage of our assets. And as we layer in the SBIC, as we grow continue to grow the portfolio, we will add people, but we manage it to that operating leverage number because that's really what the shareholders should care about, is that percentage drag, if you will, the income on the portfolio from overhead that we're spending. So we look at that metric, and we absolutely add to resources as we grow the assets.
Speaker 4
Gotcha. Thanks for taking my questions. I will, I'll let somebody else ask a few.
Speaker 3
Thanks, Mike.
Speaker 0
Thank you. Our next question or comment comes from the line of Mickey Schine from Ladenburg. Your line is open.
Speaker 6
Morning, Bowen and Michael. Nice to hear from you. Bowen, I wanted to follow-up on the prepayment risk. You know, I sort of think we're living in a world, obviously, of haves and have nots in terms of the portfolio companies. And, you know, there's a lot of private debt capital out there chasing what, you know, I would say is still a limited deal pipeline when you consider the constraints everyone has on on underwriting.
Meanwhile, there's potential changes in tax rates, and that could, catalyze some business orders to sell now this quarter. So with those trends in mind, how high do you feel prepayment risk is in your portfolio given the strength of some of your investments besides the two that you've already mentioned in the prepared remarks?
Speaker 2
Yeah, Nikki. Thanks for the question. I mean, again, if we if we, you know, the just to to quantify the number, I mean, it's 30 to 35,000,000 of of prepayments that we have some visibility on. You know, with respect to the environment and tax regime changes, you know, theoretically, you know, as we move into the end of the year because of potential pending capital gains treatment changes, that could could definitely influence deal flow. I would say that I don't I'm not I'm not as certain that that people are going to make, especially with the aging entrepreneurial population that are monetizing their their retirement in these businesses is what's generating a lot of the sales across the lower middle market.
I don't know that founder owned business makes a rash lifetime decision thirty days here or there based on a tax change. If they were already thinking about selling their business, it could absolutely accelerate it. So and push it into this this year. But, and I would also say that, you know, we won't I guess, we won't know till tomorrow or or hopefully soon after the election change and and and you would have more visible or more visibility on a theory on tax change. It'd be hard to launch a sale process right now and get it sold by the end of the year.
So long way of saying, I don't know that the tax changes necessarily were going to dramatically change or certainly our prepayment risk. But look, it's you know, as a lender, the strongest performers get prepaid, get refinanced, especially in the lower middle market where, you know, traditional banks maybe aren't willing to lend to some of these companies. We are. And then the traditional banks, in the case of Danforth, refinance us out. I mean, that's a that's a process.
And so, you know, there's a the vast majority know, the majority of portfolio companies are just kinda going along, growing, and we end up holding loans for a couple years. You know? Then you have the star performers, and then, course, you have a, you know, small universe of of guys that underperform. So if that makes sense.
Speaker 3
Yeah. And I also say that that some of the deals that are set to repay were on our list of deals that this could occur. So that's kind of being taken off the, you know, off the register. So what we're left with is a lot of companies that we've refinanced over the last two years. So we actually feel like we have a good sense that there's not gonna be, you know, another 30 to 50,000,000 in the next quarter after that.
So I I feel like that we've a lot of the stuff is happening right now.
Speaker 6
That that's that's helpful. I appreciate that. Bowen, I wanted to touch on the the nonperforming loans. If I'm not mistaken, they're
Speaker 5
all
Speaker 6
in certain, you know, stages of bankruptcy, and I think there's been some movement since our last call. So starting with American Addiction, from what I've read and, you know, the information's a little sparse, it looks like you're gonna be repaid in cash on that from asset sales. Is that correct? And and when will that be?
Speaker 2
So based on, you know, based on what's public, you know, it's it's it's gonna emerge from bankruptcy relatively soon. It'll be restructured. So the the lender group, first lien lender group, which we are a part of, will end up holding a debt security, first lien debt security in the new restructured company and then ownership of the equity in the company. So it'll be restructured. It will be a merchant bankruptcy, and Capital Southwest actually will have a board seat.
And so that's that. And it'll all be, you know, resolved, you know, relatively soon. I mean, it's not in our control, but it's but it's, you know, it's it's it's basically gotta work through taxes and various things of structuring the the recap. So the restructuring. So that's that's AAC.
Anyway, you wanna talk about Kings and and CPK as well?
Speaker 6
Well, before we go on to those, just, so you will end up with a performing piece of debt in in AAC at some point, maybe next quarter?
Speaker 2
That's correct. Yes. Okay. That's the expectation. Sure.
Speaker 6
And so CPK, it looks like, similarly you're gonna get equity and and and debt. Is that correct? And and one When is that gonna happen?
Speaker 2
So similar similar story as AAC as far as what will happen from bankruptcy perspective. So we'll end up with a, you know, a performing first lien note and equity in the in the company. We will not have a board seat in that instance.
Speaker 6
Okay. And and And we
Speaker 2
think that's gonna happen. That, you know, that should,
Speaker 7
you know, I think it
Speaker 2
may even be announced, but it'll be it'll be, it'll be relatively soon.
Speaker 6
Right. And and what's the game plan for for CPK? I mean, I've been reading headlines where lenders, you know, I I guess surprisingly are taking over some of these restaurant businesses despite everything that's going on in the world. Obviously, thinking that, you know, long term, there there must be value there. I think you've mentioned in the past that CPK was doing pretty well prior to the pandemic.
But looking ahead, you know, are there any major changes you expect to implement with with the other owners at CPK? Or or you're just gonna wait for COVID to run its course and hope for things to improve.
Speaker 2
Okay. Well, yeah, I appreciate the question. And, obviously, I'll give you my a couple of points, my view, but, you know, obviously, wanna be very careful with the confidentiality around that company. I think everybody understands that. But I will say that this management team seems to be doing a really good job with the business, and that's one thing.
And then the other thing is that, you know, the the the restaurants that have opened, people come eat there. And so, you know, and so it's it's tells me that the brand is relevant and and and it's desired, and there's a demand for that brand and that concept in the market. So that's encouraging. Clearly, COVID is a bunch of noise out there. It's affecting all the restaurants.
You know, the management team's doing some interesting creative things around that with respect to CPK. The election, you know, and any kind of unrest that may result, you know, unrest in an area affects all the retailers, all the all the the places, restaurants included in those areas. So there's clearly noise out there. But the things I grab onto is management team seems to be doing a great job. We, you know, we have weekly calls.
And the restaurants that are open, people want to eat there. And so based on those two things, that gives me a lot of encouragement as to the the future of that concept once all the market noise, COVID pandemic noise you know, fades away, which look this too shall pass. And so still challenges, but good team, and and there's some definitely some signs of of relevance of that concept and brand.
Speaker 6
I understand. That that's great. Thanks for that. And and on AG Kings, obviously, there there was a Stocking Horse bid. I I haven't seen another bid come through unless I'm mistaken.
And is is that correct? Or or, you know, are there other folks, you know, sort of, snooping around and and potentially gonna offer?
Speaker 2
Yeah. So yeah, Mickey. So that's actually been announced, and they signed a purchase agreement to sell the Albertsons. That's in a in process of of, you know, closing slash, you know, documentation process. And that's pretty much all I should really say about it.
But but, you know, our evaluation is is the best guess a best guess on waterfall analysis around the proceeds on a on a sale.
Speaker 6
Okay. I didn't see that, Albert, in the announcement. Thanks for that. And and finally, sort of just a balance sheet question. Is there any restriction, on using the remaining borrowing base in the credit facility to help fund the, SBIC once you get the license?
And at the same time, can you contribute, you know, at least part of your positions in your existing lower middle market portfolio to to capitalize it?
Speaker 3
Yes. So, yes, we're able to draw on the revolver to fund the equity. And so and the plan going forward, we expect to get the license, as we said earlier, by the end of the year, and then we'll start originating assets. The collateral will get allocated between the revolver and the FDIC. And we think that's important from a capital flexibility standpoint.
Speaker 6
I
Speaker 3
I think you've seen other BDCs that are solely focused on SBIC. And when things go bad, they don't have enough collateral in a revolver to be able to draw on. That's obviously a cash flow issue. So we will be, ramping up our revolver, in fact, to both pay down some of the 5.95% bonds, as well as to accommodate, you know, originations that are not in the SPIC going forward.
Speaker 6
I understand. And, Michael, can you sort of warehouse lower middle market deals now and contribute into the SBIC once you get the license to move things along?
Speaker 3
The answer is you you can, but the answer is that there's a process you go through. We're not gonna do that. We actually expect that we're weeks away from actually having that application. We don't wanna be presumptive, but that's the, kind of the guidance we've been given. So we're gonna just wait until probably December and likely start allocating those assets to the SBIC probably in January.
Speaker 6
As you originate them. And just directionally, how much I guess you're not gonna start out at two to one leverage in the SBIC off, you know, on day one. How's leverage in the SBIC's subsidiary going to progress?
Speaker 3
Sure. So you essentially get one turn of leverage out of the gate, and it's based on the tech notes related to the SBIC. So essentially, the first $40,000,000 of capital will be funded by us as equity, and then we'll be drawing from the SBIC thereafter.
Speaker 6
And you'll get you have access immediately to 40,000,000 of debentures then?
Speaker 4
Yes.
Speaker 6
Okay. That's it for me this morning. I appreciate your patience and your time. Thank you.
Speaker 2
Thank you. Thanks, Becky.
Speaker 0
Thank you. Our next question or comment comes from the line of Kyle Joseph from Jefferies. Your line is open.
Speaker 8
Hey, good morning guys. Thanks for taking my questions. Let me echo the comments on a nice quarter there. Just most of my questions have been answered, but just given the balance shift between the lower and upper middle market in the quarter, I think upper grew a little bit as a percentage of the portfolio. Was that a one off?
Is that something we could look forward to continue? Are you seeing any differences between risk adjusted returns between those two markets?
Speaker 2
Yeah. No. You know, we still as a macro statement, as I try to put my prepared remarks, we do think as a macro statement, we see a a more attractive risk adjusted returns in the lower middle market. And that's why we're really our that's our core to our strategy. You know, any one quarter that can you know, that we will look at upper middle market deals, and there are upper middle market deals that are attractive.
You know, we we funded a you know, I guess, Trinity three technically is an upper middle market deal now because it's so much larger. And and then what we have one other funding on the upper middle market. So we'll fund up middle market deals. We also had a fair amount of appreciation in the upper middle market too. So that's a factor as well because our metrics are all in fair value.
So generally, no, our position is still the same. We are macro for macro, we like the lower middle market risk adjusted returns better as a general comment. But we certainly are actively looking at upper middle market deals.
Speaker 8
I got it. And then, in terms of the portfolio yield, I think the consolidated portfolio yield increased in the quarter. But can you just give us refresh us on the outlook, given where rates are, floors on your in your portfolio as well as spreads you're seeing on new investments versus repayments?
Speaker 3
Yes. I would tell you it's going to be stable. I mean, obviously, you know, we're at our floors, and that's not gonna change for the next, what, eighteen months to two years or longer. There's some step ups for pricing grids that that's you know, that might be some you might see it go up point one or down point one based upon company performance that'll, that'll move those grids. But other than that, I would expect it's pretty stable where it is.
Speaker 2
Yeah. In most instances, you know, the pre COVID, post COVID world, you know, we are there's definitely competition out in the market While attachment points are, I would say, generally, are a little bit lower than they were pre COVID spreads, in most cases, are kind of back to or close to pre COVID levels.
Speaker 8
Got it. One last one for me. Just in terms of quarter to date origination activity, have you seen any sort of, you know, disruption given the the election? Are people kinda on hold until the election, or or has, origination activity remained strong?
Speaker 2
Yeah. I'd say origination activity has remained strong as far as deal looks. You know, we've we've had a handful of deals that we've lost on pricing, but that's just part of the world we live in. There are definitely some people out there, you know, in certain instances or certain companies being pretty aggressive. And so, you know, as far as the election's concerned, I wouldn't it doesn't feel like people have shut off deals waiting for what happens tomorrow.
I mean, you know, certain business models might have you know, or industries might have, you know, react differently to a democratic, you know, legislator versus a republican. But but as a general I wouldn't say that in a lot of instances, we've seen things like halting pending the election.
Speaker 8
Got it. That's it for me. Thanks very much for answering my questions, and congrats again on a good quarter.
Speaker 2
Thanks, Kyle.
Speaker 0
Thank you. Our next question or comment comes from the line of Bryce Rowe from National Securities. Your line is open.
Speaker 9
Thanks. Good morning.
Speaker 7
Good morning, Bryce.
Speaker 9
Bowen and Michael, just wanted to kind of follow-up on a comment you made a couple
Speaker 2
of questions
Speaker 9
ago around using the revolver to continue to redeem the baby bonds, the publicly traded baby bonds that are
Speaker 5
out
Speaker 9
there. So curious if you'll continue to redeem those at a measured pace, this $20,000,000 $25,000,000 measured pace that we saw here this quarter. And are you giving any thought to possibly extending out the unsecured bucket and doing another maybe another five year institutional issuance?
Speaker 3
Sure. Yeah, I would tell you that we plan to increase the size of revolver in the near term and then probably pay off the bonds, over the next two to three quarters. And that'll have to do with the pace of repayments. It'll have to do with the whether we're able to raise equity or not. But I would tell you that when we look at it, the shift between, you know, a 6% bond and the revolver that's 3%, that's an uplift of, you know, when it's done, two per know, 2¢ per quarter in NII.
We think that's pretty powerful, and it's risk free, to the extent we control that pay down. So I we'll definitely look to do that in the nearer term. And your other your other question, I don't see unsecured. I think our strategy over the next few years is gonna be to grow this revolver, as I said. We're gonna utilize the FDIC.
And quite frankly, we're hopeful over the next year to two years as we grow our balance sheet and we get closer to investment grade, we would look to go back to the unsecured bond market and, you know, tap that market at, you know, the 4% rate or or thereabouts. If there's a need for liquidity, during this coming year, 2021, we would hit the the baby bond market perhaps. But at this moment, that's not our baseline assumption.
Speaker 9
Okay. That's fair. Michael, you mentioned the compensation true up for the bonus accrual. Just curious if you could quantify that for us so we have a good run rate going forward.
Speaker 3
Sure. Sure. So last quarter, we actually brought down the bonus accrual by $200,000 based on the uncertainty in the market with COVID. So this quarter, we essentially retrenched that 200,000, into the bonus pool, to bring it back to full bonus. And so the, you know, the run rate you should be looking at is usually about on that cash compensation line, it's around 1.8.
So that's going to be the run rate going forward you should expect in the next few quarters.
Speaker 9
Okay. And then lastly, another one on the income statement. You all, in the press release, talked about nonrecurring amendment type of fees that you saw in the third quarter. So I was curious if you could quantify that. And then number two, with the visibility you mentioned into prepays in this fourth quarter, do you expect any prepayment fees to come along with that?
Speaker 3
Yes. So total fees for the quarter, I'd probably break it down like this. So we generally have recurring fees that are admin and agent fees on our debt of about $250,000 a quarter. So that's every quarter. We typically have between, you know, $203,100,000 dollars in reoccurring.
With a, you know, portfolio of 50 companies, we tend to have fees. So with this quarter, we had probably about 400,000 ish of onetime fees that are above our normal expectation or run rate.
Speaker 0
Okay.
Speaker 3
And then in terms of this quarter repayments, I don't right now, you know, I think of the one to three prepayments, one of them does not have a a make whole. And I think that there's there's maybe a one small one between the other two. So it I would tell you it's, like, 50,000 ish in the but having said that, there's always something that comes up. So there the that number could be elevated by the end of the quarter.
Speaker 9
Yep. Yep. Okay. I think that's all I had. Thanks.
Speaker 2
Thanks, Bryce.
Speaker 0
Thank you. Our next question or comment comes from the line of Robert Dodd from Raymond James. Your line is open.
Speaker 5
Hi, guys. First, a housekeeping one to kind of follow on to DeVryce. Was there anything in terms of anything material in terms of accelerated amortization in the interest income line rather than the fee income line? I mean, it seems to me that roughly, like, $250, something like that from the two, from Trinity and Danforth.
Speaker 3
No. All all of that was showed up in fee line. There was not all the interest income had to do with the 66,000,000 of originations this quarter, with a lot of them were early on in the quarter, as well as some of the pickup in income from originations that were late stage in the previous quarter.
Speaker 5
Got it. Got it. Then just on on the the kind of the the pipeline, you described it as average. I mean, how much, I mean, this quarter, a number of add on acquisitions, obviously, in the existing portfolio, I think, four there. Trinity was effectively, from from how you described it, and got refi out because of a a major add on acquisition.
Can you give us any color on how much you know, what's the what's the length of of a cycle close cycle for an add on acquisition versus a normal kind of new portfolio company? I can add on acquisitions happen at much faster pace? And of those the appetite in the market out there right now, mean, is there, you know, of that given you know, there are there are troubled companies that might be available to buy out that that that weren't before. So can you give us any any color there on the outlook for more add ons and how quick that can happen?
Speaker 2
Yeah. So generally speaking, as you can imagine, there's two ways to look at that. Portfolio company, financial sponsor PACE, and then our PACE. I mean, clearly, it can all for an add on acquisition, it's in the same space, same industry. You know, more times than not, the management team knows the other management team.
And, you know, there are just numbers of way reasons why though they tend to come together faster to your point. I think that's your behind your question. And clearly, you know, we have to do less, you know, figuring out the industry and the business model. Right? It's more focused on it's more focused on what are these companies gonna do together, synergies, you know, inter integration risk, those types of things, which generally speaking are are don't take you as much time to generate the work and do the work to figure those things out.
So and so so as a general statement, add on acquisitions are are are, in some sense, easier to get done and happen faster than a new platform where both the financial sponsor or and or us are trying to figure out and verify the core business model as opposed to some of the other things. And so so they do generally happen faster. I would say that that's one of the you know, great things about our portfolio and other BDC portfolios too, which is we do have we do back companies and we provide a capital with capital source to help them make acquisitions. And so not every company in our portfolio or every company out there, you know, have acquisitions as their strategy, but but many of them do. And so, and so that's a that's the nature of of a portfolio like ours or other BDCs as well, that you have this kinda natural in the background of potential add ons.
And so in the current environment, yeah, I mean, I think there are companies that are maybe underperforming. But I think it's more often the case where it's like, okay, operating efficiencies are really important in our industry, you know, said portfolio companies industry. And, you know, we've seen the value of that managing things like COVID and that kind of thing. And so, you know, to it it it all else equal, two businesses appreciate maybe more the efficiency of combining after an event like we've seen maybe than they did a year ago at the margin. So does that make does that mean deal flow tripled as a result?
You know, probably not. But But it's definitely a positive tailwind to deal activity on the add on front. Our
Speaker 0
next question or comment comes from the line of Chris McCampbell from Hilltop Securities. Your line is open.
Speaker 6
Good morning guys. Just quickly,
Speaker 5
do you all think
Speaker 6
We're getting to a place where factors that drove net asset value growth are part of a trend, And do you have visibility into beginning to grow the dividend again?
Speaker 2
Yeah. So as far as NAV, I think a big uplift in NAV for many BDCs, including us, will be just re appreciation of the noise that that's been created by the current market environment. So and, you know, and so I think what we we certainly expect to that. And, you know, then we have, you know, we have a a nice equity portfolio with some companies that are are growing. A couple of companies that we've had to decrease the appreciation to write it down based on COVID, which we certainly expect that to, you know, to re appreciate.
So I think that I think that, you know, clearly, there are you know, from where we sit today, there are definitely tailwinds that should support NAV growth going forward. And with respect to I don't know, Mike, do you want to talk about the the NII effect of the SBIC and some other things we've talked about?
Speaker 3
Yeah. I I think that I mean, to your direct question, I think we we do have an eye on growing the dividend, the regular dividend, over time Based upon our originations to date and sort of this transition to the five point, getting away from those unsecured bonds, we think our run rate in the next quarter or two is going to be in the $0.42 to $0.43 in terms of NII. And when we feel comfortable there, we'll probably inch up the dividend, in turn. When we make the full transition out of those notes and we start drawing on the revolver next year, we see quite a bit of an increase in NII. I mean, to quantify it long term, I think I said this on the last call, once we have fully immersed in the FDIC and fully deployed, we see a that's a 20% to 25% increase relative to using bonds in in the next two to three years.
So we're definitely looking ahead towards increasing that dividend slowly and steadily.
Speaker 6
Fantastic. Great job, guys.
Speaker 3
Thank you.
Speaker 0
Thank you. Our next question or comment comes from the line of David Miyazaki from Confluence Investment. Your line is open.
Speaker 7
Hi, good morning, guys. Just a couple of observations and questions. It seems like, you know, where the outsized returns get made tend to be where people won't go or they can't go. And I I think you guys have done a really good job of of being fully engaged in underwriting and and managing your portfolio through the COVID crisis thus far, which is kinda how you've been able to grow the portfolio so nicely. But I'm
Speaker 4
I'm wondering along those lines, when
Speaker 7
when you talk about Danforth getting refinanced by the banks, obviously, there's a point in time when they were not willing to make that loan, and then something happened where they were interested in taking you guys out. So can you guys talk about, if if not specifically to Danforth, but just generally what happens with the banks that makes them change their mind that they would come into your companies and refinance them?
Speaker 2
Yeah. Hey, David. So that's a good question. I would say, you know, two things. One is just the bank's the bank's appetite for risk, and I'm not really here necessarily to quantify that.
But with respect to a certain bank a certain company and its performance, one of the things the banks will look at is the performance of the company, obviously. As these companies, part of its size, the company as it grows, gets to an EBITDA level that the banks would consider it. Others are just the bank in a particular it's not a macro market comment, but with a particular company in a particular industry, with that particular financial sponsor who clearly would rather, in time, bring banks in because it's cheaper capital. It's just the whole story evolves. And so, again, it's some market appetite, bank appetite for that particular company in that particular industry.
Part of it's the financial sponsors that are courting those relationships and ultimately wanting to get to a point where they can graduate from a non bank lender to a bank lender. So it's part of the natural dynamic within the lower middle market is that evolution of nonbank to bank financing.
Speaker 7
And is that part of your strategic positioning? Is that your exit strategy would be to have the company grow to a point where it can be taken out by banks?
Speaker 2
So definitely in certain situations, but it's but it's it's not a macro strategy necessarily. It is a dynamic, as I described, that does exist. Some companies, as we're underwriting, that might be more of a discussion than other companies. But, you know, there's other things that banks need like amortization, scheduled amortization. They you know, things like that that we don't necessarily need on every business that also goes into our capital is more expensive than a bank, but it can be more flexible.
And especially sponsors are trying to drive growth of these companies. The next 5,100 basis points of leverage financing is not what moves their IRR needle. What moves their IRR needle is the operating changes and acquisitions and various things, and they need a capital provider that is really diving into the enterprise value of the business and the cash flows of the business, which generally speaking is not what banks necessarily are looking at as much as non bank lenders, if that makes sense. So every deal in the industry is different. So it's hard to say macro.
We're sitting around saying, okay, corporate strategy is we wanna do deals that we think within a couple years are gonna be taken out by banks. It's not quite that definitive, but it it can be a part of the conversation in certain situations.
Speaker 7
Okay. Great. Thanks. If I could just shift gears and and ask, there's been a lot of great discussion about the SBIC, and I I don't wanna count chickens before they hatch, but, you know, congratulations on the progress thus far. I'm not sure if you've talked about your targeted leverage on an economic basis versus a statutory leverage basis.
And should you get the ability to participate in SBA debentures, Can you talk a little bit about the ranges that you might work within post post that SBIC?
Speaker 3
Yeah. I think, overall, I would tell you in this environment where we're
Speaker 2
may or
Speaker 3
may not be able to raise equity in the short term, we would still point you to the 1.5 times board mandated leverage. That would be we'd say that'd be probably the max leverage that feel comfortable with.
Speaker 7
And is that is that economic or statutory?
Speaker 3
That would be economic. Exactly. But in time, when we actually look at what we'll look like, I tell you that we probably will be more focused somewhere in the one three to one four, maybe economic, with a regulatory leverage
Speaker 4
in
Speaker 3
the one to 1.1 would probably be where we'd be living as a target going forward.
Speaker 7
Okay. Okay. Great. That's very helpful. Well, I appreciate your comments, and congratulations.
And I will just step out of the queue now. Thank you.
Speaker 3
Thanks, Dave.
Speaker 0
Thank you very much. Our next question or comment comes from the line of Devin Ryan from JMP Securities. Your line is open.
Speaker 7
Hi. This is Kevin Fultz on for Devin. And I just have one more outstanding question. Most of mine have been answered already. What is the weighted average LIBOR floor for the debt portfolio, and what percent of floating rate investments have LIBOR floors?
Speaker 3
So the weighted average LIBOR on the asset portfolio is 1.4%.
Speaker 5
We're getting Yeah. Maybe a little bit lower than that
Speaker 2
because the new originations have lower floors. Yeah.
Speaker 3
So maybe one three five.
Speaker 2
Yeah.
Speaker 3
And what was the other question? Sorry.
Speaker 7
What percent of floating rate investments have LIBOR floors?
Speaker 2
Yes, pretty much all of them.
Speaker 7
Great. And that's my only question. Congrats on a strong quarter.
Speaker 3
Thank you. Thanks, Doug.
Speaker 0
Thank you. I'm showing no additional questions in the queue at this time. I would like to turn the conference back over to Mr. Bohundeel for any closing remarks.
Speaker 2
Great. Thanks, operator. And again, thanks, everybody, for the call. Thanks for all the robust questions. We appreciate it.
And we look forward to keeping you guys posted on our progress. And we'll we'll if not before, we'll be talking next quarter.
Speaker 0
Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Everyone, have a wonderful day.