Capital Southwest - Earnings Call - Q2 2022
November 2, 2021
Transcript
Speaker 0
Thank you for joining today's Capital Southwest Second Quarter Fiscal Year twenty twenty two Earnings Call. Participating on the call today are Born Deal, CEO Michael Sauner, CFO and Chris Reberger, VP Finance. I will now turn the call over to Chris Reberger. You may begin.
Speaker 1
Thank you. I would 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, everyone, for joining us for our earnings call for the quarter ended 09/30/2021, which is the second quarter of our 2022 fiscal year, which ends 03/31/2022. We're pleased to be with you this morning and look forward to giving you an update on the performance of our company, our portfolio and our progress on executing our investment strategy as stewards of your capital. 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'll begin on Slide six of the earnings presentation, where we have summarized some of the key performance highlights for the quarter. During the quarter, we generated pretax net investment income of $0.45 per share, which more than earned our regular dividend for the quarter of $0.44 per share.
Total dividends for the quarter were $0.54 per share, which included a $0.10 per share supplemental dividend. Total dividends paid during the quarter represented an annualized dividend yield on our stock price on the last trading day of the quarter of 8.6% and an annualized yield on net asset value per share of 13.2%. As a reminder, we previously announced that our Board declared an increase in our regular dividend per share to $0.47 per share for the quarter ended December 2021 from the $0.44 per share paid in the September. This increase in our regular recurring dividend reflects the increased earnings power of our portfolio resulting from portfolio growth, continued reductions in our cost of capital and continued improvements in operating leverage achieved through our internally managed structure. Our Board also declared a supplemental dividend of $0.50 per share to be paid out in the December.
This supplemental dividend represents an accelerated payout of our prior supplemental dividend program, which had been paying out $0.10 per share per quarter over the past several years. We believe that this accelerated distribution of UTI maximizes value for our shareholders today, while also maintaining an adequate UTI balance into the future. Going forward, we expect that shareholders will continue to participate in the successful exits of our investment portfolio through special distributions as we monetize the unrealized appreciation in our portfolio over time. During the quarter, we grew our investment portfolio on a net basis by 2.4% to $818,000,000 Portfolio growth during the quarter was driven primarily by a total of $112,900,000 in commitments to six new portfolio companies and four existing portfolio companies, of which $77,200,000 was funded at close. This was offset by $60,900,000 in proceeds from six debt prepayments and two equity exits during the quarter.
The portfolio generated net realized and unrealized gains of $2,800,000 during the quarter, driven primarily by unrealized depreciation in our equity co investment portfolio. On the capitalization front, we completed an amendment to our ING credit facility, extending the maturity to August 2026 and decreasing the interest rate to LIBOR plus two fifteen basis points, down from LIBOR plus two fifty basis points. Additionally, we issued $100,000,000 in aggregate principal of 3.5 notes due October 2026 and repaid in full our 5.75% notes due October 2024. Furthermore, in lockstep with our strong deal pipeline, we raised $30,300,000 of equity through our ATM program at an an average price of $26.59 per share, representing an average of 160% of the prevailing net asset value per share. On Slide seven and eight, we illustrate our continued track record of producing steady dividend growth, consistent dividend coverage and value creation since the launch of our credit strategy.
We believe the solid performance of our portfolio and our company's sustained access to the capital markets has demonstrated the strength of our investment and capitalization management strategies. Maintenance and growth of both NAV per share and shareholder dividends remain as core tenets of our long term investment objective of creating long term value for our shareholders. Turning to Slide nine. As a refresher, our investment strategy has remained consistent since its launch in January 2015. We continue to focus on our core lower middle market lending strategy, while also maintaining the ability to opportunistically invest in the upper middle market when attractive risk adjusted returns exist.
In the lower middle market, we directly originate and lead opportunities consisting primarily of first lien senior secured loans with smaller equity co investments made alongside our loans. We believe that this combination is powerful for our BDC as it provides strong security for the vast majority of our invested capital, while also providing NAV upside from equity investments in many of these growing businesses. Building out a well performing and granular portfolio of equity co investment is important to driving growth in NAV per share, while aiding in the mitigation of any credit losses over time. As of the end of the quarter, our equity co investment portfolio consisted of 31 investments across approximately half of our portfolio companies. The equity portfolio had a fair value of $69,200,000 which included $17,700,000 in embedded unrealized appreciation or approximately $0.76 per share.
Our equity portfolio, which represented eight percent of our portfolio at fair value as of the end of the quarter, continues to provide our shareholders attractive upside from the growing lower middle market businesses. As illustrated on Slide 10, on balance sheet credit portfolio as of the end of the quarter, excluding our I-forty five senior loan fund, grew 3% to $689,000,000 as compared to $671,000,000 as of the end of the prior quarter. For the quarter, all six of the new portfolio company debt originations were first lien senior secured. And as of the quarter end, 91% of the credit portfolio was first lien senior secured. On Slide 11, we lay out the $112,900,000 of capital invested in and committed to portfolio companies during the quarter.
Capital committed this quarter included $107,800,000 in first lien senior secured debt committed to six new portfolio companies, one of which we also invested $1,000,000 in equity alongside our debt $3,800,000 in first lien senior secured debt committed to one existing portfolio company and $400,000 in sub debt and equity follow on investments in three existing companies. Turning to Slide 12, we continued our track record of successful exits with six exits during the quarter. These exits generated $60,900,000 in total proceeds, realized gains of $3,300,000 and a weighted average IRR of 17.5%. To date, we have generated a cumulative weighted average IRR of 15.2% on 45 portfolio exits, representing approximately $462,000,000 in proceeds. From a macro perspective, the market for acquisition and refinancing capital was robust this quarter and has continued its strong momentum into the December, resulting in heavy volume in both origination and refinancing activity.
Our investment pipeline, as we have mentioned on previous earnings calls, has been robust in both volume and quality of deals. The deal team continues to do an excellent job broadening the top end of our deal funnel, which maximizes the number of deals in the market for which we have the opportunity to review and consider. As we have always contended, this is a critical component of building and maintaining a quality investment portfolio in a competitive market. Finally, we believe that the returns realized on exits over the past several years has proven out the investment acumen of our investment team and the merits of our investment strategy in generating strong risk adjusted returns over the long term. On Slide 13, we illustrate some key stats for our on balance sheet portfolio as of the end of the quarter, again excluding our I-forty five senior loan fund.
Beginning this quarter, we have decided to consolidate reporting on our on balance sheet upper middle market and lower middle market loans in order to give shareholders a more concise view of our portfolio makeup in total. As of the end of the quarter, the total on balance sheet portfolio at fair value was weighted 82.4% to first lien investments, 6.8% to second lien investments, 1.6% to subordinated debt investments and 9.1% in equity co investments. Turning to Slide 14, we have laid out the rating migration within our portfolio. During the quarter, we had two loans upgraded from a two to a one, one loan downgraded from a two to a three and one loan downgraded from a three to a four. As a reminder, all loans upon origination are initially signed an investment rating of two on a four point scale, with one being the highest rating and four being the lowest rating.
As of the end of the quarter, we had 61 loans representing approximately 90% of our investment portfolio at fair value, rated in one of the top two categories of one or two. We had six loans representing 9.7% of the portfolio at fair value rated a three and one loan representing less than one percent of the portfolio rated a four. During the quarter, we placed one first lien senior secured loan on nonaccrual with a fair value of $10,400,000 or 1.3% of the total investment portfolio. This company is currently working through a restructuring of its balance sheet, so we have decided to place the loan on nonaccrual pending more clarity on the post restructure loan terms. Based on conversations with the company to date, we expect a portion of this loan to come off non accrual in the near term once the restructuring is finalized, which should be completed in the coming weeks.
As illustrated on Slide 15, our total investment portfolio continues to be well diversified across industries with an asset mix, which provides strong security for our shareholders' capital. 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 subordinated debt. Turning to Slide 16, the I-forty five senior loan fund continues its solid performance. As of the end of the quarter, 95% of the I-forty five portfolio was invested in first lien senior secured debt. Weighted average EBITDA and leverage across the companies in the I-forty five portfolio was $75,000,000 or 4.7 times, respectively, down slightly from last quarter.
Portfolio continues to have diversity among industries at an average hold size of 2.6 of the portfolio. Leverage at the I-forty five fund level is currently 1.3 times debt to equity. I'll now hand the call over to Michael to review more 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 $10,000,000 or
Speaker 2
$0.45 per share.
Speaker 3
We paid out $0.44 per share in regular dividends for the quarter, an increase from the $0.43 regular dividend per share paid out in the June. As mentioned earlier, our Board has again this quarter increased the regular dividend declaring a quarterly dividend of
Speaker 2
$0.47
Speaker 3
per share for the December. Additionally, our Board previously declared a final supplemental dividend of $0.50 per share, which will also be paid out during the December. Our investment portfolio continues to perform very well, generating $2,800,000 in net realized and unrealized gains this quarter, bringing the net realized and unrealized gains over the past four quarters to $18,700,000 Though we are accelerating the current supplemental dividend program as of 12/31/2021, going forward, we will continue to distribute special dividends as we monetize the unrealized appreciation in the portfolio. As of 09/30/2021, our estimated UTI balance was $0.69 per share. Maintaining a consistent track record of meaningfully covering our regular dividend with pretax net investment income is important to our investment strategy.
We continue to maintain our strong track record of regular dividend coverage with 109% for the last twelve months ended 09/30/2021 and one hundred and seven percent cumulative since the launch of our credit strategy in January 2015. Our investment portfolio produced $20,300,000 of investment income this quarter with a weighted average yield on all investments of 9.6%. Investment income was $1,700,000 higher this quarter due primarily to an increase in average credit investments outstanding and prepayment fees. There were three loans on non accrual with an aggregate fair value of $24,200,000 or 3% of the investment portfolio as of the end of the quarter. Our weighted average yield on our credit portfolio was 9.7% for the quarter.
As seen on Slide 18, we maintained LTM operating leverage at 2.3% as of the end of the quarter. We are targeting operating leverage to approach 2% or better in the coming quarters. Turning to Slide 19, the company's NAV per share as of 09/30/2021 was $16.36 as compared to $16.58 at 06/30/2021, representing a quarter over quarter decrease of 1.3%. The main driver of the NAV per share decrease was $17,100,000 in realized losses on the extinguishment of debt on the full prepayment of our 5.375 note due October 2024. The realized loss consists of a make whole premium payment of $15,200,000 as well as the write off of related unamortized debt issuance costs of $1,900,000 The refinancing of these notes with a new five year 3.2% issuance significantly reduces our cost of capital and increases our annual net investment income run rate by approximately $0.10 per share on a risk free basis.
This was the primary catalyst for our decision to increase the regular dividend by $03 this quarter from $0.44 per share to $0.47 per share. We believe this considerable increase in earnings power enhances our market capitalization on a dividend yield basis and allows us to pass the cost of capital savings directly to our shareholders in the form of increased dividends. This transaction also pushes out our nearest debt maturity to 2026, providing significant balance sheet flexibility going forward. On Slide 20, we lay out our multiple pockets of capital. As we have mentioned on our prior calls, a strategic priority for our company is to continually evaluate approaches to de risk our liability structure, while ensuring that we have adequate investable capital throughout the economic cycle.
Our debt capitalization today includes a $335,000,000 on balance sheet revolving line of credit with 10 syndicate banks maturing in August 2026, a $140,000,000 institutional bond maturing in January 2026, the newly issued $100,000,000 institutional bond maturing in October 2026, a $150,000,000 revolving line of credit at I-forty five maturing in March 2026 and an initial $40,000,000 leverage commitment from the SBA, which is $22,500,000 left to be drawn upon. Although the majority of our outstanding debt is currently due in 2026, we will look to opportunistically amend and extend our credit facilities well before maturity consistent with past practice. Finally, as we've discussed on prior calls, we have now begun operations within our SBIC subsidiary, which you will see going forward denoted as SBIC one. As a reminder, our initial equity commitment to the fund is $40,000,000 and we have received an additional commitment from the SBA for $40,000,000 of fund leverage, which is also referred to as one tier of leverage. We expect to fully invest this initial 80,000,000 of capital over the next six months, at which point we will apply for a second tier of leverage.
Over the life of the fund, we plan to draw the full $175,000,000 in SBIC debentures alongside $87,500,000 in capital from Capital Southwest. We are excited to be part of this program and believe it is a natural fit with our investment strategy. Overall, we are pleased to report that our balance sheet liquidity continues to be strong with approximately $166,000,000 in cash and undrawn leverage commitments as of the end of the quarter. As of 09/30/2021, approximately 50% of our capital structure liabilities were unsecured and our earliest debt maturity is in January 2026. Our regulatory leverage as seen on Slide 21 ended the quarter at a debt to equity ratio of 1.18:one.
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 continues to perform well and consistent with our original vision and strategy we communicated to our shareholders when we began this journey. Our team has done an excellent job building a robust asset based deal origination capability as well as a flexible capital structure that prepares us for all environments throughout the economic cycle. We believe that our performance continues to demonstrate the investment acumen of our team at Capital Southwest and the merits of our first lien senior secured debt strategy. We feel very good about the health of our company and portfolio, and we are excited to continue to execute our investment strategy going forward.
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 for all our stakeholders. This concludes our prepared remarks. Operator, we are ready to open the lines for Q and A.
Speaker 4
Thank And our first question comes from the line of Devin Ryan with JMP Securities. Your line is open. Please go ahead.
Speaker 5
Hi, good morning. This is Kevin on for Devin. First question, just looking at non accruals, can you provide the name of the new company that was added to non accrual? And then separately, can you share any developments in the two existing non accrual investments?
Speaker 2
Yes. So I'd rather not say the name of the nonaccrual on a public call like this because it will end up in a transcript, but there'll be it'll be in the Q, which will be announced later tonight. But
Speaker 3
it's
Speaker 2
a company that's been affected by the supply chain that we've all heard about out in the market and which certainly we all hope is temporary, real. And just the company's sales cycle as a result of that in its market has extended. So restructuring this quarter, we think about a third of it or so will come back on accrual and we'll own equity in the business going forward as it recovers. What's he got to do that? DP King.
Premier. Yes, one of them is a large syndicated deal. It's currently still working on its restructuring. And so really no update on
Speaker 3
that. Good statement.
Speaker 2
Yes. And then the other one continues to actually improve. It's in the pharmaceutical services space. Kind of same reported last quarter. Pipeline continues to build, starting to convert the increased pipeline actually pretty encouragingly.
And so we think that one's going to be going to end up being fine. Yes, we've accrued a bit
Speaker 3
of PIC.
Speaker 2
There's a bit of PIC accrued
Speaker 3
on that company. So as the recovery occurs and our the enterprise value exceeds the debt value, that will come back on accrual as well.
Speaker 5
Okay. Thank you. That's helpful. That information is helpful. And then just touching on quarter to date investment activity, can you give us a sense how originations are tracking so far and then also repayment activity as well?
Speaker 2
Yes. So I mean, originations this quarter are strong. They'll be strong through the end of the quarter. Prepayments, as you can imagine, with all the market activity that's out there, prepayments are going to be heavy this quarter, too. We do believe we'll have net portfolio growth for the quarter.
So it's a fair amount of churn, which you would expect with a strong portfolio like ours that we're going to get refinanced out of a number of deals. But our guys our deal team have done a fantastic job, like as I said in my remarks, expanding the top end of the funnel. So we've been very active in the market. And again, at the end of the day, we believe we'll get to have net portfolio growth this quarter.
Speaker 5
Great. Thanks for taking my questions and congratulations on the quarter.
Speaker 6
Thanks.
Speaker 4
Thank you. And our next question comes from the line of Mickey Schleien with Ladenburg. Your line is open. Please go ahead.
Speaker 7
Good morning, Bowen and Michael. Bowen, as we all know, there's this tremendous search for yield and that's attracting more and more capital to private debt, which seems to be increasing payment risk, prepayment risk across the sector. Obviously, those can generate near term fees, which is great. But can you maybe talk a little bit more about what you're doing in your organization to help defend your market share as we look forward?
Speaker 2
I mean defending your market share really is a function of covering the market, being good partners with your deal sources, sponsors mainly, and really the track record you develop over a lot of years. And we have every market across the country covered with a primary, secondary coverage person. And it's pretty interesting to me anyway that's been doing this in this business for a long time. The number of sponsors that we've been doing business with or we have deals from that candidly that I had yet heard of, and usually that's junior partners at PE funds that spin off into their own PE funds, start their own funds and that type of thing and kind of and being able to really broaden the number of deal sources that we get deals from. And we've really seen that, which has been super encouraging.
And then when you go through the pandemic, things like a pandemic and you have stress in the portfolio and you sit across the table as a first lien lender, which by the way, gives you the freedom to make good business decisions that balance your shareholders' capital interest with the interest of that company and that sponsor to make reasonable fair decisions on how you deal with stress. We had stress in the portfolio during the pandemic. Fortunately, everything recovered nicely and we along the way, we extracted extra economics here and there where it was fair. And the sponsor supported the company where companies were necessary. And so going through something like that really gives us street credibility that we might not have necessarily had three years ago.
So that's a big deal. And then we're also seeing more and more sponsors that are new to us, ask us for references of other sponsors that we've been doing business with and actually calling those sponsors. And so, how you act, how you make decisions and how you operate market is becoming increasingly important amongst the sponsors and other deal sources. And so for me, that's hugely encouraging. So that's because that's what you want, that you want to get a benefit from the way you act and the way you operate in the market.
And so those are all ways you defend your market share at the end of the day. Yes.
Speaker 3
And the other thing, Mickey, is over the last few years, we've reduced our cost of capital. We were 5.5. Now we're down closer to 3.5%. Operating leverage came down from 5% down to 2.3%. So this allows us to be more competitive.
It doesn't mean we're chasing deals and offering less yield for riskier businesses, but we are able to look at deals at L plus six or six fifty, whereas those are deals we wouldn't have considered two, three years ago. And it also helps us when we're looking to when you say defend, there are certain deals that get refinanced that historically if it was an L850 deal, we came down to L650, we didn't bother staying in the deal just on yield alone. And today, we have the ability to look at the credit, especially credits where we know well and stay in the deal based on our net interest margin.
Speaker 2
And of course, the reason that happens, as most people on the call know, is that these companies grow, leverage comes down, clearly spread or their cost of capital is going to come down. So the question really is how long can we stay in that credit from a net interest margin perspective. And so Michael is right. As we drop our cost of capital and increase our operating leverage, then it allows us to extend the tail on growing businesses. And then on new businesses, being able to lend to companies at lower loan to value, tighter spreads, that kind of thing.
Speaker 3
And also the ATM issuance we're doing at 1.6 or 1.7 times, that's obviously a lot less dilutive than raising equity at one or 1.2 where we would have done so in the two years ago.
Speaker 7
I agree and thanks for that, Bowen and Michael. Bowen, you mentioned just now sitting across the table, you know, meetings are great, in the end of the day, I agree with you sitting at a table eye to eye engaging a new relationship is important. Are you doing more of that now or is travel still an issue for the origination team?
Speaker 2
Well, we have the industry has definitely become functional over Zoom. But the answer is yes, we're traveling again. And management meetings in person are certainly superior to Zoom calls. Candidly, from a deal professional perspective, it also adds a dynamic to your job that's interesting, right? You get to travel, get to see manufacturing plants, operations, that type of thing.
It just adds a dynamic to your the cadence of your work, which I believe, as a deal professional myself, that's a really important thing. And so we've seen that. So thankfully, yes, we're traveling again and very happy to be doing that.
Speaker 7
Thank you for that. One other high level question, Bowen. So apart from repayments this year, which is a trend across the sector, BDCs have certainly had a lot of wind at their back in terms of very strong economic growth and a very low default environment. But I'm starting to think next year will be more challenging with potential Fed tightening, probably lower economic growth and volatility around the election. How are you thinking about those risks in terms of new originations that you're seeking and your own balance sheet leverage?
Speaker 2
Yes. So well, first of all, new deals, we're kind of doing like we've always done, which is saying, okay, what could go wrong in the system, if you will? Part of that's a recession, part of that's pandemic, black swan events. Those are the type of things we stress test in models before we do deals upfront. So hopefully, we certainly believe that that's the best we can do in setting the asset base up to be able to weather different things.
Obviously, as interest rates increase, we have the vast majority of our capital is in floating rate loans. We obviously are very attuned to fixing the rate on the liability side, hence being able to issue our most recent 3.5 bond issue on an unsecured basis. And so I think those are the things that we do as we look forward really to we've always you've been hearing us say this from the very beginning. We're always paranoid about a recession in the next year or two. That's just I feel like that's what our shareholders pay us to do and then to protect the institution for that.
And if we don't have a recession, fantastic. That's upside. But we always have to be thinking about that mentally. As far as the election year, that can be there's going be volatility around that clearly. But at the end of the day, economic volatility.
And so hopefully, the all the things we do and we're underwriting and thinking about atmospherically in the system, things that can go wrong, the election could be catalyst to that, but it could be other things be catalyst to that too. But at the end of the day, it's the same answer, which is what's the economy going to do.
Speaker 3
And obviously, that's by pushing out our maturities as far as we did. I mean, that's essentially taking a lot of that risk off the table, allowing us to draw additional debt off the SBA, which will have some interest rate volatility but not nearly what you'd expect in the broader market.
Speaker 7
I got you. Just one small housekeeping question for Michael. Did you reverse any previous income accruals for the new NPL?
Speaker 3
No we didn't accrue anything this quarter for that asset.
Speaker 7
And you didn't reverse anything for previous accruals?
Speaker 3
No we just reversed out whatever was reserved for this quarter.
Speaker 7
Okay, terrific. That's it for me. I appreciate your time. Thank you.
Speaker 2
Thanks, Mickey.
Speaker 4
Thank you. And our next question comes from the line of Bryce Rowe with Hotei. Your line is open. Please go ahead.
Speaker 8
Good morning. Wanted to ask kind of about the level of commitments here over the last couple of quarters relative to funded debt investments. You've seen kind of an uptick in unfunded, so to speak, within the new investment activity. So Bowen and Michael, maybe you could speak whether you expect that structure to continue? And then any feel for kind of the pace of those unfunded commitments maybe converting to some level of funding here in the near future?
Speaker 2
Yes, sure. Well, thanks, Bryce. I mean, we're clearly managing I mean, unfunded commitments as a first lien lender, clearly, revolvers are oftentimes you providing revolvers as well as the term Revolvers that aren't used a whole lot aren't that interesting to banks. And so we can offer the revolver, get ticking fees, get the rate on the revolver is the same as the rate on the term loan, which is higher than a bank would charge. But so it ends up being a nice security for us.
But we have to manage our balance sheet liquidity such that in the pandemic, for example, I think we had 35% of our revolver capital drawn, which is lower than I maybe would have thought it would have been. But we have to have the liquidity on our balance sheet to fund that. And obviously, revolvers are obviously not obvious. Those revolver fundings are a function of the companies being in compliance. That's the revolvers.
On the delayed draw term loan, so our unfunded commitments this quarter are about half revolver, about half delayed draw term loans. Delayed draw term loans are different. Those are usually a function of a specific acquisition strategy based on buying similar businesses. Maybe it's funding and partly funding an earn out on a purchase. In other words, the earn out means that they hit a higher EBITDA number or higher earnings number.
And so then by definition, the earn out is paying out when the companies are doing well. And so that's not really those unfunded commitments are different. I mean, it's not like all of a sudden the world starts to fall apart, pandemic or otherwise, and they just all of sudden draw the delayed draw term loan. That's not how those work. But what those are, is those are future originations.
So those are companies that again, if they hit their if there's if a company grows, hits a higher EBITDA target, we're going to be funding a new origination. That's good. That's quality that we'd like to do that. Or if there's an add on acquisition, which obviously further diversifies that business, allows the business to realize synergies on the acquisition. So those are also originations that we'd like to do.
And it also sets us up in the facility to already have a pre baked financing for that acquisition. And I believe it decreases the odds significantly that that company goes out on the outside and refinances us out with another deal on acquisition. So it just kind of puts you in the pole position to fund into a very attractive situation. So delayed draw term loans are future originations. Would affect, clearly, we'd expect to fund most of that, if not all of the delayed draw.
Some of the delayed draws are usually twelve months, maybe eighteen months in extension. So when you get closer to the twelve months and you're not going to fund it or the earn out period passes and they haven't earned the earn out then that would tend to fade. But most of the most of the delayed draw term loan that we have in our financials, would intend to we would expect to fund. We've seen on a normal quarterly basis,
Speaker 3
we see about maybe 10% of the revolvers get drawn, but we also see 10% of them be repaid. So on a quarterly basis, and this is most all quarters, you have a net funding of zero on the revolvers. To Bowen's point, during COVID, the 35% that was funded, that was funded really soon after the COVID hit. And then those were all repaid as well. And then on the from a planning perspective, the DDTLs, those were all scheduled out.
They have dates in which their those earnings can be met. So we're closely monitoring that and that will impact how much equity we raise on an ATM or obviously our planning purposes for raising additional debt.
Speaker 8
Okay. That's helpful. And so kind of along those same lines in terms of kind of pace of investment activity, when we think about and it sounds like this current quarter, continue to see good activity both on the origination and on the repayment side of things. How
Speaker 2
do
Speaker 8
you all when you look at the income statement, obviously, have some prepayment activity that came into the income statement here in the September quarter. Does that feel kind of outsized relative to the amount of repayment activity that you had? Or would we expect at least another quarter of that level here in the December quarter?
Speaker 3
Yes. So I think September, I think the originations and the repayments were both above what we would have anticipated, but the net growth was modest but fine. I think this coming quarter, we're as I think Bowen said earlier, we expect to see net portfolio growth, but it's going be on significant repayments as well as significant originations. So what we're seeing, and Bowen can speak to this fast is, there's a lot of deals that are just being pulled forward into the twelvethirty one quarter. And so the I think the question mark we have is going to see how much deals in the threethirty one quarter will be left to have or how much was pulled forward and therefore it's going to be until sixthirty when you see sort of the increase come back again.
I'll Yes.
Speaker 2
I mean, that's more of a theory. I mean, I think a lot of people in the market have that theory that with tax regime changes and that type of thing that if you were a founder of a business and you were looking to monetize a portion of your earnings, a private equity transaction is attractive because you can roll over a heavy amount, stay involved with the company, but you can also monetize some of your lifelong work. And if you were thinking about doing that sometime in the next couple of years or a year or whatever, this would be a pretty good year to do it. You just live through the pandemic. You learn that life is not forever and things can happen you're not getting any younger and by the way, tax regimes are changing.
So there's a lot of things that would drive a founder owned business to seek a sale if a sale was already on the docket in their mind. And that's also sponsors selling too. So we'll see. But theoretically, I believe that a lot of the market activity is some of the dynamics, at least in the lower middle market, some of the dynamic I just described. But we'll see.
And on
Speaker 3
the P and L to your question, we would expect to see inflated prepayment penalties in the twelvethirty one quarter. And the exits are sort of spread across. I mean, we've already had significant amount of exits have already occurred and we're anticipating more in November and December. So you'll get some level of interest off of those assets, but you're also going to see those prepayment penalties.
Speaker 8
Got it. Okay. And then maybe one last one for me. You've got your liability structure cleaned up in terms of extending. Do you all do you expect the same pace of ATM activity to continue?
Or is that really more a function of net originations and where the stock is trading relative to NAV?
Speaker 2
So it's a lot of variables. Certainly, of the metrics we look at and manage to is leverage, right? And so we've talked about kind of target leverage range, but that's a function of originations, it's a function of prepayments, at the end of the day, net portfolio growth. And then against the backdrop of where the stock price trades too. But I mean, it's mainly it's net portfolio growth and portfolio BDC leverage.
It's less a function of the actual stock price. It's more of a I mean, business model is an organic growth story with respect to just developing an excellent track record, just keeping our head down and just executing what our guys know how to do and then have access to the equity market to grow slowly grow the equity as the permanent capital base in lockstep with the net portfolio growth. And so at the end of the day, again, it's your BDC leverage is what you're looking at, but you're raising equity in lockstep with portfolio growth.
Speaker 3
No, I think
Speaker 2
you'd add Michael. Yes, agree. I mean, it's very variable. Mean, this quarter before
Speaker 3
at this point right now,
Speaker 2
we know there's a lot
Speaker 3
of repayments. We're expecting a lot of originations. And so if we think that if some of the originations don't occur, then we will pull back on ATM usage. Certainly are cognizant of the dilution that the ATM brings to following quarters. So we're not going to raise equity for equity sake.
So it's about being prudent. One thing I actually I'll just take the opportunity to also mention is that we put in our shelf registration. Last week, we refreshed it as well as our ATM equity distribution agreements. And that's the whole point of that was not to raise equity in a secondary offering, but to have a shelf available to raise capital over the next three years, public debt and ATM equity. I know that there may be some level of confusion in the market on that.
But we're still resolved to raise ATM equity as our primary source, if not only source of equity
Speaker 2
going forward. I'd say, Bryce, the other thing we look at besides portfolio leverage, as I mentioned earlier, look, balance sheet liquidity, I. E, availability on the credit facility, that's also another important metric that we watch and manage to.
Speaker 8
Got it. Okay. Thanks guys. I appreciate it. Thank
Speaker 4
you. And our next question comes from the line of Robert Dodd with Raymond James. Your line is open. Please go ahead.
Speaker 6
Hi, guys. And yes, congratulations on the quarter.
Speaker 8
Just a couple of
Speaker 6
kind of market questions more than anything else. Obviously, a very high level of activity in this quarter, the quarter you reported, dollars 112,000,000 give or take, but only about 1% of that, just over 1% was equity co invest. I mean, I don't want to read a quarter into a trend, but is there anything to read in there? Is it the market is great right now for equity valuations within your equity portfolio, but is that making it less appealing for co invest right now with elevated valuations? Or are they or co invest harder to get right now?
And any color you can give us on that on maybe not just the quarter, but just the environment for that opportunity?
Speaker 2
Yes, that's a good question. I'm trying to think about I would say, first of all, I would definitely wouldn't read too much into the percentage of equity co investments this quarter or past quarters. I mean, I'd love to say, we're so precise and everybody's way overpaying and we're just not choosing to participate. I mean, that would be an exaggeration. I mean, I think it's a little bit just the kinds of deals and it could be it can be.
I mean, there are times where the sponsor has got excess liquidity and they want to over equitize the balance sheet. There may be a situation where they probably should, but the check is still small. And they our equity co investment might be so small, it's not worth the exercise of putting it on the books and valuing it. I mean, there's a number of there's a number of things that do come to play over time. But most of the time, if we have the vast majority of time, if we have the relationship with the sponsor and we like the equity story, we'll have an opportunity to invest in the equity of some amount.
So, I wouldn't read too much into this quarter in particular.
Speaker 6
Okay, fair enough. This was sort of related follow-up. So since the credit strategy, as you said, the IRR on recoup capital is about 15%. My math says about 60% of that's coupon, roughly the other 40% is fees and equity gains, etcetera. Do you think going forward, right, is the market conducive to maintaining that kind of total IRR going forward?
I mean, if coupons are coming down a little bit because your cost of debt has come down or other moving parts, I mean, you think that's a reasonable target might not be the wrong the right word for it. But is that 15% kind of sustainable? Or was that just did that benefit from a couple of big wins while you were a smaller business and maybe that number comes down going forward?
Speaker 3
I think that that comes down a little bit based on the fact that our yields have come When we started this business, again, we were looking at deals that are probably a little more weighty of the 8.50s and the eight You see now our yield has come down, where we're looking at deals that are L650 to L8. And so the likelihood is that the IRR might come down a few basis points perhaps relative to where we were before. I don't think from an overall yield NIM that will come down. But on the individual deals themselves, you'd say maybe that 15% ends up being 13.5% or 14%.
Speaker 2
You made a comment that the exits being lumpy. I mean, if you look at the list of exits, I mean, it's not I mean, track record that we referenced, the 45 exits or whatever it is, $460,000,000 of proceeds, that's pretty evenly distributed over time and over companies. And I mean, it's our guy I mean, give the guys credit. That's pretty outstanding track record. And I do think as a first lien lender, remember, we always a lot of people don't understand, mean, when a company breaches covenants, I mean, that's as a first lien lender, you have all kinds of options and things and really extract little bit economics here and there and it's market to do so.
So it's not like you're breaking relationship glass to extract economics when small companies bump in the night. And so it is an element of a first lien lower middle market strategy that we've this for, I don't know, twenty years. That's the way that works. And one of the reasons that you want to be a first lien lender and not a sub debt lender is to be able to have some of that flexibility. And so, yes, do think that maybe it comes down a little bit, but I mean, we think the business model is pretty attractive in the long term.
Speaker 6
Also have 18 So
Speaker 3
million dollars in unrealized depreciation in the portfolio and we probably would have somewhat of a glide path for us exiting some of those deals over the next twenty four months. So some of those have sizable gains as well.
Speaker 6
Understood. Yes, no, I appreciate it. And the lumpiness was not a you obviously did have a particularly big winner going back two years, I guess. But I mean, you have got a track record of delivering nice IRRs on more than those handfuls. So I appreciate that.
Speaker 2
Yes, that's interesting. It's a completely fair question. I think that IRR and that lumpy gain that you referred to is like something like 12%. So it actually brought the 15% down on an average basis if you're talking about IRRs. But that's the lumpiness in asset performance is a fair question that people should ask.
It's just pretty broad.
Speaker 3
And that's true for Titan Liner and MRI, both of them within the portfolio for years and years. So the IRRs were in the teens. Right. So
Speaker 6
Yes. Got it. Thank you.
Speaker 4
Thank you. And our next question comes from the line of Sarkis Sherbetchyan Riley Securities. Your line is open. Please go ahead.
Speaker 9
Hey, good morning and congrats on the quarter. Just wanted to touch off very quickly on kind of the cost of capital relative to the interest rate environment. It looks like you may have some nice tailwinds here to compete in the current backdrop given your lower cost of debt. I was wondering if you can maybe give an update on pricing or spreads real time, just kind of considering any potential interest rate regime shifts or kind of ideologies you guys are carrying going forward?
Speaker 3
You looking the side or the liability side?
Speaker 9
Well, from an asset and liability perspective, right? I mean in the totality of things.
Speaker 3
Yes. Well, I mean, Boen, you can speak to the asset side and I can
Speaker 2
go through what Yes. Mean, spreads in the market, I mean, if that's your answer. I mean, clearly, there's competition in the market. It's any kind of COVID premium is long But generally speaking, I wouldn't say that the universe of deals that we're working on and chasing the spreads have come down terribly in the last quarter. I mean, I think it's been relatively flat.
I think our situation is really mainly it's being able to compete in deals that just price tighter. And so you need to get your cost of capital down because at the end of the day, you live on net interest margin. And that's been the main thing. I mean, market's definitely competitive. So I don't want to leave anybody wrong in that respect.
They're also I mean, lenders, we'll see what happens throughout the end of the year, but lenders' barns are pretty full right now, right? I mean, they got a lot of deals going So when someone shows up December 1 and say, I got to get a deal done by the end of the year, that incremental lender in the market might not be quite as aggressive on pricing that deal. I mean, that's little bit more just supply demand theory, but that's we'll see it's interesting to see what happens. So but that's the asset side. I think it's mainly a cost of capital story, I believe so.
Speaker 3
Yes. So I mean on the right side, obviously, with the we amended and extended our credit facility with ING to L215 and so that's going be locked in for a number of years. We think that's pretty competitive for small mid to cap BDC. We did look down the road and opportunistically did that bond deal at 3.5% for the very reason. We do believe it's not an if, it's a when, you see the rates start coming back up.
And so blocking that in was the prudent thing to do. And then on the SBA side, they pool debentures twice a year. In between those poolings, the cost of capital is about 1% and we're in between there right now. So over the next six months, we're going to be drawing we would anticipate drawing around $60,000,000 off of the SBA at 1% and that gets pulled into maybe it'd be 1.5%, maybe being a little higher than that. But that's kind of what we alluded to earlier.
Our all in cost of capital is really trending down towards the 3% to 3.5% And you'll start seeing that as the SBA is fully ramped in the next twelve to twenty four months.
Speaker 9
Yes, understood. And I guess, if we're going to think about things here in the near term, obviously, a lot of liquidity, everyone's flush with it. But I suppose if you look at the next six, nine and twelve months, if there's any dislocations, given your liability side of the equation is pretty attractive, do you think there would be an opportunity to kind of take advantage of that NIM potentially expanding a little bit?
Speaker 2
Well, potentially, because I mean, if by we're all we manage our assets in kind of a what if world, right? What happens if there's a dislocation in the market? What happens? What if, what if, what if, right? And so obviously, in and extending out our maturities on our liability side and then maintaining adequate liquidity or flushing liquidity on our balance sheet, then if there are dislocations, the only variable that moves in your world is your asset yields expand.
And so if we have the liquidity to invest in a dislocation like that, then that's exactly what would happen. Your net interest margin would expand. And so we feel like we've kind of set the business up to weather storms on the downside and potentially take advantage of things on the upside from an asset yield perspective.
Speaker 3
Yes. And I think also on the right side, I think we would look opportunistically to raise potentially additional debt on that 3.5 issuance as we see the volume there. I mean, certainly that's at those rates, it's opportunistic and it would be it would expand NIM, immediately.
Speaker 9
Yes. No, it sounds good. One more for me. If you can maybe describe some key factors on some of the deal quality you're seeing real time. I just want to understand if maybe covenants are getting looser out there, and if this is impacting the way you're underwriting, if so?
Speaker 2
Yes. No, I would say in the lower just macro comment in the lower middle market, I would at least our deal, I don't I would imagine other lower middle market lenders would be the same way here. But I don't think covenants are really not things you have to watch for covenants getting looser, that's obvious. But the definition of EBITDA and add backs and adjustments, those are things that we watch very carefully. We just really haven't seen a lot of that.
It's a competitive market, smart sponsors that are well financed with multiple lender relationships clearly and the ones that prove to support companies when they bump in the night get better financing terms. I mean, they just do and they deserve better financing terms. Situations where the EBITDA earnings margin, EBITDA margin is higher and loan to value on the loan is lower, you get better terms, which the risk of those loans is lower and you should have better terms. But generally speaking, loan for loan, we haven't seen a bunch of in a lower middle market, and it's very different than the syndicated market. We just haven't seen a lot of deterioration on kind of covenant cushions and that kind of thing.
I mean, the looser covenant cushions are the safer deals. But just general broad covenant deterioration in our market, we really haven't seen that.
Speaker 9
Great. Thank you. That's all for me.
Speaker 4
Thank you. This concludes our question and answer session. And I would like to turn the conference back over to Bowen Diehl for any further remarks.
Speaker 2
Thank you, everybody, and thanks for joining us, and thanks for all the questions. We like answering the questions. And for the shareholders that are not answering, asking the questions, they get to hear more about our business. And so thanks for that, and I look forward to giving everyone further updates as we go forward.
Speaker 4
This concludes today's conference call. Thank you for participating. You may now disconnect. Everyone have a great day.