Capital Southwest - Earnings Call - Q3 2021
February 2, 2021
Transcript
Speaker 0
Thank you for joining today's Capital Southwest Third 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 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 more 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, Owen Deal.
Speaker 2
Thanks, Chris. And thank you to everyone for joining us for our third 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 third fiscal quarter ended 12/31/2020. I want to first say that I hope everyone, their families, their employees continue to be safe and well.
In summary, this quarter was exceptional in virtually all areas, strong originations, strong capital raises and strong portfolio performance. As we reflect back on 2020, we were very impressed by how the vast majority of our portfolio management teams and financial sponsors managed our portfolio companies, prioritizing the health and safety of their employees, realizing cost efficiencies where needed, and now recovering nicely from the worst effects of the pandemic. While the pandemic is not yet completely behind us, as we look back to where we were in March 2020 with so much economic 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. The pandemic has impacted so many people and companies in a variety of ways, and we are humbled by how well the portfolio has held up through this difficult time. The way our deal team has been able to continue to source diligence and originate high quality assets while continuing to actively monitor our existing portfolio over the past year has corroborated my confidence in them and also in the strength and quality of the assets.
During the quarter, our portfolio continued to improve, as evidenced by $7,100,000 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 non accrual. Overall, as of the end of the quarter, we had only one loan on non accrual, the junior most tranche of our loan to AG Kings, which had a fair value of $739,000 Substantial quarter end, the sale of AG Kings to Albertsons Acqueen Markets has closed. Now we're resolving this last non accrual asset for Capital Southwest.
As a well capitalized first lien lender with ample liquidity, Capital Southwest continues to be in a favorable position to seek attractive financing opportunities and to provide financial support for the growth of our portfolio companies. Executing our investment strategy under our shareholder friendly, internally managed structure closely aligns the interest 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 $0.52 per share, which more than earned both our regular dividend paid for the quarter of $0.41 per share and our supplemental dividend for the quarter of an additional $0.10 per share. Total dividends for the quarter of $0.51 per share represented an annualized dividend yield on the quarter end stock price of 11.5% and an annualized yield on net asset value per share of 13%.
I'm also pleased to announce that our board has increased our total dividends to zero five two dollars per share for the coming quarter ending 03/31/2021, consisting of a dividend increase from $0.41 per share up to $0.42 per share and a supplemental dividend of $0.10 per share. Our decision to increase the dividend emanates from our confidence in the current earnings power of our portfolio as a result of the reduction in our cost of capital and our ability to continue to improve our operating leverage as we grow the portfolio. During the quarter, we grew our investment portfolio on a net basis by 3% to $649,000,000 as of 12/31/2020. Portfolio growth during the quarter was driven primarily by 57,500,000.0 to three new portfolio companies dollars and three existing portfolio companies, offset by $28,000,000 in total proceeds from three exits. Subsequent to quarter end, we investment activity, which spilled over into the New Year, closing an additional $33,500,000 in commitments.
I will review our investment activity in a bit more detail in a moment. On the capitalization front, we were quite busy during the quarter. We successfully raised over $96,000,000 in investable capital during the quarter, consisting of $75,000,000 in aggregate principal in a new 4.5% institutionally placed unsecured bond and $21,100,000 in gross proceeds through our equity ATM program. During the quarter, we also received $15,000,000 of additional commitments to our revolving credit facility, which now stands at a total of $340,000,000 in total commitments from 11 banks. In addition, subsequent to quarter end, we paid off the remaining balance on our 5.95% December 22 baby bonds.
Turning to slide seven and eight, we illustrate our continued track record of producing a strong dividend yield, consistent dividend coverage, and value creation since the launch of our credit strategy. In fact, specific to Slide eight, as of 12/31/2020, we hit a new all time high in total value creation for our shareholders. We believe the strength of our investment and capitalization management strategies have been demonstrated through the pandemic based on the solid performance of our company and our portfolio. And now we are pleased to announce an increase in our regular dividend this quarter. We believe that the maintenance and growth of both net asset value and dividends per share are paramount to 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. We continue to focus on core middle market 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. This combination is powerful for a BDC as it provides strong security for the vast majority of our invested capital while also providing NAV upside from these growing businesses. Building out a well performing and granular portfolio of equity co investments is important to driving growth in NAV per share, while aiding in the mitigation of any credit losses over time.
As illustrated on Slide 10, our on balance sheet credit portfolio as of the end of the quarter, excluding our I-forty five joint venture, grew 2% to $531,000,000 as compared to $521,000,000 as of the end of the prior quarter. Our credit portfolio is currently weighted 86% to lower middle market loans, up from 82% last quarter, as a result of one loan prepayment in the upper middle market and six loan originations in the lower middle market during the quarter. 99% of the debt originations for the quarter were first lien senior secured. And as of quarter end, 91% of the credit portfolio was first lien senior secured. On slide 11, we lay out the 57,500,000.0 of capital invested in and committed to portfolio companies during the quarter.
This included $45,400,000 in first lien senior secured debt committed to three new portfolio companies, along with 2,000,000 invested in equity co investments alongside two of the new portfolio loans. We committed an additional $9,800,000 in first lien senior secured debt to two existing portfolio companies, which in both cases was utilized to fund strategic acquisitions. Turning to slide 12, as I noted earlier, have thus far invested $33,500,000 of capital in two new portfolio companies. We believe our ability to cultivate strong sponsor relationships in the market and be a long term dependable partner to our sponsors and portfolio companies has translated to enhanced deal activity and the ability to win more deals that fit our investment strategy. These relationships are also key to putting us in a position to make small equity co investments in growing lower middle market companies alongside many of these sponsors.
Turning to Slide 13, we had two lower middle market exits this quarter, our equity investment in Tinuiti and our first lien senior secured loan to Coastal Television. In the upper middle market, we exited our first lien senior secured loan to iEnergizer. The exit of our equity investment in Tinuiti was especially notable as it generated a realized gain of $8,100,000 on an initial capital outlay of $1,400,000 This resulted in an IRR of 73.2% and a multiple on invested capital of 6.8 times. Mountain Gate Capital, Tinuiti's sponsor during our hold, and the Tinuiti management team did an exceptional job growing this business both organically and through acquisitions and positioning it for a sale that generated an outstanding result for all parties involved. We are grateful to have had the opportunity to support the growth strategy for this company and its sponsor over the past four years.
This continues our track record of successful exits. To date, we have generated a cumulative weighted average IRR of 16.8% on 35 portfolio exits, representing approximately $336,000,000 in proceeds. On Slide 14, 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, again excluding our I-forty five joint venture. As of the end of the quarter, the total portfolio, including equity co investments, was weighted approximately 86% to the lower middle market and 14% to the upper middle market on a fair value basis. Our portfolio of 39 lower middle market portfolio companies has a weighted average leverage ratio measured as debt to EBITDA through our security of 3.8 times.
Leveraging EBITDA improved across a solid majority of the lower middle market portfolio for 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 our I-forty five joint venture, consisted of 11 companies with an average leverage ratio through our security of 3.6 times. We were also pleased with the leverage and EBITDA improvement across the upper middle market portfolio. Turning to slide 15, 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 loans to two portfolio companies, one previously rated a three and one previously rated a two, which were upgraded to a two and to a one rating respectively, both based on improved EBITDA performance and deleveraging. I'll also note that the number of loans in each category as of 12/31/2020 included new portfolio company originations during the quarter, each rated a two, while removing portfolio companies exited during the quarter. Specifically, one of the portfolio companies exited during the quarter was rated a one and one exit was rated a two.
As of the end of the quarter, over 90 of our investment portfolio at fair value was rated in one of the top two categories, either a one or a two. We had six loans representing 9.6% of the portfolio at fair value rated a three, and only one loan, our junior most loan tranche to AG Kings, representing 0.1% of the portfolio at fair value rated a four. As illustrated on slide 16, our total investment portfolio continues to be 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, but only 6% of the portfolio in second lien senior secured debt and only 2% of the portfolio in one subordinated debt investment. Turning to Slide 17, the I-forty five portfolio also continued to show improvement during the quarter as our investment in the I-forty five joint venture appreciated by $2,200,000 Leverage at the I-forty five fund level is now 1.07 times debt to equity at fair value, which is substantially improved from the peak leverage of 2.51 times debt to equity at 03/31/2020.
As of the end of the quarter, 94% of the I-forty five portfolio was invested in first lien senior secured debt with a diversity among industries at an average hold size of 2.6% of the portfolio. I'll now hand the call over to Michael to review the specifics of our financial performance for the quarter.
Speaker 3
Thanks, Bone. Specific to our performance for the December, as summarized on Slide 18, we earned pretax net investment income of $10,000,000 or $0.52 per share. This was a 23% increase from the $8,100,000 or $0.44 per share earned during the prior quarter. We paid out $0.41 per share in regular dividends for the quarter, flat from the $0.41 regular dividend per share paid out in the September. As mentioned earlier, our board has declared an increase to our regular dividend from $0.41 to $0.42 per share to be paid out during the March.
Maintaining a consistent track record of meaningfully covering our regular dividend with pretax net investment income is important to our investment strategy. This track record is demonstrated by our 107% regular dividend coverage over the past twelve months and 108% 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 declared a further $0.10 per share supplemental dividend to be paid out during the March. 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 12/31/2020, our estimated UTI balance was $1.9 per share. Our investment portfolio produced $19,000,000 of investment income this quarter, with a weighted average yield on all investments of 11.2%. This represents an increase of approximately $2,400,000 from the previous quarter. The increase in investment income was driven partly by an increase in debt investments outstanding as well as a distribution of $1,200,000 from one of our lower middle market portfolio companies as part of a dividend recapitalization. This is a prime example of the benefits of investing equity with the portfolio companies where the growth story is compelling.
As Bowen mentioned, we had no new non accruals as of the end of the quarter and our weighted average yield on our credit portfolio was 10.6% for the quarter. As seen on slide 19, our operating leverage was flat for the quarter at 2.6%. Operating expenses were slightly elevated this quarter due to the accrual for our annual bonus program. The final payout for our annual bonus will be determined and approved by the board based upon their review of company performance for the full fiscal year 2021. Based on both our strong NII performance and continued improvement in our overall portfolio, we have accrued the annual bonus above our annual target giving our board the flexibility if they so choose to pay out bonuses in excess of our stated targets.
All that said, we do expect that our run rate operating leverage going forward will be below our target of 2.5%. Turning to slide 20, the company's NAV per share as of 12/31/2020 was $15.74 as compared to $15.36 at 09/30/2020. The main driver of the NAP per share increase was $7,100,000 of appreciation in the investment portfolio, much of which was in our equity 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 de risk our liability structure while ensuring that we have adequate investable capital throughout the economic cycle.
During the quarter, we raised an aggregate principal of $75,000,000 in 4.5% unsecured notes due 2026 and paid down $20,000,000 on our 5.95% baby bond due 2022. We believe the execution on our new $75,000,000 issuance is corroboration of the market's acceptance of our investment strategy and their confidence in our portfolio and track record. This capital raise provided us the flexibility to fully repay the outstanding balance of $37,100,000 on our 5.95% baby bonds subsequent to quarter end, while also providing the company cost competitive and flexible capital to fund future investments. Our debt capitalization today includes a $340,000,000 on balance sheet revolving line of credit with 11 syndicate banks maturing in December 2023, a $125,000,000 institutional bond with over 25 institutional investors maturing in 2024, the aforementioned $75,000,000 institutional bond with six institutional investors maturing in 2026, as well as a $150,000,000 revolving credit facility at I-forty 5 with four syndicate banks maturing in 2024. Finally, as we mentioned last quarter, we continue to work with the US Small Business Administration toward becoming officially licensed as an SBIC.
We received our green light letter in July 2020 and had submitted our final application for licensure. Due to the disruptions around the election and transition between administrations, the pace of processing application approvals by the FDA slowed considerably over the past few months. We continue to expect to complete this process soon and will keep you apprised of progress where appropriate. Overall, we are pleased to report that our liquidity is strong with approximately $187,000,000 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. As of 12/31/2020, approximately 59% of our capital structure liabilities were unsecured.
And subsequent to the paydown of our December 2020 notes, our earliest debt maturity is now in December 2023. Our balance sheet leverage, as seen on Slide 22, ended the quarter at debt to equity ratio of 1.22: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 here today. Capital Southwest continues to perform very well and consistent with the vision and strategy we communicated to our shareholders six years ago. Our team has done an excellent job building both a robust asset base, reputation and deal origination capability as well as a flexible capital structure that prepares us for difficult environments like the one we experienced in 2020. In fact, performance through difficult environments like 2020 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 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 up for Q and A.
Speaker 4
Thank you. Our first question comes from Devin Ryan of JMP Securities. Your line is open.
Speaker 5
Hi, this is Kevin Fultz on for Devin this morning. First question, the stock is trading at a healthy premium to NAV. And as we saw last quarter, you were fairly active in selling shares under the ATM program. Can you provide some high level thoughts around how you balance raising equity in the current environment and how active we can expect equity issuance to be over the next few quarters?
Speaker 2
Yeah, look, that's a good question. Would say the ATM program, one of the things we like about the ATM program, on top of it being a very inexpensive way to raise equity of 2% spread to trade, but you can also you can manage the BDC's leverage over time vis a vis the pipeline, how much activity we have coming down, liquidity we have in our portfolio, the quantum of unfunded commitments. A whole host of kind of variables go into the ultimate equation, which is how much equity we think we need to raise. And we always wanna stay out in front of and prepare ourselves for hiccups in the night from the economy or what have you. So not an exact answer to your question as to how much we plan to raise, but one of the reasons we raised so much equity this last quarter was that we had a of investment activity.
Candidly, we weren't able to raise a lot of equity in the prior two quarters before that during the pandemic. So it's really a lever that we pull to manage leverage, we're looking at, again, we're looking at activity in the portfolio, liquidity of the company and unfunded commitments on our balance sheet that we need to be ready to support. Yes. I'd also say Kevin, just from a
Speaker 3
modeling perspective, I think we expect on an average probably when our stock's been trading well to raise around $15,000,000 I would say on a quarterly basis. Now something like this past quarter as Bowen said, we had higher deal origination volumes so we raised a bit more at $21,000,000 Sometimes it'll be slightly less but I think 15,000,000 is about the right size on a go forward.
Speaker 5
Okay, great. That's helpful. And then kind of another big picture question. You have a pretty robust deal making environment currently, fairly significant unused debt capacity and as mentioned, the ability to issue equity under the ATM. Can you talk about the potential for growth of the investment portfolio in 2021?
Speaker 2
Yeah. I mean, right now deal flow right now is certainly strong. Our team is really hitting its stride on just deal origination activity. We're still closing about 2% of the deals that we review. It's about, over the last twenty years of my career, that's kind of about the number.
Sometimes a little higher, sometimes a little lower. I think that having gone through the pandemic and deal sources, sponsors see how we behave, and we're very commercial and reasonable, we don't roll over. We expect fair outcomes. If we contribute capital to the company, we expect the sponsor to do the same. So it's a very commercial and balanced approach.
But candidly, one of the ways that we manage an anticipated downturn is structuring deals upfront better and more responsible. In other words, you don't go to a very strong sponsor relationship who maybe wants more debt on a deal than we think is prudent for the potential volatility of the business. We don't win those deals, candidly. We think about it upfront. Look, if we're going over lever something, we don't want to have a tough conversation with a really good sponsor of ours.
So, part of being able to manage commercially and responsibly and through a pandemic environment is the structuring and stuff you've done upfront. So, now we come of the pandemic. Candidly, I think our team has developed a lot of street credibility and comfort and track record when people are considering us as the financing partner. So, it's not always being the lowest priced deal. You've got to be in the zip code of market pricing, but you don't have to low price every deal you look at if you develop that reputation and how you conduct yourself when things bump in the night.
So, I think that's what's attributing, to some extent, our deal flow and the quantum of deals we see and the quantum of deals we win. Look, I expect deal flow to continue to be solid throughout this year, but we'll see. We'll see.
Speaker 6
Go ahead, Tekka.
Speaker 3
Yes. Just probably putting some numbers to it. I think that we project internally to do around 40,000,000 to $50,000,000 in originations each quarter and expect to see between 15,000,000 and $20,000,000 come back. Sometimes we do a little bit more on the origination side. And obviously sometimes you'll see a run on prepayments as well.
But essentially somewhere in that 20,000,000 to $30,000,000 net portfolio growth a quarter.
Speaker 5
Okay. That color is very helpful. And then lastly, touching on prepayments, what visibility do you have around that payment repayments?
Speaker 3
Yeah. You know what? I I I think we obviously, we get within a quarter, in the beginning of a quarter, we probably have some level of visibility. I'd say for this quarter, we know that there's limited amount of activity going on, and so we're not expecting probably something on the low end of that range of repayments. As you know, the interest rate environment goes up and down, obviously, you see that change.
But I think right now, you'd see it you've seen a lot of repayments come back, with people kind of settled into where the market is at the moment. So I I wouldn't expect a whole rash in the next three to six
Speaker 5
Okay. That's it for me, and, thanks for taking my questions, and congratulations on a great quarter.
Speaker 3
Thanks, Kevin. Thanks.
Speaker 4
Thank you. Our next question comes from Nikky Kline from Ladenburg Thalmann. Your line is open.
Speaker 7
Good morning, Bowen and Michael. Hope you're well. I want to ask a high level question about this year. So when we think about the pace of vaccinations and the recent mutations of the COVID virus, it looks like the pandemic will or could go on longer than we had hoped and that it could continue to stress companies in some industries. So apart from your software related investments, how do you feel about your borrowers' ability to carry them through the pandemic, particularly with respect to liquidity?
Speaker 2
Yeah, It's interesting. I mean, you know, just personal view of this, I mean, the the the things you said are are correct. You know, the pandemic's not behind us. You know, the vaccine's out there. It's We'll see how well the vaccine works, how many people take the vaccine, all those kinds of things.
And you've got new strains and lots of unknowns. But I think at some level, speaking of our portfolio, the companies are kind of they've found for the most part, they've kind of found their stride. So aside from a complete panic lockdown where everybody goes back to the living rooms, etcetera, Aside from that, I mean, feel like our portfolio has kind of found its stride. Now, if the pandemic sticks with us for another twelve or eighteen months, if I had a concern about that, it's more of it's just going to be muddy quicksand for companies that are trying to grow. And so, and growth could definitely be affected.
And that's really our equity portfolio, right? Upside of the equity portfolio, that could stretch out. So that's a concern from a credit perspective and a security of our capital perspective. I feel pretty good about that. Now, the only thing I would point out is the vast majority of our companies are small businesses, and many of them have SBICs in the capital structures in some way.
And candidly, we would expect to be an SBIC or have an SBIC relatively soon. And so there is the PPP money that's out there. So that's I don't looking across the portfolio, I don't really see any companies that are like, geez, the difference between survival and not survival is a PPP loan. But I do think that helps kind of bridge noise across the portfolio that might come from the pandemic.
Speaker 7
Thank you for that, Moen. That's really helpful. I wanted to ask you about American Addiction. It has obviously exited bankruptcy. And if I'm not mistaken, you're the new chairman of the company.
How do you feel about that specific company's prospects? And is it benefiting from the pandemic? And what's the long term sort of exit strategy for AAC?
Speaker 2
Yeah. So AAC, I was involved with an addiction treatment business for ten year, eight years, a while ago at my former firm. And so I had some experience in the space. And the firm, the Meadows, is a firm that has some posh out there. And it's a very successful company.
And so they wanted They asked me to be chairman so they could put me in the press release so that the employees would see, okay, someone on the board actually has industry experience, that type of thing. So what's not happening is I'm not running the company, but what is happening is I am on the board, which I'm happy to do. I don't want to do a lot of those things across the portfolio, but I'm happy in this instance. I am pretty positive on that platform. It's got an incredible asset base, network of facilities.
They do really, really good work saving lives in the addiction area and they do a really good job at it. So, it's just been in a tough restructuring and bankruptcy, which we're now clear of. And so now, it's kind of sunshine ahead. I mean, pretty positive on the upside on that business from where we are today, just given the quality of their network and the building blocks that the company has to work with to really recover from where they are on a valuation perspective today. So, I would say, clearly the pandemic and lockdowns has created stress in society.
And when stress in society increases, a lot of folks struggle with medicating around stress. And that obviously results in alcoholism and drug addiction, which are very, very unfortunate things and really need to be helped. People lose lives from that. And so, to be able to help those people is obviously a great mission. And it's one that can be done profitably, and one that you can build a really good business around.
So I think, from that perspective, you do have a tailwind across the addiction treatment space from that stress. But that said, these are facilities. People live there while they're going through addiction. And so COVID and COVID protocols and quarantines and lockdowns, etcetera, are all things that you could imagine go on. So you've got headwind from those types of things, but you have tailwind from the general stress in the society.
And so I feel actually great about the upside of that business going forward.
Speaker 7
Bowen, do you expect roll ups to occur in that industry? And would AAC be an acquirer? Or do you expect them ultimately to be acquired by someone else looking to grow?
Speaker 2
Yes. So I would say, first of all, the majority of the upside is just EBITDA growth from the business and signing new network contracts, filling the beds that aren't filled. Organically, the economics of adding a few beds to an existing facility, the ROI of that is staggering, actually, if you can fill them. So it's just not a lot. It doesn't cost a lot.
It's like adding a wing on a hotel or something. Or not even that, like a it's kind of like a hotel, adding on beds. And then the recurring economics, if you can fill those beds, is really attractive. So there's a lot of organic growth. There's a lot of recovery type growth or recovering from where it is today.
And then we may make acquisitions. I think that AAC could absolutely be acquired at some point. There are definitely larger platforms in the space. We have a lot of interest in the bankruptcy auction, just not at valuations that made a lot of sense, candidly. A lot of vultures swarming around in a bankruptcy.
There's lot of noise in that, people trying to take advantage. In Canada, we had a lender group, now an investor group that see a lot of upside. So we just credit bid and took over the company. And now we're the owners. And so those people are still out there.
Those big platforms are still out there. We're just going to do the things we want to do with the business or the management team with the business, and then it could absolutely be acquired in the next couple of years. I mean, that's clearly an exit strategy.
Speaker 7
Thanks for that, Gordon. My last question, just to touch on CPK, it also merged from bankruptcy and I assume the balance sheet is a lot healthier now. But I was in I was walking near my home recently and I saw that my local CPK was closed. So I have read, I think that the footprint has shrunk. So in terms of strategy for CPK in this pandemic environment, are you looking sort of to manage that business through the pandemic and status quo or do you expect some growth opportunities to occur?
What's the outlook in general for CPK in the environment that we're in?
Speaker 2
Yeah. So that CPK is different in the sense that we're not on the board there. So we're a smaller investor, I guess, in that platform. But I'll give you my impressions and kind of what I can tell you about what we hear and see. The management team there is excellent.
And they had this business doing much, much better pre COVID. They started, I think, in mid-nineteen. And the business had a difficult time. No reason other than just kind of difficult. And the management team came in, just did fantastic.
And then COVID hit. Obviously, it's a restaurant. And so that struggle, they went out during the bankruptcy process and negotiated leases. The realtors or the lessors that were landlords, there were certain landlords that they decided it wasn't worth keeping that lease and took the excuse to get out of the lease. Candidly, in my neighborhood, our CPK closed as well.
But there's a bunch of CPKs around Dallas they're doing fine. The one that closed, candidly, that was probably a really expensive lease. And
Speaker 6
so the
Speaker 2
network footprint of restaurants, yes, decreased as one would expect in a bankruptcy process. It's a chance to clean out leases that are less profitable. But if you look across the network, would tell you just thematically, the ones that are open, it's pretty interesting how well they were doing versus kind of pre COVID revenues. I mean, it's got a couple of things. It's got a licensing business with Nestle in grocery stores.
It's obviously a pizza business, and so it's got delivery that's obviously natural for people to order pizza delivery. So those are some things that help the business. And the management team's done great. They've been, as far as creativity on expanding patios and doing things creatively, we need to get past the pandemic before this thing takes off. But they've done a really good job managing it.
It's cash flow positive, so we're not thinking about funding it. We're going to have to wait a bit to get out of the malaise of the pandemic, but to be it's I mean, I really do. I think there's a fair amount of upside in that business going forward. It's just a question of pace at which we see the upside vis a vis the pandemic and timing. But if you look at the KPIs, the performance indicators that we look at, there's a lot of things about it that are You jump off the page, if the pandemic would only go back and pass, this thing is in fantastic shape.
That's the reaction you have to it. So we feel pretty good about it. Timing is somewhat dependent on pandemic.
Speaker 7
Okay. I appreciate that. I understand. That's it for me this morning. Thank you for your time.
Speaker 2
Thanks, Vicki.
Speaker 4
Thank you. And our next question comes from Kyle Joseph of Jefferies. Your line is open.
Speaker 8
Hey, good morning guys. Congrats on a nice quarter and thanks for taking my questions. Wanted to talk about net interest margins and the outlook going forward. Obviously, it's an active deal environment. Just talk about spreads and where we are versus, call it, year ago levels.
And then on the cost of funds side, talk about what the liability management you guys have done recently could how that could help on the cost of funds side?
Speaker 2
Yes, sure. I'll just comment on the asset side, the spreads. We're kind of back to pre COVID spreads. So we're not it's not there's not a we don't see a whole lot of COVID premium out there. Maybe a little bit of premium in the sense that leverage people look at the pandemic in the rearview mirror and leverage asks are slightly lower than they were a year ago.
So from my perspective, that is a risk element that's in our favor, generally. But the spreads on the loans we do are kind of back to pre COVID levels. But our cost of capital, which I'll let Michael comment on, has come down. So we feel pretty good about the asset liability relationship. You want to talk about that?
Speaker 3
Yeah. So obviously, we raised $75,000,000 on that 4.5% institutional bond, which took out if you think about it over the last two quarters, we've taken out the entire essentially I think we have $60,000,000 left on that bond. So we've converted it from 5.95 down to 4.5. So that's about 150 basis points which if you annualize that, that's, you know, it's really, about $800,000 a year, so about a penny a quarter. So that's going to be helpful.
I think going forward, the SBA is still hanging out there. The notion would be between $340,000,000 on the credit facility, which is about two and three quarters all in. And we should expect to see the SBA, if and when that comes to pass at a similar cost. So you'll have three fourths of the portfolio sub three, and then you'll have that bond at four and a half plus the 75 we have at, you know, around 5%. So the kind of your blend right now is around 4.85 percent, and we think we're gonna be coming down to, you know, like, four and a quarter, probably in the next year.
Speaker 8
Got it. Very helpful. And then, obviously, your credit's trending in the right direction and your book's in good shape, but just trying to peel back the onion a little bit. Can you give us a sense for revenue and EBITDA trends in the fourth quarter and how those compare to the third quarter either in terms of growth or contraction and kind of early performance year to date?
Speaker 2
Yeah. I would say generally, EBITDA and revenue in the portfolio for a strong majority of the companies was positive, kind of low single digits and looks pretty good. I mean, deleveraging the portfolio is good. We've got a handful of names that are kind of bumping along, from where we sit from a first lien perspective, that just means that they bust a covenant here or there. We get to charge economics you know, and and but there's plenty of cash flow to service our debt and that type of thing.
So that's part of being a first lien lender. That's a benefit you you get as things bump along a little bit. But the the you know, a very strong majority of the companies were, you know, last quarter and this quarter were positive.
Speaker 8
Got it. And then one last one for me. Just talk about your appetite for continuing the special. Obviously, you guys have a strong UTI balance, but kind of the outlook for that going forward, given where the base went to as well as the overall strong portfolio performance?
Speaker 2
Yes. So I mean, it's we're continuing until the board decides otherwise, we're continuing the supplemental dividend program like we stated. It's a liquidity thing, right? The UTI is not going anywhere, so we distribute it over time. So it's a liquidity thing for us to have the capital to do it, which we have plenty to do.
We manage it that way. And so our goal was to create a program that the market can rely on and then obviously can price the stock accordingly. But as of now, we're continuing to pay it. Yes. And I would say
Speaker 3
that you need to really look at them independent of one another. So the UTI balance is going to dictate, as Bohn said, whether it's something that will differ in is approved by the board on a quarterly basis. And obviously we have about two point five years of runway there. So plenty of time to make a decision on how we play that out over time. But on the regular dividend, all the things we're talking about, we're having a growing portfolio, our cost of debt is coming Our operating leverage, even though it was around 2.6 this quarter, the run rate for operating leverage is really around 2.2 on a normal course.
So all that being said, we think that this is the first of several dividend increases probably over the next several quarters. And, so you should expect to see growth on the regular and and supplemental should continue along the way.
Speaker 8
Got it. Very helpful. Thanks for answering my questions.
Speaker 2
Thank you.
Speaker 4
Thank you. Our next question comes from Robert Dodd of Raymond James. Your line is open.
Speaker 6
Hi guys. Congratulations on the quarter. Bowen, if I can go back to the spread issue, right? I mean, obviously, I think you said, you know, no COVID premium anymore, which I I I don't think is is that surprising. But if leverage is down, you know, can you give us any color today if you work work a risk adjusted total return expectation when you're looking at it doing doing a deal, is that wider today still than pre COVID, or is all of that evaporated as well with with this no no COVID premium?
Is is the lower leverage not enough to to kind of make you raise your expectations for what total return is going to be over the life of an incremental loan? Or is it?
Speaker 2
Yeah, it's an interesting question. I would say this. I I think generally speaking, the models we're looking at now from a debt perspective have kind of the same debt returns with a difference that I want to make here a second that's important. But the debt returns are anticipated returns on your debt, which is spread and LIBOR and OID upfront and prepayment penalties if they pay early, those types of things. It's all generally the same.
One of the things that your equity returns might be higher because some of the businesses performed really well during COVID, but they're still kind of down from COVID. And so we can underwrite. The founders wants to go ahead and derisk their personal situation and rollover maybe even more equity because evaluations maybe are down in certain instances. And so, as we look forward, the equity upside in a company like I just described might actually be higher than it was a year ago where everything is up and to the right and there's no problems in the world. Whenever there's no problems in the world, that means a problem's coming, right?
And so there are situations that we've definitely seen where the equity returns, if we had done the deal a year ago, would probably be anticipated. A base case equity return might be less. And so that's the difference. I would say, as our cost of capital, as we have always said, the of pricing in the lower middle market is a range. And some of that's competition.
But some of that's just things like leverage, but also loan to value. A company that you're lending 30% loan to value in a cash flowing, higher margin business is going to have a lower pricing than something you're 50% loan to value with maybe lower margin. And so but it's going to price cheaper. So like there's a safe end of the lower middle market and a little bit less safe end of the lower middle market, right? There's a range, right?
That shouldn't be all that surprising. And so as we manage our capitalization and get our cost of capital down, we can play more in the safer end of the lower middle market. And so it's a lower loan to value, but maybe tighter spreads. But then one of the big, as you know, one of the big drivers of long term all in returns is principal loss rates, right? I think that as we invest maybe slightly lower spreads in a safer end of the market with lower loan to value, higher margin businesses, you asked me about my anticipation.
The more we do in that, I anticipate materially less long term credit losses. So, think our track record of our team is excellent. But credit losses are an expense of our business, right? I mean, your expense is your business, right? It was a spread business, but we have three buckets, right?
One is the cost of our capital we're borrowing. Another is our overhead. That's operating leverage you hear about every quarter. And then the third cost is losses over time. So, you're always trying to gain efficiency by decreasing all three of those buckets.
And so, one of the buckets is losses over time. So, as we do slightly safer loans, I. E. Slightly lower spreads, yes, my anticipated all in return over time increases.
Speaker 3
We also expect by putting together, Robert, a portfolio of those credits that Bone just described. It's also going to enhance our investment grade portfolio, right, in terms of going to the rating agencies, which in time would mean we'll actually be able to reduce our cost of capital even further, by putting together that high quality portfolio.
Speaker 2
Hopefully that's helpful on how spreads relate to all in return. Hopefully, that's helpful.
Speaker 5
Yeah.
Speaker 6
Absolutely. Very helpful. I really appreciate that. Exactly. I mean, it's a total return vehicle.
It's not just a coupon business. On the portfolio as it stands, obviously, we don't have the Q yet, right? So when I look at the unrealized appreciation in the quarter, can you give us any color of how broad based that was? I mean, obviously, you had two upgrades. Did those account for most of the unrealized appreciation?
Or is it much more broad than that across the portfolio?
Speaker 2
I'd say it's pretty broad in a sense, but it's mainly on the equity portfolio. So that's where
Speaker 3
we put that
Speaker 2
bridge, slide 20 in the shareholder deck. And so we did that kind of football chart going across the page. And you can see the change in the equity portfolio being $0.33 a share That's not a small number for one quarter. And that's probably it's definitely two handfuls of equity investments.
Now, we did have the tenuity exit this quarter. That was materially higher than it was valued at the end of last quarter. That contributed to that equity upside as well.
Speaker 6
Got it. Got it. And then one last one, forgot. AG Kings, obviously, again, don't have the mark. The exit at the end of the quarter, was that about in line with the mark that you had at 12:31?
And if you can give us any color on where that mark was versus $9.30 since that's the only one that that's the scheduled investments we currently have right now.
Speaker 2
Yeah. So our exit was higher than where it was valued last quarter. So that's first thing I would say. And then the $739,000 that's left is basically the last interest. There's a litigation trust and the final bankruptcy cleanup and there's a final working capital adjustment and some final economics, which candidly, we believe is going to be meaningfully higher than the $740,000 we have it valued right now.
So we think there's upside in NAV from that perspective. And then our all in recovery at the end of the day will be about $0.80 on the dollar.
Speaker 6
Got it. I appreciate it. Thanks a lot.
Speaker 4
Thank you. And our next question comes from Sarkis Sherbetchyan with B. Riley Securities. Your line is open.
Speaker 9
Hey, good morning and thanks so much for taking my question here. I just want to hit on the point regarding the comments on operating leverage run rate at 2.2% on a normal course you just mentioned in your commentary. Can you maybe help us understand the timetable that you're anticipating on getting there as well as maybe the portfolio or total portfolio size that you would expect to achieve that?
Speaker 3
Well, would tell you right now, as I noted earlier in the script, that we've had a essentially one time accrual above the annual target rate which was about $700,000 So this quarter the actual run rate for cash compensation would be 1,700,000.0 Our share based compensation run rate is usually around $800,000 And so you're looking usually about $2,500,000 on a run rate basis right now. And based on that asset base, it's a 2.2%. So we would expect additional we've already said we closed $33,000,000 in assets in January. So moving forward on a normal run rate basis, we would expect that percentage to be somewhere between two point zero and two point two.
Speaker 9
Great. Thanks for that. And just want to hop on Page eleven and twelve of the slide deck for the Q3 originations and then the subsequent quarter end originations, right? So if I look at the debt spread, the weighted average was 8.2 almost on the q three originations. And then if I look at the the two in in quarter end, it's about 7%.
Is that really just deal specific, or is that an indication of what's going on from a tightening perspective in the environment? Any color there, please?
Speaker 2
Yeah. No. You don't have really it's it's deal specific. I mean, you look down through there, I mean, like, there's a couple of deals that were or one in particular is the first out, last out structure. So we brought in a first out party to take a small piece of the loan.
So our spread is higher on that. Got one of the companies had a nine fifty spread. That's a portfolio company we've been in for a long time, and there's some precedent set as to what the spreads are in that that deal. So it's not completely new deal type thing. But it's really kinda I'm just looking down the list.
It's pretty deal specific. So, you know, if you go into, you know I mean, 600 is a a larger, you know, larger club type situation, larger company. And we're fur yeah. We're actually first out in that in the 600 deal. We're actually a first out, interestingly enough.
So it's a little bit more deal specific. I I wouldn't say that the difference between slide eleven and twelve is is directly parallel to some trend in the market.
Speaker 9
Great. That's helpful. And I guess last question on me regarding kind of the leverage front. I believe from an economic leverage perspective, had you targeted kind of the 1.3 to 1.4 range assuming you get the FDIC licensure? And from a regulatory leverage perspective, you'd still kind of be in the one to 1.1 ZIP code.
Can can you kind of give me some color on that?
Speaker 3
Yeah. I would tell you from an economic leverage perspective, we really have targeted, you know, between one point two and one point three, even getting the SBA money when that when that does happen. We don't plan on levering up economic leverage beyond there. So I think to your point, we probably will show up with one point o to 1.15 on regulatory leverage and stick to 1.2 to 1.3 on our total economic leverage.
Speaker 9
Great. That's all for me. Thanks for the time.
Speaker 3
Thanks, Thank Doctor.
Speaker 4
You. And at this time, I'm showing no further questions. I'd like to hand the conference back to Mr. Bowen Diehl for any further comments.
Speaker 2
Great. Thanks, operator. Thanks, everybody, for joining us. We appreciate it. Hopefully, you got a good impression that things are going pretty well here.
And we appreciate your all support and time and look forward to keeping you posted on the business as we go forward.
Speaker 4
Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day.