MidCap Financial Investment - Earnings Call - Q1 2021

Transcript

Speaker 0

Good afternoon, and welcome to Apollo Investment Corporation's Earnings Conference Call for the period ended 06/30/2020. At this time, all participants have been placed in a listen only mode. The call will be opened for a question and answer session following the speakers' prepared remarks. I will now turn the call over to Elizabeth Besson, Investor Relations Manager for Apollo Investment Corporation.

Speaker 1

Thank you, operator, and thank you, everyone, for joining us today. Speaking on today's call are Howard Widra, Chief Executive Officer Tanner Powell, President and Chief Investment Officer and Greg Hunt, Chief Financial Officer. I'd like to advise everyone that today's call and webcast are being recorded. Please note that they are the property of Apollo Investment Corporation and that any unauthorized broadcast in any form is strictly prohibited. Information about the audio replay of this call is available in our earnings press release.

I'd also like to call your attention to the customary Safe Harbor disclosure in our press release regarding forward looking information. Today's conference call and webcast may include forward looking statements. Forward looking statements involve risks and uncertainties, including, but not limited to, statements as to our future results, our business prospects and the prospects of our portfolio companies. You should refer to our most recent SEC filings with the SEC apply to our businesses may adversely affect any forward looking statements we make. We do not undertake to update our forward looking statements or projections unless required by law.

To obtain copies of our SEC filings, please visit our website at www.apolloic.com. I'd also like to remind everyone that we posted a supplemental financial information package on our website which contains information about the portfolio as well as the company's financial performance. At this time, I'd like to turn the call over to our Chief Executive Officer, Howard Widra.

Speaker 2

Thanks, Elizabeth. Good afternoon and thank you for joining us today. Before we begin, I'd like to say we hope everyone's healthy and doing well. I'll begin today's call with an overview of our portfolio and a review of our financial results for the June quarter. I will also discuss today's distribution announcement.

Following my remarks, Tanner will review our investment activity for the quarter and will discuss the impact of the COVID-nineteen pandemic and economic shutdown on our portfolio in greater detail. Greg will then review our financial results and provide an update on liquidity. We will then open the call to questions. During today's call, we will be referring to some of the slides in our investor presentation, which is posted on our website. As we all know, the COVID-nineteen pandemic has been an unprecedented shock to the global economy.

We believe our portfolio repositioning over the last several years has allowed us to enter this challenging period with a well diversified senior corporate lending portfolio invested in less cyclical industries with granular position sizes. Despite the significant economic headwinds through the pandemic, our corporate lending portfolio continues to perform well as evidenced by a net gain during the quarter. We believe the performance of our corporate lending portfolio during this challenging period demonstrates its resiliency and quality. No investments within our corporate lending portfolio were placed on our non accrual status during the quarter. The corporate lending portfolio which represents 79% of the total portfolio is eighty five percent first lien, 100% floating rate and 86% sponsor backed.

We continue to work closely with our sponsor clients and portfolio companies and we have generally been pleased with how sponsors and borrowers have been managing through the current environment. Away from corporate lending, results for the quarter were negatively impacted by non core and legacy investments. On our last call, we said that our intention to it was our intention to reduce the fund's leverage over the coming quarters. During the June, made considerable progress deleveraging the balance sheet by exiting approximately $233,000,000 of assets on a gross basis or $95,000,000 on a net basis which reduced our leverage to 1.66 times down from 1.71 times. Since the end of the quarter, we have received net pay downs of approximately $50,000,000 including one loan with documents in escrow.

Pro form a for these additional pay downs and assuming no changes to fair value up or down, net leverage is currently approximately 1.61 times. We have visibility into meaningful additional repayments in the remainder of the September and for the December. We may focus on further deleveraging to within our target range of 1.4 to 1.6 times over the coming quarters. As the pandemic began, many of our portfolio companies joined their revolvers during the March to shore up liquidity. Many of the drawdowns were repaid in the June.

MidCap is the agent for nearly all of our revolver and delayed draw term commitments and is actively monitoring every commitment. For context, at MidCap, leverage loan revolvers were 23% utilized before the pandemic. Revolver utilization peaked at 70% in mid April and has since declined to 48% today. Greg will discuss our liquidity and unfunded commitment exposure in greater detail later in the call. Moving to our financial results.

Net investment income for the quarter was $0.43 per share reflecting a smaller portfolio given the reduction in our leverage and a lower contribution from Merx which Tanner will discuss later. In addition, given the total return feature in our incentive fee structure, no incentive fees were accrued during the quarter. The portfolio had a net loss of $25,200,000 or $0.39 per share driven by a net loss on non core and legacy assets partially offset by a net gain on corporate lending. Slide 16 in our investor presentation shows the net loss for the quarter broken out by strategy. Net asset value per share at the June was $15.29 a 2.6% decline quarter over quarter.

Turning to our distribution, in light of the challenges and uncertainty created by the COVID-nineteen pandemic and our plans to further reduce leverage, we have reassessed the long term earning power of the portfolio and included that it's prudent to adjust the distribution at this time. We believe the distribution level should reflect the prevailing market environment and be aligned with the long term earnings power of the portfolio. Going forward, in addition to a quarterly base distribution, the company's Board expects to also declare a supplemental distribution in an amount to be determined each quarter. We believe a $0.31 base distribution reflects the long term earning power of the core portfolio including Merx. We believe there are several sources of earnings which will allow us to pay an ongoing supplemental distribution including the redeployment of non earning or lower yielding assets from our non core and legacy portfolio, the recovery of earnings from Merx and the rebound of fee income to historic levels.

The base supplemental distribution construct is intended to provide shareholders with a minimum annualized yield on NAV of 8%, a level which is consistent with some of our peers and allows for some upside via a supplemental distribution. To that end, the Board has declared a base distribution of $0.31 per share payable on 10/07/2020 to shareholders as of record on 09/21/2020. The Board has also declared a supplemental distribution of $05 per share payable on 10/07/2020 to shareholders of record as of 09/21/2020. Again, the Board expects to declare quarterly supplemental distribution in amount to be determined each quarter. With that, I will turn the call over to Tanner to discuss our investment activity and our portfolio.

Speaker 3

Thanks, Howard. Starting with the market environment, since the March lows, leverage loan prices have recovered and loan spreads have tightened significantly, which had a positive impact on the fair value of our corporate lending portfolio. Given the economic backdrop, middle market loan volumes during the period were light in both the syndicated market and the private credit market. Activity in the middle market remains slow as sponsors and lenders continue to struggle to evaluate how to price risk. While deal activity has been light, we do see that pricing in terms have shifted in favor of lenders.

In addition, borrowers are increasingly seeking asset backed lending solutions, an area where we via MidCap have expertise and significant market share. Given the composition of our corporate lending portfolio which is primarily first lien loans to less cyclical businesses, we believe that the credit quality of our corporate lending portfolio has held up relatively well during this period. However, we have seen an increase in request for loan amendments. To date, AINV has completed or is in the process of completing 23 amendments across the portfolio representing 15% of portfolio companies. Most of these amendments have been for covenant waivers or resets generally in exchange for a new covenant.

To date only four amendments have impacted interest rates or principal payments. Given the lack of investment activity in the overall market and our focus on reducing leverage, new investment activity was limited during the quarter. New corporate lending commitments for the quarter were only 17,000,000 across two companies. Sales were $68,000,000 repayments were $49,000,000 and revolver pay downs were $116,000,000 for total exits of $233,000,000 These sales were executed at prices around our marks at the March. Net repayments for the quarter were $95,000,000 including $31,000,000 of net revolver pay downs.

Going forward, given our visibility into upcoming repayments, we expect to be in a position to make new commitments as market activity resumes. Moving to Merx, our aircraft leasing portfolio company. As discussed on our last call, the pandemic has caused an unprecedented decline in global air traffic, which has led to a widespread lease deferrals throughout the industry. Although aircraft air traffic trends have improved slightly more recently, it remains significantly below pre pandemic levels. Merx has been working with its lessees to provide the necessary flexibility during these unprecedented times.

During the June, AINV converted $105,000,000 of Merck's revolver into equity and reduced the interest rate on the revolver from 12% to 10%. Accordingly, at the June, our investment in Merck's totaled $329,000,000 at fair value consisting of a $200,000,000 revolver at ten percent and $125,000,000 of equity, which also reflects a $4,300,000 write down during the period. This partial equity capitalization will reduce the interest Merx pays to AINV from $36,000,000 per year or $9,000,000 per quarter to $20,000,000 per year or $5,000,000 per quarter. We believe this reduced debt burden will provide Merx with the cash flow relief needed to navigate this challenging period. We expect Merx will be able to make dividend payments on our equity investment, improving AINV's return on its overall investment when the industry recovers.

We believe Merx's portfolio compares favorably with other lessors in terms of asset, geography, age, maturity and lessee diversification. Merx's portfolio is skewed towards the most widely used types of aircraft, which means demand for Merx's fleet should be somewhat more resilient. Merx's fleet predominantly consists of narrow body aircraft serving both The U. S. And international markets.

At the June, Merx's own portfolio consisted of 81 aircraft, 10 aircraft types, 40 lessees in 26 countries with an average age of 9.5. Merx's fleet includes 75 narrow body aircraft, two wide body aircraft and one freighter. As mentioned last quarter, the majority of risk deferrals impacted cash flow in the June. We expect a recovery in lease payments going forward given the significant amount of capital that has been raised by airlines in the public markets and the level of government support around the world. So far for the month of July, cash flows are at or above expected levels.

Merx continues to diversify its revenue sources beyond aircraft leasing. Merx has built a best in class servicing platform, which generates income from aircraft managed on behalf of other Apollo affiliated capital. As you may have seen during the quarter, Apollo Global's dedicated aircraft leasing fund, Navigator, entered into a sale leaseback transaction with Delta Air Lines for 10 aircraft. As Navigator acquires additional aircraft, Merx will generate incremental income from servicing fees. Across Merx and PK Air Finance, the aircraft lending platform, was acquired by Apollo Global, Apollo's aviation platform has 45 professionals dedicated solely to aviation located across North America, Europe and Asia and providing expert in house support to the platform's various aviation strategies.

The aviation team has the experience to skillfully navigate this period of market stress and the requisite capabilities to mitigate potential adverse outcomes. In addition, the Apollo Aviation platform will seek to opportunistically deploy capital in the face of widespread uncertainty and market disruption. To be clear, Merx is focused on the existing portfolio and is not seeking new investment opportunities. However, growth in the overall Apollo Aviation platform will nerd to the benefit of Merx as the exclusive servicer for aircraft owned by other Apollo funds. Moving to overall credit quality during the quarter, our two first lien debt positions in carbon free chemicals were placed on nonaccrual status.

The company has been facing earnings headwinds due to an unprecedented slowdown for the demand for one of its products, hydrochloric acid or HCL, which is used in the fracking process. Due to the decline in oil prices and production, the company's profitability has been negatively impacted by the lack of HCL offtake. At the June, investments on non accrual status represented $182,000,000 or 6.1 percent of portfolio cost and $47,000,000 1.7% at fair value. Looking ahead, we anticipate the continued need for covenant relief in our portfolio over the next few quarters. We believe these amendments will provide our portfolio companies with the flexibility needed to operate in the economic downturn.

We can use such amendments to reprice our risk, tighten loan documentation, add covenants and secure additional equity capital. With that, I will turn the call over to Greg, who will discuss financial performance for the quarter.

Speaker 4

Thank you, Tanner. Beginning with the statement of operations, total investment income was $56,700,000 for the quarter as interest income declined due to the reduction in income from Merck's non accrual investment and the decline in LIBOR. The decline in LIBOR was primarily offset by a corresponding decline in AINV's interest expense for the quarter. The remainder of the decline was primarily as a result of muted origination and prepayment activity during the quarter. Approximately 97% of contractual interest payments for the quarter were collected and the weighted average yield at cost on our corporate lending portfolio was 8.1 versus 8.5% last quarter, reflecting somewhat the decline in LIBOR to floor levels.

Expenses for the quarter were $28,400,000 down $4,400,000 quarter over quarter primarily due to lower interest expense and lower management fees. Interest expense declined due to the decline in the average portfolio and the decline in LIBOR. The weighted average cost declined 81 basis points from 3.93% to 3.12%. Management fees declined due to the decline in the average portfolio and there were not any incentive fees paid during the quarter. Net investment income per share for the quarter was 43¢.

As Howard mentioned, net leverage at the end of the quarter was 1.66 times down from 1.71 times at the March due to 95,000,000 of net pay downs partially offset by the net write down on the portfolio. The net loss on the portfolio for the quarter totaled $25,200,000 or $0.39 per share. On Page 16, in the earnings supplement, we've broken out the net loss by strategy. Spreads in the syndicated market tightened meaningfully since the peak decline in March. And as a result, we saw several reversals of unrealized losses from last quarter.

Our corporate lending portfolio had a net gain of $4,700,000 or $07 a share during the quarter. Merx had a loss of $4,300,000 or $07 a share, reflecting the continued stress in the aviation industry. Non core and legacy assets had a net loss of 25,600,000.0 or $0.39 per share due to carbon free, a legacy position in our shipping and oil. The loss in shipping primarily reflected the decrease in the residual value of the underlying assets in our dynamic shipping investment. The loss in oil in our oil investments was primarily due to the weakness in the forward oil curve.

NAV per share at the June was $15.29 a 2.6% decline quarter over quarter. Moving to liquidity and capital. At the June, we had $1,760,000,000 of debt outstanding down 40,000,000 from the prior quarter. Adjusting for settlements at quarter end, we had $243,000,000 of immediately available liquidity, up from $224,000,000 at the March. And we had $2.00 $5,000,000 of additional capacity under the credit facility up from $131,000,000 at the March.

The net effect from the quarterly activity improved our available borrowing capacity from $350,000,000 to $450,000,000 And as Howard mentioned, the activity post quarter end has added to our overall borrowing capacity for this quarter. Moving to and lastly, we were pleased that Kroll affirmed our investment grade rating in July. Moving to our unfunded commitments. On page 18 in our earnings supplement, we have laid out the outstanding commitments at the June. During the quarter, we experienced meaningful revolver pay downs from our portfolio companies as many of them chose to pay down their revolvers as they had better visibility regarding the impact of the pandemic on their respective businesses.

Of the $275,000,000 of unfunded revolver commitments outstanding at the June, 180,000,000 are available to borrowers and 95,000,000 are not available to borrowers. Availability is based on borrowing base limitations and other covenants. There were no significant draw downs on delayed draws, term loans commitments during the quarter, which are generally used to support portfolio company acquisitions and having current covenants. As noted, a significant portion of our unfunded commitments are not available borrowers. Most of our revolver commitments are subject to borrowing base and many of the companies do not have direct collateral.

Delayed draw term loans are typically used to support portfolio company acquisitions and having current covenants and therefore we do not expect these facilities to have any material utilization in the current environment. Turning to the portfolio composition, our investment portfolio had a fair value of $2,670,000,000 at the June across 149 companies in 29 different industries. We ended the quarter with core assets representing 9091% of the portfolio. Non core assets decreased to 9% of the portfolio at the June down from 10% at the March. First lien assets account for 85% of the corporate lien lending portfolio.

The weighted average attachment point decreased to 0.8 times. Investments made pursuant to our co investment order were 77% at the end of the quarter. We continue to remain focused on preserving liquidity and accordingly no stock repurchases were made during the quarter. As our leverage and liquidity continue to improve, we will continue to evaluate repurchasing our securities as appropriate. This concludes our prepared remarks and we would like to open the call up to questions.

Speaker 0

Thank you. The floor is now open for questions. Our first question comes from the line of Kenneth Lee of RBC Capital.

Speaker 2

Hi, thanks for taking my question. Just one following up on what was mentioned during the prepared remarks. You said that you have some visibility into investment repayments over the next few quarters. Just wondering if you could just expand upon that and what gives you some comfort around that visibility? Yes.

Well, it's Howard. We have a we go through the portfolio and there's a number of companies that are basically in strategic transactions you know, for sale that are either pending or, you know, or committed. So they're like they're pending closing. So we're talking about things, you know, that are that are in a number of cases already under contract so that, you know, can't be broken up and just waiting for some regulatory approval. And and in other cases are in, you know, are in are being auctioned and are in, you know, are valuable sort of platforms and won't get executed.

So, And it's also it's sort of a granular list. So we would expect that to happen over sort of continually over the next few quarters over the next quarters. Got you. Very helpful. And just one follow-up, if I may.

In regards to the new distribution policy, you mentioned that the supplemental dividend, a couple of drivers that could help that, including noncore migration as well as recovery in Merx. Wondering for outside observers, what's the best way to think about how the supplemental dividend is there a better way for us to get a supplemental dividend could be and give us any kind of guidance around that? Yes. So I'll take a crack at it first. So we set we, you know, we tried to set the the, you know, the the base dividend based on what sort of the corporate portfolio is earning or will earn at the at the size it's expected to be at plus what we expect Merx to produce currently with with, you know, relatively sort of moderated assumptions in terms of sort of fee income.

There you know, and that that that, you know, will enable us to sort of pay that base dividend. We we do you know, in addition to that, we would expect to generate income from a, you know, a number of different items. One is returns off our non core portfolio, which which we get some today. What we said in prepared remarks were repositioning that non core portfolio and earning even more off of those. But even off the moderated amount of cash that's produced off that, that is incremental.

Merx basically picking back up to a level of distributions above where we modeled it, which could still be below where it was historically and there's room for upside there. In the interim, there's also sort of upside or or it's not really upside. There there's also further earnings coming over the next few quarters because, you know, we won't be paying an incentive fee for a little while because of the total return feature. And then lastly, you know, that base dividend was set on a fee level that is is is relatively conservative based on, you know, historical levels over the past four or five years, and that was with a smaller portfolio. So, you know, our view is that we we can support that base dividend with just the, you know, the very basics of the business.

And there should be, you know, there there should be meaningful opportunities to produce each quarter income above that, which will then be distributed based on what the Board decides each quarter, meaning the expectation is we would declare some each quarter and potentially retain some to drive NAV up and leverage down each quarter as well. Great. Very helpful. Thank you.

Speaker 0

Our next question comes from the line of Kyle Joseph of Jefferies.

Speaker 5

Hey, good afternoon, guys. Thanks a lot for taking my questions. Just in terms of capital allocation going forward, I know the key focus here is delevering. But in terms of new investment opportunities, would we expect those to be primarily focused on the existing portfolio or subject to market conditions, you look to kind of rotate some of your portfolio into new investments?

Speaker 2

Yes. I mean, as Tanner had said, as we get our leverage into sort of the range, right now we're at the sort of very top end of the range, but as we get payments, would expect to sort of deploy back into opportunities we think that are sort of effectively cherry picked for risk return off the top of what's coming through the platform. Those may be in existing portfolio companies. If those opportunities are good and we understand they may be in other opportunities. We have a couple sort of in the pipeline we expect to fund right now in the quarter that's in one of each those.

So disproportionately high return for the risk that given sort of our visibility into pay downs, we believe we can fund and then continue to sort of our path to delevering. So the answer is it's gonna be both. It will for sure, though, be in the strategy that we have sort of articulated now for extended period of time, first lien floating rate. You know, it it'll all be in those categories. You know, the the our ability to deploy, obviously, will be dictated some by the cash that we're able to sort of, you know, bring in.

But, you know, we we do expect sort of normal course, you know, churning portfolio to enable us to invest and sort of, you know, cherry pick off the best of what's coming from the platform.

Speaker 5

Got it. And one follow-up from me. So given that sort of investment considerations and then in light of the rate environment, the LIBOR floors you have on your portfolio, do you think the first quarter could reflect kind of the nadir for yields or any sort of outlook in terms of the yield on the portfolio?

Speaker 2

So it should, right, because LIBOR won't go any well, I mean LIBOR can't go much lower, but it doesn't matter. We have the floor. So our yield won't go lower and we would expect to be deploying at higher rates just because we're just like I said, we're just going to be very selective of what we pick off. The issue is, though, obviously, we're not going to be turning 20% of the portfolio every quarter. So it doesn't you know, it's not gonna move 50 basis points per quarter up.

But but I do think that that's the right assumption that we you know?

Speaker 4

Understood. Okay.

Speaker 2

Question of the speed.

Speaker 5

Our It's

Speaker 0

next question comes from the line of Simeon O'Shea of Wells Fargo Securities.

Speaker 6

Hi. Good afternoon. Hope everyone's doing well. First question on Merx. You gave a lot of input there.

Apologize if I missed this. It did. Was the reorg on on your, provided capital structure, was that just a a more conservative play on on what cash or or according to what cash comes in? Or is was there a was there any form of test strips underneath on the securitization there?

Speaker 3

Yeah. I'm having yes. Sorry.

Speaker 2

No. It's all you. Go ahead.

Speaker 3

Yeah. So hey, Pen. So the the the the change was, as Howard alluded to more appropriately reflect the earnings power that we anticipate from Merx and was not driven by as you referred to issues in the underlying financings. We remain to be in good covenant compliance in those facilities. There is some cash, not only unrestricted cash that's trapped in those facilities, but also sorry, restricted cash that's in those facilities and then unrestricted cash that sits at Merck's to help defer cash needs going forward.

Speaker 6

Okay. Thank you. That's helpful. Then just a follow on perhaps for Howard. Reading and listening a bit to the Apollo parent call, it looks like Apollo is starting a new private credit platform, strategic opportunities.

How did you know, how would you describe, this as it compares to to mid cap and and the the private credit group? Is it a different part of the house? To what extent are you integrated? And and how can we, how should we think about this as it impacts current group today?

Speaker 2

Okay. Well, first let me answer it for sort of BDC. From a BDC's perspective, it doesn't. It's just another product offering which is available for the BDC if it decides to opt to do those financings. It's sort of under the exemptive order it has a right to.

From the perspective of where it sits, it's effectively a an adjacent product. If you're you're thinking, you know, it's it's basically large market originations to take deals in the billion dollar range, which historically had not really been done in the private market. And so, you know, effectively what it does, it allows us to offer at scale to underwrite deals privately, you know, and take them down in lieu of sort of, you know, capital market solutions for for providers. So if you looked at the universe of bar of borrowers that mostly would you know, that that would be failing to themselves of that, they would be ones that would have been BSL borrowers previously, you know, not mid cap borrowers. And so the origination from those companies, they tend to be sort of large corporates or sponsors that are more diversified than middle market sponsors.

So more like Apollo than they would be the core sponsors we cover at MidCap in the basic way. So in that way, it's sort of an adjacent product offering. It's basically how do we make sure that we are able to offer sort of scaled solutions in the sort of, you know, lower BSL market, upper middle market. So stop there. Separately though, however, the coverage, you know, the origination of that of that product will be, you know, is is an Apollo effort

So it includes the origination resources that we have at MidCap and at Apollo sort of in our direct origination team, as well as sort of the originating we do and the relationships we have in the BSL market with issuers that are there now because we're of the biggest holders of those market. So, you know, the the sponsor origination of those transactions will be led by our team, you know, at and Apollo combined that, you know, that the end but but when they reach the size, you know, that they would have gone to the DSL market, they'll instead use this solution as opposed to sort of being funded primarily on MidCap's balance sheet, if that makes sense. From the BDC's perspective and the people on this call who aren't sort of as plugged into Apollo, generally, the BDC has has a a right to sort of take its portion of whatever transactions it it likes. It is less likely to do those transactions both because of yield and structure than than especially when it's it's, you know, only picking off the highest yielding, you know, stories, but that are that are, you know, asset secured, if you will, or, you know, or or first lien.

But but but that's not that's not definitive. They could do so. Does that still make sense?

Speaker 6

Yes. That's a lot of color. Thank you.

Speaker 4

And third, if

Speaker 6

I can do that. On the amendments, I think you said 23, have been done or in the works. Is this mostly, I assume these are mostly within the the core, you know, mid cap originated book, not nothing legacy. And just a question on any color you can provide. Are these companies tripping covenants?

If so, are they maintenance covenants on EBITDA? Or are they getting ahead of a covenant that they, you know, might trip later this year? Is it is it proactive or reactive? Any context you could provide there?

Speaker 2

Both. You know, it it depends, you know, it depends on the company. It it is generally you know, there is almost never a time where, you know, they trip a covenant. We we get, you know, we get their numbers and it's tripped. You know, they're gonna call in advance and we're gonna solve it.

In many cases, that tripping of the covenant or expectation is coming multiple quarters down the line, which is really what you're asking. So they're saying, okay. We're working through this over the next, you know, two, three quarters or whatever. You know, we wanna come up with a solution that we know, you know, enables us to work our way through it. And and so it has been it has been both.

As as Tanner said, you know, there's 23 and only only four of them were really sort of, you know, major. I don't know what we would call it. It would be would be sacred rights type amendments. So they tend to be like, you know, yes, you know, covenant covenant relief of, like, that's anticipatory or even something, you know, more, you know, more innocuous than that. So, Tanner, I don't know.

Would you add on Yeah. That's spot on.

Speaker 3

And and then, Tanner, we're very sensitive not to be subjective in the aggregating of data. And so a much smaller subset of that 23 would actually even be more benign as in certain of the borrowers that had access to the PPP program and would need relief there. And so we didn't want to we didn't obviously want to cherry pick and give a more comprehensive proposal. But other that comment, I would echo or corroborate as Howard described.

Speaker 6

Okay. Thank you, everybody.

Speaker 0

Our next question comes from the line of Ryan Lynch of KBW.

Speaker 2

Hey, good afternoon and thanks for taking my questions. Just had a follow-up question on the supplemental dividend. I just wanted clarify that that supplemental dividend is expected to oscillate on on a quarter by quarter basis as well as your expectation is that, that will not necessarily 100% payout net operating earnings, that there will actually be a supplemental dividend that will actually probably come under net operating earnings, and you will actually use some to to build up book value. Is that correct? Yes.

Okay. And then as far as your guys' right side of your your balance sheet, your capital position today,

Speaker 4

I've been a little

Speaker 2

bit surprised that you guys haven't made any material changes really to the right side of your balance sheet as you you we've we've entered into this this downturn. Do you foresee the the need to to to make any meaningful changes to to to the right side of your balance sheet? Or are you pretty happy with with how it sits today, you know, managing through this downturn? Greg, you wanna go first?

Speaker 4

Yeah. I and I think, Ron, I mean, I think we continue to look at it. And, you know, you know, when one, I think it was really important for us to, you know, update our crawl rating, which we were able to accomplish in July. And also create our own liquidity, you know, within the portfolio. And I think our next step will be to, you know, look at maturities.

One of the things we haven't wanted to do was ladder another five year maturity on top of the five year maturity we have with the three fifties. So we are, you know, looking at that on from a ladder point of view. And on then, we're also looking at spreads. You know, we know that there's been, you know, over a billion eight issued. And so we are looking at, you know, our cost of capital overall.

So I think it's something we continue to look at and may or may not act in the next few quarters.

Speaker 2

But I will say, Ryan, we do feel like our funding situation is stable. We have ample liquidity. Relations with the banks. We sort of shown them our capabilities of sort of operating in this environment. And so our decision on what to do is going to be driven by opportunity as opposed to sort of, you know, a real immediate need, which I think is helpful because some of the things that were done immediately by some people were fairly costly.

And so I would, you know, as Greg said, we'll continue to evaluate it. We, you know, we would expect to sort of, you know, diversify and make some choices over the next couple quarters, but we wanna do it in the in sort of a you know, at the time of our choosing because we think that will be much more, you know, cost effective. Okay. Got it. Howard, in your prepared remarks, you you you kinda commented on and said your corporate lending portfolio, continues to perform pretty well.

My question is, if you look at slide number 16, you guys had about a 7%, you know, increase per share in your corporate lending portfolio write ups in the quarter. When you compare that to the $0.97 decline in that same category, the corporate lending portfolio in your prior quarter, I was a little bit surprised given the recovery loan prices, tighter credit spreads. We've seen several other BDCs, your market portfolio is up a bit higher given just improving market conditions. So can you comment on why your portfolio didn't really seem to recover very much of the big decline? I'm talking about specifically your corporate lending portfolio.

Yeah. Well, I think first of all, think last quarter as a percentage basis, we didn't we didn't go down quite as much. So our sort of our pickup would would not have been quite as much from, you know, like, a on sort of on a gross basis. You know, I think I you know? So I think that's the first thing.

And I think I think the second thing is that, you know, we, you know, frankly probably have a little bit more pent up upside than some of some of the other people who reported have, down the road. I mean, I think we have our approach to this has been to to make sure that the valuations are driven by fundamentals as well as sort of the market flows because that's more relevant. So the recovery of a lot of these companies happens over the course of June and July. And so we were not as forward looking as maybe I think some of our competitors might have been. Okay.

Understood. I appreciate the time this evening.

Speaker 0

Our next question comes from the line of Matt Jaden of Raymond James.

Speaker 6

Just

Speaker 4

a quick one on Merx, if I can. That new $5,000,000 interest expense, was Merx able to cover that through cash flow? And then as a follow-up to that, if not, is there any risk of that toggling the PIK? Thanks.

Speaker 3

Yes, sure. Thanks for the question. So a couple of notes here. The first would be, and I alluded to this in my prepared remarks, The experience in July as a number of the previously agreed to deferrals were expiring has been above our expectations. But we caution everyone that there's still more deferrals to expire and many of those lessees ultimately come back online will have a lot to do over the next three to six months with where things correct or how air traffic recovers.

And so we endeavored in that $5,000,000 appreciating that there might be a need for capital at some point in the future as it's path dependent to reflect a more steady state, supportable earnings number. It's not our expectation right now that it would go pick. But I would imagine as you can probably well appreciate, it will be a little bit path dependent. And again to stress, while we don't want to extrapolate too far, the early experience with lessees coming back online has been positive and exceeded expectations. And really two sources of strength there, again alluded to this in our in my prepared remarks, but the amount of government funding, particularly in The U.

S. Has helped buoy lessees and their cash flow profiles. And then also in China and Asia more broadly, things are close to ninety percent of pre COVID levels and the cash flows associated with lessees, the leases to those particular counterparties have held up really well and would expect to buttress earnings going forward. And so those are the drivers for the outperformance to date. But again, distress will be path dependent.

Speaker 4

That's it for me. Appreciate the color.

Speaker 0

And that was our final question. I'd like to turn the floor back over to mister Howard Midra for any additional or closing remarks.

Speaker 2

Thank you, and thanks for everybody for listening to today's call. You know, we we all thank you for your continued support and interest in this environment. And obviously, please feel free to reach out and call any of us if you have any other questions. We hope everybody stays healthy and safe. Have a good day.

Bye.

Speaker 0

Thank you, ladies and gentlemen. This does conclude today's conference call. You may now disconnect.