Apollo Investment's (AINV) CEO Jim Zelter on Q4 2016 Results - Earnings Call Transcript

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Apollo Investment Corporation (NASDAQ:AINV)

Q4 2016 Earnings Conference Call

May 19, 2016 10:00 ET

Executives

Elizabeth Besen - Investor Relations Manager

Jim Zelter - Chief Executive Officer

Ted Goldthorpe - President and Chief Investment Officer

Greg Hunt - Chief Financial Officer

Analysts

Rick Shane - JPMorgan

Jonathan Bock - Wells Fargo

Ryan Lynch - KBW

Leslie Vandegrift - Raymond James

Doug Mewhirter - SunTrust

Christopher Testa - National Securities

Derek Hewett - Bank of America-Merrill Lynch

Kyle Joseph - Jefferies

Operator

Good morning and welcome to Apollo Investment Corporation’s Earnings Conference Call for the period ended March 31, 2016. [Operator Instructions] I will now turn the call over to Elizabeth Besen, Investor Relations Manager for Apollo Investment Corporation.

Elizabeth Besen

Thank you, operator and thank you everyone for joining us today. With me are Jim Zelter, Chief Executive Officer; Ted Goldthorpe, President and Chief Investment Officer; and Greg Hunt, Chief Financial Officer.

I would 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 to strictly prohibited. Information about the audio replay of the call is available in our earnings press release. I would 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 company. You should refer to our registration statement and shareholder reports for risks that apply to our business and that 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 would 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 would like to turn the call over to Jim Zelter.

Jim Zelter

Thank you, Elizabeth. This morning, we reported results for the quarter and the year ended March 31, 2016 and filed our Form 10-K. I will begin my remarks with some comments about market conditions, followed by a brief overview of our results. I will then discuss some additional recent business highlights. Next, Ted will review our investment activities for the quarter, including an update on some of our energy investments. Then Greg will go through some of our financial results in greater detail. We will then open the call to questions.

Beginning with market conditions, negative sentiment from the December quarter continued during the first half of the March quarter as volatility persisted in the high yield and the leveraged loan markets. The credit markets were negatively impacted by renewed concerns about overall global growth and further declines in the price of oil. That volatility pushed investors to the sidelines and forced most investors to build liquidity by selling higher quality credit names, which put downward pressure on secondary prices and cause the primary market to slow considerably. That said beginning in mid-February the credit markets began a sharp recovery essentially erasing the early quarter losses. Yields were volatile and higher intra-quarter, but were little changed quarter-over-quarter end. The recovery was attributable to moderate new issue activity and fund flows, especially from mutual funds turning positive in March. These factors allowed prices to recover and the new issue clearing spreads tightened on quality names. Similar to the syndicated markets, middle-market activity was muted during the quarter as volatility hampered new business across the board.

Moving to our results for the quarter and fiscal year, we reported net investment income of $0.20 and $0.83 per share respectively. Net asset value declined $0.28 or 3.7% to $7.28 per share during the quarter largely driven by losses on our oil and gas investments as well as credit driven markdowns on a handful of legacy investments. Oil and gas, legacy and commodities accounted for $0.22 of our $0.28 decline. There was also a $0.02 per share accretive impact to NAV from stock buybacks partially offsetting that decline.

Regarding our oil and gas exposure, we continue to closely monitor our investments and work with our portfolio companies. We continue to focus on reducing our exposure at attractive values when possible and on maximizing recovery for shareholders. We will continue to be proactive with respect to potential restructurings or future funding requirements in our portfolio. In many instances as Ted mentioned, we are the lead lender and are in a position to drive outcomes that will maximize long-term value. Ted will provide more detail on some of our oil and gas investments in his remarks.

Moving on to stock buybacks, we continue to execute on our share repurchase program during the quarter although we repurchased less stock in the March quarter than in the prior quarter. In addition to stock price, we consider other factors when we allocate capital to our buyback program. These other factors include our leverage, our liquidity and the ability of attractive investment opportunities. As always, we continue to evaluate the most prudent use of capital for our shareholders. At this time, we intend to continue to have a balanced approach by both repurchasing stock as well as making select new investments. Greg will provide more detail in his remarks regarding our share repurchase activity.

Moving to other business highlights, we are pleased to report that Apollo Investment recently received co-investment exemptive relief from the SEC. This relief provides Apollo Investment the ability to participate in negotiated joint transactions with other funds managed by Apollo. We believe this ability will provide BDC shareholders with access to a broader array of investment opportunities. We will be able to participate in larger transactions, which means Apollo Investment along with other Apollo funds will more frequently be a lead lender and in a position to drive outcomes. We look forward to providing you with updates on our co-investment activity going forward.

Next, in March, we announced that our investment advisor in consultation with our board agreed to reduce fees for fiscal year 2017. The base management fee has been reduced to 1.5% and the calculation of the incentive fee will include a performance adjustment that could lower the incentive fee to as low as 50% ongoing. Greg will provide greater detail on this calculation in his remarks.

Additionally, AGM has embarked on a program to purchase up to $50 million of Apollo Investment common stock in open market transactions. AGM currently owns 8.6 million shares or 3.8% of outstanding shares. We believe these modifications to the fee structure combined with the investment being made by Apollo, our parent, significantly improved the alignment of interest between the manager and our shareholders. Moving to our dividend, the board approved a $0.20 dividend for shareholders of record as of June 21, 2016.

I will now turn the call over to Ted.

Ted Goldthorpe

Thank you, Jim. I will begin with our investment activity for the quarter and I will provide an update on several of our core oil and gas positions. Amid the market volatility that Jim mentioned, our origination activity was relatively modest as we invested $179 million in 4 new portfolio companies and 12 existing companies. We continue to focus on secured debt opportunities, which accounted for 76% of investments made during the period. The weighted average yield on investments made during the quarter was 11.2%.

During the period, we exited $265 million of investments, of which 72% were proactive sales and the remaining balance is repayments and revolver pay-downs. The yield on debt investments sold was 10.5% and the yield on debt repayments was 9.6%. During the quarter, we exited our investments in Hunt Companies, [indiscernible] amongst others. Partial sales for the quarter include our investments in Magnetation, Deep Gulf, Asurion among others. Repayments for the quarter totaled $75 million, which includes a full repayment of Gencorp and the partial repayment of our investments in Golden Bear and Merx Aviation.

Moving to specific investment activity, beginning with corporate originations, we invested $29 million in the first lien debt of LabVantage Solutions. LabVantage Solutions offers web-based laboratory information management solutions. We also invested $20 million in second lien of Sterling Holdings to support an acquisition. Sterling is a leading technology enabled provider of comprehensive employment and background screening services. We also invested $10 million in second lien debt of GCA Services Group, an existing portfolio company. Regarding both Sterling and GCA, our scale enabled us to commit larger amounts to these transactions and generate upfront fees.

Moving to our specialty verticals and beginning with renewable energy, we invested $35 million during the period, including $20 million in Solarplicity. Renewable energy accounted for 8.7% of the overall portfolio at the end of the quarter, up from 7.7% last quarter. As intended, Solarplicity has constructed its portfolio on an un-levered basis, resulting in our current exposure. With requisite portfolio scale the company was able to secure financing, which we use to decrease our exposure over time.

Moving to aircraft, we increased our investment in Merx Aviation by $28 million during the quarter. In addition, Merx paid a $2.4 million dividend during the quarter. The net increase in our investment primarily related to purchases of some aircraft. At the end of March, Merx represented 17% of the portfolio, up from 15.2% last quarter. Although Merx Aviation is our largest portfolio company, our investment is very well diversified. At the end of March, Merx owned 75 aircrafts consisting of 12 aircraft types on lease to 35 different carriers in 18 countries. The weighted average life of the portfolio is 7.5 years and the weighted average lease maturity is 4.5 years. Since inception in 2012, Merx has acquired 87 aircrafts for its own fleet. We expect Merx to continually optimize its portfolio and opportunistically sell aircraft as well as seek new investment opportunities.

And energy exposure continues to important topic of interest, I will now discuss some of our investment in this sector. We continue to work closely with the management teams at each of our portfolio companies. As we said before, our portfolio is diversified by borrower geography and our investments are generally structured with strong legal documents, which provide us with significant protections. We believe our markets reflect the underlying fundamentals of each borrower and the stress in the industry. We continue to focus on reducing oil and gas exposure and maximizing recoveries. Oil and gas represented 11.9% of our portfolio or $347 million at the end of March, down from 12.9% or $395 million at the end of December on a fair value basis. The decline was due to the partial sale of our investment in Deep Gulf to a party, as well as fair value adjustments. At the end of March, our portfolio had seven core borrowers. And I will now provide updates on some of these investments.

Beginning with Deep Gulf, an E&P company with assets located in the Gulf of Mexico, as I mentioned during the quarter we sold half our $50 million first lien investment to a third-party at a price consistent with our marks. We are pleased with this monetization, particularly given the challenging market environment. The company has no liquidity issues for the foreseeable future. Miller Energy successfully emerged from bankruptcy in late March. As part of the restructuring, our second lien term loan was replaced with $25 million of second lien debt in addition to new equity in the company. We also provided a $10 million delayed draw of first lien loan. We along with other investor control the vast majority of the equity of the company and the reorganization substantially reduced the company’s debt and provided it with its streamline cost structure and appropriate capital structure. The company continues to reduce G&A, conserve cash and defer projects. Our pre-conditioned second lien is no longer on non-accrual status.

On Pelican Energy, an entity financing participation in certain wells of Chesapeake Energy, this company’s assets are more tied to gas, which represents 75% of production. We have a $28 million first lien investment marked at 65% of cost. The decline in value during the quarter is a result of lower oil and gas prices combined with production rolling off. Pelican may pick interest going forward to preserve liquidity and given the liquidity and lower net asset value, the risk rate in this investment was lowered to five and placed on non-accrual.

Moving to Osage Exploration, an E&P company with assets in Oklahoma, at the end of March with a $25 million first lien investment marked at 22% of cost. As mentioned in the last quarter’s call, the company filed a negotiated bankruptcy in February. The company completed an auction process in mid-April and our valuation is consistent with the net proceeds that we expect to receive from this process.

Moving to Spotted Hawk, an E&P company with four Bakken assets, with $84 million first lien investment marked at 76% of cost, the risk rate on this investment is downgraded from 3 to 4 [ph] and the investment was placed on non-accrual in the quarter. Despite being a core of the good basin, having good drilling results and taking steps to preserve cash, the company’s liquidity remains constrained. We believe the company may go through restructuring in the near term. And lastly, moving to Venoco, an E&P company with assets located in Southern California, the company filed the prearranged bankruptcy in mid-March after entering into a restructuring support agreement. The reorganization plan contemplates that the secured creditors will take the majority interest in the company, exchange for debt forgiveness. We provided $35 million delayed draw debt that will likely remain unfunded given the company’s cash position. At the end of the quarter, we had $41 million of first lien marked at 87% of cost and a $48 million second lien marked at 43% of cost. The risk rating of the first lien remained at 3 and the second lien was downgraded from 4 to 5 and placed on non-accrual status. We expect the company to emerge from bankruptcy in the late summer or early fall.

To summarize four of our oil and gas positions are on non-accrual status at the end of March. Since then, as mentioned the auction process for Osage has been completed. In addition, Miller recently emerged from bankruptcy and is no longer a non-accrual and was successfully sold with half of our investment in Deep Gulf to a third-party during the quarter. We believe our remaining core positions, Canacol, Deep Gulf and Extraction are performing in line. Extraction continues to raise junior capital and raised $93 million of equity in April. Canacol, whose assets are primarily gas related is benefiting from higher cash flows from newer gas contracts with local power plants. In addition, our $25 million unfunded commitment to Canacol expired in April. We do not currently anticipate any additional capital requirements or restructurings for any of these companies.

Outside of energy, we also placed our unsecured debt investment in Delta Education in non-accrual status. As a reminder, Delta is a for profit education company, an industry that is expressing significant headwinds. At the end of March, we had eight investments on non-accrual status across six different portfolio companies. Investments on non-accrual represented 4.2% of the fair value of the portfolio and 8.4% on cost basis compared to 2.5% and 6%, respectively at the end of December. The portfolio’s weighted average risk rating on a cost basis remained at 2.4, on a fair value basis remained at 2.2 consistent with the end of December. The current weighted average net leverage of our investments is 5.4x down from 5.5x and our current weighted average interest coverage remains at 2.7x.

With that, I will turn the call over to Greg, who will discuss the financial performance for the quarter.

Greg Hunt

Thank you, Ted. Total investment income for the quarter was $85.3 million, down 9.5% quarter-over-quarter and down 16.4% year-over-year. The decline quarter-over-quarter was primarily attributable to a lower asset base, an increase in investments on non-accrual partially offset by higher fee income. Fee and prepayment income was $4.5 million in quarter compared to $1.1 million in the December quarter and $7.8 million in the year ago quarter. Dividend income for the quarter was $11.4 million, down $6.9 million quarter-over-quarter due to – due in part to the repayment of our investment in Golden Hill, the conversion of our investment in Solarplicity from preferred to secured debt as well as lower dividend income from our Dynamic Product Tankers and Merx Aviation investments.

As we indicated in the past, our quarterly dividend run rate should approximate $10 million to $11 million. Expenses for the March quarter totaled $40.7 million, compared to $46.2 million last quarter and $50 million for the same period a year ago. The sequential decrease was due to lower incentive fee associated with the decreased level of invested income, lower management fee associated with the decrease in the average portfolio, a decrease in interest expense primarily associated with the maturity of our $200 million of convertible notes, which was repaid with funds from our credit facility and lower G&A. Repayment of the convertible notes help to reduce our weighted average interest rate to 4.4% compared to 4.7% at the end of the December quarter. As Jim mentioned, the investment advisor has agreed to waive a portion of its management fee, management incentive fee so that during the fiscal year 2017, the management fee has been reduced to 1.5% and incentive fee has a minimum rate of 15%, to the extent the company experiences cumulative net realized and unrealized losses during the period. Please prefer to the related party section within our 10-K.

Net investment income was $44.6 million or $0.20 per share for the quarter. This compares to $48.1 million or $0.21 per share for the December quarter and $52.1 million or $0.22 per share for the year ago quarter. For the quarter, the net loss on the portfolio totaled $68 million or $0.30 per share compared to a net loss of $74 million or $0.32 a share for the December quarter and a net loss of $64 million or $0.27 per share for the year ago quarter. The net loss of $68 million includes $75 million of realized losses of which $68 million has previously been recorded as unrealized loss.

As Jim mentioned, the primary contributors to the NAV decline were associated with our energy and certain legacy investments and included valuation adjustments to our Miller Energy, Venoco and Spotted Hawk investments and certain legacy names such as Garden Fresh, Delta and SquareTwo. In total, our quarterly operating results decreased net assets by $23 million or $0.10 per share compared to a decrease of $26 million or $0.11 per share for the December quarter and a decrease of $12 million of $0.05 per share for the year ago quarter. At the end of March, our portfolio had a fair value of $2.9 billion and consisted of 89 companies across 25 industries. The weighted average yield on the portfolio at cost was 11%, down 40 basis points quarter-over-quarter. The decrease in the overall yield was primarily due to the placement of higher yielding investments on non-accrual.

On the liability side of our balance sheet, we had $1.3 billion of debt outstanding at the end of the quarter. As I mentioned in January, we repaid $200 million of 5.75% convertible notes upon their maturity. We used borrowings under our revolving credit facility to repay these notes. The repayment of its higher cost debt benefited earnings during the period. The company’s net leverage, which includes the impact of cash and unsettled transactions stood at 0.76x at the end of March unchanged from December.

Stepping into quarter end, we were aware of a few near-term repayments. For example, it was recently announced the Generation Brands was being purchased by a middle-market sponsor. At the end of March, our investment in Generation Brands had an aggregate fair value of $67 million. During the March quarter, we also repurchased 2 million shares or $10 million of our common equity. Since commencing our repurchase program in August, we have repurchased 10.6 million shares or 4.5% of our shares outstanding for a total cost of $62.4 million. And it leaves us $38 million remaining for the future – for future purchases under the current board authorization. This concludes our remarks.

Operator, please open the call for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question comes from the line of Rick Shane of JPMorgan.

Rick Shane

Guys, good morning and thanks for taking my questions. I think the interesting thing here is to tick up and leverage at the end of the quarter. And Greg, you may have addressed this in terms of the Generation Brands exit, but the leverage is pretty high at this point, and I do wonder given that if you are going to continue to buyback shares? And I am also wondering just from a fiduciary perspective right now given stocks trading at about 27% discount to NAV, does it make sense to accelerate the sales of assets within the portfolio, take the leverage down and actually start to turn this into a little bit of cash?

Greg Hunt

Yes. I think Rick, you hit right on the point. We came into the end of the quarter. We have a very good visibility as to the activity coming into the first quarter. And therefore, our leverage was somewhat higher than normal and we would expect that to come down in this quarter.

Rick Shane

Hey, Greg. And given the volatility on the Merx and look you guys have a unique – not unique to BDCs, but BDCs have unique quality, which is that the fair value Merx, mean that your leverage can move around despite repayments or investment activity in a way that a lot of financial institutions don’t experience that. Given the environment we are in right now does it makes sense to run at a lower leverage and what do you think the right leverage is in this environment?

Greg Hunt

Yes. I think as we have been working with our board and looking kind of at the composition of our portfolio, I would say that probably the mid-6s is probably a goal that we are – we will move to in the next few quarters.

Rick Shane

Great. Hey, Greg. Thank you for the questions. Thank you everybody.

Greg Hunt

Thank you.

Operator

Our next question comes from line of Jonathan Bock of Wells Fargo.

Jonathan Bock

Good afternoon or excuse me good morning and thank you for taking my questions. Starting first, Jim, as we look at the BDC space, we actually saw one BDC in particular take a proactive move and reduce the dividend as it relates to the fact that the returns that are being offered in the market, senior secured, mezzanine or otherwise are certainly lower than what you have experienced in the past and so we don’t want to – we don’t want to reach for income or for yield and possibly put a bad asset on the books. And I have seen consistency of 11% kind of yields coming off both your secured and unsecured portfolio and when I think about that plus the prospects for just getting a bit more difficult to-date. I am curious if you would still peg the forward returns of around 11% as on investment yields as sustainable going forward, because even with those yields today, we are just at the dividend?

Jim Zelter

Yes. Let me sort of tie that question with – make sure that the question before was answered in clarity. So as Greg mentioned, we came in the quarter a little bit higher leverage, but we had a very visible forward view on prepayments and sales that would occur. So, we feel comfortable we are at a lower level of leverage and we ended the quarter. So, let’s put that out there. To your question, it really gets to the yield issue and the earnings power certainly like we take a long-term view of our dividend and we said it several years ago and the market was focused on the ability to have your NII and have your NII cover your dividend, we had been focused on that and did so well for quite some time. Certainly, in the last handful of quarters, there has been NAV volatility and as we have really focused on trying to get NAV stability, there is going to be an impact over time with how we want to deal with forward investments, we don’t want to reach in an effort to have NAV stability we don’t want to have to reach. So, certainly, we are very aware of that not to your specific question with the yields on our portfolio 11%, we have been able to do so, but certainly we are making sure that we, as our goal of having NAV stability comes more into focus going forward. I think that we are going to – we are going to not to – we are not going to reach to make that dividend. And as a result, some assets maybe booked at lower yields, which again we don’t want to look at it quarter-to-quarter, we want to look at over a longer period of time. So, certainly, I think your question stems from very good insight in how these businesses are managed and we respected a little bit quieter on the front end this past quarter. We do think that the exemptive order that we have just achieved – just received, excuse me, is quite unique in the industry. And now the onus is on us collectively to be able to show evidence of us being able to exercise that for the benefit of our shareholders. But certainly you are right, as I said before, we were always very focused on our dividend in terms of the NII which is what the industry was focused on, but we realized in a more volatile NAV environment, we might need to be – have a second look at that and we don’t want to reach if that’s what the yields that are being demanded from our shareholders.

Jonathan Bock

And look we maybe say, we always appreciate taking a proactive look is absolutely the right thing to do and people should be kind of applauded for it. And so kind of in light of that maybe an additional question, so clearly the BDC space in general trades off as a result of hawkish comments. And Greg, I know we have got about of $150 million of CLO equity structured product stuff on the balance sheet that can – whose return can be hampered to the extent the LIBOR curve or short end LIBOR rises. So how do we think about distributable income and cash coming off that portfolio and modeled CLO equity returns, as well as modeled I would say earnings power of the business as the short end of the curve increases and pinches our spreads a little bit, because we are still well under the floor on your revolver, I believe as well as owning a little bit of CLO equity that levered of 10x of 50 basis point moving your cost of fund is a big deal.

Jim Zelter

I know you asked that question to Greg, Jonathan. But let me just answer one – let me say one thing first. There is structured credit and there is CLO equity. We have a portion in structured credit which Greg will go through are – will all be syndicated CLO equity is actually a very small portion. But let me have Greg – I would differentiate obviously, we think we are a market leader in terms of how we mark these products. But certainly, Greg can talk about the impact to earnings from what we own today.

Greg Hunt

Yes. So Jonathan, I think you are very well aware of that when we look at our CLO equity, we have about $100 million, middle market CLO equity that primarily makes it up. Those had been marked obviously, volatility in the marketplace and we looked at certain of these variables have widened in that and then they are all marked by third-party evaluation firm. With regard to the earnings off of those, I would say to you that we leveled yields so that we are very comfortable with the earnings power that we see quarter-over-quarter. And so that – I think we are comfortable with where we are with that and including that within our $10 million to $11 million of the dividend income in the quarter. The remainder are really the rate cap trades, which I think we have taken you through which are very senior loans although they are the equity conditions first look. Again there was performance, underlying portfolios all perform very well given the underlying credits.

Jonathan Bock

Got it. And I would assume the credit link notes are fairly I mean that’s a fairly similar to the point, where there is leverage, but still at the end of the day, you model the forward curve, the forward curve likely have that incorporated. Okay. Then two more and I greatly appreciate it. Jim, the fee waiver greatly appreciated certainly kind of as a lot of folks are going to see just a step that folks should certainly take notice of and respect and the question was just, I know we also – there is an offer of the Scion management fee that goes and reduces the all-in fees paid by Apollo, being a non-traded BDC that’s managed by the general Apollo franchise. And I am curious, if the Scion fee contribution to the lower fee of Apollo, excuse me, for the very poorly worded sentence, if that still continues post the base fee reduction as well as the incentive fee reduction as well?

Jim Zelter

No, for just for just clarity and it’s really well laid out in our public documents and Greg answer as well. But we really wanted to wipe the slate clean of some of the historic waivers we had done on equity deals. We wanted to wipe the slate clean on the Scion. So in an effort to do so, we think we put together an interesting structure, our Board embraced it. And so the answer to your question is the previous waiver of our all are put to the side, the Board, which we set to this new 1.5 and then the various incentives based on our overall performance.

Jonathan Bock

Okay. And then the last question just relates to Venoco, so clearly see the first lien at 80 and the second lien at 58, Ted. As we look at just general reports across the space, can you tell us your confidence level in receiving a 58 recovery on that asset in light of the fact there may be other points to say that recovery on that loan maybe something less, is there something that perhaps we are missing or the market is missing that allows a second lien market that level to-date?

Jim Zelter

Yes. So what I would say is, we are seeing from the second lien market, I think the second lien was actually much a little lower than what you just kept in that. So I would say on Venoco, I would say they have a very large asset that is a big contributor to value that may or may not happen. And so the valuation of Venoco specifically vis-à-vis everything else we do is probably more variable what I am saying, because the future prospects for the company had more upside and more downside dependent on one large asset that’s subject to regulatory approval. And so that’s why when you see a first lien, I am assuming the question is if the first lien is marked at 80, why is second lien marked so high? And the answer is, if you look at the future outcomes for the business, there is a whole bunch of scenarios where there is value for the second liens and there are also scenarios where the second lien is impaired.

Greg Hunt

And so it’s a little bit of a one-off vis-à-vis everything else, because so much – there is so much future values depending on approvals, future lease rates and that’s why the numbers might look a little bit strange to you.

Jonathan Bock

Got it. And then I just...

Greg Hunt

A good question, that was a good question.

Jonathan Bock

The only other one and just because we are closer to the line on the dividend, but also appreciate as you guys work it out, there is always upside opportunity. But so if we think about Garden Fresh going from $36 million to $25 million or kind of 83 marked, some of that in the 50s, what’s driving that decline and how do we feel about that name – that name and that’s ability to remain on accrual status? And thank you for taking my questions.

Jim Zelter

Yes. I mean, that means definitely at risk, it’s a highly levered restaurant company that was originated 10 years ago. And we are at the bottom of capital structure. So small changes in the company’s performance leads to changes in valuations, because again there is mezzanine piece of paper. So I would say we can’t assure you it’s going to remain on accrual status going forward. And we also – and also we think that there is definite risk to getting back our principal on this investment. It’s a long-term – again, we have had it for long time companies doing, okay. But again, we are at the bottom of the capital structure in the restaurants, valuations are very, very sensitive to small changes in the company performance.

Jonathan Bock

Got it. Guys, thank you.

Jim Zelter

Thanks Jonathan.

Operator

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

Ryan Lynch

Good morning. First question is just on the fee reduction, it definitely simplifies your guys fee structure and I think it gives you guys all the credit for some of the previous fee waivers you guys have been – previously you have been waiting and in some of the previous years. But this fee reduction it’s only been put in place for 1 year or so, my question is this kind of creates a little bit of uncertainty because this fee waiver, I guess the fee reduction down to 0.5% and it’s only temporary so why not make this fee reduction permanent or extend the fee waiver just to give the markets some more clarity about future earnings past March of 2017?

Jim Zelter

We have had this question in the past, I think our Board views that because of the contracts or 1-year rolling contracts that’s how they chosen to deal with it. Certainly, we are very aware of how the market would react, if we were to reverse the trend that we have been taking so far. So again I think that we are some folks have all also pointed out that why don’t you make these things permanent. I think we are comfortable with the trend that we have shown over the last several years and continue to lean into doing what’s right by shareholders with regard to this theme. And I think that any reversal of that theme, we would be punished if we did so. So I understand the question, but that’s how our Board has chosen to deal with these types of issues on the vehicles.

Ryan Lynch

Okay, that makes sense. And it’s good to hear where your guys thoughts are as far as that going forward and so technically 1-year waiver. And then just one on Merx Aviation, I mean that’s been growing pretty consistently over the last several quarters, now sits about 17% of your portfolio, so what is your outlook on growth in that business, I mean is it like 17% of your portfolio is hitting kind of an upper limit or do you guys see that investment expanding going forward?

Jim Zelter

Let me give you an overview and I will pass along to Ted for details, but yes, I think you characterized it properly. We always had mid to high-teens. I think we feel very comfortable about the portfolio like we have done in diversified manner. But also as we have been prudent about the rest of our portfolio and it has shrunk, the result of Merx has kicked up a little bit, but I think you characterized it properly in terms of the overall high side of where we are right now.

Ryan Lynch

Okay. And then just one last one, yes one more last one, I don’t know if you guys mentioned this, but other income had a pretty big jump in this quarter. Can you just give any drivers of what drove that increase?

Jim Zelter

I think, as Ted mentioned, there were – when you look at certain of our investments, you see a Sterling, they were larger facilities than we were able to take down and then syndicate out and we earned fees on those.

Ryan Lynch

Okay, that’s all the questions for me. Thanks, guys.

Operator

Our next question comes from the line of Leslie Vandegrift of Raymond James.

Leslie Vandegrift

Hi, good morning. Most of my questions have already been answered this morning. But I have just got a quick one on the purchase program by Apollo Global. I know that we are probably going to shift focus away from repurchase program for a little while at least what you guys talking about leverage coming down this quarter, but what’s the timeline for the use of that $50 million program?

Jim Zelter

Well, I think that we operated those two programs in concert as required by securities regulators and we did so in this quarter. And I think that we want to be a – we want to be a prudent purchaser of our stock. So, I think that, that program like as you said I think we are trying to balance from the company’s perspective doing the appropriate balance sheet management with regard to purchasing stock. But I think that Apollo certainly does – would like to increase exposure and will do so. I don’t want to put a strict timeline on it. But I think there was certainly an expectation that we would in time exercise that ability to purchase the stock is laid out for the program. So, I think we will have obviously certainly more information in the next quarter.

Leslie Vandegrift

Okay. And then my last question then would just be on the new – your new right to co-invest with other Apollo Global and other Apollo managed funds. Have you seen much come through this quarter in the pipeline then interests you already? Is this something that we are going to see slowly ramp over the next few or something we are going to see really hit this quarter?

Jim Zelter

Yes. I mean I think we just got approval for it. And as part of the approval process, there is a lot of controls and procedures we had to put in place and get approval from our board as well. So, I don’t think you are going to see a very large impact in the June quarter, but I think you will see a very large impact on a go forward basis. We have reorganized our whole business to have integrated front ends that includes a finance company we bought a couple of years ago that has grown materially and is very, very well run. So, this allows us now to with banks pulling bank in the leveraged finance markets as opposed to AINV only being able to commit $50 million, $75 million to transaction. Now, as a firm we can commit to much larger transactions while keeping concentrations lower than AINV. So, this has been a lot of work by our General Counsel over a long period of time. And I think it’s a big, big, big advantage for us on a go forward basis, but I don’t think you are going to see a lot of material impacts in the June quarter.

Leslie Vandegrift

Okay, perfect. Thank you, guys.

Operator

Our next question comes from the line of Doug Mewhirter of SunTrust.

Doug Mewhirter

Hi, good morning. Just a couple of questions on some investments. First SquareTwo has been marked down for a while now I think you may have even taken additional mark. I know that there are larger publicly traded competitors have also hit some turbulence, which implies some softness in the industry. I guess what are the general, but it still looks like it’s still on accrual, so does it look like your last update is like there is any kind of sign of conditions turning around, what are your expectations for that investment and so forth?

Jim Zelter

Yes. So, they have publicly announced an exchange offer, which you can look at publicly, whereby the bonds, the bonds will be converted into a new package of securities. So, this will kind of de-lever the balance and give the company and clean up at least the liability side of company. I would say we really haven’t seen on big pickup on the actual day-to-day business side of the company. I think, these guys have a very, very good mousetrap. But again just given some of the CPB headwinds, I think they continue to – I don’t think you have seen a material change good or bad in their business prospects since we updated people last quarter.

Doug Mewhirter

Okay, thanks. Shifting over to the energy side, the energy transportation side, there has been obviously a lot of movement in both the product markets and the oil markets, especially with regards to the big oil producing powers like Iran and Saudi Arabia and in the U.S. and how has that affected your tanker business? Has that boosted it? Is it more challenging now? How are those investments going?

Jim Zelter

Yes. I mean, they continue to perform very, very well. So, remember most of our portfolio is contracted. So, we don’t – we are not impacted by day-to-day changes in day rates and other things. And our contracts that we have are well below where current market rates are, but our counterparties are people like Shell and British Petroleum very, very high quality. And obviously, the benefit of low oil prices has been increased demands. And so obviously, there has been more demand for these tankers to ship oil around the world. And the way more and more of the product has been refined now in Middle East which requires longer shipping distances. So, we continue to very good performance in the underlying portfolio. Again, I don’t think that this portfolio was not going to grow. If anything, it will shrink over time and we continue to keep you apprised of performance. But yes, most of it is contracted, so it’s not – again, if day rates go up materially, because of all these factors, we don’t really benefit that much from that.

Doug Mewhirter

Okay, thanks. That’s all my questions.

Operator

Our next question comes from the line of Christopher Testa of National Securities.

Christopher Testa

Hey, good morning guys. Thanks for taking my questions. Just the convertible note maturing and being retired, are you looking to replace that with another issue of fixed rate debt or are you more comfortable having the revolver as sort of a boost to our earnings?

Jim Zelter

Yes, I think currently we are comfortable with both the utilization of our revolver, which is probably about 50% utilized and then our mix of unsecured debt at the time it’s about 50:50 we are comfortable with that ratio.

Christopher Testa

Okay. And just thoughts on energy going forward obviously, this has been a thorn in your side as many other BDCs as well. As these either our restructured or the performing ones are repaid. Are you looking to sort of shy away from more cyclical industries going forward or do you see this as a core part of your strategy regardless?

Jim Zelter

I think I will answer the question. I say, we don’t expect our oil and gas exposure to increase materially over the next couple of quarters. We think that portfolio will continue to decrease as things get monetized and everything else. I will say that we have had to restructure some of these companies roll forward 3 to 4 months and effectively the whole portfolio will be either restructured or in very good shape. So, I think from that perspective kind of the worse is behind us. And now, we have equity upside in a number of different companies. So, to the extent that oil prices recover which you have seen in the June quarter to the extent it continues obviously there maybe some benefit for our shareholders of this portfolio. But I don’t think we are exiting the energy business per se, but I think – I think you will see portfolio shrink rather than grow over the next couple of quarters unless there is a material increase in oil prices which reduce fair value.

Christopher Testa

Okay, got it. And just with the attachment points then hovering around 5.5x, is this something where you are comfortable being. I know that you have steadily increased senior secured exposure, should we expect this to tick down or should this kind of remain stubbornly high given where the marks are on the non-accruals. Just any color there is appreciated?

Jim Zelter

Yes. I would say in the December quarter and March quarter as you have heard from all other BDCs, activity levels are really, really, really from the lowest activity levels we’ve seen since 2009. We have seen a pick up like very materially, but I would say terms and spreads are still very wide today vis-à-vis where they were in the middle market, at least be where they were call it 12 months ago. So I think the attachment point will be reasonably stable, if not lower over time on new originations and our existing portfolio. Our existing portfolio company, you just strip out the energy names EBITDA and leverage being going down and EBITDA has been going up. So I wouldn’t expect to see a material uptake in total leverage on the overall portfolio.

Christopher Testa

Got it. And just with the exempt of relief you were granted, do you see this assisting your pricing going forward given that there is not as many as BDCs, the smaller ones that operate in the lower part of the middle market and now you are able to move more up-market, do you this having a beneficial impact on your pricing and if so how much benefit do you expect to receive from this?

Jim Zelter

I think it would preliminary to say, we have a view on specific pricing. I mean certainly what we believe we will be able to originate a broader higher quality product set, hopefully with better structure and better economics to us. But I think it would be premature to put an actual number on that at this point. Let us get a couple of quarters behind us and show you some evidence of that. And then we can give you more specifics in due course.

Christopher Testa

Okay, great. Thanks for taking my questions.

Operator

Our next question comes from the line of Derek Hewett of Bank of America-Merrill Lynch.

Derek Hewett

Good morning. And thank you for taking my question. With the stock trading at about roughly at 25% discount to NAV and the exemptive relief now presumably reduces the need for liquidity to surface clients going forward, what is preventing you from accelerating buybacks at this point or if not now given that you are going to do some selective de-leveraging in the back half of this year?

Jim Zelter

I am not sure – I mean I understand the question about buybacks, but I am not sure with exemptive order, what’s the comment about that?

Derek Hewett

Not needing as much liquidity to service new clients go forward, because you can co-invest with across the entire Apollo platform?

Jim Zelter

I think that we are showing the willingness to buyback stock as much as most of our peers and so we feel good that we have announced the program and had shown steady progress on it. As we alluded to early on the phone call, I think it’s just we are trying to be thoughtful about the overall leverage in the marketplace at a time like right now and we chose to operating a little bit lower leverage. So I think we are intrigued and excited and expect to have some more buybacks going forward in the coming quarters.

Greg Hunt

You are making a good point, which is for us to buyback stock is obviously very accretive and for AGM to buy stock is very good for shareholders. And so, if you look at our new origination activity, it’s been evidenced that we are much, much more discerning around new originations and new portfolio companies vis-à-vis buying back our stock. So, as Jim said, there is a huge trade-off between leverage and liquidity you have to be mindful of that. But given where our stock is trading I think we are still focused on executing the buyback program.

Derek Hewett

Okay, great. Thank you very much.

Operator

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

Kyle Joseph

Good morning guys. Thanks for taking my questions. Most of them have been asked and answered, but I just want to get a sense of yields in the markets you guys are seeing. I know you guys had yield compression, but I think that was mostly a result of some non-accrual additions and I know deal flow is light, but sort of give us your outlook for the core portfolio yield going forward?

Jim Zelter

Yes. I would say, you have to really break it down by vertical. So I would say in our sponsor origination business or direct origination business spreads are definitely wider. But as you know, if you breakdown our book by vertical some of the yields in the other asset classes are higher. So I would say market yields are wider, middle market yields are definitely wider, which is very good for our business. But again that’s typically on the lower end of yields of our portfolio. So we think there is spread widening, I think you will see that part of our business, I think you will see yields either increase or at least remain stable, but obviously as energy and other parts of our business shrink those are typically a higher yielding verticals.

Kyle Joseph

Got it. Thanks for answering my question.

Operator

And that was our final question. I would now like to turn the call back over to Jim Zelter, for any additional or closing remarks.

Jim Zelter

Well, as usual thank you for your focus and your questions on our company. We look forward to talking to you in the future or in the interim as appropriate. Thank you.

Operator

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

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