Saratoga Investment Corp (SAR) CEO Chris Oberbeck on Q4 2019 Results - Earnings Call Transcript

Saratoga Investment Corp (NYSE:SAR) Q4 2019 Earnings Conference Call May 9, 2019 10:00 AM ET

Company Participants

Henri Steenkamp - Chief Financial Officer, Chief Compliance Officer, Treasurer and Secretary

Chris Oberbeck - Chief Executive Officer

Mike Grisius - President & Chief Investment Officer

Conference Call Participants

Mickey Schleien - Ladenburg Thalmann Financial Services Inc.

Timothy Hayes - B. Riley FBR, Inc.

Christopher Testa - National Securities Corporation

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Saratoga Investment Corp's Fiscal Fourth Quarter and Fiscal Year 2019 Financial Results Conference Call. Please note that today's call is being recorded. During today's presentation all parties will be in a listen-only mode. Following management's prepared remarks, we will open the line for questions.

At this time, I would like to turn the call over to Saratoga Investment Corp's Chief Financial and Compliance Officer, Mr. Henri Steenkamp. Sir, please go ahead.

Henri Steenkamp

Thank you. I would like to welcome everyone to Saratoga Investment Corp's fiscal fourth quarter and fiscal year 2019 earnings conference call. Today's conference call includes forward-looking statements and projections. We ask you to refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these forward-looking statements and projections. We do not undertake to update our forward-looking statements unless required to do so by law.

Today, we will be referencing a presentation during our call. You can find our fiscal fourth quarter and fiscal year 2019 shareholder presentation in the Events and Presentations section of our Investor Relations website. A link to our IR page is in the earnings press release distributed last night.

A replay of this conference call will be available from 1 PM today through May 16. Please refer to our earnings press release for details.

I would now like to turn the call over to our Chairman and Chief Executive Officer, Christian Oberbeck, who will be making a few introductory remarks.

Chris Oberbeck

Thank you, Henri, and welcome, everyone. In reflecting on the past year, we made substantial progress in growing our high quality asset base, and strengthening our organization and capital base, enabling us to maintain our industry leadership in key performance metrics and performance.

We raised more than $90 million in the public capital markets this year adding to our long-term capital structure, and further developing our diversified sources of cost-effective liquidity. This new capital supported this year's record level of investments made from our growing pipeline of available investment opportunities.

Importantly, we have accomplished this in a highly competitive and challenging market environment. To briefly recap the year and quarter on Slide 2, first, the high-quality nature of our portfolio and our strong performance continued, maintained a high level of investment credit quality with 98.6% of our loan investments having our highest internal rating, generating a return on equity of 10.6% on a trailing 12-month basis, outperforming the last 12 months BDC industry average of approximately 8.9% and maintaining a gross unlevered IRR of 13% on our total unrealized portfolio at year end, with a gross unlevered IRR of 13.8% on $358 million of total realizations.

Second, we expanded our assets under management to $402 million, a 17% increase from last year and a 9% decrease from Q3, including an increase to realizations, which we will discuss. This year is illustrative of the success of our growing origination platform. We originate investments totaling $188 million, a record for us. These were offset by record repayments of $136 million. In Q4, $29 million of originations were offset by $77 million in repayments.

Third, the continued strength of our financial foundation has enabled us to increase our quarterly dividend, the 18th consecutive quarter. We paid a quarterly dividend of $0.54 per share for the fourth fiscal quarter of 2019 on March 28, 2019. This was an increase of $0.01 per share over last quarter's dividend. All of our dividend payments have been exceeded by our adjusted net investment income for the same periods. This distinguishes us from most BDCs.

Fourth, we strengthened our capital structure this quarter by both upsizing our 2025 baby bonds by $20 million in February 2019 and issuing $3.2 million under our ATM equity program at an average price of $23.20, bringing our total debt and equity issuances to more than $90 million of debt in the form of baby bonds and equity through both secondary and ATM offerings.

And finally, our base of liquidity remained strong. We continue to have significant dry powder to meet future potential opportunities, and a change in credit and pricing environment. Our existing available year-end liquidity allows us to grow our current assets under management by 27%, without any new external financing. In addition, all our current outstanding debt is fixed rate and long-term in nature, with no financial covenants, soundly structured for an uncertain rate environment.

We made steady performance within our key performance indicators as compared to the previous year and at February 28, 2018. Our adjusted NII of $18.6 million is up 36% versus the $13.7 million last year. Our adjusted NII per share is $2.63 per share, up 16% from $2.27 per share last year.

Our net asset value per share of $23.62 was up 3% from $22.96 last year. And our return on equity was 10.6% versus 13.2% last year and above the industry average of 8.9%.

Looking at the current quarter ended February 28, 2019 as compared to the quarters ended November 30, 2018 and February 28, 2018, adjusted NII is $4.9 million this quarter, up 31% from $3.8 million last year, and up 2% from $4.85 million last quarter.

Adjusted NII per share is $0.66 this quarter, up 10% from $0.60 last year and up 2% from $0.65 last quarter. And adjusted NII yield is 11.2% this quarter, up from 10.7% last year and consistent with 11.2% from last quarter. Henri will provide more detail later on any significant variances.

As in the past, we remain committed to further advancing the overall size and quality of our asset base. As you can see on Slide 3, our assets under management have continued to steadily grow and the quality of our credits remain high. We look forward to continuing this positive trend.

With that, I would like to now turn the call back over to Henri to review our financial results, as well as the composition and performance of our portfolio.

Henri Steenkamp

Thank you, Chris. We are pleased to provide everyone our Q4 and year-end results a week earlier than last year. In order to provide more in-depth information, we have also added our schedule of investments as of February 28, 2019 to our earnings release financial statements, which will also be included in our Form 10-K. Our 10-K is due to be filed on Tuesday, May 14.

Slide 4 highlights our key performance metrics for the quarter ended February 28, 2019. Across all these metrics you can see the positive impact of a long-term trend of increased assets when paired with strong credit quality. When adjusting for the incentive fee accrual, related to net unrealized capital gains in the second incentive fee calculation, adjusted NII of $4.9 million this quarter was up 1.9% from $4.85 million last quarter and up 31.1% from last year's Q4.

Adjusted NII per share was $0.66, up $0.01 from $0.65 last quarter, and up $0.06 from $0.60 last year. The increase from last year primarily reflects our higher level of investments and results in higher interest income, with AUM up 17% from last year.

This quarter benefited from the full impact of Q3's originations and additional interest income from accelerated OID on certain repayments with a partial negative impact of these significant repayments in Q4, offsetting most of that increase. These factors all led to adjusted NII yield of 11.2% for the quarter, up 50 basis points from 10.7% last year and unchanged from 11.2% last quarter.

In addition, we experienced a net gain on investments of $3.8 million for the quarter or $0.50 per share resulting in a total increase in net assets resulting from operations of $7.9 million or $1.04 per share. The $3.8 million net gain on investments was comprised of $4.7 million in net realized gains offset by $0.4 million in net unrealized depreciation on investments and $0.6 million of net deferred tax expense on unrealized appreciation on investments in our blocker subsidiaries.

The net realized gain relates to the $4.7 million gain on the exit of our Health Media Network investment discussed last quarter.

The $0.4 million unrealized depreciation primarily reflects the following: first, a reversal of the previously recognized appreciation following the realization of our HMN investment; and second, a $1.1 million unrealized depreciation on our Roscoe Medical investment. These unrealized depreciations were almost fully offset by, first, a $1.4 million unrealized appreciation on the Netreo Holdings investment; second, a $0.6 million unrealized appreciation on our Ohio Medical investments; third, a $0.6 million unrealized appreciation on our CLO equity investment, reflecting fourth quarter performance exceeding projections; and finally, numerous smaller unrealized appreciations across the portfolio on various investments.

Excluding the Health Media Network reversal to realized gain, unrealized appreciation in Q4 across our whole portfolio was $4.3 million.

As this is our year-end period, it is also important to focus on a couple of key numbers for the full year ended February 28, 2019 as compared to prior years. Looking at this on Slide 5, the strength of our performance over the longer term becomes apparent, eliminating any quarterly lumpiness.

Year-over-year, all of our metrics are up. Adjusted NII is up 55.9% to $18.6 million. Adjusted NII per share is up $0.36 to $2.63 per share and adjusted NII yield is up 40 basis points to 10.6%. Return on equity remains an important performance indicator for us, including both realized and unrealized gains.

Return on equity was 10.6% for the past year, down from 13.2% last year, but up from 9.0% in fiscal 2017. This ROE figure easily beats the current BDC industry average of 8.9% and our 5-year ROE is a strong 10.3%.

A quick note on expenses, total expenses, excluding interest and debt financing expenses, base management fees and incentive management fees decreased slightly from $4.8 million last year to $4.5 million this year and decreased from 1.2% to 1.1% of average total assets. This decrease does include a deferred tax benefit of $1.0 million primarily resulting from net operating loss carry-forwards in some of the taxable blocker entities.

Excluding that, expenses saw an increase reflecting the change in the administrator expense cap and overall higher public company cost during the year. The additional KPI slides and net interest margin analysis are again included on Slides 29 to 32 in the appendix, highlighting our BDC's strong performance and continued upwards trend.

These slides demonstrate our increased performance year-on-year as we have grown AUM in strong credits.

Moving on to Slide 6, NAV this quarter was $180.9 million as of yearend, $57.2 million increase from last year and a $7.6 million increase from $173.3 million last quarter. NAV per share was $23.62 as of yearend compared to $22.96 as of last year and $23.13 as of last quarter.

For the 12 months ended February 28, 2019, $18.3 million of net investment income and $2.0 million of net realized and unrealized gains were earned, offset by $1.8 million of deferred tax expense on net unrealized gains in Saratoga's blocker subsidiary, and $14.2 million of dividends declared.

In addition, $30.8 million of common stock was issued, net of offering costs. And $2.2 million of stock dividend distributions were made through our dividend reinvestment plan. 146,549 and 136,176 shares were sold above NAV through our At-the-Market equity offering during the year and Q4 respectively.

Our net asset value per share has also steadily increased over the past couple of years as seen on Slide 29. And we continue to benefit from our history of consistent realized gains.

On Slide 7, you will see a simple reconciliation of the major changes in NII and NAV per share on a sequential quarterly basis. Starting at the top, adjusted NII per share increased from $0.65 per share last quarter to $0.66 in Q4. The significant changes were a $0.09 decrease in net interest margin, excluding the CLO, reflecting the impact of the significant repayments earlier discussed in Q4, offset by a $0.03 increase in CLO interest income, $0.05 increase in other income and $0.03 increase in Q3's deferred tax benefit. There was also a $0.01 dilution from increased shares issued under our DRIP and ATM programs.

Moving on to the lower-half of the slide, this reconciles the $0.49 NAV per share increase for the quarter. The $0.54 generated by our GAAP NII in Q4 and the $0.58 net realized and unrealized gains on investments were partially offset by the $0.53 dividend declared for Q3 with a Q4 record date, and $0.10 dilution, primarily reflecting the impact of the discounted shares issued under our DRIP program at the beginning of January.

We have also performed the same reconciliation of adjusted NII and NAV per share for the full-year period on Slide 8. When looking at the year, this slide particularly highlights the benefit of our increased assets this year on net interest margin as well as how we have continued to over-earn our dividend through this period, while also issuing accretive equity.

Slide 9 outlines the dry powder available to us as of year-end, which is $107.1 million in total. This is spread between our available cash, undrawn SBA debentures and undrawn Madison facility. All our borrowings, except for our Madison facility is fixed rate debt with at least 4 years of maturity remaining on all outstanding debt.

We are pleased with our liquidity position especially taking into account the overall conservative nature of our balance sheet and the ability we continue to have to grow our assets by 27% without the need for external financing. This level of liquidity is inclusive of the repayments we experienced in Q4.

Moving on to the asset side of the balance sheet, almost 84% of our investments have floating rates. And although they have LIBOR flaws, we have to do all of them, which means we are a beneficiary of rising short-term rates. We continue to show the impact of rising rates on Slide 10 as required. However, current market conditions are such that future interest rate changes are uncertain and the upward trajectory has changed for the past month, while we are also slowly starting to see flaws creep up in the market in certain deals.

Now, we'd like to move on to Slides 11 through 13, and review the composition and yield of our investment portfolio. Slide 11 is our usual slide, highlighting the portfolio composition and yield at the end of the fiscal year. Our composition and weighted average current yields remain relatively consistent with the past with $402 million invested in 31 portfolio companies and one CLO fund and approximately 51% of our investments in first lien.

On Slide 12, you can see how the yield on our core BDC interest-earning assets, excluding CLO and syndicated loan, as well as our total portfolio yield has remained consistent, around 11% for the past several years, despite high levels of repayments and the continued replacement of these assets. This quarter, our overall yield as compared to Q3 decreased slightly from 10.8% to 10.7%, primarily due to LIBOR decreasing this quarter.

Our core BDC asset yields decreased slightly this year as spreads narrowed and high-yielding assets repaid. Year-over-year, the weighted average CLO yield has decreased, factoring in the impact of our December refinancing of the CLO and the reinvestment period being pushed out another two years.

Turning to Slide 13, during fiscal 2019, we made investments of $187.7 million in eight new portfolio companies with 15 follow-ons and had $135.7 million in 10 exits and repayments, resulting in a net increase in investments of $52 million for the year. Our investments remain highly diversified by type as well as in terms of geography and industry, spread over eight distinct industries with a large focus on business, education and healthcare services. We continue to have no direct exposure to the oil and gas industry, a fact that has served us extremely well.

Of our total investment portfolio, 8.9% consists of equity interests and remain an important part of our overall investment strategy. As you can see on Slide 14, realized gains this year were $4.9 million, primarily reflecting our Health Media Network realization. For the past seven fiscal years, we had a combined $16.7 million of net realized gains from the sale of equity interests or sale or early redemption of other investments.

When factoring in our available capital loss carry forwards, these are similar to equity raises for us. This consistent performance highlights our portfolio credit quality, as how to grow our NAV and is reflected in our healthy long-term ROE.

That concludes my financial and portfolio review. I will now turn the call over to Michael Grisius, our President and Chief Investment Officer for an overview of the investment market.

Mike Grisius

Thank you, Henri. I'll take a couple minutes to describe the current market as we see it, and then I'll focus on our current portfolio performance and investment strategy. The market is as competitive as we described in our last earnings call in January and it continues to be a borrower-friendly environment. Deal activity is growing, but the overabundance of capital persists. Leverage is still aggressive for quality credits and the supply demand imbalance continues to drive price.

We continue to see no spread expansion despite the slight reduction in LIBOR this past quarter and the talk of near-term cessation of rising rates. While the volatility we saw in the debt capital markets in the prior quarter has subsided, it's important to point out that we believe our portfolio is less exposed to capital market swings. It is our observation that valuations in the large leverage loan market can be immediately affected by the daily newswire and the massive ebbs and flows of capital that follow suit. As a result, loan spreads and leverage levels in this market are subject to sizeable changes that can occur on a weekly and even daily basis.

The lower middle market, where we invest capital does not behave in quite the same manner. Loan spreads and leverage points generally do not change overnight based on the whims of the broader capital markets. Rather credit metrics in our market tend to be driven by longer-term supply and demand factors, and thus our portfolio is less exposed to the volatility of a larger loan market.

Therefore, although market spreads and leverage points are certainly incorporated into our evaluation process and impact valuation, credit performance tends to be a greater driver. This results in our portfolio with its much more hands-on structuring and better protections as compared to the large leverage loan market and even a larger BDC market, remaining less sensitive to market dislocations.

Our approach is to underwrite each of our investments working directly with management and ownership to make a thorough assessment of the long-term strength of the company and its business model.

We invest capital with the objective of finding differentiated businesses, where our capital can be put to work to produce the best risk-adjusted accretive returns for our shareholders over the long run. We believe this approach has contributed to our successful returns and our ability to support so many of our portfolio companies with follow-on capital as they grow. It is worth pointing out that we believe this approach and our commitment to steady risk-adjusted performance has also positioned us well for any future market downturn.

Now looking at leverage on Slide 15, you can see that debt multiples increased in calendar Q1 with almost 80% of market multiples above 5 times versus two out of three deals last year. Against this backdrop, we have been able to achieve our results, while maintaining a relatively modest risk profile. Our total leverage is 4.7 times similar to last quarter and including recent repayments.

As we frequently highlight, rather than just considering leverage our focus remains on investing in credits with attractive risk return profiles and exceptionally strong business models, where we are confident that the enterprise value of the businesses we sustainable - will sustainably exceed the last dollar of our investment.

Now while absolute leverage metrics are an important consideration, we always evaluate leverage relative to the strength of an underlying business. For example, we have developed an expertise in lending to businesses across a widely diverse set of industries that deliver their services through a software platform.

Good business is utilizing a software-as-a-service platform that can have terrific credit characteristics with exceptional recurring revenue, customer retention and gross margins. As a result, the valuations for these businesses are high and the corresponding debt multiples are also higher than average. However, because the credit profile of some of these businesses are so strong, we believe we can achieve attractive risk-adjusted returns lending to good businesses of this type.

This slide also illustrates our consistent ability to generate new investments despite difficult market dynamics. While we just closed two follow-ons this past calendar quarter, the last 12 months resulted in investments in eight new portfolio companies and 16 follow-ons, while applying consistent investment criteria.

And subsequent to year-end, we have also closed approximately $14 million of investments with two new portfolio companies, both of which are platforms that may desire expansion capital from us in the near future. Closing of a third new portfolio company is imminent. We remain confident that we can continue to grow our AUM steadily over the long-term.

Now moving on to Slide 16, our team's skill set, experience and relationships continue to mature and our significant focus on business development has led to new strategic relationships that have become sources for new deals. The 35% of our term sheet issued this past 12 months and three of our new platform companies are from newly formed relationships, help demonstrate this. These new relationships then become the source of new deals that often lead to more follow-ons.

This chart also illustrates our discipline over the past three plus years. While the size of the funnel at the top has increased significantly, deals executed have only increased slightly. For calendar year 2018, we passed on approximately 70 deals in the year that other firms closed after we passed. In just the past two weeks, we passed on two deals that were awarded to us, but we ultimately could not get comfortable with their credit profiles. Passing on a deal that is right in front of you is difficult, but maintaining discipline is ingrained in our culture, because we know it's how we can preserve and grow the enterprise value of Saratoga.

Looking at our deal sources, about half of our deal flow is from private equity sponsors although 80% of the term sheets issued are the companies with private equity ownership. Our overall portfolio quality remained strong.

As you can see on Slide 17, the gross unlevered IRR on realized investments made by the Saratoga management team is 13.8% on $357.8 million of realizations. On the repayments in Q4, excluding the CLO, the weighted average unlevered IRR is just under 17%.

On the chart to the right, you can also see the total gross unlevered IRR on our $374.2 million of combined weighted SBIC and BDC investments, is 13% since Saratoga took over management. You will also notice that we have put our Roscoe Medical second lien investment on non-accrual this quarter.

Our total investment comprises the $4.2 million second lien that has been marked at fair value of $2.5 million this quarter as well as an equity investment of $0.5 million that has been written down to zero. These marks reflect both fundamental weakened performance as well as operational issues. While we believe the operational issues have been largely addressed, we expect the company to continue to face headwinds in a competitive industry.

Saratoga is working with the senior lenders and sponsor to evaluate alternatives in the near-to-medium term. As a reminder, this is a good example of how solid, high-quality portfolio interacts as a whole. Our total realized and unrealized gain for the year was in that positive $0.2 million, which included significant unrealized appreciation in our Easy Ice, Netreo, Grey Heller, Censis and Vector investments, among others, and more than offset notable unrealized depreciation in My Alarm Center, Elyria and Roscoe.

Slide 18 highlights that the mix of securities in our SBIC portfolio is relatively conservative with 42% of our investments comprised of senior debt first lien investments, and 52% either first lien in last out or second lien. The leverage profile of these 21 investments remains relatively low at 4.09 times, especially when compared to overall market leverage. Our favorable cost of capital from this program allows us to deliver highly accretive returns to our shareholders without stretching out on the risk spectrum.

Now moving on to Slide 19, you can see our SBIC assets reduced to $221.7 million as of year-end, representing 55% of our overall portfolio. Our current SBIC license is fully drawn and we continue to work through the formal licensing process with the SBA on our second license, following their issuance of a green light letter to us last year. As of year-end, we had $17.2 million total available SBIC investment capacity, all cash within our current first license.

Now overall, we feel our operating results for the year and the quarter demonstrate the strength of our team, platform and portfolio, while we remain extremely diligent in our overall underwriting and due diligence procedures. This culminates in high-quality asset selection within a tough market. Credit quality remains our top focus and we remain committed to this approach.

This concludes my review of the market. And I'd like to turn the call over to our CEO. Chris?

Chris Oberbeck

Thank you, Mike. As outlined on Slide 20, we recently increased our fourth quarter dividend to $0.54. This was our 18th sequential quarterly dividend increase and we have over-earned our dividend each quarter. As you can see on Slide 21, we've had an 8% year-over-year dividend growth, which places us at the top of our peers. And one of only seven BDCs have grown dividends in the past year. With most BDCs having either no increases or decreasing the size of their dividend payments, our continually increasing dividend has differentiated us within the marketplace.

Moving to Slide 22, our total return for the last 12 months, which includes both capital appreciation and dividends, has generated returns of 27%, significantly ahead of the BDC index of 10%.

Turning to Slide 23, you'll see that our 12-month performance puts us in the top 10 of all BDCs, while our three- and five-year return places us in the top 3 and 5 of all BDCs respectively. Over the past three years, our 93% return exceeded the 29% return of the index and over the past five years, our 150% return exceeded the 24% return of the index.

Slide 24 highlights our outperformance in the context of the broader industry and specific to certain key performance metrics. We continue to achieve high marks and outperform the industry across diverse categories, including interest yield on the core BDC portfolio, latest 12-month NII yield, latest 12 months return on equity, dividend coverage, year-over-year dividend growth, net asset value per share and investment capacity.

Of note, is that our assets have grown with - as our assets have grown, we are achieving scale economics. Our expense ratio is moving closer towards the industry averages. We continue to emphasize our latest 12 months return on equity and net asset value per share outperformance, which reflects the growing value our shareholders are receiving.

Moving on to Slide 25, all of our initiatives we have discussed on this call are desired to make Saratoga Investment, a highly-competitive BDC that is attractive to the capital markets community. We believe that our differentiated characteristics outlined in this slide will help drive the size and quality of our investor base, including the addition of more institutions.

These characteristics include: maintaining one of the highest levels of management ownership in the industry currently at 20%; a strong and growing dividend that is well covered by NII, strong long-term return on equity; access to low cost and long-term liquidity with which to grow our asset base, including the recent equity and baby bond offerings; obtaining a BBB investment grade rating; solid earnings per share; an NII yield with substantial growth potential; and steady high-quality expansion of assets under management.

Importantly, Saratoga has an attractive risk profile with protection against potential rising interest rate risk from its almost 84% floating rate portfolio and fixed rate liability structure. In addition, our high credit quality portfolio contains minimal exposure to cyclical industries.

Finally looking at Slide 26, we have delivered solid financial results and remain on course with our long-term goal to expand our asset base without sacrificing credit quality, while benefiting from scale. We also continue to increase our capacity to source, analyze, close and manage our investments by building our management team and capabilities.

In closing, I would again like to thank all of our shareholders for their ongoing support. We are excited for the growth and profitability that lies ahead for Saratoga Investment Corp.

I would like to now open the call for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And our first question comes from Mickey Schleien with Ladenburg. Your line is open.

Mickey Schleien

Yes, good morning, everyone. I wanted to start by asking the following. I've noticed other BDCs exhibiting problems in some of their healthcare names, and you've noted issues at Roscoe. Can you be a little more specific about Roscoe? And perhaps more importantly, are you seeing some sort of problem trend developing in the healthcare sector in general, which we all know is a really large consumer of middle market loan capital?

Mike Grisius

Good morning, Mickey. It's Mike talking. It's a really good question. And I would tell you this. And of course, it's a private company, so we have to be careful what we can convey to you. But the company certainly experiences challenges. I would say that the challenges that they're facing at Roscoe have a lot less to do with the fact that they operate in and around the healthcare space and more to do with the fact that they're a highly competitive market.

So the portion of their business that has faced the more extreme challenges really is the portion where they're distributing to the broader retail environment. And so, it's been less indicative of a larger trend that would be natural to ask about. But we haven't seen or experienced in our portfolio relative to healthcare in general.

Mickey Schleien

Thanks for that Mike. That's helpful. My next question is the following. Over half of the portfolio is in the business services category, which is a pretty broad label. Could you give us a sense of your investment strategy in that sector and how cyclical you believe the borrowers are in that group?

Mike Grisius

Well, I think the way I'd respond to that is the business services to some degree is a catch all. Most of the...

Mickey Schleien

Yeah, that's my point.

Mike Grisius

Yeah. And so, we tend not to look at it as a concentration. So, if I were to pull out the credits that fall into business services, I'm certain that they would be a very wide range of end-markets and industries that they operate in.

We use that as a term, because it's more reflective of any business that's operating - a term that's used in the marketplace is B2B, but any business that's delivering a product or service to another business vis-à-vis consumer for instance. And it's been our experience that many of these business models can be extremely strong. And we probably all had this experience operating in businesses ourselves.

If you provide a very quality service or product as a business to another business, and you do that very well and it's not core to what they do, it's really a side show relative to what their core business is. You can you can end up with really sticky relationships and fabulous margins and fabulous return on capital.

Now, not all businesses do that, but there are plenty out there that do. And we view that category as one that we'll continue to have significant investment in. But, again, it's not reflective of an industry end-market that would all cycle at the same way. It really is more just reflective of that business model and describing it as a business that's delivering service or product to another business.

If you can do that really well, as I said those going to be sticky customers and you can turn return - it can result in very favorable returns on capital.

Mickey Schleien

And, Mike, would they be sticky in a downturn? In other words, are these relatively defensive business models?

Mike Grisius

Absolutely. I mean, we think that they're absolutely defensive business models. I wouldn't want to go to the point to say that there - I'd have to look at each company because we're evaluating each company on its own merits. We don't believe that they would all move in sync in a downturn in the economy.

I think for each of the deals that we look at, we evaluate what a down-cycle might look like and do a rigorous analysis to get comfortable, that under all reasonable circumstances that our capital in the spot that we occupy in the balance sheet is a safe one for our investors. So I'd have to sort of look at each one of the portfolio companies, but I can tell you broadly, they're not going to - they're not all going to be correlated. And we do look at cyclicality very carefully when we make an investment in any of our portfolio companies.

Mickey Schleien

I appreciate that. Just one more question, if I may. I noticed that one of your objectives towards the end of the deck is to increase your sourcing capacity. And I noticed that a good portion of the portfolio is in the South and the Midwest, so I'd like to understand how you're thinking about structuring your sourcing to perhaps help you diversify the portfolios geography

Mike Grisius

Where we're focused on - I think it's a very good question because it's from a strategic standpoint, a very big focus for us this year and in the coming years. You can see from that slide that we've done I think a really good job. Our business development team has done a really good job of increasing the number of deals that we're bringing in-house, that we can evaluate. If you do that right, it enables you to continue to be highly, highly selective when you're evaluating where you want to invest.

Our primary focus right now is looking at trying to make sure that we're developing relationships with more relationships, with firms where the yield, that the number of deals that will actually get done and be competitive on is greater. We don't want to just increase the top of that funnel on that slide forever. The idea is with the number of deals we're seeing now that's a lot, let's try to grow our relationships where we feel like there's a really good fit from a size perspective, from a type of deal perspective, et cetera.

I think as it relates to the geographic side of things, we don't feel like we have any exposure to or concentration in geography. And the reason for that is that if you look at the businesses, by and large, it's not 100% true, but by and large, if you look at a business, I think you mentioned the Southeast for instance, most of those businesses happen to be - happen to reside in the Southeast, because it's a cheap place to do business. It's generally a business-friendly geography within our country.

But the market that they're selling to is national. So usually, when we look at geographic concentration, we tend to look at it, is this a business where because of where it's located, if that geography were to happen to have a decline in its market for some reason, would we be exposed?

And across our portfolio, if you look at where the companies are domiciled, where their domiciled has a lot less to do with the success of the company. It's really driven by the core value proposition of whatever is that they're selling or the service they're providing. And that's usually on a national level.

But having said that, you make a very good point, I mean, we think it's very strategic for us to continue to develop our sourcing relationships. We're very proud of the relationships that we've built over the years and did it from a standing start, when we took over management of Saratoga back in 2010.

Right now, if you polled the marketplace, we think lower middle market participants were very well known. I think we're very respected and we're proud of the reputation that we have, and people know that we do extremely thorough due diligence and we try to deliver on what we say. We're going to deliver on and that's worked very well for us.

So the approach that we have in expanding our relationships is to continue to do that. And we gain a lot of relationships by providing referrals as well, because of the way we operate. And we think we are among the better operators in our market.

Mickey Schleien

That's really helpful, Mike. I appreciate all your time this morning. Thank you.

Mike Grisius

Thanks, Mickey.

Operator

Thank you. Our following question comes from the line of Tim Hayes with B. Riley. Your line is open.

Timothy Hayes

Hey, good morning, guys. Thanks for taking my questions. My first one, just loan origination activity, a little light, repayments are rather large. I know they can both be lumpy on a quarter-by-quarter basis, but just wondering if the volatility played a part in that or if it was just a timing thing and if it was volatility related, has your pipeline picked back up?

Mike Grisius

I would say it wasn't volatility related. I think, as I mentioned in our prepared remarks, we largely live and operate outside of that marketplace. So the lower middle market businesses that are seeking capital and trying to grow, generally aren't affected by where the capital markets are and what they - what the capital markets are experiencing at the higher end of the market, what you see in the broader large syndicated world that really just doesn't affect us as much. It's a very good question.

But I think what's also - something that we're very much focused on is our production this quarter. We didn't have as much production as we would have liked, but we tend not to look at that quarter-to-quarter. I think, I've said in the past that if you see a BDC that has just steady [Technical Difficulty] in some cases, it's not likely that there'll be follow-ons.

In these two investments, they're both ones where this may or may not happen, but they look to be investments where there's a good chance that those portfolio companies could be seeking more capital as they grow and we're delighted by that, and of course that's been a big part of the recipe for our growth historically if you sort of look at our portfolio over the years.

Many of our best investments have been ones that started off small and then the companies have done well, and they've come to us as a financial partner and we've been able to fuel their growth and that's worked out really well not only for the debt capital that we deploy, but in many instances we've been co-investors in the equity and that's also worked out well.

Timothy Hayes

Yeah. No. I appreciate those comments as well. Would you be willing to give an update on repayments so far this quarter?

Mike Grisius

I think, we're trying to - I think, the comments relative to production were really meant to address what we felt like. Naturally someone would say, boy you didn't do any deals. I think we were trying to address and hopefully give folks comfort that we're still active in the marketplace and getting deals done. But just trying to avoid the precedent of right up to the earnings call, giving an update on exactly what's coming and going.

Henri Steenkamp

Yeah. I think, Tim, I would just add things obviously change quickly in our business. Mike's prepared remarks also noted a deal is imminently - a deal is closing imminently. So there's so many moving parts and we try to give you guys some extra color, but at the same time not sort of try to be like day by day basis sort of projecting what's closing and what's repaying. But it's very relevant to what Mike noted about new portfolio companies from new relationships and continuing to grow that, which is the key to the long-term growth of ours.

Timothy Hayes

Yeah. That's completely fair and those comment extra comments are appreciated, so I'll try not to be too greedy here. And then of the loans you've closed so far this quarter and those in the pipeline, can you just give us an idea of the ratio of sponsor deals versus non-sponsored, how much is senior? The range of leverage multiples - are they just largely consistent with historical levels?

Mike Grisius

Largely consistent with historical levels.

Timothy Hayes

Okay.

Mike Grisius

And I think, we have said historically, and we're careful to emphasize it when we were in the prepared portion of our presentation, we have never taken the viewpoint that a first lien loan with low leverage is necessarily a good deal, and a second lien or junior capital with a high leverage is necessarily a bad deal. I think, the approach that we've always taken, we resorted to never put ourselves into that boxes.

For ourselves when we evaluate the investments on behalf of our shareholders, we've always said let's evaluate the strength of the business. And based on our determination of that relative strength, then we can decide where's the best place to occupy in the company's balance sheet. So there are businesses that we like a lot, where we'll provide capital to them, but we'll only do that in a first lien unit tranche position, because we think perhaps there's some volatility potentially that you could face or there's some elements of the deal, where you wouldn't want to be too deep in the capital structure and you wouldn't want to be junior.

There are other deals, where we think the fundamentals of the business are so strong they may have a lot less cyclical - exposure to cyclicality. The cash flow characteristics are super strong, the steadiness of the business would allow us to feel comfortable moving into more of a junior capital position. And that's how we evaluate it. What is the best risk-adjusted return opportunity for our shareholders and what makes sense, where we feel like our principal is very highly likely protected and that just depends on the opportunities that we see. It's less driven by our predetermination that we want to do all first lien or all junior capital.

Timothy Hayes

Yeah. No. That makes sense. That definitely makes sense. Okay. And one more follow-up for me. Just looking for an update on the second SBIC license. Following the shutdown have you seen approvals pick back up. We've seen at least one BDC get approval for other license in the past, but I'm just - I know the SBA works at their own pace, but just wondering if you have an updated timing in mind?

Chris Oberbeck

This is Chris, Tim. I think we've tried to be very consistent in how we discuss are our licensing process. I mean, I think you kind of answered your own question a bit. They have a process and obviously they shut down. They were part of the shutdown. So they didn't answer the phone. They weren't even in the office during that shutdown. So the answer is yes, that did have an impact on their process. Where we sit in the whole firmament down there, we're not - we don't we don't know exactly.

We continue to respond and submit, and then do all the things that we need to do. I mean, I think we have confidence that our performances that - where our strong performance and we're certainly one of the better performing BDC - SBICs and so we think ultimately that, that should have a lot of weight. But precise timing and all that, we're really subject to how they are doing things.

And I think as you point out, there have been some new license issued. There's been relative to history the recent period of time has had fewer licenses than the past, and we're certainly hopeful, I think the industry is certainly hopeful that they'll start issuing more licenses.

Timothy Hayes

Got it. Okay. Well, thanks for taking my questions this morning.

Chris Oberbeck

Thank you.

Operator

Thank you. And our last question comes from Christopher Testa with National Securities. Your line is open.

Christopher Testa

Hi, good morning, guys. Thank you for taking my questions. I just wanted to touch on a couple things. The incentive fees on the CLOs continued to be earned. I remember something being said about no more incentive fees being earned, but they were earned during the quarter. Just wondering on a go forward basis, if that will be the case.

Henri Steenkamp

Yes. So the only - well, let me - the first answer Chris is that when we refinanced our CLO, the incentive fee concept was removed from the agreements. So there'll be no incentive fees going forward. The only reason why there still was in Q1 - Q4 was, if you recall that with the change in the revenue recognition standard, it changed recognition to when you actually receive the incentive fee rather than on an accrual basis - from accrual basis effectively to cash. And when we refinance the CLO, we received our final incentive fee payment related to the CLO up to that point in time. And so that's why it's reflected in the P&L for Q4.

Christopher Testa

Got it. Okay. That's helpful, Henri. Thank you. And sticking with the theme on CLOs, obviously you guys have the reduced asset coverage that is now effective as of last month. I'm just wondering, given you have a good track record, you have a lot of senior secured debt and now sort of a brand name so to speak.

Have you given thoughts to securitization financing as opposed to notes and revolvers, because what spreads as well as they are, it seems that you could get a very favorable pricing for middle market CLO, and as we know that provides much more flexibility especially in a downturn, where banks could cut advance rates and what not, but that's not the case, if you're financing with the CLO?

Chris Oberbeck

Well, I think that - I think that a middle market CLO would be largely comprised of pretty senior debt like maybe more senior debt, more senior than the type of investments that we make. I mean, we make first lien loans, but they're generally in smaller type of companies. So that would be a slightly different market than we are addressing.

And we work with companies that do all that. Clearly, it is an attractive marketplace, but I think, we're - I think, if you look at the absolute returns there, the gross returns on those investments, those will be substantially lower than what our gross returns are which is kind of reflective of a sort of a different segment of the market.

I think, as Mike had mentioned in his section and the Q&A, we don't have any kind of challenge in terms of deal flow. I mean our pipeline is very, very robust, obviously, closing the deals that we want to close. This is challenging, but there's a lot out there. And so we don't feel like we need to go to a different segment to get - to move our whole enterprise forward. We feel like our - the world that we are addressing has plenty in it for us. And so at this time, that approach is not - it's not as much a priority as really just continuing to press on with our existing focus.

Christopher Testa

Okay. No. That's fair. And sticking on the topic of leverage, just please remind me, did you guys give a leverage target, any sort of guidance given you have to reduce the asset coverage?

Henri Steenkamp

No. Chris, we haven't given guidance. We've obviously said that we feel comfortable with the level that we're at the moment. And then we - as Mike said in his remarks, we assess sort of any change in that as we close deals and assess the risk-adjusted returns of the investments and where we on the leverage, would play a part in that assessment as well. But we haven't given specific guidance.

Christopher Testa

Without fishing too much on that, Henri, is it reasonable to assume that you could go above one to one on a regulatory basis, obviously excluding the SBIC?

Henri Steenkamp

Yes, that could be a possibility, yes.

Christopher Testa

Okay. All right, great. And given you guys have had so much success with the company and kudos on that, just wondering, it seems like a lot of your peers who basically couldn't fall out of a boat and hit water, have raised a significant amount of private debt funds. Just wondering if there is any thoughts on you guys raising some more private debt funds to provide bigger ticket sizes and provide more certainty of close to the sponsor community as you move forward and continue to grow out?

Chris Oberbeck

Well, I think, clearly, it's attractive from a franchise standpoint to have a broader array of funds. I think, where we are in our lifecycle is, we still believe we've got ways - still good ways to go to achieve scale in our BDC. And so - and we have had success in what we've been doing here. And we don't really see a limit. We don't see a reason to need to go elsewhere at this time.

We see plenty of opportunity in front of us and we just need to do more of it. You mentioned something about having different funds, to have larger deal sizes. Once you get to a larger deal size, and I think that - what we're focused sort of a funding side somewhere on the low-end $5 million, the high-end $30 million, that area is a very fertile ground for us.

And so, I think once you start moving into a higher level than that, it's a very different competitive set that's out there. It's different leverage metrics, it's different credit characteristics like you start losing covenant protection. It's much more competitive in terms of the documentation, the process for winning, et cetera.

So we are very attracted to the market approach that we have right here. We feel there's plenty of room to grow our assets, consistent with how we've grown them in the past. And that's really where we're focused right now. I think let me…

Christopher Testa

Got it. And - I was just going to say I certainly appreciate that Chris. And maybe I should have phrased it differently, not necessarily making loans to a larger borrower, but for example, let's say you had a [sister and private debt firm] [ph] with the same AUM, when you write that $15 million ticket, if it gets splits pro rata, then you'll only have a $7.5 million exposure at SAR and $7.5 million exposure there.

So you're just enhancing your diversification. So if something goes sour, then it's less of an impact on the SARs and NIIs as well as the NAV per share. So I think that would be more of the benefit.

Chris Oberbeck

Right, but along those lines, I think in our view, we would rather have twice the level of assets at the BDC to achieve that same goal. And that was if we were to grow our assets substantially, we would still be doing very much a similar type size investment. So as our assets grow, we start to achieve what you just described.

Christopher Testa

Got it. Okay, that's fair. And what was the prepayment related income during the quarter?

Henri Steenkamp

I'm sorry. Just repeat the question, Chris, the what income?

Christopher Testa

What was the prepayment related income in the quarter, both fees and OID acceleration?

Henri Steenkamp

Yeah, we had a couple - while had a couple - we had a pretty big repayment quarter. So a couple of our loans that's included in the $70-odd-million that we had of repayments were obviously early repayments. And so, there are prepayment penalties associated with those. And so, that would flow through the other income line.

Christopher Testa

Got it. Okay, that's fair. Those are all my questions. I appreciate your time today, guys.

Chris Oberbeck

Thank you.

Henri Steenkamp

Thanks, Chris.

Operator

Thank you. And I'm showing no further questions at this time. I would now like to turn the call back to Chris Oberbeck for closing remarks.

Chris Oberbeck

Okay. We'd like to thank everyone for joining us today. And we look forward to speaking with you next quarter.