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Saratoga Investment Corp (SAR) Q3 2024 Earnings Call Transcript

Saratoga Investment Corp (SAR)

Q3 2024 Earnings Conference Call

Company Participants

Henri Steenkamp - Chief Financial and Chief Compliance Officer

Christian Oberbeck - Chairman and Chief Executive Officer

Michael Grisius - Chief Investment Officer

Conference Call Participants

Erik Zwick - Hovde Group

Mickey Schleien - Ladenburg Thalmann

Robert Dodd - Raymond James

Casey Alexander - Compass Point Research & Trading

Bryce Rowe - B. Riley

Presentation

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Saratoga Investment Corp's 2024 Fiscal Third Quarter 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 Chief Compliance Officer, Mr. Henri Steenkamp. Sir, please go ahead.

Henri Steenkamp

Thank you. I would like to welcome everyone to Saratoga Investment Corp's 2024 fiscal third quarter 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 third quarter 2024 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 also be available. 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.

Christian Oberbeck

Thank you, Henri, and welcome everyone.

Saratoga's adjusted net investment income per share increased 31% as compared to last year, yet decreased slightly as compared to last quarter. The sequential quarterly per share decrease equates to the $0.07 dilution from the increased weighted average shares outstanding from our recent ATM equity issuances, with much of that cash yet to be deployed. This quarterly performance significantly exceeded our recently increased dividend by 40%.

The level of interest rates stabilized in the recent quarter, resulting in elevated margins on our growing portfolio relative to the past year. In addition, the continued general contraction of available credit for smaller middle market businesses and our ongoing development of sponsor relationships has created an abundant flow of attractive investment opportunities from high-quality sponsors at attractive pricing terms and absolute rates.

We believe Saratoga continues to be well positioned for potential future economic opportunities and challenges. Saratoga's credit structure with largely interest-only, covenant-free, long-duration debt incorporating maturities primarily two to 10 years out has positioned us well with the increase in interest rates delivering increased margins. Most importantly, at the foundation of our performance is the high-quality nature, resilience and balance of our approximately $1.11 billion portfolio, which has been marked down 3% overall versus cost in this challenging environment.

Our core BDC portfolio, excluding our CLO and JV, is down less than 1% versus cost, including markdowns in four specific credits, partially offset by $4.3 million of net realized appreciation in the rest of the core BDC portfolio. This overall portfolio performance reflects the strength of our underwriting and our solid growing portfolio of companies and sponsors in well selected industry segments.

Our portfolio strength is further manifested in our many key performance indicators this past quarter outlined on Slide 2, including: first, quarterly adjusted NII increased by 44% and NII per share increased by $0.24 or 31% over the past year; second, current assets under management grew to approximately $1.11 billion, a record level; and third, our dividends increased to $0.72 per share, up 6% from $0.68 per share in Q3 last year and over-earned by 40% as compared to this quarter's $1.01 per share adjusted NII.

We continue to approach the market with prudence and discernment in terms of new commitments in the current environment. Our originations this quarter demonstrate that despite an overall robust pipeline, there are periods like the current one where many of the investments we review do not meet our high quality credit standards. We originated no new portfolio investments in this fiscal quarter, but had 14 smaller follow-on investments in existing portfolio companies we know well with strong business models and balance sheets.

Originations this quarter totaled $36 million, with $2 million of repayments and amortization. Our credit quality for this quarter remained high at 97.1% of credits rated in our highest credit category, despite adding our Zollege investment this quarter as our third investment on non-accrual. With 86% of our investments in quarter-end -- at quarter-end in first lien debt and our overall portfolio generally supported by strong enterprise values and balance sheets in industries that have historically performed well in stress situations, we believe our portfolio and leverage is well structured for challenging economic conditions and uncertainty.

Saratoga's annualized third quarter dividend of $0.72 per share and adjusted net investment income of $1.01 per share implied an 11% dividend yield and a 15.4% earnings yield based on its recent stock price of $26.16 per share on January 8, 2024. The over-earning of the dividend by $0.29 this quarter or $1.16 annualized per share increases NAV, supports the increasing dividend level and growth, and provides a cushion against adverse events.

In volatile economic conditions, such as we are currently experiencing, balance sheet strength, liquidity and NAV preservation remain paramount for us. First, we raised $48 million of equity since the end of Q1, increasing our NAV from $338 million as of May 31, 2023, to approximately $373 million on a pro forma basis, including the equity raise at the beginning of December using our November 30, 2023 NAV as a basis. This equity provides additional balance sheet strength, reduces our regulatory leverage and supports our strong originations. And second, at quarter-end, we had a substantial $222 million of investment capacity available to support our portfolio companies with $145 million available through our newly approved SBIC III fund, $30 million from our expanded revolving credit facility and $47 million in cash.

Saratoga Investment's third quarter demonstrated solid performance within our key performance indicators as compared to the quarters ended November 30, 2022 and August 31, 2023. Our adjusted NII is $13.1 million this quarter, up 44% from last year and down 1% from last quarter. Our adjusted NII per share is $1.01 this quarter, up 31% from $0.77 last year and down 6% from $1.08 last quarter. Latest 12-month return on equity is 6.6%, up from 4% last year and down from 9.6% last quarter. Our NAV per share is $27.42, down 2.9% from $28.25 last year and down 3.6% from $28.44 last quarter. And our quarter-end NAV is up to $360 million from $336 million last year, but down slightly from $362 million last quarter. Henri will provide more detail later.

As you can see on Slide 3, our assets under management have steadily and consistently risen since we took over the BDC 13 years ago and the quality of our credits remains high with only three credits on non-accrual. Our management team is working diligently to continue this positive trend as we deploy our available capital into our growing pipeline, while at the same time being appropriately cautious in this volatile and evolving credit environment.

While this past quarter and fiscal year have seen some markdowns to a handful of credits in our core BDC portfolio as well as our CLO and JV investments in the broadly syndicated loan market, Slide 4 demonstrates how our long-term average return on equity over the past 10 years is well above the BDC industry average and has remained consistently strong over the past decade.

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.

Slide 5 highlights our key performance metrics for the fiscal third quarter ended November 30, 2023, most of which Chris already highlighted. Of note, the weighted average common shares outstanding of 13.1 million shares in Q3 increased from 11.9 million last year and 12.2 million last quarter.

Adjusted NII increased this quarter, up 43.8% from last year but down 1% from last quarter primarily from: first, the impact of higher interest rates, both base rates and spreads with a weighted average current coupon on non-CLO BDC investments increasing from 11.7% to 12.5% year-over-year and relatively unchanged from last year -- from last quarter; second, average non-CLO BDC assets increasing by 15.7% year-over-year and by 1.6% since last quarter; and third, other income including a $1.3 million dividend received from the Saratoga Investment joint venture. Adjusted NII yield was 14.6%. This yield is up from 10.8% last year but slightly down from 15.0% last quarter.

Total expenses for this quarter, excluding interest and debt financing expenses, base management fees and incentive fees and income and excise taxes increased from $2.1 million both last quarter and last year to $2.3 million this quarter. This represented 0.8% of average total assets on an annualized basis unchanged from both Q3 last year and last quarter.

Also, we have again added the KPI slides 28 through 31 in the appendix at the end of the presentation that shows our income statement and balance sheet metrics for the past nine quarters and the upward trends we have maintained, including a 57% increase in net interest margin over the past year.

Moving on to Slide 6, NAV was $359.6 million as of this quarter-end, a $2.5 million decrease from last quarter and a $23.8 million increase from the same quarter last year. This quarter, the main drivers of the decrease was the $10 million of equity issued under the ATM program and the $14.2 million of net investment income that was more than offset by $18.2 million of net realized and unrealized losses and $8.4 million of dividends declared net of stock dividend distributions through the company's DRIP plan. No shares were repurchased during this quarter.

This same chart also includes our historical NAV per share, which highlights how this important metric has increased 20 of the past 27 quarters with -- sorry, with Q3 down $1.02 per share, primarily reflecting the markdowns discussed. Over the long term, our net asset value has steadily increased since 2011, and this growth has generally been accretive as demonstrated by the consistent increase in NAV per share over the long term. We continue to benefit from our history of consistent realized and unrealized gains.

On Slide 7, you will see a simple reconciliation of the major changes in adjusted NII and NAV per share on a sequential quarterly basis. Starting at the top, adjusted NII per share was down $0.07, primarily due to the net dilution from the additional 1.2 million shares issued in the recent ATM equity offering, with all the other changes offsetting each other. On the lower half of the slide, NAV per share decreased by $1.02, primarily due to the $1.36 in unrealized depreciation and the $0.71 dividend recognized in the quarter exceeding the $1.09 in GAAP NII.

Slide 8 outlines the dry powder available to us as of quarter-end, which totaled $222 million. This was spread between our available cash, undrawn SBA debentures and undrawn secured credit facility. This quarter-end level of available liquidity allows us to grow our assets by an additional 20% without the need for external financing, with $47 million of quarter-end cash available and thus fully accretive to NII when deployed and $145 million of available SBA debentures with its low cost pricing, also very accretive.

This quarter, we also added a column showing any call options of our debt. This shows that our $321 million of baby bonds, effectively all our 6% plus debt, is callable within the next year, creating a natural protection against potential future decreasing interest rates, which will protect our net interest margin in a declining rate environment, if needed. We remain pleased with our available liquidity and leverage position, including our access to diverse sources of both public and private liquidity and especially taking into account the overall conservative nature of our balance sheet, the fact that almost all our debt is long term in nature and with almost no non-SBIC debt maturing within the next two years. Also, our debt is structured in such a way that we have no BDC covenants that can be stressed during volatile times.

Now, I'd like to move on to Slides 9 through 13 and review the composition and yield of our investment portfolio. Slide 9 highlights we now have $1.1 billion of AUM at fair value, and this is invested in 55 portfolio companies, one CLO fund and one joint venture. Our first lien percentage is 86% of our total investments, of which [32%] (ph) is in first lien last out positions.

On Slide 10, you can see how the yield on our core BDC assets, excluding our CLO, has changed over time, especially this past year. This quarter, our core BDC yield was down slightly 10 bps to 12.5%, primarily due to our Zollege investment going on non-accrual with base rates relatively unchanged. The CLO yield increased to 8.0% from 6.0% last quarter, reflecting the decrease in value from weaker performance. The CLO is performing and current.

Slide 11 shows how rates have stabilized the past three months. The average three-month SOFR is now basically the same as the average rate used in our portfolio and the closing quarter-end rate. We will continue to benefit from these levels while rates remain elevated and until rates reset.

Slide 12 shows our investments are diversified through the U.S. And on Slide 13, you can see the industry breadth and diversity that our portfolio represents, spread over 43 distinct industries in addition to our investments in the CLO and joint venture, which are included as structured finance securities.

Of our total investment portfolio, 8.3% currently consists of equity interest, which remain an important part of our overall investment strategy. Slide 14 shows that for the past 11 fiscal years, we had a combined $81.6 million of net realized gains primarily from the sale of equity interests. This consistent realized gain performance highlights our portfolio credit quality has helped grow our NAV and is reflected in our healthy long-term ROE.

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

Michael Grisius

Thank you, Henri.

I'll take a few minutes to describe our perspective on the current state of the market and then comment on our current portfolio performance and investment strategy....

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