Saratoga Investment Corp
NYSE:SAR
Earnings Call Analysis
Q3-2024 Analysis
Saratoga Investment Corp
Saratoga Investment Corp reported a robust quarter with a 31% year-over-year increase in adjusted net investment income (NII) per share, although a slight sequential decline was noted due to the dilution from additional equity issuances. The company's assets under management reached a record high of approximately $1.11 billion, with dividends climbing to $0.72 per share, up by 6% from the previous year, and 40% over the quarter's adjusted NII per share of $1.01. Despite generating no new portfolio investments, Saratoga Investment upheld high credit quality standards, demonstrated by a 97.1% rating in their highest credit category, and 14 smaller follow-on investments in well-understood existing portfolio firms totaled $36 million for the quarter.
Saratoga's NAV decreased slightly to $27.42 per share, a 2.9% decline year-over-year, influenced primarily by unrealized depreciation. The quarterly NAV of $359.6 million marked a minor $2.5 million decrease from the previous quarter due to equity issuance and net investment income being offset by net losses and dividends declared. A significant portion of this decline in NAV per share was attributed to $1.36 per share in unrealized depreciation, which was mentioned as the main factor driving down the adjusted NII per share by $0.07.
Saratoga Investment highlighted ample liquidity indicating a 'dry powder' total of $222 million, setting up the potential to increase assets by an additional 20% without needing external financing and with $47 million available in cash. The company's resilient core BDC portfolio, with 86% in first lien debt and the overall portfolio marked at just 0.9% below cost, signals a strong foundation amidst a selective investment approach.
The internal credit quality rating continued to be robust with 97.1% of the portfolio at the top credit rating, reflecting the company’s selective co-investment equity strategy. Additionally, the average leverage across the portfolio was maintained at 4.3x which compares favorably to the industry average, reiterating the firm's discipline in investment selection and management. Saratoga's effective relationship management and business development were evident, with new strategic partnerships forming sources for deal flow, reflecting the strong position of the company to capitalize on future opportunities.
The company's overall portfolio credit quality remains solid, with a gross unleveraged internal rate of return (IRR) of 15.7% on realized investments and 10.9% on combined weighted SBIC and BDC unrealized investments. However, challenges in the macroeconomic environment affected the portfolio and led to three investments being placed on nonaccrual status, with specific attention being drawn to Pepper Palace and Zollege as examples of how the company handles underperforming investments.
Management expressed confidence in the capital deployment prospects despite market volatility and emphasized the company's readiness to take advantage of the best opportunities for accretive investments to shareholders. As part of the management’s strategy, initiatives are in place to improve performance and address the negative impacts of the macro environment on valuation multiples and growth rates of portfolio companies.
Saratoga Investment's management adopted a block sale approach for equity issuance, aiming to minimize market impact and align with long-term investors, reinforcing the sensitivity to stock trading implications and shareholder value. Additionally, a portion of dividend income was noted as non-recurring, suggesting investors should not expect the same level in subsequent quarters.
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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. [Operator Instructions] 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.
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 Presentation 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.
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 2 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 decline, there are periods like the current one, where many of the investments we would [ use ] 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 nonaccrual. With 86% of our investments in quarter end -- at quarter end and first lien debt, and 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 condition and uncertainty. Saratoga's annualized third quarter dividend of $0.72 per share and adjusted net investment income of $1.01 per share imply an 11% dividend yield and 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 concussion 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 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 months 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 nonaccrual. 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 I've seen some markdowns to a handful of credits in our core BDC portfolio as well as our CLO and JV investments in the globally 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.
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 or 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 9 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 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 offerings with all the other changes offsetting each other. On the lower half of the slide, NAV per share decreased by $1.02 primarily 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 2 years. Also, our debt is structured in such a way that we have no BDC covenants that can be stressed during volatile times. Now we'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, 1 CLO fund and 1 joint venture. Our first lien percentage is 86% of our total investments, of which 52% 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 nonaccrual 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 3 months. The average 3-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 how 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 will now turn the call over to Michael Grisius, our Chief Investment Officer, for an overview of the investment market.
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. The overall deal market has remained relatively unchanged since our last update as it seems to be in a bit of a holding pattern and see what happens in the broader macro environment. While liquidity among private equity firms remains abundant, an opaque economic outlook, high financing costs and elevated levels of inflation continue to constrain the private equity deal market, which drives much of the demand for new credits. Lenders, especially banks, remain more risk-sensitive, backing off historically volatile sectors and taking a harder stance on the use of capital, which create a lending vacuum for borrowers. Overall, lenders are requiring greater equity capitalizations regardless of the enterprise multiples and in some cases, have reduced their pace of deployment as well as their hold positions. All of these factors are positive for us and support the confidence we have in our ability to carefully deploy capital in a manner that is accretive to our shareholders. Leverage levels appear to be increasing and remain full for strong credits. The growth in absolute yields appears to have abated. And with fears of an economic slowdown dampening among some market participants, we have seen some lenders offer tighter spreads to win mandates. The Saratoga management team has successfully managed through a number of credit cycles and that experience has made us particularly aware of the importance of first, being disciplined when making investment decisions; and second, being proactive in managing our portfolio. We're keeping a very watchful eye on how continued inflationary pressures and labor costs, high rates and a potential economic slowdown could affect both prospective and existing portfolio companies. A natural focus currently remains on supporting our existing portfolio companies through follow-ons. Our underwriting bar remains high as usual yet we continue to find opportunities to deploy capital. Follow-on investments in existing borrowers with strong business models and balance sheets continue to be a healthy avenue of capital deployment as demonstrated with 69 follow-ons this calendar year, including delayed draw. In addition, we invested in nine new platform investments this calendar year. The portfolio management continues to be critically important, and we remain actively engaged with our portfolio companies and in close contact with our management teams, especially in this uncertain market environment. There are a couple of credits specifically that are experiencing varying levels of stress that we have worked down this quarter that I will touch on shortly. But in general, our portfolio companies are healthy and 83% of our portfolio is generating financial results at or above the prior quarter. This quarter, we added our Zollege investment to nonaccrual as they missed their October and November interest payments. This means we have three investments on nonaccrual, including Knowland and Pepper Palace. After recognizing the net unrealized depreciation on our overall portfolio this quarter, Saratoga's core BDC portfolio is 0.9% below cost. Despite the write-down of a handful of specific assets this quarter, the remaining portfolio generated $4.3 million of unrealized appreciation, reflecting certain attributes of our portfolio that bolster its overall durability. 86% of our portfolio is in first lien debt and generally supported by strong enterprise values in industries that have historically performed well in stress situations. We have no direct energy or commodities exposure. In addition, the majority of our portfolio is comprised of businesses that produce a high degree of recurring revenue and have historically demonstrated strong revenue retention. Our approach has always been to stay focus on quality of our underwriting. And as you can see on Slide 15, this approach has resulted in our portfolio performance being at the top of the BDC space with respect to net realized gains as a percentage of portfolio at cost. We are only one of 13 BDCs that have had a positive number over the last 3 years, currently fifth overall. Even taking into account the challenges and corresponding write-downs in a few of our portfolio companies, under Saratoga management, the sum total of realized gains and unrealized appreciation have far outstripped realized losses and unrealized depreciation in our core non-CLO portfolio over time. Our internal credit quality rating reflects the impact of current market volatility and shows 97.1% of our portfolio at our highest credit rating as of quarter end. A part of our investment strategy is to selectively co-invest in the equity of our portfolio companies when we're given that opportunity and when we believe in the equity upside potential. This equity co-investment strategy has not only served as yield protection for our portfolio, but also meaningfully augmented our overall portfolio returns as demonstrated on the slide and the previous one, and we intend to continue this strategy. Now looking at leverage on Slide 16, you can see that industry debt multiples have come down this year from their historically high levels. Total leverage for our overall portfolio was 4.3x, excluding Knowland, Pepper Palace and Zollege while the industry is now again at above 5x leverage. In addition, this slide illustrates the strength of our deal flow and our consistent ability to generate new investments over the long term despite ever-changing and increasing competitive market dynamics. During the fourth calendar quarter, we added no new portfolio companies and made 15 follow-on investments. Despite the success we're having investing in highly attractive businesses and growing our portfolio, and the healthy deal flow we are seeing, it is important to emphasize that, as always, we're not aiming to grow simply for growth's sake, especially in the face of uncertain macroeconomic environment. Our capital deployment bar is always high and is conditioned upon healthy confidence that each incremental investment is in a durable business and will be accretive to our shareholders. Slide 17 provides more data on our deal flow previously discussed, demonstrating how our team's skill set, experience and relationships continue to mature and our significant focus on business development has led to multiple new strategic relationships that have become sources for new deals. 5 of the 9 new portfolio companies over the past 12 months are from newly formed relationships, reflecting notable progress as we expand our business development efforts. The significant progress we've made in building broader and deeper relationships in the marketplace is noteworthy because it strengthens the dependability of our deal flow and reinforces our ability to remain highly selective as we rigorously screen opportunities to execute on the best investments. As you can see on Slide 18, our overall portfolio credit quality remains solid. As you can see on the chart on the left, the gross unleveraged IRR unrealized investments made by the Saratoga Investment management team is 15.7% on $917 million of realizations. On the chart on the right, you can see the total gross unlevered IRR on our $1.2 billion of combined weighted SBIC and BDC unrealized investments is 10.9%, including the markdowns of this quarter. Notably, the unleveraged IRR on the combined realized and unrealized $2.1 billion of capital invested by the Saratoga management team is 13.8%. We now have three investments on nonaccrual with Pepper Palace classified as red and Knowland and Zollege as yellow. Knowland has been yellow for a while and no significant change to the Q2 mark occurred. Pepper Palace continued to suffer from poor performance and liquidity issues, reflecting the $4.1 million markdown this quarter. We are working with a sponsor and a financial adviser to assess future options and evaluate the ongoing viability and profitability potential of the business in the current consumer retail environment. The remaining fair value of this investment is $5 million. Zollege started facing liquidity issues this quarter resulting in its inability to pay its October and November interest on time, which has led us to move this to nonaccrual. Despite recent challenges, we believe that the core Zollege business model and value proposition remains solid, evidenced by the company's reasonably stable student enrollment trends. In addition to these nonaccrual investments, we also want to highlight 2 other investments that we marked down this quarter. We marked our Netreo investment down by $8.3 million, of which $6.1 million was the reversal of appreciation previously recognized in our common equity. This markdown reflects a combination of factors, including recent weaker financial performance and a significantly lower market multiple due to changing market conditions. We continue to believe that all of our debt is covered by the enterprise value of the business and that the ultimate equity realization will be determined by market factors and company performance. We also marked down our ETU investment by $1.8 million, primarily related to our equity position. This reflects weaker financial performance driven by lower revenue growth than expected amid a weaker macro selling environment for corporate learning and development. The company has a blue-chip customer base. And we continue to believe that the business offers market-leading technology and a unique value proposition within this space. In addition, the CLO and JV have had a $6.5 million of unrealized depreciation, primarily driven by the performance of certain individual credits in the broadly syndicated loan portfolio. Of note is that the rest of the core BDC portfolio has continued to perform well, resulting in $4.3 million of net unrealized appreciation across our remaining 50 portfolio companies. 82% of our portfolio is generating financial results at or above the prior quarter. Our overall investment approach has yielded exceptional realized returns and recovery of our invested capital and our long-term performance remains strong as seen by our track record on this slide. Moving on to Slide 19, you can see our first and second SBIC licenses are fully funded and deployed with our first license recently surrendered. We are currently ramping up our new SBIC III license with $145 million of lower cost undrawn debentures available, allowing us to continue to support U.S. small businesses. This concludes my review of the market, and I'd like to turn the call back over to our CEO. Chris.
Thank you, Mike. As outlined on Slide 20, our latest dividend of $0.72 per share for the quarter ended November 30, 2023, was paid on December 28, 2023. This is the largest quarterly dividend in our history and reflects a 6% and 36% increase over the past 1 and 2 years, respectively. The Board of Directors will continue to evaluate the dividend level on at least a quarterly basis, considering both company and general economic factors, including the current interest rate environment's impact on our earnings. Recognizing the divergence of opinions on when interest rate cuts will commence and at what pace, the expected overall economic performance, Saratoga's Q3 over-earning of its dividend by 40% or $1.01 per share versus $0.72 per share this quarter provides a substantial cushion should economic conditions deteriorate or base rates decline. Moving to Slide 21. Our total return over the last 12 months, which includes both capital appreciation and dividends, has generated total returns of 14%, uncharacteristically underperforming the BDC index of 30% for the same period. Our longer-term performance is outlined on our next slide, 22. Our 3- and 5-year returns place us in the top quartile of all BDCs for both time horizons. Over the past 3 years, our 66% return exceeded the average index return of 45%. Over the past 5 years, our 100% return exceeded the index' average of only 64%. Since Saratoga took over management of the BDC in 2010, our total return has been 712% versus the industry's 241%. On Slide 23, you can further see our performance placed in the context of the broader industry and specific to certain key performance metrics. We continue to focus on our long-term metrics such as return on equity, NAV per share, NII yield and dividend growth and coverage, all of which reflects the growing value our shareholders are receiving. While NAV per share is down 2.9% this past year, we continue to be one of the few BDCs to have grown NAV over the long term, and we've done it accretively. Moving on to Slide 24. All of our initiatives discussed on this call are designed to make Saratoga Investment a leading BDC that is attractive to the capital markets community. We believe that our differentiated performance characteristics outlined on this slide will help drive the size and quality of our investor base, including adding more institutions. These differentiated characteristics, many previously discussed, include maintaining one of the highest levels of management ownership in the industry at 13%, ensuring we are aligned with our shareholders. Looking ahead on Slide 25. We remain confident that our reputation, experienced management team, historically strong underwriting standards and time and market tested investment strategy will serve us well in navigating through the challenges and uncovering the opportunities in the current and future environment. And that our balance sheet, capital structure and liquidity will benefit Saratoga's shareholders in the near and long term. In closing, I would again like to thank all of our shareholders for their ongoing support. And I would like to now open the call for questions.
[Operator Instructions] And our first question comes from Erik Zwick with Hovde Group.
I wanted to start first with the question on the pipeline. I wonder if you could kind of break out how you characterize the opportunities that are likely to enter the portfolio in terms of new investments versus existing. It sounds like, at this point, based on what transpired in the last quarter, there's certainly more attractive opportunities to extend to existing investments. I'm curious if your kind of near-term outlook for the next quarter or 2 is similar or if you're seeing some more attractive opportunities for new investments?
That's a good question. We are continuing to see good opportunities to deploy capital. We didn't find anything in this past quarter, and that was mostly reflective of the fact that the deals that we saw in terms of the leverage that they were looking for relative to the strength of the business model, we just couldn't get comfortable and didn't pass our underwriting bar. I think -- I wouldn't say that that's characteristic of our pipeline in general, but that certainly was characteristic of what we -- where we ended up this past quarter. The pace of investment that we're experiencing is certainly being influenced to some degree by lower deal activity just in general in the middle market. We're still seeing a disconnection between what value sellers think that they ought to fetch and what buyers are willing to pay in this market. So there's not as much deal volume as we've seen historically. But we still are seeing healthy activity and have confidence that we'll find opportunities to deploy capital.
That's helpful. And then you mentioned in the comments on one of the slides that you've got quite a bit of liquidity on hand right now and the ability to potentially grow AUM as much as 20% without harnessing or kind of capping the external financing. Just curious, is that a goal to actually get that full 20%? And over what time horizon would you expect to put that to work?
It's interesting that we -- go ahead. Go ahead, Chris.
I'm sorry, Mike. Just at a very high level, we've tried to run our business with ample liquidity to take advantage of opportunities. And so we have the dry powder available. We have a large group of portfolio companies that continue to grow as you saw this past quarter. There's a lot of follow-on opportunities. We're financing a number of buildups. And so the -- we want to make sure that we're there for and available to be there for our portfolio companies when they need the capital for whatever reason, mostly positive reasons, but -- so we want to have that available for that. And then we also want to be available for new opportunities for our existing relationships and for building new ones. And so that's a stance we've kind of maintained for really the whole time, the last 13 years, and that's what we continue to maintain. As to the pace of deployment and our expectations for that, I mean, that's sort of not in our control. I mean, I think as Mike said just earlier if we had a lot of opportunities, we could have put a whole lot more money this past quarter, but we refrained from doing so. So we're going to pick our spots. We're going to support our portfolio companies when merited and we're going to be selective going forward. So unfortunately, we can't give a hard forecast for when and how we would deploy that. And it's really going to be subject to the opportunity set both from our existing portfolio and for new opportunities.
The only thing I'd add to that, too, just to augment that is that you had asked if we had a goal to deploy that additional capital. We tend not to think about our business that way, as Chris was explaining. We just really set ourselves up for the best opportunities we can to deploy capital in a way that we feel very comfortable to be accretive to our shareholders and let the rest take care of itself, but definitely don't set goals around kind of where we want to move the balance sheet. It's really more a function of what opportunities we see. And if we see those, we certainly want to avail ourselves of those opportunities and let the shareholders benefit from it.
Got it. And one last one, and I'll step aside. Just in terms of the Zollege investment, I think I didn't get the exact quote, but I think you mentioned the core business and operating trends remained solid, but they did miss the two interest -- monthly interest payments. So just curious, it's -- kind of balancing those two, what led to their decision to skip those payments? And any time frame expectations for when they might return to accrual?
The company is experiencing some execution and cost challenges that have constrained their liquidity. And we're working with a sponsor and management on some initiatives to improve performance. But the decision certainly was made as a result of the liquidity challenges to suspend interest payments. We are -- and as we look at the core business though, a lot of the fundamentals that we originally liked in the business remain intact. So we're seeing a lot of stability in terms of student starts and enrollment and things that you point to fundamentally to feel comfortable that the business model has a compelling value proposition for its customers but work to do on the execution side. Can't really put a date or time around kind of a time frame for improved performance, but that's what we're focused on for sure.
[Operator Instructions] Our next question comes from Mickey Schleien, Ladenburg Thalmann.
Wanted to follow up on your comments on Netreo. It sounded like you attributed most of the decline in the valuation to comparable valuation. But I saw in the Q that you also mentioned higher leverage. Was that due to declining EBITDA or a bank coming in ahead of you? Or could you just expand on that, please?
There's higher leverage because we've been supporting the growth of the business with our own debt. So there's nothing that's coming in front of us but there is a higher debt load. Most of the change, just to reiterate, in value was due to a change in multiple as we looked at macro factors, just where valuation is, combined with lesser performance of the underlying business. And then the thing I'd point out to, Mickey, is that the vast majority of that write-down was reversal of appreciation that we have -- unrealized depreciation that we had before that.
I understand. Your last fiscal quarter also includes December, which is historically the busiest month of the year for BDCs. Could you give us any sense of how active you were in December in terms of fulfilling your pipeline?
We tend not to get into that detail post quarter end. But I think we've continued to support our portfolio companies kind of consistent with what we've done in the past. Haven't seen a whole lot of change in sort of what you saw through the last reported quarter.
Okay. My last question is in regards to the notes coming due in March. I understand that they're extendable at your discretion for a year. Those are at 8.75%. I'm just trying to understand whether you're more predisposed to trying to refinance those or just extend them for a year and see how rates go?
Yes. I don't think we've made a decision on that yet. We've still got 2.5 months to go, Mickey. So I think we're still sort of considering our options, but it's obviously nice to have the flexibility with an instrument like that, especially a short-term instrument like that.
If I could just add also to that. I mean, I think inside of that optionality to do that, I think that's something that we try and preserve. I think Henri did a very good job in negotiating that, to allow us that opportunity. It could have been straight up to your facility, but we gave ourselves the option to be able to repay it. So I think it's reflective of how we think about our capital structure relative to potential changes in interest rates. The other thing I would say, and this is sort of a broader concept, it's running through the broader marketplace and the BDC marketplace is what is the course of interest rates next year? What do people expect? What's going to happen? And I think the core answer is that nobody really knows. I think if you were to put up the charts of all the forecasts of short-term interest rate cuts that have been forecast over the last several years, I think they've been universally wrong. So we just don't know enough right now about the market, right, for debt instruments to make that call. And just look what's happening in the last 2.5 months. What people would have said or didn't say 2.5 months ago and what they've been saying the last couple of weeks is pretty radically different. And there's a lot of more information we're going to get before we have to make the call on that, as Henri said. So we're going to wait right up to it and obviously, evaluate all our financing alternatives relative to that extension.
Yes. I completely agree with you. I know that we don't know where interest rates are going to go and I understand your rationale. And I suppose it's similar with undistributed taxable income, you seem to be carrying, right, Henri, that's something you'll evaluate sort of, I guess, in the middle of this year? Is that correct?
Absolutely. I mean, we actually -- we talk about it the whole time. And again, it's being able to have optionality and flexibility, especially at a time like this, where one sort of at a moment in the market where a lot could be changing. It might not, it might, but it's just nice to have the flexibility right now.
[Operator Instructions] Our next question comes from Robert Dodd with Raymond James.
First question, if I can, on leverage. Obviously, you've brought the regulatory leverage down a bit versus where a couple of quarters. I mean, raising equity and the manager supporting that financially. So are you -- is this an area where you're kind of -- we should expect you to remain comfortable in the 160s? Or is it contingent or market? If the market gets more active, you're willing to go higher again on the regulatory leverage side? Or can you give us any thought? I know you don't give us an explicit target, but some framework around where we should expect leverage to play out?
Sure. I think that, again, that -- as we answered the last question, that's something we think about, talk about continuously. I think also just going back to consistent theme on this call and all of our prior calls is that we tend not to forecast and project what our deployment is going to be against any kind of goal per se. We try and address each opportunity as it comes. And as you can see in the last quarter, we declined to make further new platform investments. That wasn't driven by any broader sort of metrics that we're operating to, but it really was sort of on a case-by-case basis us not seeing the risk-reward situation sitting within what we felt it should fit in with it. And we will continue that going forward. So we really -- it's possible we may see some tremendously opportunistic deals coming our way, in which case, we will be favorably inclined. But we're going to be judicious and prudent as we said, about how we deploy relative to sort of everything. Obviously, leverage is a factor and opportunity is a factor and credit quality is a factor. So again, it's difficult for us to answer that question for you prospectively because it's going to be a function of the opportunities that are presented or that we generate for ourselves.
Got it. I think that actually is pretty clear. I appreciate that. On the two -- I do want to ask a couple of questions on Zollege and Netreo. So on Zollege, was there any negotiation with the sponsor as to whether to not pay or to potentially PIK the interest? If this is a transitory cost issue you believe is fixable, wouldn't it -- was a PIK considered as option and in paper, but the straight to not paying the interest when PIK has been increasing cost of the industry, there's more and more of it, it wouldn't have stood out that much if you've done it. Can you just give us any thoughts on why that either didn't come up in view or was rejected?
Well, we're -- it's a good question. We're continuing to work with the sponsor and the management team in terms of one, focusing on improved performance this year and then the general direction that the business is going to go. It's interesting, if we were to convert to a PIK toggle, let's say, in that case, typically, that kind of discussion becomes one where you're agreeing to not get paid your interest, and you're hoping to get something in exchange for it. I think our view is that that at this point, that interest is due. So it's -- from a legal perspective, the interest is accruing legally, not from an accounting perspective because they're not paying on a current basis. But that interest is still due to us. If we were to convert to -- in any of these negotiations, if you're going to convert to a PIK toggle, you're sort of saying to the sponsor, it's okay not to pay us and we're fine with that. Given all the circumstances here and the fact that we're not being paid, we prefer to be in a position where kind of we own a default, if you will, and it allows us to negotiate kind of the course of action from a better position of strength at this juncture.
Got it. I appreciate that. And then on Netreo, I mean, if we look at 2 years ago, the asset was marked well above cost across all the security tranches. And you've put in additional capital a couple of times since then. And it seems like it's been on a gradual valuation deterioration from where it was 2 years ago. So it just -- it looks like today, it's not performing how you thought it would. But we're a pretty long -- prolonged period and it's been gradual deterioration. I mean what's in the works to fix that? I mean I understand your comments, you think the equity market's primarily comps and performance. But -- yes, it's been, I think, 25% of your unrealized appreciation over the last 2 years, that one asset. The NAV performance would have been noticeably better if this asset has been performing better. So what is it that's the problem that still doesn't seem to have been resolved over a couple of years?
Try to be careful in terms of...
Like it's a sponsored investment and you don't want to say too much, but anything you can would be appreciated.
Sure. So if you think about valuation of this business, and we have a material component of the equity here, a lot of the driver of the value of a business like this is the rate of growth and then there's also just macro multiples that affect the value in general. In this case, it's not that the business' performance has deteriorated in a really meaningful way, but they have faced growth challenges. So for a business where a lot of that value driver is dependent upon continued growth when that growth gets dialed back, the valuation multiple has to come in, unfortunately, and that's what we've experienced here. When you couple that with an overall decline in valuation multiples in the macro environment, the combination of those things has caused the value to come down. So we're obviously very disappointed because we were quite excited about the appreciation that we're experiencing in this asset. We think that the primary volatility around it is in the equity, of course, but -- and the vast majority of our capital is in the debt.
[Operator Instructions] Our next question comes from Casey Alexander with Compass Point Research & Trading.
First question with a little series of questions here. There was a quarter-over-quarter reduction in PIK income. Can you tell us what that is attributable to?
Just trying to look at it here.
It was actually -- a big part of it was Zollege, I think, because there was a PIK component to Zollege as well, Casey. And so obviously, going on to nonaccrual, we also stopped the PIK on Zollege. I mean PIK is very small in general for us. So it has an outsized impact just because not that it was a huge PIK amount, but it has an outsized impact because the overall amounts is.
Okay. That's fine. Secondly, are you -- as part of your optionality, is it deemed dividend considered part of that optionality for some of the back income?
What do you mean by deemed dividend, Casey?
Well, I think you know what I mean.
You mean cash or noncash?
Yes. So noncash dividend.
Well, I think you obviously know that, that is an option. Yes, absolutely. That -- the statutory requirements for BDC is to pay out anything is -- it has an option for a stock issuance. So that is a statutory option that is out there. We have not made a decision one way or the other on how to address that.
Okay. Does the JV own any Pepper Palace or Zollege?
No.
Not, okay. Is the CLO experiencing -- when you talk about individual credits, has it experienced actual defaults in the CLO?
No. It's mainly been -- it's not necessarily defaulting assets, but the market price of a handful of assets has deteriorated significantly from a mark-to-market, which then makes it classified as a default for purposes of the valuation, which obviously lowers the principal cash flows that you use in your valuation.
So in essence, it's the bid price that puts it in violation of the CLO measuring stick. Is that what you mean?
Well, just for valuation purposes. So if mark moves from, let's say, 80 to 50, it is not necessarily in default from a payment terms perspective. But for purposes of our valuation, we treat it as a default. So we take its cash flows out of the valuation.
Okay. Great. All right. And then, Chris, I'd like to invite you to take this opportunity to have kind of an open discussion with your shareholders about the manner in which you guys are raising equity and why you think a shareholder should be comfortable with the manner in which you're raising equity in the market.
Sure. And I think it's a very good question. I guess, when we started 13 years ago, I think the BDC had $50 million of equity. And today, we're at $373 million of equity. And the bulk of that has come through share issuances over time. And fortunately, we've also had some very good success in terms of capital gains. And so retention of capital gains has also contributed to that. And over that period of time, we've taken the BDC from kind of inconsequential BDC to certainly consequential relative to our niche in the marketplace, if you will, but we're substantially larger than we were. We were like $80-something million. Now we're $1.1 billion. And so we've built our franchise very substantially. And as you know and as you point out, there's leverage capabilities in a BDC that have limits. And in order to grow, one has to raise equity to grow. And we have done that over time. And pretty much, we've done it when we can and when we could have. And the results, I think if you look at our performance, total return performance, I think all the equity -- relative to almost every period -- I mean if you get to super short periods, trading and things like that, less than a year, less than 6 months, maybe it's a problem. But I think if you look at annual periods or multiyear periods for all the parties that have invested in our equity and stayed with it for a year or more, I'm pretty sure that every single person has had a very, very sizable returns and generally speaking, has outperformed the industry average of the BDC. So we think all our equity issuances have been accretive, if you will, for people that bought that stock that it's gone up on a total return basis. I think if you look at our stock right now, we have close to 16% earnings yield. That's a very substantial earnings yield, which I think is helping to build our equity, cover our dividend by 40%. So I think the stock is certainly, from our standpoint, in our internal ownership, very attractive stock to own. Now we have traded below NAV. And as you know, one doesn't issue stock, can't issue stock below NAV at the BDC level. And so as a manager, this past year, we issued about $50 million of stock and the manager itself has invested [ $4.5 million ] to basically support or subsidize that so that the BDC, when it sells that stock gets 100% of NAV. And I think that, that investment by the manager is reflective of our belief in the business. In essence, it's an investment by the manager in our equity -- in our business, in the growth and opportunities that we see in the business. And I think if you look across the shareholders, we're not selling stock. I think I've -- my stock have declined, but most of the stock I own has declined as a result of the issuances to the management team. So we are long term, equity owners, equity holders, equity buyers, many of us reinvest in our stocks. So we are believers in our own stock. The manager is a very firm believer having invested more in that stock. And there's obviously -- there's two -- there's more things than this, but there's two things, obviously, that we have to watch for. One is growth. And without equity as a cornerstone, given the average limitations on BDCs, we can't grow unless we have equity. And so we've been issuing equity to support our growth. And our growth has been a profitable growth. I think obviously, this quarter, a lot of things converged. And so not the best news this quarter relative to some others. But if you look over the long haul, we've had very, very positive performance, which we expect to continue. And we're very sanguined about the opportunities in our field. But in order to grow, we need to issue equity. And so we took advantage of some opportunities including our willingness to invest to support the BDC in the past period of time. The other element, which you and others have commented on is the leverage ratios that Saratoga has. And we kind of have a statutory leverage, and we also have a -- that we have to comply with. And then because of certain technicalities of SBIC accounting, we can borrow more than the statutory limits for a regular way BDC are. And so we have historically taken advantage of that opportunity over the long run, and it's worked out very, very well for us. We've had lots of discussions on these calls about the character of our leverage. And a lot of people point to absolute leverage and say, okay, your leverage is X and that's quote too high or higher than everybody else and things like that. And we have said, well, at a point in time, that's right. But if you look at the dynamic of our leverage, and the term structure of our leverage and the absence of covenants and the absence of mark-to-markets and the absence of advance rates and all those types of things, our leverage is very well structured and very well structured for horror shows like when we had in COVID. When everything sort of fell apart, I mean, we were able to go forward and put money to work and support our portfolio companies and support our sponsors because our leverage structure was very solid and was not being perturbed by the external environment. We're very prominent BDCs in our universe. They had to write checks to cover out of formula asset-based loan requirements to basically stay in business. And so I think our leverage structure has been time and event-tested. And so -- but -- so we're very comfortable with it as we said many times. However, if there is -- there are absolute metrics associated with leverage and the issuance of equity basically allow us to have more either cushion in a down environment or support opportunity in an up environment or up set of opportunities environment. So I think we've been very -- I think our equity performance -- I think, it's been very good all along for anyone who's ever gotten into the stock, and we would anticipate anyone who's bought the stock recently, we'll share in that performance. And we think our stock is -- we don't think people are looking at it the right way. And where else are you going to get 16% earnings yield at this point in time with the type of historical performance and portfolio that we have assembled. So we think Saratoga is a very good value at this point in time.
Well, I appreciate that answer. I'm looking at Slide 21, and the period of underperformance of Saratoga relative to the BDC index kind of clearly corresponds with the time period where you've been in the market and selling stock at around 90% of book. So can you explain until a shareholder is confident that you're no longer in the market at 90% of the book? And look, I appreciate the fact that you're making up the difference at the manager. I understand that fully, but you still supplying the market at 90% of the book. So can you tell me as a shareholder, why I should be willing to pay more than 90% of book, if I know that you're willing to sell stock at 90% of book?
Well, when you say you, the BDC is not selling at 90% book. Okay. BDC is selling...
That's fine.
By the way, Casey...
That's your answer. That's your answer.
But Casey, just by the way, I'm not sure your headline of your report...
The supply is coming into the market at 90% of book, okay? You're making up the difference. But the supply coming into the market at 90% of book. That's where we know the supply is coming, right? So -- to me why someone should be willing to pay more than that?
Well, the BDC....
So they're confident that you're no longer in the market at that level.
Well, first of all, just say what's going into the BDC at 100%. So BDC is getting a...
I'm aware of that. I already acknowledge that.
Okay. And then whether we're in the market or not, I mean, we can't say. Just as we've answered these other questions about the -- what are we going to deploy over the next period of time and our targets versus leverage, it's a consistent answer relative to this, which is it's going to be a set of opportunities. I mean these stock sales were done in blocks. These were not like open market sales. These were block sales to specific investors with long-term investment outlook. So in terms of float and all those types of things, again, we're not driving what those investors are thinking and how they're doing it. But those investors aren't buying in blocks at this scale to then kind of trade out much in the volume situation of our stock, okay? So we believe they're long-term investors. So on the one hand, you're saying, oh, yes, it's adding to the supply. But it's adding the supply of people that are long-term holders. They're not -- I mean, it's not such a great idea to buy a big block and then trying to get out of it right away. I mean, as you know.
So let me ask you one more question. All right. The shares that you have already sold in the fourth quarter, okay, will you be making up the difference to an NAV of $28.44 or $27.42? -- demand...
The higher number, right, Henri?
That's all my questions.
[Operator Instructions] Our next question comes from Bryce Rowe with B. Riley.
Don't necessarily want to extend the call here, but did want to ask a couple of questions. I want to follow up on that last discussion. With Casey, Chris, certainly understand the quality of the leverage profile and do acknowledge that balance sheet leverage is -- on an absolute basis, is elevated relative to the space. And appreciate that you all are subsidizing the equity issuance here to allow the BDC to take it at 100% of NAV. To what extent are you -- is the manager willing to subsidize especially with the stock now down in the, let's call it, 80%, 85% of NAV range now?
Well, again, that's a prospective question, and I hope you appreciate that we have to be very careful on what we say we're going to do prospectively. I think much like our investment discussions, selling stock is also similar. I mean, in other words, it's not our decision to sell stock. We need a buyer on the other side that's ready to acquire. And as we said before, the stock sales have been in blocks. We haven't been selling stock. Just we haven't been like having a sell in the open market every day, okay? Well, that's not what we've been doing to achieve these sales. And we are very cognizant of trading volumes and things like that. These are specific sales by appointment as opposed to us sort of saying, okay, we're going to sell all the stock to anybody all day and just having an open sell order. No.
So these arguably have been sort of off market right now on the stock has been traded in blocks and it hasn't really affected the market. It's a separate kind of trade. So we obviously are very sensitive to where our stock trades, how our stockholders effectively are affected by these events. We've been very thoughtful and careful about that. And we think that, that is very, very positive for the company. But we're really excited. And we're also -- we're sort of slightly puzzled by getting so much pushback on selling equity when analysts like yourselves are asking us about our leverage ratio. We would think we would get maybe more -- applaud us for raising equity that is improving that metric on that side, recognizing that the next question everyone has is like, well, are you going to deploy it and increase your leverage again? And our answer has always been, we will or we won't depending on the opportunity set. And I think what's missing from in our mind, from a lot of this discussion we have, it's sort of like risk-adjusted returns, right? You can have an absolute return of X. But the question is how risky is X? And so on a risk-adjusted basis, X risk might be X plus 50% risk or it might be X. And so on our leverage structure, it's sort of similar, like what is our risk-adjusted leverage. And if you compare our leverage at fixed rates and with the term structure, the absence of covenants, all those types of things, you say, okay, let's compare that to another BDC that has a tremendous amount of bank leverage with asset-based formulas. And let's say, their leverage is substantially less than our leverage. But if they get a bunch of markdowns, they're going to have a default in that credit facility. And we had the exact same portfolio on the exact same markdowns, we wouldn't have it in. So on a risk-adjusted leverage basis, we think our leverage is -- should be discounted. You should take the absolute number of our leverage and say that's what their leverage is. You should put a discount on that because of the structure relative to the BDC industry because the BDC industry has a tremendous amount of essentially bank leverage. And you look at when people got into trouble, most of that trouble has come from bank leverage when assets have to be marked down and things come out of formula. So anyway, so we feel our leverage is on a risk-adjusted basis, should be substantially discounted from the absolute number.
Understood that. I appreciate that. Maybe I'll just move on to another topic here. Henri, the quarterly dividend income, you called out $1.3 million from the senior loan fund. There is an additional, let's call it, $500,000 that came in there. Is that -- would we characterize that as kind of recurring in nature? Or is that more of onetime?
Yes. There's one portfolio company that regularly pays us a dividend every quarter, but it's more $100,000, $150,000. I'd say the additional piece, you're right, Bryce was sort of a -- it definitely won't be recurring every quarter. It was another one of our portfolio companies who distributed some of their excess cash flow from operations.
Okay. That's helpful. One more for me. And certainly, I understand you're not going to give specific guidance around kind of repayments, but we've -- or exits, but we've seen relatively muted activity on the repayment exit side for the last few quarters, understandably. So can you speak to -- and maybe this is a question for Mike, but can you speak to kind of the market activity right now within the portfolio? Is there interest in potential exits? And if there is, can you kind of speak to maybe the velocity or the probability of stuff kind of coming to market over the next little bit.
Bryce, this is Mike. As it relates to that, it's a big question mark, right? I think that's going to coincide with the overall deal market picking up. So really hard to tell. I would say some of the things that we look at is for some of our assets, they've been in sponsor ownership for a period of time. So at some point, even if they feel like they're not going to optimize the valuation relative to what they would have gotten 18 months ago or a couple of years ago, let's say, they're going to be inclined to exit. So we think that at some point, that will turn, and probably we'll start to see some redemptions within our portfolio. At the same time that, that starts to occur, we would expect, and this is just naturally how it tends to work, the deal volume in general will pick up. And so we'll be a little bit back on that typical cadence that we have where we're getting redemptions and then our origination activity has to outstrip that, which it has comfortably for a long time now. But right now, we're in a position where deal volume and originations are skewing more towards supporting our portfolio companies, which we're delighted by and we're not getting much redemption. So our portfolio growth, even though our new platforms are not increasing, our portfolio growth is still solid. But hard to say on the redemptions. We -- I can't tell you that, hey, we see that on the horizon and there's going to be a big wave this year although that could occur. It's just hard to say.
Thank you. This concludes the question-and-answer session. I'd now like to turn it back to Chris Oberbeck for closing remarks.
Well, we want to thank all of you, all our shareholders and everyone on this call for listening, for considering Saratoga. And we look forward to speaking to you next quarter. Thank you.
This concludes today's conference call. Thank you for participating. You may now disconnect.