Earnings Call Transcript - CCAP Q2 2024

Operator, Operator

Good day, everyone, and welcome to the Q2 2024 Crescent Capital BDC Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, you will have the opportunity to ask questions during the question-and-answer session. It is now my pleasure to turn the conference over to Dan McMahon, Head of Investor Relations. Please go ahead.

Dan McMahon, Head of Investor Relations

Good morning, and welcome to Crescent Capital BDC, Inc.'s second quarter ended June 30, 2024, earnings conference call. Please note that Crescent Capital BDC may be referred to as CCAP, Crescent BDC or the Company throughout the call. Before we begin, I'll start with some important reminders. Comments made over the course of this call and webcast may contain forward-looking statements and are subject to risks and uncertainties, the Company's actual results could differ materially from those expressed in such forward-looking statements for any reason, including those listed in its SEC filings. The Company assumes no obligation to update any such forward-looking statements. Please also note that past performance or market information is not a guarantee of future results. Yesterday, after the market closed, the Company issued its earnings press release for the second quarter ended June 30, 2024, and posted a presentation to the Investor Relations section of its website at crescentbdc.com. The presentation should be reviewed in conjunction with the Company's Form 10-Q filed yesterday with the SEC. As a reminder, this call is being recorded for replay purposes. Speaking on today's call will be CCAP's Chief Executive Officer, Jason Breaux; President, Henry Chung; and Chief Financial Officer, Gerhard Lombard. With that, I'd now like to turn it over to Jason.

Jason Breaux, CEO

Thank you, Dan. Hello, everyone, and thank you all for joining us today. It was great to see some of you in person at our inaugural Analyst and Investor Day in June. I'll start today's call by highlighting our second quarter results, follow that with some thoughts on our investment approach and touch on our portfolio. Yesterday evening, we reported another quarter of solid earnings with continued strong credit performance across the portfolio. Net investment income, or NII, was $0.59 per share, which translates into an annualized NII return on equity of 11.7%. With our earnings, again, well in excess of the recently increased regular dividend, our Board has declared a supplemental dividend for the second quarter of $0.09 per share. When coupled with our previously declared regular dividend of $0.42 per share, this equates to a 10% annualized dividend yield on June 30, 2024, NAV. The strength of our earnings also led to growth in our net asset value, increasing to $20.30 per share, which is the highest it has been since June 2022. Let's shift gears and discuss the investment portfolio. Before I get into specific data points, I'd like to spend a minute on our investment approach and where we seek to meet new opportunities. It's no secret that in recent quarters, there has been a lot of competition in private credit, both with the syndicated markets and significant capital that we have seen raised in the sector. In recent quarters, the average tranche size of transactions being refinanced by the direct lending markets from the syndicated markets is well north of $1 billion. This segment of the market is not where we focus. Where we focus our efforts is in what we call the lower and core middle market, segments of the market that are typically not able or less able to access the syndicated loan markets due to issuer size. So think issuers with EBITDA of $10 million on the low end, up to roughly $150 million to $200 million on the high end. In the lower and core middle market, we are able to directly negotiate terms with our sponsors that have structural features around collateral protection that we deem critical for investing in the space. This is in direct contrast with the looser documentation for some of the mega unitranche deals that we have seen over the past few quarters that resemble broadly syndicated loan documents, some of which have garnered significant public attention. Our segment focus provides us with opportunities to truly lead our transactions and drive the documentation. We are focused on strong cash flow generation, tight EBITDA definitions as well as enhanced monitoring rights, which allow us to be proactive versus reactive as we think about our approach to portfolio management. We are cash flow lenders, so we focus on underwriting businesses that have been operating for a long time and have a history of being able to generate cash flow consistently with low working capital requirements. It's for these reasons that we do not invest in annual recurring revenue or ARR loans. Please turn to Slides 13 and 14 of the presentation, which highlight certain characteristics of our portfolio. We ended the quarter with approximately $1.6 billion of investments at fair value across a highly diversified portfolio of 183 companies with an average investment size of approximately 0.5% of the total portfolio. We've deliberately maintained an investment portfolio that consists primarily of first lien loans, collectively representing 90% of the portfolio at fair value at quarter end, unchanged from the prior quarter. We continue to focus our investing efforts on non-cyclical industries and remain well diversified across 20 broad district categorizations. Our investments are almost entirely supported by well-capitalized private equity sponsors with 98% of our debt portfolio in sponsor-backed companies as of quarter end. We have been pleased with the fundamental performance of our portfolio, as indicated by our performance ratings and non-accrual levels. Our weighted average portfolio grade of 2.1 remained stable quarter-over-quarter and on Slide 17, you will see the percentage of risk-rated one and two investments, the highest ratings our portfolio companies can receive, accounted for 89% of the portfolio at fair value, also stable quarter-over-quarter. As of quarter end, we had investments in eight portfolio companies on non-accrual status, representing 1.6% and 0.9% of our total debt investments at cost and fair value, respectively, which was flat quarter-over-quarter. I'd now like to turn it over to Henry to discuss the market, our Q2 investment activity and the portfolio. Henry?

Henry Chung, President

Thanks, Jason. Middle market loan volume for the first half of the year increased nearly 20% compared to the second half of 2023, with most of the pickup in volume driven by refinancing activity. LBO activity, which represented approximately 1/3 of middle-market loan volume in the first half of 2024, continues to increase, albeit modestly, driven by continued strong business fundamentals, better clarity on rates, declining spreads, and strong demand from the private credit market. Coupled with the margin pressure from LPs to return capital, we believe that conditions are in place for LBO volumes to continue to accelerate in the second half of the year. And while the syndicated markets are open, as Jason discussed, we believe the direct lending market remains the market of choice for sponsors in the lower and core middle market given the benefits of the direct lending expertise offered by managers like Crescent, including speed and certainty of execution and flexibility around the ability to craft bespoke capital structures. Please turn to Slide 15 where we highlight our recent activity. Gross deployment in the first quarter totaled $119 million. As you can see on the left-hand side of the page, 92% of which was in senior secured first lien and clean net tranche investments. During the quarter, we closed six new platform investments totaling $62 million, with the remaining $57 million coming from incremental investments in our existing portfolio companies. Incremental investments as a percentage of overall activity was elevated in the first half of 2024 compared to prior periods as we continue to see higher levels of opportunistic refinancing and add-on opportunities within our existing borrower universe. This provides an ongoing opportunity set for us to make incremental investments in existing well-performing companies seeking to grow via pursuit of accretive M&A. The $119 million in gross deployment compares to approximately $73 million in aggregate exits, sales, and repayments, resulting in $46 million of deployment on a net basis. The new investments during the first quarter were loans to private equity-backed companies with sulfur floors, attractive fees, and a weighted average spread of approximately 530 basis points. We continue to back well-capitalized borrowers with significant equity cushions and the weighted average loan to value of our new investments for the quarter was 31%. Turning back to the broader portfolio, please flip to Slide 16. You see the weighted average yield of income-producing securities at cost came down modestly quarter-over-quarter to 12.2% primarily due to lower yielding assets that we originated in the second quarter, coupled with the exit of higher yielding assets. As a reminder, this metric represented by the line at the top of the chart now includes the impact of income-producing equity investments. This includes dividends from the Logan JV as well as our partnership interests in GACP II and WhiteHawk. As of June 30, 97% of our debt investments at fair value were floating rate with a weighted average floor of 80 basis points, which compares to our 67% floating rate liability structure based on debt drawn with yield floors. Overall, our portfolio continues to perform well with strong year-over-year weighted average revenue and EBITDA growth. That being said, we have continued to closely monitor the impact of borrowing costs on our portfolio companies given the elevated interest rate backdrop. The weighted average interest coverage of the companies in our investment portfolio at quarter end remained stable at 1.7x compared to the prior quarter. As a reminder, this calculation is based on the latest annualized base rate each quarter. We also continue to closely monitor how our portfolio companies are managing fixed operating costs. Our analysis demonstrates that our portfolio companies in the aggregate are well-positioned to address fixed charges with operating cash flows and available balance sheet liquidity. As expected, we saw a modest decrease in the aggregate of all utilization during the second quarter, with approximately 57% of aggregate vulnerable capacity available across the portfolio at quarter end, which is sufficient in our view. It is worth noting that we have seen an increase in repricing requests given tight spreads. Our approach to repricing is that a portfolio company ought to have demonstrated improvement in creditworthiness since underwriting through growth and deleveraging in order to justify repricing. The strength of our portfolio continues to benefit from the substantial amount of equity invested in our companies. Most of it is applied by large and well-established private equity firms with whom we have long-standing relationships and have partnered with in multiple transactions. And we note that the weighted average loan to value in the portfolio at the time of underwriting is approximately 40%. With that, I will now turn it over to Gerhard.

Gerhard Lombard, CFO

Thanks, Henry, and hello, everyone. Our net investment income per share of $0.59 for the second quarter of 2024 compared to $0.63 per share for the prior quarter and $0.56 per share for the second quarter of 2023. Total investment income of $49 million for the second quarter compares to $50.4 million for the prior quarter. The primary driver of this decrease relates to what we classify as nonrecurring investment income, consisting of accelerated amortization, fee income, and common stock dividends. Nonrecurring income of $1.8 million decreased quarter-over-quarter from $2.6 million. As noted on last quarter's call, while we expect some level of nonrecurring or transactional investment income every quarter, our nonrecurring investment income last quarter, driven primarily by two large realizations and an increase in structuring fees for a new platform investment, was meaningfully higher than in previous quarters. Importantly, our recurring yield related income continues to represent the lion's share of total investment income, contributing over 95% of this quarter's total income, consistent with prior quarters. PIK income continues to represent a modest portion of our revenue at 4% of total investment income, which compares favorably to the BDC peer group. We remain highly focused on the level of PIK income, particularly in this environment and believe that this will be a differentiator for BDC performance in the coming years. Our GAAP earnings per share or net income for the second quarter of 2024 was $0.55. This was primarily the result of net investment income outpacing the regular and supplemental dividend offset by $0.07 per share of net unrealized and realized losses. As of June 30, our stockholders' equity was $752 million, up modestly from the prior quarter, resulting in a net asset value per share of $20.30. Now, let's shift to our utilization and liquidity. I'm on Slide 19. As I noted in June at our Analyst Day, in terms of our leverage strategy, we have generally prioritized measured growth and have historically operated at a relatively conservative debt-to-equity ratio. This quarter's investment activity brought our debt-to-equity ratio up to 1.18x from 1.11x in the prior quarter. This quarter's increase puts us closer to the midpoint of our stated leverage range of 1.1x to 1.3x. With $294 million of undrawn capacity, subject to leverage, borrowing base and other restrictions, and $36 million in cash and cash equivalents as of quarter end, we have sufficient liquidity to fund further investment activity while maintaining a debt-to-equity ratio that we are comfortable operating at. The weighted average interest rate on the total borrowings was 6.91% as of quarter end. And as we've highlighted on the right-hand side of the slide, there are no debt maturities until 2026. One additional item I'd like to highlight here relates to our SPV asset facility. In May, we tightened the spread by 30 basis points to SOFR plus 2.45% and extended the maturity from March 2028 to May 2029. As Jason mentioned, for the third quarter of 2024, our Board has declared our recently increased regular dividend of $0.42 per share, which we believe we are well positioned to cover over the longer term. We also plan to continue to declare and pay quarterly supplemental dividends pursuant to the current calculation to provide further distributions to stockholders. And with that, I'd like to turn it back to Jason for closing remarks.

Jason Breaux, CEO

Thanks, Gerhard. In closing, we are pleased with this quarter's financial results and the performance of our investment portfolio. We've continued to maintain a defensively positioned portfolio that delivers a stable net profile with consistent dividend coverage. At our Analyst and Investor Day in June, one thing we hope everyone left with was that CCAP benefits from its affiliation with Crescent, a proven cycle-tested manager. As credit investors, Crescent's approach to investment selection has remained consistent and disciplined for over three decades, and we believe this level of experience will serve as a point of real differentiation for CCAP in less benign credit environments. Even though the private credit landscape continues to rapidly evolve, we want to assure our shareholders that our investment approach remains disciplined and consistent. As we look forward over the remainder of 2024, we remain confident in the continued strong performance of CCAP's portfolio, and believe we are on track to continue to deliver attractive risk-adjusted returns to our stockholders. And with that, we can open the line for questions.

Operator, Operator

We'll take our first question from Lee Cooperman with Omega Family Office. Please go ahead.

Lee Cooperman, Analyst

First, two questions, when I need a little help. All these calls I listened to, everybody says, interest rates are very high. What is the evidence that interest rates are very high? They're higher than they've been, but the stock markets are at record high. If you take the unweighted averages, the market is at a record high. There's speculation going on in the market. Prior to 2008, the 10-year government bond yield in line with nominal GDP. So, if you take 2% to 3% inflation, 2% to 3% real growth, the ten-year wouldn't be undervalued or a 4% to 6% yield. So, what is the evidence that interest rates are too high? That's number one. And then I have a second question.

Jason Breaux, CEO

Hi, Lee. Thanks for joining. Thanks for the question. I think we would agree with you. I think we would say that interest rates are high when looking back at the last, let's say, 10 years, they're high. But if you go back historically over a longer period of time, I wouldn't call them necessarily high today.

Lee Cooperman, Analyst

Secondly, Wall Street has created a lot of companies in the BDC space or IT space that only make sense when stacked over the premium to NAV because the game was sell stock, buy assets, raise the dividend, you sell stock by adds raise the dividend. And once the stocks go to a discount to NAV, it's game over. And you want to be with the guys that are smart enough to understand that the game has changed and are willing to engage in capital management. So, with our stocks below book value, do you guys have a plan to return capital via repurchase? Or is this something that you don't consider?

Jason Breaux, CEO

Yes. Lee, thanks again. It's Jason. This is something that we evaluate, and we will continue to evaluate. As of today, the asset yields that we're getting are still compelling with leverage, even more compelling. That said, I think that's something that we're going to continue to be mindful of as we look at our stock price, and we evaluate where the rate environment is going in the future because we obviously need to consider both of those measures. We also have to take into consideration buybacks to ensure we balance that with the benefits of having scale in the space, given the fixed charges that are associated with managing a registered vehicle. And then, the last point is where our leverage is at. So today, for instance, we're basically at our leverage limit; a buyback would be a leveraging transaction. But it is something we will consider and ensure we manage that within our target leverage.

Operator, Operator

We'll take our next question from Robert Dodd with Raymond James. Please go ahead.

Robert Dodd, Analyst

Reviewing the liability slide on the balance sheet, could you provide some insight into your plans? Currently, approximately 60% of your debt is scheduled to mature in eight months in 2026. The SMBC facility also has an amortization schedule, indicating that the situation is quite tight during that period. Although it's a couple of years away, could you share your expectations on how you might distribute it over the time you have left to manage this?

Gerhard Lombard, CFO

Yes. Robert, it's Gerhard. Thanks for the question. It's a good question. We certainly feel good about our cost of capital today. Those unsecured debts, as you know, have kind of a low fixed coupon relative to what it was today, so that's very attractive. We are not in a rush to refinance those notes immediately. As you saw from the 8-K on our SPV facility and the prepared comments we made a few minutes ago, we are actively looking at our capital structure and taking advantage opportunistically of opportunities to manage and optimize the capital structure. But as you might imagine, we are in constant dialogue with the market and with our lenders. And so, you should expect that we will take action on those notes as they reach maturity. And to comment about laddering, I think that does make a lot of sense. I don't think we necessarily like the idea of having a large bullet maturity on our unsecured debt. And so, I think we like the idea of laddering that. You're in the market all the time; you are diversifying a way that refinancing risk that you would have otherwise if you had a much larger single maturity on your unsecured capital.

Robert Dodd, Analyst

I understand, thank you. Regarding the portfolio's overall liquidity, 57% of our revolver capacity is currently available, which is quite positive. Are you observing any changes at the margin? Given the overall performance, I would anticipate that the portfolio companies are doing well. However, have there been any marginal shifts? It doesn't seem so based on your ratings, correct? Is there anything specific you are keeping an eye on as you adjust the monitoring at a higher rate, particularly considering the relatively high rates we've experienced for an extended time and the liquidity that has been utilized for shareholders due to those rates and the increased funding costs from portfolio companies?

Henry Chung, President

Yes. This is Henry. I can comment on that. I would say that there's certainly, on the margin, we're focused on as indicated by our watch list, which represents just around 10% of our overall portfolio. Within the watch list, I'd say that liquidity needs are really concentrated in less than a handful of portfolio companies that we're highly focused on. And these are companies where it's not necessarily just a rate issue. There are some operating performance, near-term challenges that those companies are working through that, coupled with the higher fixed charges arising from the current rate environment, are creating some needs for liquidity. Given that 99% of our portfolio companies are sponsored-backed, we look to the sponsors to solve those liquidity needs to the extent that outside capital is needed. But to your comments, if you were to look at it on an aggregate basis, we're not seeing any heightened revolver utilization, which is something we track in real-time given that we are typically the revolver lenders in these transactions as well. It's really going to be on the margin, as you said, and really a subset of our watch list.

Robert Dodd, Analyst

I appreciate that. And the sponsors to the point of the change of comments at the beginning as well. Sponsors to different parts of the market appear to be acting differently. Are you seeing those sponsors step up? I mean, certainly in some of the large mega-deals we have clearly. Are you seeing the sponsors continue to step up to provide liquidity where needed in your segment of the market?

Jason Breaux, CEO

Yes. The short answer is we absolutely are. And it really comes down to the assessment of the constituents within the capital structure of whether the issue that the company is facing is really a secular or a longer-term fundamental issue or something that's short-term that can be bridged with some amount of equity capital. We've certainly been fortunate within our portfolio, and I think this is really given our investment approach and our underwriting process to be in situations where any liquidity needs that we have seen have been really short-term in nature. This allows the sponsor to be comfortable putting in capital beneath us in a position where they feel like they'll get a return on that capital, and also for us to credibly come to a view that all that's needed within that respective situation. So, I'd say that certainly in the situations where we've seen sponsors need to step up, we've seen them continue to do so.

Operator, Operator

We'll take our next question from Paul Johnson with KBW. Please go ahead.

Paul Johnson, Analyst

So, I just wanted to ask a question on the PIK income statistics you gave at 4%. I was just wondering if you can talk to why that is so much lower than the average kind of BDC PIK across the space. The average leverage of 5.5x. We would expect in this environment that might be higher, but is it simply because there are fewer borrowers in the portfolio that have this option available, or is less being utilized at the moment? Any color there would be helpful.

Jason Breaux, CEO

Hi, Paul. It's Jason. Thanks for the question. Let me take a stab at that and Henry, feel free to chime in if you've got additional thoughts. A little bit of this is speculation around maybe why we're lower than our peers. I can certainly comment on why we're low, which is we are and have been since inception, very focused on earning cash at the top line since we're distributing cash at the bottom line. We have a high degree of sensitivity to PIK toggle options, for instance, in deals at underwrite. I can't say that we don't do them, but we do them very selectively in terms of deals and underwrite that have a PIK option. That probably falls in contrast to some of our peers who do more of that. ARR loans, for instance, oftentimes have a PIK feature because they don't necessarily generate profitability as they're investing in their business, and so, ARR loans are not an area of focus for Crescent, really never have been. Secondarily, I would say the other way you find PIK in portfolios is when you've got amendment or workout activity. I would say we certainly have some of those situations contained within our watch list. Oftentimes, as Henry mentioned, when sponsors are wanting to write a check to support a business, they are also looking for concessions from lenders. The top asks these days is cash interest burden relief in the form of PIK. So that's the other way that you would come into portfolios. I would say we do our utmost on those types of situations to make sure that if we are picking, we are getting real value from ownership as well to compensate for that concession that we're making. And as you know, we try to be extremely selective in terms of the credits that we choose to put in our portfolio. My hope is that over the long term, you won't see that as a material part of our portfolio at any time.

Gerhard Lombard, CFO

Yes. The other thing I'll comment on there, Jason already touched on ARR loans. During that of '21 and early '22 vintage, a lot of, or I shouldn't say a lot, but a deal structure that was fairly popular was a unique PIK preferred structure where sponsors were looking to be able to stretch leverage without overburdening from a cash interest perspective to pay those top decile multiple needed to prevail in auctions. That was something that I think, especially the paid preferred piece, we shied away from given our focus since the inception of CCAP to stay away and minimize PIK income as much as we can on the front end. So that's certainly something that you'll see as a minority in our profile relative to some of the other peers out there. I think the last point I'll make is that if you were to ask us two years ago, I think we would have seen more PIK amendment requests than we've seen now. But the other side of the coin, I think has been a positive surprise is that the business fundamentals have just been quite strong. Revenue and EBITDA growth on an aggregate basis has continued. We've seen a robust growth both at the top-line and bottom-line across the book. As a result, while borrowers are certainly contending with higher fixed charges, the numerator has grown to be able to address that. So that's been, I'd say, certainly a positive development that has helped ameliorate what we would have thought several quarters ago would have been a much more robust environment for PIK requests.

Paul Johnson, Analyst

That's great color. And then on the new activity, $190 million in the quarter. I know it looks like there was about six new deals in there. What was kind of the mix of just the repricing activity that you mentioned and then the new deals within that, and then as well as just kind of the pipeline overall?

Jason Breaux, CEO

Let us get that information. While he does, I can broadly comment on the market; we're definitely seeing an increase in overall activity. The middle market loan volume in the first half was up 20% compared to the second half of last year, although a significant portion of this was due to refinancings. Leveraged buyouts made up about one-third of the volume in the second quarter, which is still below our target, but it represents a significant increase over the first quarter, with LBO activity rising more than 70% compared to Q1.

Henry Chung, President

Yes. And to follow back up on the first part of your question, six new platforms totaling $62 million, and then we had 13 add-ons to $33 million and then the remainder were fundings on our existing unfunded commitments, DBTLs, and revolvers. The new platform that you referenced were new LBOs versus repricing.

Paul Johnson, Analyst

And then last question. I was just wondering if you can give kind of an update on the performance of the Logan JV and where that's at. It looks like that was written down a little bit this quarter, but just a status update there would be helpful.

Jason Breaux, CEO

Yes. So, the JV, just as a reminder, the largest investment in the JV is a middle market CLO. As a result, you'll see that fair value kind of move on a quarter-to-quarter basis based on the mark-to-market of the underlying loans within that CLO. In terms of the performance of the JV as a whole, we're very focused on assessing the distribution that we're receiving from that CLO and the loans within relative to our projections. I'd say that they've been in line since we've onboarded the asset. One thing to note with the loan JV is that the CLO that's in the JV, the reinvestment period is coming up; it's going to expire in April of next year. So right now, the base case here, the thought around that is that once that invested period lapses, the portfolio will monetize here, but that's something that we're evaluating real-time as you think about the next steps with respect to that vehicle. But I'd say performance-wise, it's kind of been in line with the cash flow expectations that we've been expecting to receive from that vehicle.

Operator, Operator

We will move next to Finian O'Shea with Wells Fargo. Please go ahead.

Finian O'Shea, Analyst

I wanted to go back to the debt side discussion. It sounded like there will be emphasis on or perhaps more of a ladder seeing what that might look like, if we'll have even more and smaller pieces that would thereby presumably be more expensive or if you think that you'll be able to do this and keep that cost down or perhaps reduce them?

Gerhard Lombard, CFO

Fin, this is Gerhard. Yes, that's a great question. Currently, we have three tranches of notes maturing in February, May, and July of 2026, all issued through the private placement channel. We are exploring both private placement and DCM options. However, we don't anticipate that debt costs will necessarily increase due to size; we will ensure the issuances are sized appropriately for the best market execution. Given that the current pricing of those notes is at 4%, 5%, and 7.5%, it is likely that they will increase slightly based on the current spread environment. Aside from that anticipated pricing effect, we will be sure to size those tranches correctly.

Jason Breaux, CEO

Fin, thanks for the question. I just wanted to add that as we continue to look at the market, we want to be very opportunistic about when we penetrate the market, but we will also be looking at swapping as well given the environment that consensus seems to think we're in today.

Finian O'Shea, Analyst

Okay. That's helpful. And for a follow-up, Jason, to your opening commentary on sticking with the lower middle market. To what extent do you see the larger players moving into that territory? And what's the sort of level of competition that brings?

Jason Breaux, CEO

Thank you, Fin. Everyone has their own definition of the middle market, but we generally define the lower mid-market as having EBITDA between $10 million and about $35 million to $40 million. The core middle market we consider to be from around $40 million to $150 million. These are the two primary areas of focus for CCAP. I would say that competition from those targeting the upper middle market hasn’t significantly impacted the lower mid-market, as the market dynamics and sponsor focus are quite different from those of upper middle market players. Additionally, much of the deal-making in the upper middle market is fueled by substantial investments flowing into the non-traded space, where managers are accepting monthly subscriptions and must quickly deploy that capital. This allows them to invest larger sums into each deal. In the core market, we do notice that some upper mid-market players occasionally venture into the core. These are often firms that have experience in the core middle market, so there is some activity from those handling mega tranche deals who also dip into the core from time to time.

Operator, Operator

Thank you. We'll take our next question from Derek Hewett with Bank of America. Please go ahead.

Derek Hewett, Analyst

Focusing on Slide 13. What's driving that 71% of the portfolio with financial covenants? I would have expected the percentage to be a little bit higher just given the focus on the lower and core middle market.

Jason Breaux, CEO

Sorry, Derek, you said Slide 13. Can you repeat your question?

Derek Hewett, Analyst

Yes. What is driving the 71% of the portfolio that has financial covenants? Given the focus on the lower and core middle market, I would have expected that number to be higher. Does this relate to any legacy investments from First Eagle, or is there another factor influencing that figure?

Henry Chung, President

No, I think it's Henry speaking, Derek. It's really a function of the segmentation of the two different markets. When we define the lower middle market as having $35 million of EBITDA and below, virtually all those deals will have at least one maintenance covenant. In the core middle market, which we define as a larger range of $35 million to $200 million in EBITDA, you may encounter situations without a maintenance covenant at the upper end of that spectrum. That's why you're seeing that mix; it's a result of how we focus on the two different markets. It's worth noting that this is almost a direct inverse of what you observe in the upper middle market regarding covenants, especially more recently, due to the wide range of company sizes in the core middle market compared to larger issuers.

Jason Breaux, CEO

I would like to add to everything Henry said. Even in the core segment, where we may not have maintenance covenants, we remain highly focused on documentation and ensuring we have protections in place to the greatest extent possible, negotiating around aspects like baskets and asset dispositions. Therefore, while this reflects true financial covenants, it does not imply that our core middle market documents resemble those of broadly syndicated loans.

Henry Chung, President

Yes. And I think that's an important point because there certainly can be a tendency to kind of oversell the protection you get with maintenance covenants. We've seen that in certain situations, those covenants are quite wide relative to having some real teeth to them. We covered this during a segment within our Analyst Day presentation. The key here is really the document as a whole and our ability to ensure that our collateral stays within our credit box, limiting leakage of our collateral to the extent that a situation may go sideways regarding the operating performance. This is just one barometer, and we really use this to indicate that our deals are not merely variations of what you're seeing in the public loan market. If you were to dig beneath that, you would really see that even in deals that are compliant, the documentation does not resemble that of what you would see in an upper middle market broadly syndicated loan type construct.

Derek Hewett, Analyst

Okay. And then circling back to PIK, I realize that PIK is well below industry peers. But how would you characterize it? Was the PIK that you have structured into the original deals or was that a result of amendments?

Henry Chung, President

Yes. This is Henry. I can respond to that. I'd say the majority of that PIK income is going to be related to investments that had a PIK component at origination. I mentioned in my comments to an earlier question that the volume of PIK amendments that we've seen has actually been quite a bit lighter than we would have initially guessed several quarters ago. So, the majority of what you'll see there is going to be related to investments that have a PIK component at origination, and that will really be more for investments that are second lien or unsecured, which represent a minority of our portfolio.

Operator, Operator

Thank you. And this will conclude our Q&A session as well as our conference call. Thank you for your participation, and you may disconnect at any time.

Jason Breaux, CEO

Thank you all.