Earnings Call Transcript - FDUS Q3 2022

Operator, Operator

Good morning. My name is Abby, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fidus Quarter Three 2022 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Thank you. Jody Burfening, you may begin your conference.

Jody Burfening, Conference Moderator

Thank you, Abby, and good morning, everyone, and thank you for joining us for Fidus Investment Corporation's third quarter 2022 earnings conference call. With me this morning are Ed Ross, Fidus Investment Corporation's Chairman and Chief Executive Officer; and Shelby Sherard, Chief Financial Officer. Fidus Investment Corporation issued a press release yesterday afternoon with the details of the company's quarterly financial results. A copy of the press release is available on the Investor Relations page of the company's website at fdus.com. I'd also like to call your attention to the customary safe harbor disclosure regarding forward-looking information included on today's call. The conference call today will contain forward-looking statements, including statements regarding the goals, strategies, beliefs, future potential operating results and cash flows of Fidus Investment Corporation. Although management believes these statements are reasonable based on estimates, assumptions and projections as of today, November 4, 2022, these statements are not guarantees of future performance. Time-sensitive information may no longer be accurate at the time of the telephonic or webcast replay. Actual results may differ materially as a result of risks, uncertainties and other factors, including, but not limited to, the factors set forth in the company's filings with the Securities and Exchange Commission. Fidus undertakes no obligation to update or revise any of these forward-looking statements. With that, I would now like to turn the call over to Ed. Good morning, Ed.

Edward Ross, CEO

Good morning, Jody, and good morning, everyone. Welcome to our third quarter 2022 earnings conference call. On today's call, I'll start with a review of our third quarter performance in our portfolio at quarter end, and then offer you an update of our views on market conditions in the lower middle market. Shelby will cover the third quarter financial results and our liquidity position. After we have completed our prepared remarks, we'll be happy to take your questions. For the third quarter, our portfolio delivered strong results generating a 27% increase in adjusted NII on a larger debt portfolio with higher yields and net realized gains of $40 million or $1.64 per share from monetizing a meaningful portion of our equity portfolio. We ended the quarter in a net originations position with a portfolio that overall remains healthy even in the face of higher interest rates, persistent supply chain and inflationary challenges, and potential for a recession. Although deal activity is slowing down relative to the high velocity we experienced last year, ample opportunities in the lower middle market that meet our investment criteria continue to be available to us. As a result, we continue to redeploy proceeds from equity realizations into income-producing assets further building our debt portfolio while adhering to our proven strategy of investing in high quality companies that operate in industries we know well, generate cash flow to service debt and support growth, and possess resilient business models and positive long-term outlooks. Adjusted net investment income, which we define as net investment income, excluding any capital gain incentive fee, attributable to realized and unrealized gains and losses, was $12.7 million, or $0.51 per share, an increase of $2.7 million, or $0.11 per share compared to last year. Growth in adjusted NII reflects both an increase in debt investments under management and higher yields at quarter end compared to the second quarter; debt yields increased 100 basis points. NAV was $474.4 million or $19.41 per share at quarter end. For the third quarter, Fidus paid a base dividend of $0.36 per share and a supplemental dividend of $0.07 per share. In August, the Board also declared a base dividend of $0.36 per share and a minimum supplemental dividend of $0.07 per share for the fourth quarter. This skewed NAV at quarter end as the fourth quarter dividend declaration was recognized for GAAP purposes in the third quarter. As a reminder, the early declaration of a fourth quarter dividend was intended to satisfy the distribution requirement of our 2021 investment company taxable income. Adjusting for the early declaration of the fourth quarter dividend, NAV at quarter end was $19.84 per share for a modest increase of $0.04 compared to $19.80 per share at the end of the second quarter. As of September 30, our spillover income is estimated to be $2.86 per share. On last quarter's call, I mentioned that we were evaluating a variety of options with respect to our excess of spillover income, including increasing the base dividend, payout of incremental supplemental dividends, a special cash distribution, and/or a deemed distribution. In evaluating these options and looking ahead to 2023, we've carefully assessed our ability to continue delivering stable to growing dividends to our shareholders while retaining liquidity to grow NAV over the long term. If we look at the portfolio today, in light of the recent period of high levels of M&A and investment activity, we have successfully built our debt portfolio on a fair value basis from $549.8 million as of December 31, 2021, to $747.3 million as of September 30, 2022, in part by redeploying proceeds from equity realizations into income-producing assets. In addition, since the beginning of 2020, we have generated proceeds from equity realizations totaling $192.3 million and accumulated net realized gains of $155.3 million. Based on this performance and our strong liquidity position, we believe we are well-positioned to continue growing adjusted NII, extending our track record of generating cumulative adjusted NII in excess of cumulative base dividends. For the fourth quarter, the Board of Directors has increased the supplemental dividend to $0.15 per share and declared a special cash dividend of $0.10 per share for a total cash dividend of $0.61 per share. The fourth quarter dividends will be payable on December 16, 2022, to stockholders of record as of December 2, 2022. For the year, we will have paid shareholders total cash dividends of $2 per share, a 25% increase over the prior period. For 2023, our Board has approved a dividend policy that encompasses a base dividend, a supplemental dividend, and a special cash dividend. First, with respect to the base dividend, I am pleased to announce that the Board has decided to increase the base dividend to $0.39 per share, restoring our pre-COVID base dividend. In addition, we will retain our formula for calculating a supplemental dividend equal to 100% of the excess adjusted NII over the prior quarter's base dividend. We will also pay out a special cash dividend of $0.10 per quarter. Finally, in order to satisfy the RIC distribution requirements, we will be making a deemed distribution for 2022. While the amount of the deemed distribution will depend on final 2022 results, our planned approach, as we have consistently stated, is to maintain a certain level of spillover in the business to ensure the stability of our base dividend. We plan to communicate more information regarding the 2022 deemed distribution in January 2023. Moving to originations and repayments for the quarter. We invested $107.9 million in keeping with our proven strategy of investing in debt securities to generate recurring interest income and in equity securities to generate a margin of safety and incremental profits. $75.1 million was invested in first-lien debt, consistent with our focus on that security. Of the $107.9 million, a total of $82.3 million was invested in six new portfolio companies comprised of $10.8 million in AmeriWater, LLC, a leading provider of water purification systems and aftermarket parts and consumables for healthcare and industrial applications, consisting of $7.8 million in first-lien debt, $2 million in subordinated debt, and $1 million in common equity. $21 million in BP Thrift Buyer LLC, a thrift store operator specializing in the sale of secondhand merchandise consisting of $20 million in first-lien debt and $1 million in common equity. $7.2 million in second-lien debt of Magenta Bayer LLC, doing business as Trelix, a global cybersecurity company. $27 million in first-lien debt of MBS OpCo LLC, doing business as Marketron, a leading provider of enterprise software solutions for radio and television broadcasters. $11.5 million in OnePath Systems LLC, a leading provider of a full suite of managed IT services, consisting of $11 million in first-lien debt and $0.5 million in common equity, and $4.8 million in second-lien debt of SonicWall U.S. Holdings, Inc., a global provider of network and access security solutions. The remaining $25.6 million was comprised of add-on investments in 8 existing portfolio companies, including a $10 million subordinated debt investment in Van Steel. In terms of repayments and realizations in the third quarter, we received proceeds totaling $60.2 million, of which monetization of equity investments accounted for $43 million or a little more than 70% of the total. As you may recall, some of our portfolio companies had initiated strategic alternative discussions toward the end of 2021. In terms of sales and exits, we received a distribution on our common equity investment and realized a gain of approximately $1.9 million related to the sale of Palisade Company, LLC. We received a distribution on our common equity investment and realized a gain of approximately $3.2 million related to the sale of Bandon Fitness, Inc. We received payment in full of $4.5 million on our first-lien debt investment in Precision Parts, and we received a distribution on our common equity investment and realized a gain of approximately $9 million related to the sale of SES Investors, LLC, doing business as SES Foam. We received payment in full of $5.3 million, including a prepayment penalty, on our first-lien debt investment in Health Fuse LLC. We sold a portion of our equity investment in Fan Steel and realized a gain of $24.3 million. In conjunction with the transaction, we invested $10 million in subordinated debt, and we received a distribution on our equity investment and realized a gain of approximately $1.4 million related to the sale of the Transonic companies. With originations exceeding repayments, the fair value of the portfolio at quarter end reached $856.9 million, a record level and equal to 103.6% of cost. We ended the third quarter with 75 active portfolio companies and 13 companies that have sold their underlying operations. Debt investments reached $747.3 million, demonstrating continued success in building our debt portfolio this year. In fact, our debt portfolio as of September 30, 2022, is now $197.5 million larger than it was as of December 31, 2021, on a fair value basis. Similar to the second quarter, the total portfolio mix on a fair value basis continued to shift in favor of debt investments, largely as a result of equity monetization. As of September 30, debt investments comprised 87% of the total compared to 83% as of June 30 and about 80% as of March 31. First lien debt as a percentage of debt has held steady at around 66%; equity investments as a percentage of the total portfolio on a cost basis was 7.1%, within the boundary of our target allocation of 10%. Taking into account the changes to the portfolio this quarter from net originations and the rotation of equity to debt investments, overall, our portfolio remains healthy with credit quality solid and well-structured to produce recurring income and through our equity investments to provide us with not only incremental profits but also a reasonable margin of safety. With resilient business models designed to weather adverse economic conditions and geopolitical uncertainties, the vast majority of our portfolio companies are performing reasonably well even in the face of ongoing inflationary cost pressures and supply chain disruptions. However, risk is a bit elevated compared to the beginning of the year as these tougher economic conditions are weighing more heavily on select companies. In the third quarter, we experienced modest depreciation in our debt portfolio due to calibration and the financial performance of various companies. We did not place any conditional companies on non-accrual, and as of September 30, non-accruals accounted for less than 1% of our total portfolio on a fair value basis. We will continue to proactively monitor operations of our portfolio companies especially in light of current market headwinds. Subsequent to quarter end, we invested $1 million in common equity of EPL LLC, which was acquired under a new holding company, Evolent Holdings LLC, and became a controlled affiliate investment. In conjunction with the transaction, we amended the terms of our second lien debt investment and committed up to $0.4 million in incremental common equity. In addition, we exited our debt investment in UPG Company LLC. We received payment in full of $17 million on our first-lien debt, which includes a prepayment fee. We also exited our debt and equity investment in OMC Investors LLC, doing business as Ohio Medical Corporation, received payment in full of $5.2 million on our second-lien debt, which includes a prepayment fee. We received a distribution on our equity investment for a realized gain of approximately $0.7 million. Finally, we invested $6 million in second-lien debt of Education Inside LLC, doing business as Acceleration Academies, a leading provider of alternative education academies focused on high school dropout recovery throughout the United States. As we enter the last quarter of the year, we remain well-positioned to continue building our portfolio in the current economic environment without sacrificing credit quality due to the strength of our rigorous underwriting standards, strong relationships with deal sponsors, and industry knowledge. For this reason, even with deal activity slowing down in the lower middle market, we remain optimistic about our opportunities to grow our debt portfolio for continued adjusted NII growth. While we are focused on growth, we will, as always, be patient and deliberate in our selection of investments in high quality companies, and we will continue to structure our debt investments with a high percentage of equity cushion. Our focus on managing the business for the long term continues to serve us well, supporting our goals of preserving capital and generating attractive risk-adjusted returns for our shareholders. Our performance over the past two years positions us to continue delivering shareholder value through increased cash dividends while growing NAV over the long term. Now I'll turn the call over to Shelby to provide some details on our financials and operating results. Shelby?

Shelby Sherard, CFO

Thank you, Ed, and good morning, everyone. I'll review our third quarter results in more detail and close with comments on our liquidity position. Please note, I will be providing comparative commentary versus the prior quarter, Q2 2022. Total investment income was $25 million for the three months ended September 30, a $3.8 million increase from Q2, primarily due to a $2.1 million increase in interest income, including PIK, a $1.1 million increase in fee income due to higher levels of investment activity and prepayment fees, and a $0.6 million increase in dividend income. The increase in interest income was driven by an increase in average debt investment balances outstanding as well as an increase in the yield on our debt investments, given the increase in interest rates on variable rate loans. Total expenses, including income tax provision, were $12.3 million for the second quarter, $2.1 million higher than Q2, primarily driven by a $1.9 million increase in the income incentive fee. As a reminder, expenses will be higher in the fourth quarter as we will incur an annual excise tax expense, which I would estimate to be roughly $0.06 to $0.07 per share. We ended the quarter with $400 million of debt outstanding comprised of $133 million of SBA debentures, $250 million of unsecured notes, and $17 million of secured borrowings. Our debt to equity ratio as of September 30 was 0.8 times or 0.6 times statutory leverage, excluding exempt SBA debentures. The weighted average interest rate on our outstanding debt was 3.9% as of September 30. Net investment income or NII for the three months ended September 30 was $0.52 per share versus $0.45 per share in Q2. Adjusted NII, which excludes any capital gains, incentive fee accruals, or reversals attributable to realized and unrealized gains and losses on investments, was $0.51 per share in Q3 versus $0.43 per share in Q2. For the three months ended September 30, we recognized approximately $40 million of net realized gains primarily from the partial sale of our equity investment in Fan Steel and the sale of our equity investments in SES Foam, Bandon Fitness, PALISADE, and Transonic. Turning now to portfolio statistics. As of September 30, our total investment portfolio had fair value of $856.9 million, our average portfolio company investment on a cost basis was $11 million, which excludes investments in 13 portfolio companies that sold their operations and are in the process of winding down. We have equity investments in approximately 77.3% of our portfolio companies with an average fully diluted equity ownership of 3.7%. The weighted average effective yield on debt investments was 12.9% as of September versus 11.9% at June 30. Approximately 72% of our debt portfolio on a fair value basis has variable rates with interest rate floors. The weighted average yield is computed using the effective interest rate for debt investments at cost, including the accretion of original issue discount and loan origination fees, but excluding investments on non-accrual, if any. Now I'd like to briefly discuss our available liquidity. As of September 30, our liquidity and capital resources included cash of $40.4 million, $27 million of available SBA debentures, and $100 million of availability on our line of credit, resulting in total liquidity of approximately $167.4 million. Taking into account our subsequent events, we have approximately $183.9 million of liquidity. Now I will turn the call back to Ed for concluding comments.

Edward Ross, CEO

Thanks, Shelby. As always, I'd like to thank our team and the Board of Directors at Fidus for their dedication and hard work and our shareholders for their continued support. I will now turn the call over to Abby for Q&A. Abby?

Operator, Operator

Your first question comes from Bryce Rowe from B. Riley Financing. Your line is open.

Bryce Rowe, Analyst

Thanks. Good morning.

Edward Ross, CEO

Good morning, Bryce.

Bryce Rowe, Analyst

Yeah. I think I'll try to start here on the dividend and I appreciate the approach you're taking here, maybe in terms of the deemed, and trying to think about kind of what an optimized spillover level might be. Can you help us think about what that might look like and maybe we'll just start there. Just what do you think that might look like from an optimization perspective on the spillover?

Edward Ross, CEO

Sure. Great question, Bryce. Over the last couple of years, we've observed that spillover has been at a higher level, approximately three quarters of dividends. Our intention is to maintain it around that level. Ideally, we would like to keep it at about two to three quarters' worth of dividends as a long-term spillover position, subject to performance, of course.

Shelby Sherard, CFO

And Bryce, I would add that's kind of three quarters worth of the base dividend.

Bryce Rowe, Analyst

Okay. That's helpful. And so Shelby, maybe you can help us kind of think about what the deemed impact will be depending on whatever the dollar amount is, there will be some level of taxes, I assume, that kind of come out of that level to leave you with the retained capital.

Shelby Sherard, CFO

That's correct. Fidus will end up paying a 21% C-corp tax on the amount of the deemed distribution that is ultimately declared; that will then be passed through to the shareholders. But there will be a 21% tax impact to NAV in Q4 related to the deemed distribution.

Bryce Rowe, Analyst

Okay. That's helpful. And then maybe shifting just to some of your prepared comments, Ed, around company performance. You talked a little bit about some unrealized depreciation within the debt portfolio. Can you talk about kind of maybe what metrics or what's happening within specific portfolio companies to have led to some level of depreciation?

Edward Ross, CEO

Sure. That's a very good question and an important topic. Looking at the current landscape, I can say that over 90% of our portfolio companies are doing quite well or are stable, which provides us with a solid cushion to manage fixed expenses and invest as needed. We feel secure in our positions. However, we are also facing well-documented challenges in today’s environment, such as supply chain disruptions, rising interest rates, inflationary pressures, and labor cost issues. These are real challenges we cannot ignore. Consequently, some of our companies are experiencing underperformance or stress due to these factors. We maintain strong communication with those companies, but this is the current reality. Regarding credit quality in this context, we’ve enjoyed a favorable environment for the past 18 months, resulting in unusually high credit quality. My expectation is that credit quality will return to more typical levels, which should still be manageable. The issues we encounter are legitimate, and while most companies are handling them reasonably well, a few are finding it more challenging, and we are working with those companies to improve their circumstances as best we can.

Bryce Rowe, Analyst

Great. That’s helpful. I’ll jump back in queue, get somebody else a chance. Thanks.

Edward Ross, CEO

Okay. Thank you. Good talking to you, Bryce.

Operator, Operator

The next question comes from the line of Robert Dodd from Raymond James. Your line is open.

Robert Dodd, Analyst

Hi, everyone. Congratulations on the quarter and the outlook. Ed, you still seem quite optimistic about the ability to grow the debt book and deploy more capital moving forward, even though the environment is challenging. Can you provide any insights on how your underwriting process has adjusted? It seems that you have always underwritten with a recession in mind, but how have your requirements changed regarding structure or coupon when evaluating new deals for capital commitments?

Edward Ross, CEO

Sure. I guess I'll start, Robert, with we do think despite the issues of today, there are plenty of good opportunities to invest today, but then your question is, okay, so how are you doing that? And we're going about that in an obviously very deliberate way. We are excited about the market opportunity, quite frankly. But if you think about things like pricing, to spreads, obviously, SOFR is up, LIBOR is up, but just spreads are up as well. So that's a good thing from our perspective. And then leverage levels have come down. So risk levels have come down. And we're obviously looking for the types of companies that are not being meaningfully impacted by the issues of today that I just articulated, so we like this environment. We think it's a great time to invest. At the same time, we're being very cautious and deliberate with our approach, but we think we'll continue to be able to uncover opportunities as we move forward at the same time. Hopefully, that's helpful.

Robert Dodd, Analyst

That's very helpful. I have a follow-up question regarding the deemed distribution. You mentioned that the spillover is close to optimizing at three quarters' worth of dividends, which aligns with the maximum level without changing declaration dates, which you did this quarter. Regarding that three quarters, it appears that your dividend plan for next year involves distributing all of the earnings plus an additional $0.10. Essentially, it's the base amount plus what you earn, plus an extra ten cents. Is the plan to take the deemed distribution down to three quarters and then over-distribute or avoid over-distributing next year? Will there be an intention to reduce that spillover to a lower level in the near or medium term?

Edward Ross, CEO

To take the what down, I'm sorry.

Robert Dodd, Analyst

The spillover down because if the deemed distribution, hypothetically brings it down to three quarters, the incremental $0.10 would actually make it decline from there as well. The incremental $0.10 special dividend each quarter next year.

Edward Ross, CEO

What I would say is that we don't want to provide too much information since there are still two quarters to go and we lack the specifics. However, I anticipate that the deemed distribution will likely be $1.50 or more per share, and that's our current plan. Clearly, the net asset value will decrease by the $0.10 you mentioned each quarter, but we believe this will align us with our needs for rig purposes at that time. It's uncertain where we'll stand in the third quarter, which is crucial, but we expect to be very close. The situation is a bit fluid, but I'm trying to offer some insight into our thinking on this matter.

Robert Dodd, Analyst

That's incredibly helpful. Sorry, go ahead.

Shelby Sherard, CFO

Robert, I would just add, I would think about the spillover level of three quarter base dividend as kind of a desired normalized run rate. So to your point, there's a little bit of magic in how do you solve for 2022 and 2023 in light of the $0.10 special, but I would also highlight, if we had net incremental realized gains in 2023, that would also increase the spillover position. So there are a variety of factors, as Ed suggested, that kind of go into once we see how the year end closes, what's the right amount of spillover for 2022, taking into account what we've already declared for 2023.

Robert Dodd, Analyst

Understood. And yeah, none of this is a bad thing for shareholders because I just want to clarify a couple of points. So I appreciate it. Thank you.

Edward Ross, CEO

Yeah. Good talking to you, Robert.

Operator, Operator

Your next question comes from the line of Ryan Lynch from KBW. Your line is open.

Ryan Lynch, Analyst

Hey. Good morning, and thanks for taking my questions.

Edward Ross, CEO

Good morning, Ryan.

Ryan Lynch, Analyst

First one, I just had was as far as you guys are monitoring your portfolio and as interest rates continue to go up, could you provide a little insight on your overall interest coverage levels on your portfolio today? How does that compare to where it was maybe six months ago for your borrowers?

Edward Ross, CEO

Sure. It's a great question. The answer is a bit complex, so I'll explain. Historically, we've used an average EBITDA to calculate average interest coverage. As of June 30 last quarter, we were at 3.4 times. In fact, that number has increased this quarter because the additions to our portfolio in Q2 and Q3 were under-leveraged. Our leverage has decreased, meaning our debt to EBITDA ratio is now around 4 times. This figure excludes our ARR investments and three large EBITDA businesses that don't reflect our usual operations, as those have higher leverage and skew the analysis. Therefore, the leverage for our core portfolio has actually reduced. We’ve also added eight companies in the last two quarters that have strong interest coverage, which affects the analysis. Overall, we believe interest coverage levels are still healthy, and we have a strong buffer for potential rate increases across more than 90% of the portfolio. The main concerns lie with specific situations, such as supply chain issues or interest rate hikes impacting certain companies, as well as inflation. While many companies have managed to increase prices to cope with inflation, the experience has been mixed. In summary, we feel confident about covering general interest expenses, but we are closely monitoring the specific challenges, which we believe are manageable even if they do present some risk.

Ryan Lynch, Analyst

Okay. That's helpful and definitely makes a lot of sense. The other question I just had was, obviously, one of the main core benefits you guys have had so much success in over the years is your equity realizations over time. I would just love to get a little color. Obviously, we know that the lending environment has improved significantly for lenders, given some of the choppiness in the environment, but I would think that, that would come at some of the pain from the equity holders. And so I would just love to hear your thoughts on how has the market environment changed for companies' ability to transact and exit positions as well as how are those multiples changed over the last six months or so?

Edward Ross, CEO

Sure. That's a great question, Ryan. Reflecting on the market environment from a year ago, the level of investment activity was very high, but it has significantly decreased now. This reduction is due to a lower number of M&A processes occurring today. The positive aspect is that our market remains highly fragmented, with considerable add-on activity creating investment opportunities. A few M&A processes are still happening, generally involving companies that are not significantly affected and have specific reasons for the transaction, such as growth or liquidity. So, there are still opportunities to invest. Additionally, debt repayments are much lower compared to last year, which saw extremely high repayment levels. We expect this trend of lower repayments to continue in the near term. However, we also have the ability to make incremental investments and grow our portfolio. The lower middle market is different from last year; it remains highly fragmented with various reasons for financing and opportunity creation. Overall, it's definitely a different market than it was 12 months ago.

Ryan Lynch, Analyst

Yeah. That makes a ton of sense. That’s all from me. I appreciate the time today.

Edward Ross, CEO

Yeah. Absolutely. Good talking to you, Ryan.

Operator, Operator

Your next question comes from the line of Mickey Schleien from Ladenburg. Your line is open.

Mickey Schleien, Analyst

Yes. Good morning, Ed and Shelby. A lot of good questions have already been asked. I just wanted to follow up with one question. Ed, your company has a lot of expertise in investing in second liens. I know that you have purposefully moved away from those. But in the last quarter, I think you were a little disappointed that there actually weren't more opportunities in second liens, and I'm curious whether the current market dislocation has made that segment more interesting to you, notwithstanding the outlook for an economic slowdown in the coming quarters?

Edward Ross, CEO

Sure. Great question, Mickey. Our approach remains quite consistent. For some time now, we have mainly focused on providing first lien solutions to our borrowers. However, we have always engaged in second lien and sub-debt investments, and we will continue to do so. We hope to see some high-quality junior debt opportunities as we move forward. Recently, we took advantage of a few more liquid market opportunities that were small, as I mentioned in my prepared remarks; these involved recurring revenue businesses that experienced some technical trading down, but the overall returns appear to be quite positive. We are actively seeking the right companies and situations to invest in second lien and sub-debt. There are companies currently thriving with a positive outlook, which aligns with what we look for. Overall, market activity levels are down and at a different level, and we haven't encountered anything recently that has captured our interest. Nonetheless, we will continue to pursue these types of investments; first lien investments make a lot of sense and enhance our ability to manage those securities. We are also providing a solution that resonates well in today's marketplace. This will remain at the core of our strategy, as it has for the past few years, while we expect to continue investing across all the different asset classes we have discussed.

Mickey Schleien, Analyst

I appreciate that. Ed, can you remind me within first lien, how much unit tranche are you doing, if any? And do you typically sell first out pieces in that business model?

Edward Ross, CEO

Great question, Mickey. The answer is yes. Most of our first lien investments or some form of unitranche whether we’re doing 100% of that capital or we are bringing in for style partners. I would tell you, a majority of our first lien investments are first out last out structures, where we bring in a bank typically to partner with on that solution. So that is a majority of the first lien, but it's not a large, large majority.

Mickey Schleien, Analyst

In those unitranche deals, do you usually have the option to call on the first lien in the event of a covenant breach when a company faces difficulties so you can take control of the situation?

Edward Ross, CEO

Yes, in most cases. Generally speaking, we act as the primary representative for the client, or the borrower. So, the answer is yes. We do have the ability to manage those types of issues if necessary. Thankfully, we haven't faced any, and we hope not to, but one should never say never in this world.

Mickey Schleien, Analyst

Right. I understand. That’s it from me this morning. I appreciate your time. Thank you.

Edward Ross, CEO

Thank you, Mickey. Good talking to you.

Operator, Operator

There are no further questions at this time. Mr. Edward Ross, Chief Executive Officer, I turn the call back over to you.

Edward Ross, CEO

Thank you, Abby, and thank you, everyone, for joining us this morning. We look forward to speaking with you on our fourth quarter call in early March 2023. Have a great day and a great weekend.

Operator, Operator

This concludes today's call. You may now disconnect.