Earnings Call Transcript - MFIC Q4 2020

Operator, Operator

Good morning and welcome to Apollo Investment Corporation's Earnings Conference Call for the period that ended on March 31st, 2020. At this moment, all participants are in listen-only mode. There will be a question-and-answer session following the prepared remarks from the speakers. I will now hand the call over to Elizabeth Besen, Investor Relations Manager for Apollo Investment Corporation.

Elizabeth Besen, Investor Relations Manager

Thank you, operator and thank you for everyone for joining us today. Speaking on today's call are Howard Widra, Chief Executive Officer; Tanner Powell, President and Chief Investment Officer; and Greg Hunt, Chief Financial Officer. I'd like to advise everyone that today's call and webcast are being recorded. Please note that they are the property of Apollo Investment Corporation and that any unauthorized broadcast in any form is strictly prohibited. Information about the audio replay of this call is available in our earnings press release. I'd also like to call your attention to the customary Safe Harbor disclosure in our press release regarding forward-looking information. Today's conference call and webcast may include forward-looking statements. Forward-looking statements involve risks and uncertainties, including, but not limited to statements as to our future results, our business prospects and the prospects of our portfolio companies. You should refer to our most recent filings with the SEC for risks that apply to our business and that may adversely affect any forward-looking statements we make. We do not undertake to update our forward-looking statements or projections unless required by law. To obtain copies of our SEC filings, please visit our website at www.apolloic.com. I'd also like to remind everyone that we posted a supplemental financial information package on our website, which contains information about the portfolio, as well as the company's financial performance. At this time, I'd like to turn the call over to Chief Executive Officer, Howard Widra.

Howard Widra, CEO

Thanks, Elizabeth. Good morning and thank you everyone for joining us today. First and foremost, we'd like to express our deep gratitude to all the healthcare and EMS professionals and essential business workers who continue to work tirelessly to save and to serve our communities. We extend our deepest sympathies to all those directly affected by the pandemic. Our view on the call today is that we hope each of you and your families are safe during these difficult times. I'll begin today's call with a discussion about how AINV is positioned during these unprecedented times and will also provide an overview of our results for the quarter. Following my remarks, Tanner will review our investment activity for the quarter and will discuss the impact of the COVID-19 pandemic and economic shutdown on our portfolio. Greg will then review our financial results in greater detail and discuss our liquidity position. We will then open the call to questions. During today's call, we will be referring to some of the slides in our investor presentation which is posted on our website. Since the onset of the COVID-19 pandemic, Apollo has seamlessly transitioned to a remote work environment, while ensuring full business continuity. Our priority has been the health and safety of our employees, while maintaining normal business operations. As a firm, we're well-equipped to work remotely from the most senior levels on down. We've been in regular dialogue with our portfolio of companies and their respective owners to evaluate the impact of the pandemic on their businesses and liquidity in order to identify and address issues as early as possible. We have long-standing relationships with most of the sponsors that own the companies in our portfolio and we are working closely with them to support these companies. We have found these conversations to be thoughtful and constructive as we collectively manage the economic impacts of the pandemic. To date, we have generally been pleased with how management teams and sponsors have handled these conditions. In the coming months, we expect to see an increase in discussions with borrowers and their sponsors regarding the need for covenant amendments and requests for additional support. Our investment committee is meeting frequently to discuss portfolio company development and how to address each situation. Clearly, there are many unknowns regarding the full impact of the pandemic and economic shutdown on each one of our companies. We would like to provide you with some general observations. As we all know, the COVID-19 pandemic has been an unprecedented shock to the global economy. AINV entered this volatile period with a well-diversified senior corporate lending portfolio in less cyclical industries with granular positions, which we believe is generally well-positioned to withstand economic volatility. 88% of our corporate lending portfolio is sponsor-backed and as I mentioned earlier, we're having constructive dialogues with these sponsors to find solutions for our companies as needed. We believe our portfolio repositioning over the past several years has allowed us to enter this period in a stronger position. That said, outside of our corporate lending portfolio, we do have exposures to industries that are experiencing a direct impact from the economic shutdown, including aircraft leasing and oil and gas, which Tanner will discuss in his remarks. We have already been reducing our exposure to some of these more impacted areas prior to the pandemic precisely because of their concentration and inherent susceptibility to volatility. It is during this type of challenging environment where AINV can most benefit from its affiliation with the broader Apollo Global platform. Apollo has successfully navigated many market cycles, disruptions, and periods of heightened volatility. We're able to avail ourselves of the expertise of more than 450 investment professionals globally to gain insight into the broader economy and on specific industries. Regarding our liquidity, we believe we have adequate liquidity to meet our commitments. Many of our borrowers did draw on their revolvers during the period. Mid-cap is the agent for nearly all our revolver and delayed draw term loan commitments and is actively monitoring every commitment. A significant portion of our unfunded commitments are not available to borrowers. Most of our revolver commitments are subject to a borrowing base and many of the companies do not have the requisite collateral. Delayed draw term loans are typically used to support portfolio company acquisitions and having current covenants, and therefore, we do not expect these facilities to have any material utilization in the current environment. Furthermore, we and our affiliates are extremely well-situated to support our existing borrowers with new commitments as needed by virtue of mid-cap being a well-capitalized co-lender on much of the portfolio and given the SEC's recent co-investment relief, which allows certain of our other affiliated funds to also provide capital to our existing borrowers, subject to the satisfaction of certain conditions contained in the exemptive order. Greg will discuss our liquidity and unfunded commitment exposure in greater detail during the call. Moving to our financial results, net investment income for the quarter was $0.59 per share driven by portfolio growth in the December quarter and good fee income, including the syndication of several loans and the total return feature in our incentive fee structure that resulted in no incentive fee. Results were negatively impacted by the COVID-19 pandemic, which has caused severe disruptions in the global economy and negatively impacted the fair value of our investment portfolio. Net asset value per share at the end of March was $15.70, a 14.1% decline quarter-over-quarter. The $2.58 decrease is attributable to a $2.81 net loss per share on the portfolio, partially offset by net investment income in excess of the distribution by $0.14 and a $0.10 accretive impact from the stock buybacks below NAV. Slide 16 in the investor presentation shows the net loss for the quarter broken out by strategy. As you can see, our corporate lending portfolio accounted for $0.97 or 35% of the total net loss. Our investment in Merx, our aircraft leasing portfolio company accounted for $0.44 or 16% of the net loss and non-core and legacy assets accounted for $1.39 or 50% of the net loss, while only representing 10% of the total portfolio. Greg will discuss the drivers of the net loss in greater detail. Due to the net loss on the portfolio and a small amount of net fundings, the company's net leverage rose to 1.71 times at the end of March. It is our intention to reduce the fund's net leverage as new commitment activity has slowed and we expect some amount of repayment activity, although below normal levels. Turning to our distribution, the Board has approved a $0.45 per share distribution to shareholders of record as of June 18th, 2020. We, in consultation with our Board, will continue to evaluate and monitor the appropriate distribution level in light of the impact of the COVID-19 pandemic and economic shutdown on our portfolio companies, taking into consideration the yield on the portfolio, its credit performance and resilience, and incentive fees. With that, I will turn the call over to Tanner to discuss our investment activity and our portfolio.

Tanner Powell, President and Chief Investment Officer

Thanks, Howard. First, I want to echo Howard's comments and I hope everyone is healthy and doing well. My remarks today will focus on four topics: the current market environment, our investment activity, a review of our portfolio, and our outlook for future activity. Starting with the market environment, the volatility triggered by COVID-19 sent massive shockwaves through the broadly syndicated leveraged loan segment. The pandemic has led to an unprecedented disruption in business activity across a broad swath of industries. Uncertainty over the duration of the crisis has led many companies to enact measures that will ensure that they have ample financial resources to ride out the storm. To that end, companies have been drawing on available capacity on their credit facilities or securing other financing to enhance liquidity. Activity in the middle market remains slow as sponsors and lenders continue to struggle to evaluate how to price risk due to the low visibility surrounding the duration of the pandemic and resulting economic shutdown. Against this backdrop, new corporate lending commitments for the quarter totaled $153 million across 14 companies. 100% of the new debt commitments were first lien floating rate loans. All of these new commitments were made prior to the market dislocation. Net fundings for the quarter were $8 million, including $47 million of net revolver funding. As Howard mentioned, we did see an increase in revolver draw requests during the period, but that has since leveled off. I wanted to take a few minutes to review our oil and gas and aviation investments, which were significant contributors to the net loss during the period. Our oil and gas exposure decreased from $117 million or 4% of the portfolio at fair value at the end of December to $64 million or 2.3% at the end of March. The decline was due to a $52 million net loss recorded during the quarter, primarily due to the decline in the price of oil and a $1 million repayment. The oil market is experiencing a significant oversupply due to a combination of a demand shock from the pandemic and excess supplies as producers were slow to adjust production. Our largest oil and gas exposure, Spotted Hawk, had a total fair value of $47.2 million at the end of March, representing 1.7% of the total portfolio or 73% of our oil and gas exposure. Spotted Hawk is an exploration and production company operating in the Bakken Basin with significantly hedged production through the middle of this year. The company has reduced expenses and capital expenditures to necessary maintenance items and temporarily curtailed production to adjust to the lower commodity price environment. One of our positions in Spotted Hawk was placed on non-accrual status during the quarter. Our second largest oil and gas position is Glacier Oil & Gas, which had a total fair value of $14.7 million at the end of March, representing 0.5% of the total portfolio or 23% of our total oil and gas exposure. Glacier is an exploration and production company with Alaska-based reserves. Glacier's production is hedged through the end of 2020. During the quarter, the company repaid its remaining $1 million first lien debt to AINV, and we placed our second lien debt position on non-accrual status. Before discussing aviation, let me briefly comment on our shipping exposure which had a total fair value of $138.2 million and represented 5% of the total portfolio at the end of March. As I mentioned, the oil market is experiencing significant oversupply. The oversupply is being put into various types of storage, which is driving up prices for that storage. As a result, there's significant increased demand for tankers to simply store oil, which is driving up tanker rates. We have seen a modest increase in charter rates for our product tankers consequently. Moving to aviation, as you are aware, the coronavirus has had a significant adverse impact on the global economy with direct implications for the aviation sector. Aviation is considered to be part of the critical infrastructure of the global economy. Our aircraft leasing portfolio company, Merx Aviation, continues to closely monitor the situation and proactively maintain dialogue with its airline clients globally. Across Merx and PK AirFinance, which was recently acquired by Apollo Global, Apollo's aviation platform has 45 professionals dedicated solely to aviation, located throughout North America, Europe, and Asia providing expert in-house support to the platform's various aviation strategies. The aviation team has the experience to skillfully navigate this period of market stress and the requisite capabilities to mitigate potential adverse outcomes. In addition, the Apollo aviation platform will seek to opportunistically deploy capital in the face of the widespread uncertainty and market disruption. Be clear, Merx is focused on its existing portfolio and is not seeking new investment opportunities. However, growth in the overall Apollo aviation platform will emerge at the benefit of Merx as the exclusive servicer for aircraft owned by other Apollo funds. Increased pressure on airline finances has resulted in airline-specific outcomes ranging from rent deferral requests to insolvency. As certain airlines dissolve an aircraft or return, updated lease rates and residual values will gradually make their way into the market. We continue to witness regional governments providing assistance where possible to avoid insolvencies given the nature of this situation. In addition, lower fuel prices provide a slight offset to the coronavirus' impact on airline costs that have not otherwise been hedged. We believe that Merx's portfolio compares favorably with other major lessors in terms of asset, geography, age, maturity, and lessee diversification. At the end of March, the portfolio consisted of 81 aircraft, 10 aircraft types, 40 lessees in 27 countries. 78 of its aircraft are narrow-body. Like most lessors, Merx has received rent deferral requests from most of its lessees. To date, Merx has received requests for rent deferment from 36 out of its 40 lessees for 70 of its 81 aircraft. We are evaluating each request on a case-by-case basis. First, in all cases, Merx is working with its aircraft customers to provide the necessary flexibility during these unprecedented times. Second, our investment in Merx reflects the underlying aircraft collateral. Merx's portfolio is skewed towards the most widely used types of aircraft, which means demand from Merx's fleet should be somewhat more resilient. Lastly, as we've mentioned on prior calls over the last few years, Merx has diversified its revenue beyond aircraft leasing. Merx has built a best-in-class servicing platform, which generates income from aircraft managed on behalf of other Apollo-affiliated capital. Shifting back to our overall portfolio, as Howard mentioned, we are having ongoing discussions with our portfolio companies and their financial sponsors regarding how to address the impact from the coronavirus-related shutdown. I'd like to make some high-level observations about our portfolio. Prior to the onset of the pandemic, our corporate lending portfolio companies were generally performing well, meaning they entered this period in relatively good condition. Although we have received some data from our companies, we expect to get a much better idea of the financial impact in the coming months. We believe most of the corporate lending portfolio has been relatively resilient during the economic shutdown. Our corporate lending portfolio is generally invested in less cyclical industries, such as healthcare and pharmaceuticals, business services, and high tech industries, and is underweighted to the more impacted industries such as travel, restaurants, hospitality, dental, and retail. Investments on non-accrual status rose as six new positions across five companies were placed on non-accrual status during the quarter, including our second lien investment in Glacier Oil & Gas, a first lien tranche, and in Spotted Hawk, our first lien investment in Solarplicity, our first lien investments in ZPower, and a small first lien position in Garden Fresh. At the end of March, 12 positions in eight different companies were on non-accrual status. In total, investments on non-accrual status represented $159 million or 5.1% of the portfolio at cost at the end of March, up from 2% at the end of December and $49 million or 1.7% at fair value at the end of March, up from 0.7% at the end of December. For reference, the new investments placed on non-accrual status during the March quarter contribute approximately $0.03 per share on a quarterly basis. Looking ahead, we expect to see a significant increase in the number of amendments and restructurings in our portfolio. We believe these amendments will provide our portfolio companies with the flexibility needed to operate in this economic downturn and may include things like waiving covenants, converting cash interest to pick, and delays in amortization payments. We can use such amendments to reprice our risk, tighten loan documentation, add covenants, and secure additional equity capital. With that, I will now turn the call over to Greg, who will discuss the financial performance for the quarter.

Greg Hunt, CFO

Thank you, Tanner, and good morning everyone. Beginning with the income statement, total investment income was $71.6 million for the quarter, up $3.1 million or 4.6% from the prior quarter. The increase was attributable to higher interest income and fee income, partially offset by lower dividend income. Interest income rose due to a higher average portfolio, partially offset by a decline in the yield of the portfolio due to the decline in LIBOR and a lower yield on new investments compared to sales and repayments. The weighted average yield on our corporate lending portfolio declined to 8.5%, down from 9% last quarter. Quarter-over-quarter, one-month LIBOR declined 77 basis points from 1.76% to 1% and three-month LIBOR declined 46 basis points from 1.91% to 1.45%. Fee income was $3.3 million for the quarter, up from $1.2 million last quarter. Prepayment income was $2.5 million, down slightly from the prior quarter. Dividend income was $2.4 million, down from $3.2 million last quarter. Approximately 97% of contractual interest payments for the quarter were collected and we received a similar percentage for the payments that were due on May 1st. Expenses for the quarter were slightly up due to higher interest expense given the increase in the average portfolio. Due to the net loss, no incentive fee was accrued or paid during the quarter. Interest expenses rose $800,000 quarter-over-quarter due to higher average debt balance, partially offset by a decline in the weighted average funding cost due to the decline in LIBOR. Quarterly weighted average interest cost on our portfolio declined approximately 26 basis points from 4.2% to 3.93%. Net investment income per share for the quarter was $0.59 compared to $0.54 for the December quarter. As Tanner mentioned, new investments placed on non-accrual status impacted net investment income by $0.03. Net leverage at the end of March was 1.71 times compared to 1.43 times at the end of December. The net loss on the portfolio for the quarter totaled $286 million or $2.81 per share. On page 16 of the earnings supplement, we've broken out the net loss by strategy. Our corporate lending portfolio accounted for $0.97 or 35% of the net loss. Merx accounted for $0.44 or 16% of the net loss and non-core and legacy assets accounted for $1.39 or 50% of the net loss. The net loss on the non-core portfolio was primarily driven by oil and gas investments due to the significant decline in the price of oil. The net loss on our investment in Merx was attributable to the impact of rent deferral that Tanner mentioned earlier and higher discount rates due to weaker conditions in the industry. Approximately $0.77 per share or 79% of the net loss on the corporate lending portfolio was driven by the impact of credit spreads widening on the valuation of the company's investments. The vast majority of our corporate lending portfolio is valued using a yield approach. Changes in market spreads are incorporated into the quarterly evaluation of our investment. In addition to looking at the weighted average life or duration of a loan, LIBOR floors, industry characteristics, and specific issuer factors. NAV per share at the end of March was $15.70, a 14% decline quarter-over-quarter. Moving to liquidity, our capital and liquidity at the end of March, we had $1.79 billion of debt outstanding, up slightly $9 million from the prior quarter. As a reminder, we have no term debt maturities until 2025. During the quarter and prior to the volatility caused by the pandemic, we worked with our lenders to improve our revolving credit facility and liquidity. We greatly appreciate the support from our banks. We amended our credit facility to remove the 200% borrow asset coverage covenant. In addition, we increased commitments to our facility by $100 million, increasing the total size of the facility from $1.7 billion to $1.8 billion. At the end of March, we had $224 million of immediate availability in liquidity and $131 million of additional capacity under the credit facility. Moving to unfunded commitments, Page 18 in our earnings supplement shows our outstanding commitments at the end of March. During the month of March, we experienced increased draw requests on revolving credit facilities that we provide to our portfolio companies, as many of them sought to solidify their liquidity. We have seen draw requests drop off significantly in April and May. Of the $270 million of unfunded revolver and bridge loan commitments outstanding at the end of March, $132 million are not available to borrowers and $138 million are available. Availability is based on borrowing base limitations and other covenants. Since the end of March, we've had modest net repayments from revolvers. There has been no significant draw on delayed draw term loan commitments during the quarter, which are generally used to support portfolio company acquisitions and have current covenants. Turning to the portfolio composition. Our investment portfolio had a fair value of $2.79 billion at the end of March and was distributed across 152 companies in 28 industries. We ended the quarter with core assets representing 90% of the portfolio, up from 88% at the end of December. Non-core assets decreased to 10% of the portfolio, down from 12%. First lien assets increased to 85% of the corporate lending portfolio, up from 82% last quarter. The weighted average attachment point remained at 0.9% times. Investments made pursuant to our co-investment order were 76% at the end of the quarter. Lastly, during the quarter, we repurchased approximately 1.3 million shares of our stock at an average price of $11.62 for a total cost of $15 million, leaving $27 million available for future stock purchases. This concludes our prepared remarks. Operator, please open the call to questions.

Operator, Operator

Thank you. Our first question comes from Finian O'Shea with Wells Fargo Securities.

Finian O'Shea, Analyst

Hi, good morning. Hope everyone's doing well. First question for Howard, you guys filed a new shelf yesterday, updated from just a few months ago. Can you tell us what' changed, what you're applying for? And how we should think about it?

Howard Widra, CEO

Greg, do you want to answer that?

Greg Hunt, CFO

Sorry. What was that again Fin?

Finian O'Shea, Analyst

I was asking about the change in your new shelf application filed yesterday?

Greg Hunt, CFO

We filed it to ensure it aligns with current standards. We made updates in January and needed to make several additional adjustments. It's just to keep it current.

Finian O'Shea, Analyst

Okay. I'll move on to Merx. Tanner, you provided some very insightful information there, thank you. As you discuss the potential rent deferrals or contract renegotiations you've mentioned, can you elaborate on the impact those discussions might have on the triggers related to Merx's securitization debt or other term debts? Additionally, what level of asset coverage is sufficient for those to remain performing?

Tanner Powell, President and Chief Investment Officer

Yes, Fin, I hope you're doing well. To provide a bit more detail on the lease deferrals, this is a unique situation affecting airlines and lessors globally. Generally, the deferrals tend to be around three months, sometimes longer, with repayment occurring six to nine months later. In relation to your question, one positive aspect regarding our funding is that over two-thirds of our exposure is in securitizations, which typically offer more flexibility in management and are linked to the payment of senior interest. While it's challenging to predict outcomes given the severity of the current situation and the duration of the pandemic, we are confident in our securitization structures. Additionally, we have liquidity as Greg mentioned, along with cash at Merx and within the securitization structures to support any potential needs.

Finian O'Shea, Analyst

Sure, very helpful. And then one final one for me, I'll jump back in. I think Greg and Howard mentioned a bit of deleveraging through repayments. Can you give us any color on sort of what level of leverage or portfolio that you're thinking given the current environment?

Howard Widra, CEO

Our goal is to maintain a steady state within the range we previously discussed, around 14 to 16, and right now we're at 17. There is a consideration of potential further pressure on NAV in the upcoming quarters depending on how the global economy performs. Setting that aside, we need to reduce our net pay downs to reach our desired level by a couple of hundred million dollars. We're focusing on identifying which borrowers have liquidity options. In a normal market, repayments occur regularly, but currently, we're not in a normal market. However, every borrower is reviewing their capital structure, and many have opportunities to refinance or other alternatives that we encourage them to pursue. We hope to achieve our deleveraging goals in the next few months or quarters. The process should be straightforward, but the pace will depend on our success. We have a list of transactions that we anticipate will generate liquidity, including those that have ongoing sale processes or signed sales contracts. Other transactions are asset-based and clearly have additional financing options. We're concentrating on this, aiming for a reduction of a few hundred million dollars over the next three to four months.

Finian O'Shea, Analyst

Okay, thanks so much everyone.

Operator, Operator

Your next question comes from the line of Kenneth Lee with RBC Capital Markets.

Kenneth Lee, Analyst

Hi, good morning and thanks for taking my question. I think you've touched upon this in the prepared remarks, but wondering if you could just further elaborate on the potential benefit from the SEC recent relief on co-investment restrictions. Thanks.

Howard Widra, CEO

Sure. One of the constraints prior to that relief was any affiliate of AINV, which was not a lender in the transaction when AINV entered couldn't step into the transaction and lend as well. That meant that if there was an add-on to a company or sort of another lending opportunity, that pool of capital was not available; it needed to come from a third party or one of the other Apollo entities that were already in the deal. In AINV's case, as you know, a lot of the deals already had mid-cap in them, and so there's an opportunity. But now, there's also this relief which changes that rule, as I described and said, affiliates can invest subject to certain conditions, even if they were not in it at the outset. So what that means is it gives you another tool to use if there are capital needs or liquidity needs of companies beyond AINV's balance sheet and we're just underlining that because it's important to be able to support our companies both defensively and offensively. At the same time, it's really important that we hit that delivering mark we want to hit, and so that SEC relief just provides the full array of Apollo capital available for opportunities that make sense.

Kenneth Lee, Analyst

Right, very helpful. And just one follow-up if I may, you mentioned in the prepared remarks seeing a drop-off in revolver requests from portfolio companies in the April to May timeframe. I wonder if you could just share with us any particular details on what potentially causing that drop-off and whether you expect requests to pick up in the near-term? Thanks.

Howard Widra, CEO

Sure. There are a couple of reasons for this. First, across our entire BDC industry, particularly with non-ABL leveraged loan revolvers, many borrowers acted quickly towards the end of March, drawing on their revolvers in response to potential liquidity needs. While not everyone did this, the majority did. The highest amount of revolver draws occurred just before the quarter ended. As we moved into early April, there was a general pause as borrowers assessed their situations. In the last three weeks, we have seen net paydowns as borrowers realized they wouldn't need the capital and wanted to avoid paying interest on unused cash. Each week, there has been a small amount of repayments and very few new draws. This trend on revolver usage is consistent with what most of our competitors in leveraged lending are experiencing. In terms of percentage, revolver utilization is now in the single digits due to market dynamics. Additionally, as we negotiate amendments with clients, we aim to facilitate repayments by shrinking revolvers in exchange for covenant relief, which should also pressure utilization downward. Furthermore, regarding ABL commitments, their utilization may fluctuate based on collateral. With several healthcare deals and the influx of stimulus money for those companies, they have had ample liquidity since the quarter ended, also contributing to decreased ABL utilization.

Kenneth Lee, Analyst

Great, very helpful. Thanks again and hope everyone stays safe.

Operator, Operator

Your next question comes from the line of Casey Alexander with Compass Point.

Casey Alexander, Analyst

Hi, good morning. A lot of good questions already. Let me ask a couple here. First of all, in relying on the executive order for co-invest, does that preclude AINV from making new investments or participating in structuring in origination fees? Do those restrictions only apply to the BDC if you sell additional senior securities?

Howard Widra, CEO

It can be more technical than that. First, the example of orders is generally structured to protect the BDC. I'll provide two points on how the BDC is protected. First, if there's an opportunity to lend in the future, the BDC has the option to take as much as it wants or to take its share of that origination. It can choose to participate or not. Second, when new lending comes in, it typically requires an amendment to the existing facility. As required lenders, AINV must approve the new funds entering. Usually, they may not receive origination fees if they invest new capital, but they would receive fees on the existing capital for allowing the capital structure to grow. To put it another way, AINV should benefit because it can always choose to invest if the opportunity is attractive, and it won’t be at a disadvantage, ensuring it has a higher priority or yield based on the risk taken across the board. Does that answer your question?

Casey Alexander, Analyst

I think so. Maybe I'll try to follow-up with Greg on that one afterwards. Because it is quite technical, let me rephrase my question. Your leverage ratio suggests that you need to reduce debt, which you mentioned is about a couple hundred million dollars. This is expected to come from repayments and the repayment of healthy interest-earning investments. At the same time, you noted an increase in discussions with borrowers, indicating that more nonaccruals may be forthcoming, which could negatively impact your interest-earning investments. How does the board view maintaining the dividend at $0.45? Shouldn't you consider adjusting the dividend to a more sustainable level for the long-term, given the current interest rate environment, while also allowing for some net asset value growth as you exceed that dividend?

Howard Widra, CEO

Yeah. So without obviously, I don't speak for the Board, I'm on the Board, but then speak for the Board. I think the intent of the Board is to set a dividend policy that is long-term sort of achieves the goals you just talked about. Putting aside the specifics, all the pressures you're talking about, like I don't know, it's sort of the court for example of the corporate discussions will necessarily give rise to significantly more nonaccruals. But that said, if shrinking book obviously loses interest income, as well as sort of less velocity of transactions means less transaction fees. So that's another source of pressure and potentially less dividend income at Merx. All things put pressure on our earnings. And I think, the intent of the board will be to set a dividend that is in the ballpark of what most BDCs pay against their NAV in order to achieve the goals you're talking about. So, I think the shorter answer is, we want to have a clearer picture as we work through this next quarter, in terms of how some things will play out both with Merx cash flow and portfolio cash flows, and give the board a clearer picture with regard to how to think about that for the longer term.

Casey Alexander, Analyst

Okay, that's a very fair answer. Thank you. And lastly, on lease deferrals on the aircraft, since they're deferrals, do you still accrue that income from a book standpoint? And then if the lessor filed for bankruptcy down the road that has to be reversed? Or does that sort of go on like an internal nonaccrual versus that lease? And hopefully recaptured down the road?

Howard Widra, CEO

Any one of us can answer that. I guess, Greg, do you want to take a shot?

Greg Hunt, CFO

Yes. I'll answer it. Yes. I mean, our Merx financials which were filed today along with our 10-K, we apply GAAP standards. As I'm sure you're very familiar with, you do accrue income within Merx, okay, not at the AINV level. And then we also provide reserves against those receivables to the extent that there's short term impairment, so we evaluate that every month. And so hopefully that answers your question.

Casey Alexander, Analyst

Okay. I think it definitely gives me an idea. I'll step back in the queue and open it up for other questions now. Thank you very much.

Operator, Operator

Your next question comes from the line of Kyle Joseph with Jefferies.

Kyle Joseph, Analyst

Hey, good morning, guys. Thanks for taking my questions and hope everyone is doing well. I just wanted to step back and go more high level question given the current environment where your leverage is. Just talk about how you envision capital allocation priorities over the coming months in terms of debt pay downs, investing in new companies, investing in existing companies, or even share repurchases?

Howard Widra, CEO

Sure, our first priority is our portfolio companies because we have the best understanding of their opportunities, and they align with our existing clients and investments. If there are capital needs, we plan to support them. Most of our portfolio involves mid-cap companies. The amount AINV decides to invest will depend on the attractiveness of the opportunity and our pay down activity each quarter. We will likely allow other balance sheets to contribute extra capital, especially if the overall facility becomes stronger economically and credit-wise. Regarding new opportunities, the market is still stabilizing, despite many claiming they are ready to invest. We don't expect to undertake significant new business while we are reducing our portfolio. However, under our exemptive order, to invest in future companies, we need to participate in facilities from the outset. There’s a good chance we will take small amounts of new origination to maintain our involvement in these facilities moving forward. Concerning share buybacks, we will consider them if they are appealing investments that create value for our shareholders, especially when we are trading at a significant discount to NAV. The math behind buybacks is generally more favorable than new origination. We intend to incorporate buybacks into our strategy depending on market conditions, but our main focus right now is on reducing leverage. This will be a lower priority until we have more liquidity or there’s exceptional value that necessitates it.

Kyle Joseph, Analyst

Yes. Yes. That's very helpful. Thank you. And then just one follow-up from me in your discussions with sponsors and tracking your portfolio companies, I know it's early, but any sort of positive signs, since the economy kind of started to reopen slowly?

Howard Widra, CEO

Yes. I would say there are positive signs, or at least fewer negative ones. Initially, projections from sponsors for the upcoming quarters were quite pessimistic. However, we are now observing real-time results that exceed those negative forecasts, as conditions are improving more quickly than anticipated. For instance, many expected revenue to begin on June 1, but it has started earlier, which is significant. This means that companies have more cash on hand than they predicted, potentially reducing their need for additional capital and allowing them to pay down debts. While I wouldn’t label this as fully positive, it’s definitely an improvement. We are seeing consistent results coming in that surpass the baseline expectations set in March, which is encouraging. As a first lien lender, having these companies with good liquidity helps. The increase in revenue and incoming cash—not necessarily cash flow—extends their financial runway and alters the potential capital requirements for these companies. We are indeed observing these trends, but it’s not sufficient to make any grand claims.

Kyle Joseph, Analyst

Got it. Well, thanks very much for answering my question. Less negative is definitely a positive in this environment. Thanks, guys.

Operator, Operator

Thank you. The last question is from Arren Cyganovich with Citi.

Arren Cyganovich, Analyst

Thanks. Just one, I was wondering, you mentioned kind of wanting to get it back down to a leverage level of 1.4% to 1.6%. Is this really the right level of leverage you should be targeting? Should it be lower? I think that seeing that companies that have started in 1.5%-ish type of leverage heading into this are forced to raise capital or forced to deleverage. You don't have much free dry powder to work as we get out of this. Is that something that you might want to reconsider as to the appropriate amount of leverage you need for the vehicle?

Howard Widra, CEO

In an environment like this, it's important to reevaluate your strategy. Our strategy has always been to operate at a higher leverage range compared to other BDCs because we focus on building granular and high-quality portfolios. As we analyze what happened over the next few quarters, we need to look at the performance of our corporate book, its volatility, and how it compared to others to determine if our approach was appropriate. We feel confident about the stability of our corporate book, but we are aware that the situation might change. It's crucial to reassess where our strategy stands as we navigate this. So far, we haven't seen evidence to suggest that our strategy wasn't the safest option available to us. However, we still need to complete the development of our portfolio, which has absorbed some of the impacts. Therefore, we might see significant effects moving forward. Operating with a focused first-lien granular book at 1.4% to 1.5% leverage is likely to be less volatile than having a 1.1% to 1.2% book with substantial second-lien or subordinate exposures that carry hidden risks.

Arren Cyganovich, Analyst

Okay. And then, I guess, looking at the SOI there, the chemicals company, they got marked down pretty dramatically, but not on non-accrual. Is there anything you could comment about that particular investment?

Howard Widra, CEO

Yes. That's a legacy. That's one of those legacy investments, carbon-free. Tanner, do you want to spend time on it?

Tanner Powell, President and Chief Investment Officer

Yes, certainly. This is a petrochemical plant in Texas that is considered carbon-free and utilizes a technology which can be perceived as a more eco-friendly alternative to carbon capture. The facility has faced challenges in its ramp-up process and has garnered significant equity investment throughout its history. It produces three distinct outputs, one of which is hydrochloric acid, commonly used in the fracking of wells. The market prices for hydrochloric acid have fallen considerably, but this is somewhat balanced by the demand for its other two products, particularly bleach and caustic soda. Bleach has maintained stable demand and pricing. Additionally, we have restructured our investment to better align our value with the intellectual property, which we believe holds significant worth. The company's strategy moving forward is to seek a partner for utilizing that IP, especially considering the growing focus on making such processes more environmentally friendly. We are optimistic that this will generate value from the investment.

Arren Cyganovich, Analyst

Thank you.

Operator, Operator

You do have several more questions. The next question is from Rick Shane with JPMorgan.

Rick Shane, Analyst

Thank you for taking my questions. I hope everyone is well. I wanted to discuss the aircraft portfolio and ask about the mix between classic and next-generation planes within the fleet. Specifically, I’m interested in how this affects your ability to re-lease the aircraft and the collateral value. The reason I bring this up is that jet fuel prices have returned to 20-year lows, and historically, when this occurs, the price gap between classic and next-gen planes narrows because fuel efficiency becomes less of a concern. I'm curious about your perspective on your portfolio and the actual impacts.

Howard Widra, CEO

Sure, I can address this. There are three categories to consider, and the terminology can sometimes be confusing. The classics include the 700 and older 737 models, while the next generation encompasses planes produced in the last 10 to 15 years. The latest next-gen models are the NEO and MAX. Your observation was quite astute. Previously, we had invested in some classic models and older equipment like the MD-80. When oil prices dropped significantly during 2015 and 2016, we saw many end-of-life assets that would have been retired instead continue to operate due to lower fuel prices. Currently, our fleet comprises very few classics. Most classic planes have reached a 20 to 25-year lifecycle, and only a handful remain operational. Our fleet largely falls into the next category. We have limited exposure to the latest technologies like the NEO and MAX, and consequently, fewer opportunities there. Although not as significant, I want to clarify that while the benefits from these technologies in relation to classics aren't as pronounced, they still provide some fuel efficiency advantages. This is something we believe can enhance our resilience going forward. Additionally, as I mentioned earlier, our fleet is primarily narrow-body, which is expected to be more resilient as domestic flying in various countries is likely to recover more quickly compared to transatlantic routes. We're entering this phase with less imbalance, so while the benefits are not as marked as in 2016 with our classics, there is still a modest advantage. We take some comfort in knowing that our portfolio is almost entirely narrow-body at this time.

Rick Shane, Analyst

Got it. That's a very helpful answer. I do appreciate the clarification or the strong point on the narrow bodies in terms of how we could imagine air travel starting to pick back up domestically first. Thank you, guys.

Operator, Operator

Your next question comes from the line of Robert Dodd with Raymond James.

Robert Dodd, Analyst

Hello, everyone. I hope you are all doing well. I have a few questions that I'll keep brief regarding the oil and gas sector, specifically Spotted Hawk and Glacier, as we approach the end of our hedges this year. They have the potential to generate immediate cash flow through those hedges. However, looking at the long term, considering the duration of low oil prices and our intention to limit exposure to this sector, what is your willingness to invest more capital in these businesses? Is hedging still a viable strategy for protecting against a possible recovery? Could we expect to see growth in this segment in the near future?

Howard Widra, CEO

No. Yes. I mean, Glacier is mostly focused on the near term. Most of its value will either be realized through hedges or production. A significant portion of Spotted Hawk’s evaluation remains in the ground, so its valuation will remain steady. Therefore, if prices remain low, its value will also be suppressed for an extended period. However, a lot of its valuation is based on options value since it’s not immediate. We don’t want to invest additional capital there. Of course, if any defensive measures are necessary to protect downside value, we will take those steps, but other than that, no.

Robert Dodd, Analyst

On Merx, regarding the liquidity mentioned in the prepared remarks, what level of open lease deferrals could Merx manage in terms of near-term cash flow impact while still servicing the debt? Is there a risk that Merx might choose to defer interest in the second or third quarter, or is the current cash level sufficient to maintain cash payments on the debt to AINV?

Howard Widra, CEO

I don't think Tanner or Greg want to answer that. Greg?

Greg Hunt, CFO

Yes, Robert, we are currently evaluating the situation. When you consider the debt as part of our overall investment alongside our equity, we plan to combine our debt and dividend to determine the appropriate level to support retaining capital as we did this quarter. However, this will largely depend on what transpires in July when most of the deferrals are concluded. At that point, we will assess how the industry begins to recover. As Howard mentioned, we will analyze all aspects of income to decide on the level of distributions moving forward.

Robert Dodd, Analyst

I appreciate that. Yes. Things are really hard to project right now. One last one, if I can, okay. In the prepared remarks, Howard, you said 1.4% to 1.6% leveraging as opposed to one of the questions you talked about 1.4% to 1.55%. I mean, is it fair to say that the target on the immediate term would be to get down towards the lower end of your target leverage range?

Howard Widra, CEO

Yes. I mean, it's hard to be that precise because you have revolvers that fluctuate a little bit. I think the answer is, we don't want to be at 1.59%. Because we want to have some room to sort of take on new opportunities as things pay off and things like that. So, we'll assess that when we get there, but we're not; I would say, it's probably the right target is the middle of that. It is probably 1.5% if I just had to choose one because we feel like from a risk perspective, if it's a corporate portfolio, we can operate well there. From the perspective of sort of new investments and liquidity choices and things like that, obviously, the less leverage you have, the more new things you can do. So that comes into the mix. But I would say, we're targeting to get into that range and probably sort of hover around on the middle of that range.

Robert Dodd, Analyst

Okay. Got it. Thanks.

Operator, Operator

Your last question comes from the line of Ryan Lynch with KBW.

Ryan Lynch, Analyst

Hey, good afternoon, guys and I hope all is well. I wanted to follow back up with the leverage and liquidity discussion. So obviously leverage increased a decent amount as was expected for you in most BDCs and, as I look at your limited amount of capacity on your credit facility, which is obviously subject to change via how your borrowing base moves. I know a lot of investors coming into this quarter was looking at Apollo potentially needing to do some sort of equity raise to manage through this downturn. You kind of mentioned that that your plan is just to use repayments from your current portfolio, deleverage and manage through this. So as you sit here today, and as you try to look through, forecast out the outlook going forward, which I know is very hard to do. Do you anticipate and do you think that there will potentially be the need to raise additional equity capital to manage through this downturn?

Howard Widra, CEO

A couple of things to note: ultimately, it's a decision for the Board, and anything is possible. There are many disclaimers I need to include regarding predictions about the future. Our goal is to find the most value-creating options based on the situation we are currently facing, and typically, conducting a dilutive equity raise is not a priority. As we shared, our plan has the flexibility to allow for execution without resorting to that. I hope this answers your question. I don’t want to limit our Board's choices regarding what they might see as appropriate. However, we believe we have a solid plan with sufficient flexibility to improve our metrics without engaging in dilutive equity.

Ryan Lynch, Analyst

I understand that it’s a challenging time to assess the outlook. I appreciate your insights. Regarding the valuation of your equity interest in Merx, can you clarify how that valuation is calculated? Is it based on a yield and discount rate applied to the income it generates or is expected to generate, or is it performed through a liquidation assessment of the underlying assets? My curiosity stems from the significant net loss Merx reported for the 2020 fiscal year in their recent financial filings. I would like to understand better how the equity aspect of your Merx investment is appraised.

Howard Widra, CEO

Greg, do you want to?

Tanner Powell, President and Chief Investment Officer

Yes, I'm happy to address that. For all our illiquid positions, we engage a third party to provide actual valuations. What you described touches on several aspects, primarily involving a discounted cash flow analysis into the future. The discount rate is determined based on market comparisons, while the cash flow forecasts represent our best estimates of the future, which also include an assumption regarding the ultimate residual value. It’s important to note that this is not a yield analysis nor a simple assessment of asset value at a specific point in time. It's a discounted cash flow model that incorporates a residual assumption at the end of the lease or the projected holding period.

Ryan Lynch, Analyst

Okay. Got it. Those are all my questions. I appreciate the time today.

Howard Widra, CEO

Okay. Thanks. Thank you everybody for listening to today's call on behalf of all of us. We thank you for plenty of support as we navigate this time period. Obviously, reach out to any of us if you have any questions and we hope everybody stays healthy and safe.

Operator, Operator

Thank you. This does conclude today's conference call. You may now disconnect.