Earnings Call
Saratoga Investment Corp. (SAR)
Earnings Call Transcript - SAR Q3 2023
Operator, Operator
Good morning, ladies and gentlemen, thank you for standing by. Welcome to Saratoga Investment Corp.'s Fiscal Third Quarter 2023 Financial Results Conference Call. Please note that today's call is being recorded. During today's presentation, all parties will be in a listen-only mode. Following management's prepared remarks, we will open the line for questions. At this time, I would like to turn the call over to Saratoga Investment Corp.'s Chief Financial and Compliance Officer, Mr. Henri Steenkamp. Sir, please go ahead.
Henri Steenkamp, Chief Financial and Compliance Officer
Thank you. I would like to welcome everyone to Saratoga Investment Corp.'s fiscal third quarter 2023 earnings conference call. Today's conference call includes forward-looking statements and projections. We ask you to refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these forward-looking statements and projections. We do not undertake to update our forward-looking statements unless required to do so by law. Today, we will be referencing a presentation during our call. You can find our fiscal third quarter 2023 shareholder presentation in the Events and Presentations section of our Investor Relations website. A link to our IR page is in the earnings press release distributed last night. A replay of this conference call will also be available. Please refer to our earnings press release for details. I would now like to turn the call over to our Chairman and Chief Executive Officer, Christian Oberbeck, who will be making a few introductory remarks.
Christian Oberbeck, Chairman and Chief Executive Officer
Thank you, Henri, and welcome everyone. Saratoga's 33% sequential quarterly increase in adjusted net investment income per share substantially outpaced its recent record 26% dividend increase, as rising interest rates positively impact the company's largely floating rate assets and drive increasing spread margin due to Saratoga's largely fixed rate liabilities. Saratoga's credit structure with interest-only, covenant-free, long-duration debt incorporating maturities two to 10 years out positions us well for rising and higher for longer interest-rate environment. Importantly, overall portfolio quality continues to remain high as demonstrated by NAV per share remaining essentially flat over the prior quarter. In this challenging capital markets environment, access to capital for growth is critical and we successfully recently raised more than $100 million in two baby bond offerings, maintaining our BBB+ investment-grade rating and received an important third SBIC license. In addition to providing liquidity for continued growth, these debt offerings further improve Saratoga's credit structure by extending its maturities five to 10 years out. Our existing portfolio companies are generally performing well with our overall fair value close to cost and our current business development pipeline strong. Our AUM continue to grow this quarter to $982 million as we originated $88 million of new follow-on investments offset by $57 million of repayments. We continue to be highly discerning in terms of new commitments in the current environment. Our pipeline remains robust with many actionable opportunities, and we executed 18 follow-on investments exclusively in existing portfolio companies with strong business models and balance sheets which are well known to us. Our NAV per share this quarter was essentially flat with a 0.1% decrease from Q2 to $28.25, with headwinds from our CLO exposure in the broadly syndicated loan market almost completely offset by the positive financial performance of our core BDC portfolio and the over-earning of our Q2 dividend. This quarter's approval for our third SBIC license allows us to continue to expand upon our existing investments in support of the SBA's mission to provide growth capital to small businesses which are so important to our economy. Our SBA guaranteed debentures are of great benefit to our capital structure, further enabling us to provide innovative and cost-effective solutions to the many smaller and middle-market companies we finance. From an earnings perspective, we are reaping benefits from interest rate increases with 98% of our interest-earning portfolio at floating rates and 96% of our borrowings at fixed rates. Our adjusted net investment income yield of 10.8% reflects a robust 32% increase over the prior quarter's 8.2%, consistent with LIBOR and SOFR trends. The average LIBOR base rate utilized for our portfolio for interest rate receipts and accruals during the quarter was 3.59%. Quarter-end LIBOR was 33% higher at 4.78%, implying that the entire impact of the current rising rate environment is not yet fully reflected in our reported earnings. To briefly recap the past quarter on Slide 2. First, we continue to strengthen our financial foundation in Q3 by maintaining a high level of investment credit quality with 96% of our loan investments retaining our highest credit rating at quarter-end and still only one investment on non-accrual, generating a return on equity of 4% on a trailing 12 month basis versus the industry average of 3.1%, recognizing $3.2 million net unrealized depreciation primarily reflecting broadly syndicated loan market volatility in the CLO and JV, offset by the core BDC portfolio appreciating by $2.6 million, and registering a gross unlevered IRR of 11.2% on our total unrealized portfolio and a gross unlevered IRR of 16.4% on total realizations of $879 million. Second, our assets under management increased to $982 million this quarter, a 3% increase from $955 million as of last quarter, a 20% increase from $818 million since year-end, and a 48% increase from $662 million at the same time last year. Our new originations were exclusively in 18 follow-on investments in our existing portfolio companies and our current pipeline remains robust. Third, in volatile economic conditions such as we are currently experiencing, balance sheet strength, liquidity and NAV preservation remain paramount for us. Our capital structure at quarter-end was strong with $336 million of mark-to-market equity supporting $459 million of long-term covenant-free non-SBIC debt, $243 million of long-term covenant-free SBIC debentures and $25 million of long-term revolving borrowings. Our total committed undrawn lending commitments outstanding to existing portfolio companies are $19 million. Our debt maturity schedule ranges from two to 10 years out, providing a solid credit structure at fixed cost, positioning us well in a rising rate environment. Further expanding our liquidity base, we issued $46 million of new baby bonds in October, followed by another $60 million of new baby bonds in December subsequent to quarter-end, both including the fully executed green shoes signaling maximum issuance demand, five year maturities callable after two years and trading under the tickers SAJ and SAY respectively. Our quarter end regulatory leverage of 173% has significant cushion over our 150% requirement. And prior to the $60 million new baby bond issued after quarter-end, we had $179 million of investment capacity available to support our portfolio companies with $107 million available through our newly approved SBIC III Fund and $47 million in cash. Finally, based on our overall performance and liquidity, the Board of Directors declared a quarterly dividend of $0.68 per share for the quarter ended November 30, 2022, an increase of a record $0.14 or 26% from last quarter and our largest quarterly dividend ever, which was paid on January 4, 2023. Saratoga Investment's third quarter demonstrated solid performance within our key performance indicators as compared to the quarters ended November 30, 2021, and August 31, 2022. Our NII is $9.1 million this quarter, up 50% from last year and up 31% from last quarter. Our adjusted NII per share is $0.77 this quarter, up 45% from $0.53 last year and up 33% from $0.58 last quarter. Latest 12 months return on equity is 4%, down from 14.6% last year and 4.8% last quarter, and our NAV per share is $28.25, down 3.2% from 29.17 last year and down 0.1% from $28.27 last quarter. Henri will provide more detail later. As you can see on Slide 3, our assets under management have steadily and consistently risen since we took over the BDC 12 years ago, and the quality of our credits remains high with only one credit currently on non-accrual, the same as last quarter. Our management team is working diligently to continue this positive trend as we deploy our available capital into our growing pipeline, while at the same time being appropriately cautious in this volatile and evolving credit environment. With that, I would like to now turn the call back over to Henri to review our financial results as well as the composition and performance of our portfolio.
Henri Steenkamp, Chief Financial and Compliance Officer
Thank you, Chris. Slide 4 highlights our key performance metrics for the fiscal third quarter ended November 30, 2022. When adjusting for the incentive fee accrual related to net capital gains, adjusted NII of $9.1 million was up 31.1% from last quarter and up 49.8% from last year's Q3. Adjusted NII per share was $0.77, up $0.19 from $0.58 per share last quarter and up $0.24 from $0.53 per share last year. Across the three quarters, weighted average common shares outstanding were 11.9 million for this year's Q3, 12.0 million for last quarter and 11.5 million for last year's Q3. There was zero accretion or dilution due to share repurchases and DRIP plans this quarter. Adjusted NII increased significantly as compared with last year with a 59.1% increase in investment income resulting primarily from a 48.4% increase in AUM and the increase in the current coupon on non-CLO BDC investments from 9.9% to 11.7%, partially offset by increased base management fees and interest expense resulting from the various new Notes Payable and SBA debentures issued during the past year and quarter. The full benefit of higher rates on AUM is not yet fully reflected in interest income. Sequential quarter changes reflect the same factors as year-over-year. However, the increase in current coupon is greater being from 8.8% to 11.7%. Adjusted NII yield was 10.8%, this yield is up from 8.2% last quarter and 7.3% last year. For the third quarter, we experienced a net loss on investments of $3.9 million or $0.32 per weighted average share, resulting in a total increase in net assets from operations of $6.0 million or $0.51 per share. The $3.9 million net loss on investments was comprised of $0.7 million in net realized loss on investments, $3.2 million in net unrealized depreciation on investments, and $0.4 million of deferred tax expense on unrealized depreciation on equity investments held in our tax blockers. This was offset by a $0.5 million income tax benefit from realized gains on investments. The $0.7 million net realized loss on investments represents a $1.1 million realized loss on the sale of the company's Targus Holdings investment which is a legacy investment that was originated prior to Saratoga taking on the management of this company, offset by $0.4 million realized gain on the sale of the company's Ohio Medical equity investment. The $3.2 million net unrealized depreciation primarily reflects, one, the $5.8 million unrealized depreciation on the company's CLO and JV equity investments, reflecting the volatility in the broadly syndicated loan market as of quarter-end, and two, the $2.6 million unrealized depreciation on the company's Pepper Palace investments primarily reflecting company performance. These decreases were then offset by, one, a $1.5 million unrealized appreciation on the company's Vector Controls investment, two, approximately $1.0 million unrealized appreciation on both the company's Modern Campus and Hematerra investments, and three, approximately $1.8 million net unrealized appreciation across the remainder of the portfolio. All of the above appreciation primarily reflecting company performance. Return on equity remains an important performance indicator for us, which includes both realized and unrealized gains. Our return on equity was 4.0% for the last 12 months, beating the industry average of 3.1% despite the depreciations from our CLO and JV broadly syndicated loan investments discussed previously. Total expenses for Q3 excluding interest and debt financing expenses, base management fees and incentive fees and income and excise taxes was $2.1 million as compared to $1.2 million for last year and $1.6 million for last quarter. This represented 0.8% of average total assets on an annualized basis, up from 0.6% last year and unchanged from last quarter. Also, we have again added the KPI Slides 27 through 30 in the appendix at the end of the presentation that shows our income statement and balance sheet metrics for the past nine quarters and the upward trends we have maintained. Of particular note remains Slide 30, highlighting how our net interest margin run rate has continued to increase and is more than quadrupled since Saratoga took over management of the BDC and also increased by 20% over the last 12 months while still not yet receiving the full period benefit of putting to work the significant amount of Q3 cash nor the full impact of the currently rising rate environment. Moving on to Slide 5, NAV was $335.8 million as of this quarter-end, a $1.4 million decrease from last quarter and a $6.8 million decrease from the same quarter last year. In Q3, main drivers were $3.9 million of net realized losses and unrealized depreciation and $6.4 million of dividends declared that were partially offset by $9.9 million of net investment income. In addition, during Q3, $1.2 million of stock dividend distributions were made through the company's DRIP plan offset by $2.2 million of shares repurchased at an average price of $23.17. NAV per share was $28.25 as of quarter-end, down from $29.17, 12 months ago and $28.27 last quarter. This chart also includes our historical NAV per share, which highlights our NAV per share has increased 15 of the past 19 quarters. Over the long-term, our net asset value has steadily increased since 2011 and this growth has been accretive as demonstrated by the consistent increase in NAV per share. On Slide 6, you will see a simple reconciliation of the major changes in NII and NAV per share on a sequential quarterly basis. Starting at the top, adjusted NII per share increased to $0.77 per share, a $0.24 increase in non-CLO net interest income from the partial impact of higher AUM and higher rates and $0.01 increase in other income was offset by a $0.01 decrease in CLO net interest income, a $0.01 increase in base management fees and a $0.04 increase in operating expenses. Moving on to the lower half of the slide, this reconciles the $0.02 NAV per share decrease for the quarter. $0.83 of GAAP NII and $0.02 net accretion from share repurchases and DRIP was offset by $0.33 of net realized losses and unrealized depreciation and the $0.54 dividend paid in Q3. Slide 7 outlines the dry powder available to us as of quarter-end, which totaled $179.3 million. This was spread between our available cash, undrawn SBA debentures and undrawn secured credit facility. This quarter-end level of available liquidity allows us to grow our assets by an additional 18% without the need for external financing with $47 million of pro-forma quarter-end cash available and that's fully accretive to NII when deployed, and $107 million of available SBA debentures with its low-cost pricing also very accretive. The $107 million is available as a result of the receipt of our third SBIC license approved this quarter. In December, we also issued a new 8.125% 2027 baby bond, generating net proceeds of $58.1 million, which is in addition to the above available liquidity. We remain pleased with our available liquidity and leverage position, including our access to diverse sources of both public and private liquidity and especially taking into account the overall conservative nature of our balance sheet, the fact that almost all our debt is long-term in nature with no non-SBIC debt maturing within the next 2.5 years. Importantly, almost all our debt is fixed rate in this rising rate environment. We will talk more about this later. Also, our debt is structured in such a way that we have no BDC covenants that can be stressed and with available call options in the next two years on the debt with higher coupons, which is very important during such volatile times. Now I would like to move on to Slides 8 through 12 and review the composition and yield of our investment portfolio. Slide 8 highlights, we now have $982 million of AUM at fair value or $986 million at cost invested in 50 portfolio companies, one CLO fund and one joint venture. Our first lien percentage is 82% of our total investments, of which 25% is in first lien last out positions. On Slide 9, you can see how the yield on our core BDC assets, excluding our CLO, has changed over time, especially the past quarter. After an extended period of low rates and tightening spreads, we are seeing both these trends reverse. We have already seen some benefit in Q3 with our core BDC portfolio yield increasing from 9.9% last quarter and 8.8% last year to 11.7% this quarter and total yield increasing from 9.0% last quarter to 10.4% in Q3, but the full impact of the rising rate environment through today is still not yet reflected in our earnings. In addition, we have started seeing spreads widening as well with 98% of our interest-earning portfolio being variable rate. All of our investments are above their floors and rates continue to rise significantly, we expect to benefit going forward from the earnings impact of rising rates to our NII, as you can see on the next slide. The CLO yield decreased from 8.9% to 7.4% quarter-on-quarter, reflecting current market performance. The CLO is performing and current. Slide 10 shows how at the end of Q3, the average three-month LIBOR used in our portfolio was 359 basis points versus at quarter end when three-month LIBOR closed at 478 basis points and versus today at approximately 475. With 98% of our interest-earning assets using variable rates, earnings will benefit from this additional increase in Q4 and Q1 next year, while all but $25 million of our debt is fixed rate and will not be impacted by these increases in base rates. The increases in SOFR base rates are similar. All indications are that rates could be rising further than this. As a result, we stand to continue to gain significantly as rates rise. That said, there will be a lag in the effect this dynamic has on our earnings due to timing of rate resets and invoicing terms. Slide 11 shows how our investments are diversified throughout the U.S. And on Slide 12, you can see the industry breadth and diversity that our portfolio represents. Our investments are spread over 39 distinct industries with a large focus on healthcare and education software, HVAC services and sales, IT, real estate, education, consumer and healthcare services, in addition to our investments in the CLO and JV, which are included as structured finance securities. Of our total investment portfolio, 9.6% consists of equity interest, which remains an important part of our overall investment strategy. For the past 11 fiscal years, we had a combined $81.5 million of net realized gains from the sale of equity interest, and two-thirds of these historical total gains were fully accretive to NAV due to the unused capital loss carryforwards that were carried over from when Saratoga took over management of the BDC. This consistent realized gain performance highlights our portfolio credit quality has helped grow our NAV and is reflected in our healthy long-term ROE. That concludes my financial and portfolio review. I will now turn the call over to Michael Grisius, our Chief Investment Officer, for an overview of the investment market.
Michael Grisius, Chief Investment Officer
Thank you, Henri. I'll take a few minutes to describe our perspective on the current state of the market and then comment on our current portfolio performance and investment strategy. Since our last update in October, we've observed the persistence of aggressive market conditions for premium credits with lenders remaining open for business and competing heavily for these high-quality opportunities. Liquidity remains abundant after the large-scale fundraising of last year, but lenders are being more risk-sensitive backing off historically volatile sectors and taking a harder stance on the use of capital. Leverage levels remain elevated but where we are seeing movement is on the rate side, as Henri mentioned a couple of slides ago. Absolute yields are growing significantly as LIBOR and SOFR increased almost 170 basis points this past fiscal quarter, although they have moderated slightly in December. In addition, spreads are continuing to widen in the lower middle market, where up until recently, it had mainly been happening in the broader syndicated loan and capital markets. In the first half of calendar year 2022, we saw high transaction volumes and M&A activity, albeit slightly lower than in 2021. In the second half of the calendar year 2022, deal volumes remained reasonably healthy in our market despite lower macro volumes. As a result, we continue to enjoy an actionable deal pipeline. In a competitive market, investors continue to differentiate themselves in other ways, such as accelerated timing to close and looser covenant restrictions. That said, lenders in our market remain wary of thinly capitalized deals and for the most part, are staying disciplined in terms of minimum aggregate base levels of equity and requiring reasonable covenants, particularly given the concerns around a potential economic recession forecasted for some time in 2023. The Saratoga management team has successfully managed through a number of credit cycles and that experience has made us particularly aware of the importance of first being disciplined when making investment decisions; and second, being proactive in managing our portfolio. We're keeping a very watchful eye on how continued inflationary pressures and labor costs, supply chain issues, rising rates, and slowing growth could affect both prospective and existing portfolio companies. A natural focus currently is on supporting our existing portfolio companies through follow-ons as was seen this quarter. We have confidence in our strong position entering a different credit and rate environment. Our underwriting bar remains high as usual, yet we continue to find opportunities to deploy capital as we will discuss shortly. Calendar year 2022 was a very strong deployment environment for us with a strong pace of originations. Follow-on investments in existing borrowers with strong business models and balance sheets continue to be an important avenue of capital deployment as demonstrated with 47 follow-ons in the last 12 months ending December 31 and 12 in the last calendar quarter alone, including delayed draws. In addition, we have invested in nine new platform investments this past calendar year with 15 total investments in these new companies during the year. Portfolio management continues to be a critically important aspect for us, and we remain actively engaged with our portfolio companies and in close contact with our management teams especially in this volatile market environment. All of our loans in our portfolio are paying according to their payment terms, except for our Nolan investment that we put on non-accrual this quarter, as we work with the company on an agreement that will likely have us pick our interest for a period of time. Nolan is our only non-accrual investment across our portfolio. To recognize the unrealized depreciation from spread widening and performance on our overall portfolio this quarter, Saratoga's overall assets are now just 0.5% below cost basis. We believe this strong performance reflects certain attributes of our portfolio that bolster its overall durability. 82% of our portfolio is in first lien debt and generally supported by strong enterprise values in industries that have historically performed well in stressed situations. We have no direct energy or commodities exposure. In addition, the majority of our portfolio is comprised of businesses that produce a high degree of recurring revenue and have historically demonstrated strong revenue retention. Our approach has always been to stay focused on the quality of our underwriting. And as you can see on Slide 14, this approach has resulted in our portfolio performance being at the top of the BDC space with respect to net realized gains as a percentage of portfolio at cost. We are number two on a list of only 11 BDCs that have had a positive number over the past three years. This strong underwriting culture remains paramount at Saratoga. We approach each investment working directly with management and ownership to thoroughly assess the long-term strength of the company and its business model. We endeavor to peer as deeply as possible into a business in order to understand accurately its underlying strengths and characteristics. We always have sought durable businesses, investing capital with the objective of producing the best risk-adjusted and accretive returns for our shareholders over the long term. Our internal credit quality rating reflects the impact of current market volatility and shows 96% of our portfolio at our highest credit rating as of quarter end. Part of our strategy is to selectively co-invest in the equity of our portfolio companies when we're given that opportunity and when we believe in the equity upside potential. This equity co-investment strategy has not only served as yield protection for our portfolio, but also meaningfully augmented our overall portfolio returns as demonstrated on this slide and the previous one, and we intend to continue that strategy. Looking at leverage on Slide 15, you can see that industry debt multiples remained relatively unchanged for calendar Q2 to Q3 at historically high levels. Total leverage for our overall portfolio was 4.19x excluding Nolan and Pepper Palace, while the industry is now well above 5x leverage. Through past volatility, we have been able to maintain a relatively modest risk profile throughout. Although we never consider leverage in isolation, rather focusing on investing in credits with attractive risk-return profiles and exceptionally strong business models, where we are confident the enterprise value of the businesses will sustainably exceed the last dollar of our investment. In addition, this slide illustrates the strength of our deal flow and our consistent ability to generate new investments over the long term, despite ever-changing and increasingly competitive market dynamics. During the fourth quarter, we added no new portfolio companies but made 15 follow-on investments, increasing our 12-month production to 62 total new investments versus 47 for the same time period last year. Despite the success we have had investing in highly attractive businesses and growing our portfolio, it is important to emphasize that, as always, we are not aiming to grow simply for growth's sake. In the face of this uncertain macro environment, we're keenly focused on investing in durable businesses with limited exposure to inflationary and cyclical pressures. Our capital deployment bar is always high and is conditioned upon healthy confidence that each incremental investment will be accretive to our shareholders. Moving on to Slide 16, our team's skill set, experience and relationships continue to mature, and our significant focus on business development has led to multiple new strategic relationships that have become sources for new deals. Our top line number of deal sources remains robust, but has dropped in the past two years, initially due to COVID but more recently reflecting our efforts to focus on attracting a higher percentage of quality opportunities. Most notably, the number of deals executed during the last 12 months is markedly up from last year's pace, demonstrating that this more focused sourcing strategy is yielding results. What is especially pleasing to us is that four of the nine new portfolio companies over the past 12 months are from newly formed relationships, reflecting notable progress as we expand our business development efforts. As you can see on Slide 17, our overall portfolio credit quality remains solid. The gross unleveraged IRR unrealized investments made by the Saratoga Investment management team is 16.4% on $879 million of realizations. On the chart on the right, you can see the total gross unlevered IRR on our $936 million of combined weighted SBIC and BDC unrealized investments is 11.2% since Saratoga took over management. As of this quarter, we continue to have two yellow-rated investments, still only being our Nolan Group and Pepper Palace investments. Nolan has been yellow for a while now since COVID being more dependent on in-person business interaction and was also added to nonaccrual status earlier this year. The current unrealized depreciation reflects the current performance of the company but does not change our view of the fundamental long-term prospects for the business. The other yellow investment is Pepper Palace. In this quarter, we recognized another $2.6 million of unrealized depreciation on this investment, increasing the total depreciation to $10 million since investment on our first lien term loan and preferred equity investments. Now this markdown reflects the current performance of the company, but they continue to pay interest. We are working closely with the company and the sponsor as they work to improve performance. Our overall investment approach has yielded exceptional realized returns and recovery of our invested capital. Moving on to Slide 18. You can see our first and second SBIC licenses are fully funded and deployed with $10 million of cash available for distribution to the BDC in SBIC II. We are also pleased to have received approval for our third SBIC license this quarter, which means we practically have access to another $107 million of low-cost SBIC debentures currently allowing us to continue to support U.S. small businesses. To summarize this quarter, the way the portfolio has proven itself to be both durable and resilient against the impact of COVID-19 and the subsequent calendar 2022 market adjustments and volatility really underscores the strength of our team, platform and portfolio and our overall underwriting and due diligence procedures. Credit quality remains our primary focus and new investments have a higher bar, especially at times with such increased activity levels for premium credits as we are seeing now. And while the world is in continuous flux, we remain intensely focused on preserving asset value and remain confident in our team and the future for Saratoga. This concludes my review of the market. I'd like to turn the call back over to our CEO. Chris?
Christian Oberbeck, Chairman and Chief Executive Officer
Thank you, Mike. Turning to Slide 19. As outlined, our latest dividend of $0.68 per share for the quarter ended November 30, 2022, was paid on January 4, 2023. A 26% increase, this is the largest quarterly dividend increase in our history. The Board of Directors will continue to evaluate the dividend level on at least a quarterly basis, considering both company and general economic factors, including the near-term impact of rising base rates and increased spreads on our earnings. Moving to Slide 20. Our total return for the last 12 months, which includes both capital appreciation and dividends, has generated total returns of negative 2%, outperforming the BDC index of negative 6% for the same period. This performance reflects the current market volatility impacting both us and the industry. Our longer-term performance is outlined on our next slide. Our three and five year returns place us in the top quartile of all BDCs for both time horizons. Over the past three years, our 27% return exceeded the index average of return of 12%. Over the past five years, our 71% turn more than doubled the index average of 35%. When Saratoga took over the management of the BDC in 2010, our total return has been 626%, versus the industries of 171%. On Slide 22, you can further see our performance placed in the context of the broader industry and specific to certain key performance metrics. We continue to focus on our long-term metrics such as return on equity, net asset value per share, NII yield and dividend growth, which reflects the growing value our shareholders are receiving. Notwithstanding the slight decline of 0.1% in NAV this quarter, we continue to be one of the few BDCs to have grown NAV over the long term, and we have done it accretively by also growing NAV per share, 15 of the last 19 quarters. Moving on to Slide 23. All of our initiatives discussed on this call are designed to make Saratoga Investment a leading BDC and is attractive to the capital markets community. We believe that our differentiated performance characteristics outlined on this slide will help drive the size and quality of our investor base, including adding more institutions. Our differentiating characteristics include maintaining one of the highest levels of management ownership in the industry at 14%. Access to cost-effective and long-term liquidity with which to support our portfolio and make accretive investments recently demonstrated with our SBIC III license approval this quarter and new baby bond raised in December, a BBB+ investment grade rating in active public and private bond issuances, solid historic earnings per share and NII yield benefiting from the rising rate environment, with 98% of our credit AUM floating rate, while 96% of our debt is fixed rate. Strong and industry-leading long-term return on equity accompanied by growing NAV and NAV per share, putting us at the top of the industry over the long term, high-quality expansion of AUM and an attractive risk-reward profile. In addition, our historically high credit quality portfolio contains minimum exposure to conventionally cyclical industries including the oil and gas industry. In closing, I would like to refer to Slide 10 that Henri walked you through earlier in the presentation. In this rising rate environment, Saratoga is a beneficiary of increased short-term LIBOR and SOFR interest rates. In Q3, Saratoga's average three-month LIBOR used for interest rate income purposes was 3.59%. At November quarter end, the closing LIBOR rate was 119 basis points or 33% higher at 4.78%, with the spot rate today at a similar level, implying that the entire impact of today's rate levels is not fully reflected in this quarter's reported earnings. We remain confident that our reputation, experienced management team, historically strong underwriting standards and time and market tested investment strategy will serve us well in navigating through the challenges and uncovering opportunities in the current and future environment. Our balance sheet, capital structure, and liquidity will benefit Saratoga's shareholders in the near and long term. In closing, I would again like to thank all of our shareholders for their ongoing support. And I would like to now open the call for questions.
Operator, Operator
Thank you. Our first question will come from Bryce Rowe of B. Riley. Your line is open.
Bryce Rowe, Analyst
Thank you very much. Good morning. I appreciate the opportunity to ask a question. I wanted to inquire about the dividend. It's great to see the increased dividend, especially following a nice rise in earnings. Chris, Henri, and Mike, could you share your thoughts on the dividend strategies? We've observed other BDCs using a variable approach that includes a base dividend along with a supplemental payout based on excess earnings. How are you approaching the dividend structure in light of the current rate environment and the possibility of rates decreasing again in the future? I'm trying to understand your perspective on the dividend and whether you're considering a base plus supplemental model. Thank you.
Christian Oberbeck, Chairman and Chief Executive Officer
That's a very good question and something we've considered extensively. Looking at our earnings in this recent quarter, they are significantly up, but the base rate of LIBOR they are based on is actually much lower than the market rate at this time. The forward curves indicate that rates are expected to rise next year before coming back down in 2024, and they are projected to revert to levels not far from our average rate in the most recent quarter. At this moment, we believe we are well positioned with our core dividend rate, which we can sustain over the long term. While it’s uncertain how much higher rates might go, we are currently over-earning our dividend by a substantial amount, and there’s potential for continued over-earning. We have the flexibility to do so, which might be sensible for our shareholders. We need to monitor how this situation evolves. If interest rates seem likely to remain elevated for an extended period, we can adjust our core dividend. Conversely, if the rise appears more temporary, we might explore a bifurcated approach similar to what some others have done. However, all of this remains to be seen, as there is considerable uncertainty regarding the rate environment. Nevertheless, we are confident that our current level is sustainable over the long haul, and we will aim to build upon that as our earnings grow and the rate environment clarifies.
Bryce Rowe, Analyst
Great. That's good color, Chris. Maybe a follow-up question around rates and the impact on your borrowers. Can you speak to how borrowers are reacting to the higher rates? Obviously, it's the same for all borrowers expecting with the floating rate debt, but just kind of curious how borrowers are reacting to the higher debt service. And it looks like from a fair value mark perspective, most are performing really well. But any color around borrowers and reaction to debt service would be great. Thanks.
Michael Grisius, Chief Investment Officer
Bryce, this is Mike. That's a really good question. We feel good about our portfolio construction in terms of interest rate coverage. While most of these deals are reasonably leveraged, we spent a lot of time looking at and trying to seek out businesses that have not only really solid dependable cash flow but really strong cash flow margins. So they're generally businesses that can withstand some increase in rates and still produce plenty of excess cash flow with which to comfortably service our debt. So when we look at the interest coverage that we have across our portfolio, there's healthy room there to support the interest coverage in terms of how people react to it. Yes, they don't like to see rates up, but it's kind of the market environment. So anybody else that they're talking to about borrowing money, it's kind of they're facing the same thing. So it's a little bit of it is what it is, but the important thing, I think, is that our portfolio companies are demonstrating that they continue to perform well and are producing sufficient excess cash flow to handle the increase in rates that we've experienced.
Bryce Rowe, Analyst
Great. I appreciate that.
Christian Oberbeck, Chairman and Chief Executive Officer
If I could just add regarding the new deals, everyone is set in their positions. However, we are exploring many new opportunities, factoring in the new debt levels. Companies and sponsors are pleased to adapt to these changes. We are observing a strong pipeline, and it seems that the balance of power between borrowers and lenders, which has favored borrowers in recent years, is shifting back toward lenders. The extent of this shift varies depending on the market, the deal, and the sponsor. Nonetheless, we are noticing an improvement in the overall competitive landscape and negotiating power. As a result, the rate structures we are encountering are being accepted for new deals.
Michael Grisius, Chief Investment Officer
No, it's a good point, Chris. I mean, I should have emphasized that. So one development that certainly we're seeing, especially in this last quarter and in the environment that we're in now is Bryce, is that spreads are widening as well. So just in terms of receptivity to a higher rate environment, not only are new borrowers seeing higher indexes but we're able to get wider pricing now than we were even a few months ago. So we're finally starting to see that in our market as well. So if there's an indication of sort of the reaction to rates. Now I do think the higher rate environment is affecting M&A activity in general. So there may be in the broader market fewer deals just in general because of kind of the macro environment. But for the deals that we are seeing, which are high-quality deals and kind of the micro market that we occupy at the lower end of the middle market, we're seeing plenty of activity. And for those deals that we're seeing, they're expecting higher rates, and we're getting them.
Bryce Rowe, Analyst
That's great. Appreciate the commentary guys.
Operator, Operator
Thank you. Our next question will come from Casey Alexander of Compass Point Research & Trading. Your line is open.
Casey Alexander, Analyst
Hi, good morning. This quarter really emphasizes the often-overlooked earnings potential among BDCs, which I believe the market is not fully recognizing. If it weren't for the widening spreads, your NAV would have actually increased by $0.40 per share. That's very positive, and I appreciate the discussion about the dividend. Retaining those excess earnings now to either build NAV or safeguard against possible credit issues seems like a wise strategy. Given these positives, I'll do my part to identify a few opportunities. One area of interest is the new baby bond deal you executed in December; the absolute and regulatory leverage ratio appears to be quite high. Could you elaborate on those leverage ratios and how comfortable you are with maintaining such a high leverage ratio? I calculate the regulatory leverage ratio to be close to 1.5x when considering the new baby bond deal. Can you provide some insights on those leverage ratios?
Christian Oberbeck, Chairman and Chief Executive Officer
Sure, I'll begin and then Henri can add more. First off, Casey, leverage has several components, and the nature of that leverage is very significant. We've always maintained a structure that is currently performing well in the market. Our leverage consists of long-term, fixed-rate, interest-only, and covenant-free debt, with maturities ranging from two to ten years. This means we won't have to repay our leverage for a while. The spreads related to our leverage are widening, which benefits our profit margins and strengthens our leverage structure. Alongside this, our portfolio is stable and robust, positioning us for substantial earnings, as demonstrated in the recent quarter. Earlier this year, we faced some challenges related to market adjustments and rate fluctuations, but we've moved past that. Now, the improvements are directly impacting our bottom line. We're generating significant earnings against our leverage, which is structured favorably. Regarding future rates, while there is uncertainty about whether we'll see the same rates in the next couple of years, nearly two-thirds of our debt is callable in two years or less. This allows us to adapt our fixed-rate structure if rates decline. Additionally, there's been a slowdown in mergers and acquisitions due to gaps between buyer and seller expectations and financing challenges. This has led to slower repayments of our high-quality loans, as they typically only get repaid during M&A transactions, which have decreased. Therefore, our core portfolio is remaining stable for longer periods, while we are also seeing growth in new investments and improving relationships, allowing us to acquire more high-quality assets. Finally, our long-duration leverage paired with relatively shorter-duration assets positions us well, and the earnings flow we are experiencing reflects this setup.
Casey Alexander, Analyst
All right. Thank you. My next question is for Mike. Mike, looking at the fact that all of your new issuance in this quarter was follow-ons. I'm curious, do you have what you would call a higher bar for new investments than you have for follow-ons? And is it more important in this environment with what you see coming at you economically to make sure that you're more supportive of existing portfolio companies as opposed to new companies, which you don't have that history with?
Michael Grisius, Chief Investment Officer
Great question. The short answer is yes. Our priority is to ensure we have capital available to support our existing portfolio companies. There's nothing better in our industry than receiving a call from a borrower who is performing well. You know them, you have confidence in the ownership group, and they are looking for additional capital to grow their platform. We successfully did this last quarter, which is a significant part of our institutional strategy. Typically, we start with smaller investments as we familiarize ourselves with a portfolio company, and most of our best deals have begun small and evolved into larger investments. Although we are seeing promising opportunities, this past quarter we didn’t find any that met our underwriting standards, partially due to our high initial benchmarks. We are increasing our focus on the potential outlook for businesses in the face of a challenging economic environment, which is likely raising our standards slightly. The decrease in the number of portfolio companies last quarter reflects the overall decline in M&A activity. However, our business doesn’t change suddenly, and it's hard to predict these trends. Currently, our pipeline for new opportunities is quite robust, and we have several interesting prospects. In fact, now is an excellent time to invest in new portfolio companies. If a deal is currently on the market, it indicates strong performance, and the company is generating substantial cash flow despite rising cost pressures, allowing for thorough underwriting. Additionally, we can offer capital at better pricing and with less competition compared to six months ago. It’s truly a favorable time for capital investment, especially for deals that exceed our already high standards.
Casey Alexander, Analyst
All right, thank you. Appreciate you taking my questions. Thanks, Mike.
Michael Grisius, Chief Investment Officer
Thanks, Casey.
Operator, Operator
Thank you. Our next question will come from Robert Dodd of Raymond James. Your line is open.
Robert Dodd, Analyst
Hi, guys, and congratulations on the quarter. One sort of a follow-up to Casey actually. On follow-on investments being a greater portion of the mix. I mean all the credit and knowing the borrower, I understand. So the other question though is when doing a follow-on, do you get the opportunity to put incremental equity into an investment where you've already got an equity investment? Or is it the equity goes in day 1, the follow-ons are debt only? I mean, just trying to get a feel of so much of your performance historically has been generating realized gains on equity, et cetera. If you shift on to follow-ons, are you at the margin losing a little bit of opportunity to keep equity at some portion of the portfolio that you want to target?
Michael Grisius, Chief Investment Officer
Yes, it's an interesting question. So here's how we think about it. And the answer is that it depends. So in some cases when an existing borrower is looking for more capital to grow, the capital that they need requires both debt and equity. There's a portion that makes sense to fund with debt, but also we need to step up with additional equity. In those cases, we have co-investment rights for our equity, and we typically almost always participate and co-invest alongside the control owner. So when that happens, we're co-investing along the way. Now in other cases, they're looking for follow-on capital and the business is performing so well that when you look at the capital structure pro forma for whatever the growth initiative is, it may be an acquisition, it may just be growth to fuel growth in EBITDA. When you look at the capital structure, it may not need equity. But if you're already an existing equity investor, it's very accretive to the existing equity that you have. So that's still good news as well. So to the extent that we have an equity investment in an existing portfolio company, whether we're co-investing along the way or sitting on our current position or our initial position of equity, it typically benefits our initial equity investment very significantly and that's proven out well over time.
Casey Alexander, Analyst
I understand your points about the dividend and the expected increase in earnings power as we reach the middle of the year, especially with the current forward curve. I recognize the need to retain some earnings to grow net asset value, but we do have to comply with the BDC distribution requirements. If we anticipate an increase in dividends accompanied by potential earnings power that might reach around $1 per share each quarter in the future, we could generate a significant amount of spillover income quickly. What are your thoughts on how to manage that situation if interest rates remain high for an extended period? While it’s a favorable situation to be in, it could turn problematic if we accumulate too much spillover income while missing out on a major earnings dividend.
Christian Oberbeck, Chairman and Chief Executive Officer
Sure. These are the kinds of challenges we enjoy tackling. You're correct that there are strict guidelines in place. Essentially, we have a two-year timeframe to distribute a high percentage of our income, and while we currently have plenty of room in our spillover equation, any increase in earnings will naturally lead to an increase in that spillover amount. Ultimately, this needs to be returned to shareholders. In the interim, it will enhance our net asset value, benefiting shareholders either through NAV growth or dividends. The biggest concern is the future of our economy, as we’re at an inflection point in a uniquely challenging environment characterized by prolonged high interest rates and inflation—conditions not seen consistently for 40 years. The Fed remains very hawkish, and the market's reactions to their stance raise many questions. If we experience a scenario of rising interest rates followed by substantial cuts toward a highly stimulated economy, we need to be ready for that possibility, although the likelihood is uncertain. Currently, we’re seeing a 26% increase in dividends and a 33% increase in earnings, so we aren’t facing immediate issues. We will reassess in the next quarter. The embedded rate increases suggest a base increase just from the math of where rates were at the quarter's end compared to their average. The forward curves indicate a conflict: Will the Fed maintain its course, or will market conditions dictate a different path? Larry Summers recently mentioned he believes it will align more with the Fed's direction, though predicting that is challenging. We are well-positioned to make informed decisions, given our increased earnings and spillover capacity. As mentioned before, we have the ability to manage dividend payouts in both temporary and permanent ways. Our goal is to instill confidence in our shareholders regarding a dependable dividend level while confirming that excess funds will contribute to NAV for a time, ensuring they benefit in the long run. Henri, would you like to add anything?
Henri Steenkamp, Chief Financial and Compliance Officer
Yes, Robert. The advantage of the RIC rules and their structure is that they enable effective long-term planning and management of payments and spillover. As you noted, when rates increase, our earnings, or taxable income that we need to distribute, will rise rapidly. However, this doesn’t mean we have to distribute it quickly since the payment rules under the RIC structure allow for flexibility. If we manage our spillover effectively, which we believe we have, it provides a better opportunity for long-term planning of distributions, especially in an uncertain economic environment. While earnings may grow quickly, the actual payments do not have to occur at the same pace, offering a beneficial planning mechanism under the RIC rules.
Christian Oberbeck, Chairman and Chief Executive Officer
One further point I want to make is that we have been very careful with our spillover. As you may recall from our lengthy conference call in April 2020, we have treated our spillover as a sort of rainy day fund. Some other BDCs are at their limits with spillover and see it as a capital source, which doesn't leave them much flexibility. If they have an increase, they often have to distribute it immediately. However, we've created flexibility for ourselves, allowing us time to consider the best approach between permanent and temporary dividends. Our goal is to establish a sustainable and dependable dividend rate for our shareholders. We're also focused on the levels of dividend increases we can anticipate in the upcoming quarters. Overall, I believe the availability of considerations for these increases will be greater in the near term compared to what we've experienced in the past.
Robert Dodd, Analyst
Understood. I really appreciate the color, and to your point, you've managed spillover such that it's not going to force your hand by being near a cap. So that's a good spot to be in as well. So, thank you for the color.
Operator, Operator
Thank you. Our next question will come from Erik Zwick of Hovde Group. Your line is open.
Erik Zwick, Analyst
Thanks. Good morning. Most of my questions have been asked and answered at this point. And I guess the one I still have is a bit of a follow-up in some terms. So I guess thinking about the health of the borrowers in your current portfolio? And what could impact them certainly based on the outlook for the Fed funds curve, there's another 50 basis points, maybe 75 that would happen here at the beginning of the year in LIBOR would likely follow suit higher to a similar magnitude. There's also a concern about the trajectory of the economy and whether we dip into a mild recession or something more moderate or severe. As you think about the potential for credit and the health of your borrowers. At this point, what would be a larger risk if the Fed had to continue hiking further beyond current expectations which would put a higher debt burden on your companies or material slowdown in the economy that would materially impact EBITDA and the cash flow of those companies? Just curious how you think about that and weigh those risk factors today?
Christian Oberbeck, Chairman and Chief Executive Officer
Let me address this from a high-level perspective first, and then Mike can provide more specific insights about our portfolio. Overall, we are fortunate to invest in the smaller middle market, where each of our companies has its unique opportunities and challenges. While macroeconomic factors can influence the broader economy, they don't always impact our companies directly. We recently had discussions in our investment meetings about one of our portfolio companies wanting to reduce its rate because they are generating significant profits. However, we advised against that because they are experiencing a surge in revenues. The U.S. market is vast, with numerous opportunities and efficiencies, especially with the Software as a Service companies we support, which are enhancing their products. This growth trend is likely to continue, even during a recession. If we face a mild recession, it may not significantly affect many of our companies. In the case of a severe recession, there are still several companies within our portfolio that are likely to thrive. I don't want to suggest that everything is entirely positive, but our companies tend to be less impacted by wider economic trends, partly due to the nature of our portfolio and their positions as smaller entities. Unlike large corporations like Walmart or McDonald's, which are more susceptible to shifts in the overall economy, our companies operate in specific niches and markets that can be more insulated from broader economic fluctuations.
Michael Grisius, Chief Investment Officer
Yes. Let me elaborate on that, Chris, as you raised a good question with an interesting observation. We invest a lot of time at the beginning when underwriting deals, considering various factors. However, our primary focus is ensuring that the businesses we lend to can maintain their cash flow under most reasonable circumstances. We achieve this by analyzing their end markets and the value they provide to their customers. We evaluate potential future vulnerabilities and assess whether they can continue delivering that value profitably. This underwriting process is crucial to our operations; it guides us toward certain industries, particularly those that are less cyclical and that have strong margins and cash flow. We prefer businesses that can set prices high enough to maintain healthy margins because customers appreciate their offerings. The consistency of cash flow is paramount in our underwriting and capital structure decisions. While we consider downside scenarios during underwriting, the stability of cash flow remains the most critical aspect. We also analyze the capital structure and appropriate leverage for each business, considering all the fundamentals I mentioned earlier. In our portfolio, businesses tend to be more adversely affected by decreases in cash flow than by rising interest rates. We structure our lending to ensure that we are confident in the persistence of cash flow and generally expect growth. Although interest rate changes may impact businesses' free cash flow, the effect is marginal compared to the fundamentals. I want to emphasize that our current portfolio consists of strong businesses in favorable markets, well-positioned to continue delivering value to their customers while maintaining solid profitability.
Erik Zwick, Analyst
That's great color. I appreciate the commentary from both of you. Thanks so much. That's all I had today.
Michael Grisius, Chief Investment Officer
Thank you.
Christian Oberbeck, Chairman and Chief Executive Officer
Thank you, Erik.
Operator, Operator
Thank you. I see no further questions in the queue. I would now like to turn the conference back to Mr. Christian Oberbeck for closing remarks.
Christian Oberbeck, Chairman and Chief Executive Officer
I would like to thank all of you for joining us today, and we look forward to speaking with you next quarter.
Operator, Operator
This concludes today's conference call. Thank you all for participating. You may now disconnect, and have a pleasant day.