Saratoga Investment Corp. — FY2023 Form 10-K
Reporting period: Fiscal year ended February 28, 2023 (not calendar-year 2022 Q4). Filed May 2, 2023. Saratoga is an externally managed BDC and RIC that lends to U.S. middle-market companies and makes some equity and structured-finance investments.
Key financial results and position
| Metric | FY2023 / February 28, 2023 | Prior comparable period |
|---|---|---|
| Total investment income | $99.1 million | $70.7 million |
| Net investment income (NII) | $35.2 million; $2.94 per share | $19.9 million; $1.74 per share |
| Net increase in net assets from operations | $24.7 million; $2.06 per share | $45.7 million; $3.99 per share |
| Net realized investment gains | $7.4 million | $13.4 million |
| Net unrealized investment change | $(15.2) million depreciation | $17.0 million appreciation |
| Total assets / investments at fair value | $1,078.2 million / $972.6 million | $876.2 million / $817.6 million |
| Net assets / NAV per share | $347.0 million / $29.18 | $355.8 million / $29.33 |
| Operating cash flow | $(130.4) million | $(203.1) million |
| Cash and reserve accounts | $96.1 million total, including $65.7 million cash and $30.3 million restricted/reserve cash | $52.9 million total |
Investment income increased 40.1%, primarily as investments grew 19.0% and portfolio weighted-average current yield rose to 10.7% from 7.7%. Interest and debt financing expense increased to $33.5 million from $19.9 million; average debt rose to $663.0 million from $417.4 million, and its weighted-average rate increased to 4.48% from 4.15%. Total operating expenses increased to $63.9 million from $50.8 million. The filing reports a 10.23% NII-to-average-net-assets ratio, compared with 6.05%.
Investment purchases were $385.1 million and sales, repayments and exits were $222.2 million, producing $162.9 million of net investment activity. Financing cash flow was $173.6 million. The negative operating cash flow largely reflects portfolio investment activity and is not equivalent to negative operating earnings.
Portfolio, leverage and distributions
- Portfolio fair value was $972.6 million across 49 portfolio companies and 115 investments. Composition: 82.1% first-lien loans, 1.5% second-lien loans, 2.1% unsecured loans, 4.3% structured-finance securities and 10.0% equity.
- Weighted-average current portfolio yield was 10.7%; approximately 96.9% of debt investments had floating rates. About 77% of the debt portfolio was interest-only, with principal generally due at maturity.
- One investment, Knowland Group, was on non-accrual at a $9.8 million fair value; the company recorded a $2.2 million reserve against interest receivable. No investments were reported on non-accrual at February 28, 2022.
- Principal debt obligations totaled approximately $728.4 million, including $202.0 million of SBA debentures, $32.5 million drawn on the Encina facility and $493.9 million of notes. BDC asset coverage was 165.9%, down from 209.2% a year earlier, against a 150% minimum.
- The Encina facility commitment was increased from $50 million to $65 million, its maturity extended to January 2026, and its pricing changed to Term SOFR plus a 4.25% margin. At year-end, $31.1 million was available based on the borrowing base.
- Unfunded commitments were $108.8 million, up from $83.4 million. The company said cash and available Encina capacity provided coverage for them.
- Distributions declared for FY2023 were $2.28 per share. The company accrued $1.1 million in federal excise tax on undistributed taxable income. Some distributions were paid partly in newly issued shares.
Changes, outlook and material risks
Results improved at the NII level, but total return and operating results declined from the prior year as market-related valuation losses replaced prior-year unrealized appreciation. NAV per share edged down to $29.18 from $29.33. Total return was 9.46% based on NAV and 10.35% based on market value, versus 15.88% and 28.19%, respectively, in FY2022.
Management provided no specific earnings or portfolio guidance. It described inflation, rising rates, economic uncertainty, supply-chain and labor pressures, and capital-market disruption as risks to borrowers and investment values. It said distributions could be reduced or deferred to preserve cash and flexibility; any decision remains subject to board approval, RIC requirements, asset-coverage limits and debt covenants.
- Valuation: $959.5 million of investments were Level 3 fair-value assets relying on significant unobservable inputs. The auditor identified valuation of these investments as a critical audit matter. Actual realizations may differ materially from reported values.
- Credit and portfolio concentration: Loans are predominantly below investment grade, private and illiquid. Healthcare Software was 12.2% and IT Services 9.0% of portfolio fair value; the filing separately reports substantial SaaS exposure.
- Interest rates and leverage: Higher rates may raise borrower debt-service burdens and funding costs; leverage amplifies gains and losses. The filing’s sensitivity analysis estimates that a 100-basis-point rate move changes annual investment income by about $8.5 million, before other effects and assumptions.
- CLO exposure: Saratoga owns the first-loss subordinated notes of a CLO with about $658 million of underlying loans, plus a junior note. CLO cash flows depend on loan performance and coverage tests; losses may impair distributions and investment value.
- Debt and liquidity: Notes are unsecured and structurally subordinated to secured and subsidiary obligations. Asset coverage leaves limited headroom above the 150% regulatory floor, and debt covenants or collateral tests could restrict borrowing or distributions.
- RIC and taxes: Failure to meet RIC qualification or distribution requirements could cause corporate-level tax. Accrued PIK and other noncash income can create taxable income without matching cash receipts.
- After year-end financing: Saratoga issued $20 million of 8.75% notes due 2024 in March and May 2023, and $57.5 million of 8.50% notes due 2028 in April 2023. Proceeds were intended for investments, general purposes and, for the April issuance, repayment of some Encina borrowings.
Investor facts to verify
- Reconcile the reported debt totals and confirm the treatment of SBA debentures in asset coverage and available borrowing capacity.
- Review Level 3 valuation assumptions, particularly market yields, borrower financial performance and the CLO discount-rate and loss assumptions.
- Assess Knowland’s non-accrual, the $9.8 million fair value and the adequacy of the interest-receivable reserve.
- Test liquidity against $108.8 million of unfunded commitments, restricted cash, facility borrowing-base limits and scheduled debt maturities.
- Confirm the sustainability and cash-versus-stock mix of distributions, including the impact of undistributed taxable income and excise taxes.
- Review the effect of higher borrowing costs and 2023 note issuances on interest expense, asset coverage and refinancing needs.