Saratoga Investment Corp. — Form 10-Q Summary
Reporting period: Quarter and six months ended August 31, 2022. Saratoga is an externally managed business development company (BDC) investing mainly in loans to U.S. middle-market companies. Its fiscal year ends February 28, so the quarter is fiscal Q2 2023, despite the request metadata’s “2022 Q2” label.
Key financial results
| Metric | Three months ended Aug. 31, 2022 | Three months ended Aug. 31, 2021 | Six months ended Aug. 31, 2022 | Six months ended Aug. 31, 2021 |
|---|---|---|---|---|
| Investment income | $21.9 million | $18.4 million | $40.5 million | $35.3 million |
| Net investment income | $7.7 million | $6.4 million | $15.7 million | $8.9 million |
| Net realized investment gains | $7.9 million | $1.5 million | $8.1 million | $3.4 million |
| Net unrealized investment change | $(13.3) million | $3.4 million | $(22.6) million | $20.2 million |
| Change in net assets from operations | $0.9 million | $7.9 million | $(0.5) million | $29.0 million |
| Basic and diluted earnings (loss) per share | $0.08 | $0.71 | $(0.04) | $2.59 |
- Quarterly net investment income was about 35% of investment income, versus about 35% a year earlier. For the six-month periods, it was about 39%, versus 25%.
- At August 31, investments at fair value were $954.7 million, up from $817.6 million at February 28. Total assets were $973.0 million; net assets were $337.2 million.
- Net asset value per share declined to $28.27 from $29.33 at February 28. Six-month distributions were $1.07 per share; $12.8 million in total distributions were reported for the period, including stock distributions.
- Cash and reserve-account balances totaled $12.6 million, down from $52.9 million at February 28. Operating cash flow was $(140.5) million, reflecting $257.5 million of investment purchases against $105.2 million of sales and repayments. Financing activities provided $100.2 million.
- Principal debt outstanding totaled approximately $634.2 million: $233.7 million of SBA debentures, $25.0 million under the Encina revolving facility, and $375.5 million of notes. Statutory asset coverage was 184.2%, above the company’s 150% minimum; the company reported $25.0 million of available Encina borrowings.
Material changes and portfolio developments
- Investment income rose 18.5% in the quarter and 15.0% for the six-month period year over year. Growth reflected a larger portfolio and, in the quarter, a higher weighted-average portfolio yield. Portfolio fair value increased by $137.1 million from February 28.
- Net investment income improved year over year for both periods. However, six-month results shifted to a small operating loss as unrealized depreciation outweighed net investment income and realized gains.
- First-lien loans represented 83.0% of portfolio fair value, compared with 77.3% at February 28. The weighted-average current yield on the portfolio rose to 9.0% from 7.7%. About 98% of the interest-earning portfolio was floating-rate debt.
- Unrealized depreciation included declines in the Saratoga CLO investment and Saratoga Senior Loan Fund JV, as well as Pepper Palace and other holdings. Management attributed selected valuation changes to higher discount rates and market conditions, company performance, and lower prices of underlying CLO warehouse assets.
- One portfolio-company investment, Knowland Group, was on non-accrual, with fair value of about $9.7 million, or 1.0% of the portfolio; the company recorded an interest-receivable reserve of $1.2 million. No investments were on non-accrual at February 28.
- Unfunded portfolio commitments rose to $90.7 million from $83.4 million. These are off-balance-sheet obligations, some at Saratoga’s discretion and others dependent on borrower conditions.
Outlook, risks, and unusual items
- The filing provides no specific earnings or portfolio-growth guidance. Management describes plans to fund operations and investment growth through portfolio cash flows, borrowings, SBA debentures, and potential debt or equity offerings, while noting that access to capital is not assured.
- Management highlights exposure to rising interest rates, inflation, supply-chain and labor constraints, geopolitical uncertainty including the Russia-Ukraine conflict, COVID-19 effects, credit deterioration, and valuation uncertainty in privately held investments. Fair values rely substantially on Level 3 inputs and management estimates.
- A hypothetical 100-basis-point rate increase was estimated to raise annual investment income by about $8.1 million and net investment income by about $8.0 million, assuming portfolio balances and terms remained constant. A 100-basis-point decrease was estimated to reduce net investment income by about $7.6 million. Most borrowing is fixed-rate; the Encina facility is floating-rate.
- Debt refinancing and issuance affected results: Saratoga redeemed $43.1 million of 7.25% 2025 notes in July, recognizing a $1.2 million extinguishment loss, and issued $105.5 million of 6.00% 2027 notes by quarter-end. Interest and debt-financing expense rose 52.8% in the quarter and 55.3% for the six months year over year, mainly as average debt increased.
- After quarter-end, Saratoga issued $12.0 million of 7.00% 2025 private-placement notes on September 8, 2022. On September 29, it announced approval for a third SBIC license that could provide up to $175 million of additional SBA-guaranteed debentures, subject to an SBA leverage commitment and applicable limits.
- The board declared a $0.54-per-share dividend on August 29, payable September 29; the filing reports cash and stock settlement. The share repurchase plan remained in effect through January 15, 2023. Saratoga reported no material legal proceedings and effective disclosure controls.
Important facts for investors to verify
- Whether portfolio fair values and the drivers of the $22.6 million six-month unrealized depreciation are supported by subsequent operating results and realizations.
- Knowland’s non-accrual status, collectability of accrued interest, and any additional portfolio-company loans moving to non-accrual.
- Distribution coverage by recurring net investment income and cash generation, particularly given the six-month operating loss and reduced cash balances.
- Leverage, 184.2% asset coverage, borrowing-base availability, and ability to meet $90.7 million of unfunded commitments alongside debt obligations.
- The impact of rates and benchmark transitions on floating-rate portfolio income, funding costs, borrower credit quality, and fair values.
- The conditions and timing for the third SBIC license’s potential leverage, and the terms and use of proceeds from post-quarter-end note issuance.