Q2 2025 Saratoga Investment Corp Earnings Call

Participants

Henri Steenkamp; Chief Financial Officer, Chief Compliance Officer, Treasurer, Secretary, Director; Saratoga Investment Corp

christian Oberbeck; Chairman of the Board, President, Chief Executive Officer; Saratoga Investment Corp

Michael Grisius; Co-Managing Partner and Chief Investment Officer; Saratoga Investment Corp

Erik Zwick; Analyst; Lucid Capital Markets LLC

Robert Dodd; Analyst; Raymond James

Mickey Schleien; Analyst; Ladenburg Thalmann

Presentation

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Saratoga Investment Corp.'s 2025 fiscal second-quarter financial results conference call. Please note that today's call is being recorded. (Operator Instructions)
At this time, I'd like to turn the call over to Saratoga Investments Chief Financial and Chief Compliance Officer; Mr. Henry Steenkamp. Please go ahead.

Henri Steenkamp

Thank you. I would like to welcome everyone to Saratoga Investment Corp's 2025 fiscal second-quarter 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 SE 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 second quarter 2025 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

Thank you, Henri, and welcome, everyone. Saratoga Investment Corp., highlights this quarter will include the successful full repayment and resolution of our non-investment, the last of our four non-accrual or watch list investments in our portfolio resolved this past year (inaudible) return to increasing NAV per share and continued substantial overearning of our record level of dividends. Our annualized second quarter dividend of $0.74 per share implies a 12.7% dividend yield based on the stock price of [$23.26] per share on October 7, 2024.
The substantial overearning of the dividends this quarter continued to support the current levels of dividends, increases NAV, supports increased portfolio growth and provides a cushion against adverse events.
While short-term interest rates have decreased from their highs, this quarter's earnings continue to benefit from elevated levels of rates and spreads on Saratoga Investments largely floating rate assets. While cost of long-term balance sheet liabilities are largely fixed but callable either now or in the future.
Our ongoing development of sponsor relationships continues to create attractive investment opportunities from high-quality sponsors despite the recent constrained general volume of M&A. We appear to be seeing the early stages of a potential increase in M&A in the lower middle market reflected in multiple repayments over the past few months.
In addition to significant new originations, including importantly, two new portfolio investments closed subsequent to quarter end. We believe Saratoga continues to be favorably situated for potential future economic opportunities as well as challenges.
At the foundation of our strong operating performance is the high-quality nature, resilience and balance of our $1.04 billion portfolio in the current environment. Where we have encountered challenges in four of our portfolio companies over the past year, we have taken decisive action. The Zollege restructuring was completed last quarter and the Pepper Palace restructuring this quarter.
As of quarter end, both investments are now being held at a total combined remaining fair value of $3.6 million. And Saratoga has taken control over both investments and brought in new CEOs and through consensual restructurings with the prior sponsors and former management.
We continue to actively implement management changes, capital structure improvements and business plan adjustments, which have the potential for future increases in recovery value. Our [Noah] investment repaid its full principle as well as all accrued and reserved interest through a sale transaction.
As of August 31, 2024, we recognized a $7.9 million previously reserved interest into NII, and this also -- and also booked a $0.5 million unrealized appreciation. This leaves $2.7 million that will be recognized into unrealized appreciation in the third quarter reflecting full repayment of the investments subsequent to quarter end.
And our Netreo investment was also sold in the prior quarter with full recovery of our invested debt capital and a modest overall return. The remaining core non-CLO portfolio was relatively unchanged this quarter, and the CLO and JV were marked down by $2.7 million for a total net reduction in portfolio value of $4.7 million this quarter.
Our total portfolio of fair value is now 0.2% above cost, while our core non-CLO portfolio is 3.3% above cost. With the completion of the Pepper Palace and Zollege restructurings and Nolan and Netreo have been repaid in full, we have resolved uncertainties related to all four portfolio companies on our watch list. The overall financial performance and strong earnings power of our current portfolio reflects strong underwriting and our solid growing portfolio of companies and sponsors in well-selected industry segments.
We continue to approach the market with prudence and discernment in terms of new commitments in the current dynamic interest rate environment. Our originations this quarter demonstrate that despite an overall robust pipeline, there are periods like the current one, where many of the investments we review do not meet our high-quality credit standards.
During the quarter, we originated no new portfolio company investments while benefiting from five smaller follow-on investments in existing portfolio companies, we know well, with strong business models and balance sheets. With the originations this quarter totaling $2.6 million versus [$60 million]. $1 million of repayments and amortization, our quarter end cash position has grown to $162 million, improving our effective leverage from 159.6% regulatory leverage to 172.0% net leverage netting available cash against outstanding debt.
Subsequent to quarter end, reflecting positive trends in our pipeline we executed approximately $56.7 million of new originations in two new portfolio companies and two follow-ons. At the previously mentioned repayment of [$5 million] from Nolan for a net increase in investments of [$36]. Overall, credit quality for this quarter increased to 99.7% of credits (inaudible) category, with the two investments currently still on nonaccrual being the fully restructured Zollege and Pepper Palace, representing only 0.3% and 0.4% of fair value and cost, respectively.
With 85.2% of our investments at quarter end and first lien debt and our overall portfolio generally supported by strong enterprise values and balance sheets in industries that have historically performed well in stress situations. We believe our portfolio and leverage is well structured for challenging economic conditions and further changes in interest rates.
As always, and particularly in the current environment, balance sheet strength for and NAV preservation remain paramount for us. At quarter end, we maintained a substantial $385.5 million investment capacity to support our portfolio companies, with $136 million available through our existing SBIC III license, $87.5 million from our two revolving credit facilities and $162 million in cash.
Saratoga Investment's second quarter demonstrated a solid level of performance within our key performance indicators as compared to the quarters ended August 31, 2023, and May 31, 2024. Our adjusted NII was $18.2 million this quarter, up 38.3% from last year and 26.9% from last quarter.
Our adjusted NII per share is $1.33 this quarter, up 23.2% from $1.08 last year and up 26.7% from $1.05 last quarter. Adjusted NII yield is 19.7% this quarter, up from 15% last year and from 15.5% last quarter. Latest 12 months return on equity is 5.8%, down from 9.6% last year and up from 4.4% last quarter.
Our NAV per share is 27.07%, down 4.8% from 28.44% last year and up 0.8% from 26.85% last quarter. And our quarter end NAV was $372.1 million up from $362.1 million last year and up from $367.9 million last quarter.
While these past 12 months has seen markdowns to a small number of credits in our core BDC portfolio, Slide 3 illustrates how our long-term average return on equity over the last 10 years is well above the BDC industry average at 10.0% versus the industry's 6.9% and has remained consistently strong over the past decade, beating the industry, 8 of the last 10 years.
As you can see on slide 4, our assets under management has steadily and consistently risen since we took over the BDC 14 years ago, and the quality of our credits remain solid with the two credits on nonaccrual, down from three last quarter being a successfully restructured Pepper Palace and Zollege.
Our management team is working diligently to continue this positive trend as we deploy our available capital into our 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

Thank you, Chris. Slide 5 highlights our key performance metrics for the fiscal second quarter ended August 31, 2024, most of which Chris already highlighted. Of note, the weighted average common shares outstanding in Q1 and Q2 of this year were $13.7 million shares, increasing from $12.2 million last year.
Adjusted NII increased this quarter, up 38.3% from last year and up 26.9% from last quarter. This quarter's investment income increases were primarily due to the reversal of the Nolan interest reserve of $7.9 million that was previously on nonaccrual status following the investments full repayment going to quarter end, including accrued interest.
Investment income reflects a weighted average interest rate of 12.6%, consistent with last quarter and last year and does not yet reflect the future impact of declining rates. The increases in investment income were primarily offset by first, increased interest expense resulting from the various new notes and SBA debentures issued during the past year; and two, increased incentive management fees from higher AUM and earnings.
Total expenses for the second fiscal quarter, excluding interest and debt financing expenses, base management fees and incentive fees and income and excise taxes increased $0.1 million to $2.2 million as compared to $2.1 million last year and decreased $0.7 million from $2.9 million last quarter. This represented 0.7% average total assets on an annualized basis, unchanged from last year and down from 1.6% last quarter.
Also, we have again added the KPI slides 26 through 29 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, including a 37% increase in net interest margin over the past year.
Moving on to slide 6. NAV was $372.1 million as of this quarter end, a $4.2 million increase from last quarter and a $100 million increase from the same quarter last year. This chart also includes our historical NAV per share, which highlights how this important metric has increased 22 of the past 28 quarters, and following the recent resolution of our nonaccrual investments up again this quarter as well, with Q2 up $0.22 per share as compared to Q1.
Over the long term, our net asset value has steadily increased since 2011, and this growth has been accretive, as demonstrated by the long-term increase in NAV per share. Over the past five years, NAV per share is up $3.45 per share or over 14%. We continue to benefit from our history of consistent realized and unrealized gains.
On slide 7, you will see a simple reconciliation of the major changes in adjusted NII and NAV per share on a sequential quarterly basis. Starting at the top, adjusted NII per share was up $0.28, primarily due to the increase in non-CLO net interest income resulting from the release of the Nolan nonaccrual and a $0.03 decrease in operating expenses, offset by $0.04 lower other income from reduced originations this quarter.
On the lower half of the slide, NAV per share increased by $0.22, primarily due to the gap NII excess earned over the Q1 dividend more than offsetting the $0.34 net realized losses and unrealized appreciation. Slide 8 outlines the dry powder available to us as of quarter end, which totaled $385.5 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 37% without the need for external financing with $162 million of quarter end cash available and thus fully accretive to NII when deployed, and $136 million of available SBA debentures with its low-cost pricing, also very accretive.
We also include a column showing any call options of our debt. This shows that our $321 million of baby bonds effectively all our 6% plus debt is callable either now or within the next year, creating a natural protection against potential future decreasing interest rates, which should allow us to protect our net interest margin, if needed.
Additionally, during this quarter, we upsized our three-year Live Oak Bank secured revolving credit facility from $50 million to $75 million included in these numbers. We remain pleased with our available liquidity and our 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 and with almost no non-SBIC debt maturing within the next two years. Also, our debt is structured in such a way that we have no BDC covenants that can be stressed during such volatile times.
Now I would like to move on to slide 9 to 12 and review the composition and yield of our investment portfolio. Slide 9 highlights that we now have $1.04 billion of AUM at fair value and invested in 50 portfolio companies one CLO fund and one joint venture. Our first lien percentage is 85.2% and of our total investments, of which is (inaudible) in first lien last out positions.
On slide 10, you can see how the yield on our core BDC assets, excluding our CLO, has changed our time, especially the past two years. This quarter, our core BDC yield remained at 12.6%, with base rates remaining relatively unchanged during the fiscal quarter and some decline being seen at the end of the quarter.
We continue to see rates decline over the next 12 months. The CLO yield increased slightly to 13.0% from 12.4% last quarter, reflecting lower fair values. The CLO is performing and current. Slide 11 shows how our investments are diversified through the US. And on slide 12, you can see the industry breadth and diversity that our portfolio is spread over 41 distinct industries in addition to our investments in the CLO and JV which are structured finance securities.
Moving on to slide 13. 8.5% of our portfolio consists of equity interest, which remain an important part of our overall investment strategy. This slide shows that for the past 12 fiscal years, combined $27 million of net realized gains from the sale of equity interest or sale or early redemption of other investments.
This is net of the Zollege, Netreo, and Pepper Palace realized losses booked for accounting this year. This long-term realized gain performance highlights our portfolio credit quality, has helped grow our NAV and is reflected in our healthy long-term ROE.
That concludes financial and portfolio review. Our Chief Investment Officer, Michael Grisius, will now provide an overview of the investment market.

Michael Grisius

Thank you, Henri. Today, I will focus on our perspective on the changes in the market since we last spoke with everyone and then comment on our current portfolio performance and investment strategy. While broader middle market deal volumes are showing signs of improvement, deal activity in the lower middle market where we operate has yet to pick up.
Year-to-date deal volumes through calendar Q3 for transactions below $150 million are down significantly over prior year and down further still over 2021 and 2022. We believe a number of factors are influencing the decline in lower middle market deal activity, including a disconnect between where buyers and sellers are willing to transact. Elevated interest rates making debt financing more expensive and the trend toward PE firms holding on to assets longer in order to meet their return expectations.
The combination of historically low M&A volume and an abundant supply of capital is causing spreads to tighten and leverage to remain full as lenders compete to win deals, especially premium ones. As a result, we're anticipating further payoffs like we saw this quarter, in some cases, due to lender offering extremely aggressive pricing on some of our low leverage assets. This historically low deal volume we're experiencing has positive and less positive elements.
On the positive side, we've been (inaudible) fewer payoffs and our follow-on deal activity alone has outpaced our repayments over the past 12 months. On the less positive side, lower market activity has made it more difficult to find quality new platform investments than in prior periods.
Now that said, the relationships and overall presence we've built in the marketplace, Combined with our ongoing business development initiatives, give us confidence in our ability to achieve healthy portfolio growth in a manner that we expect to be accretive to our shareholders in the long run. Since quarter end, we closed two new platform investments, and our investment pipeline is solid. I'll also point out that we continue to believe that the lower middle market is the best place to be in terms of capital deployment.
As compared to the larger end of the middle market, the due diligence we're able to perform when evaluating investment is much more the capital structures are generally more conservative with less leverage and more equity. The legal protections and covenant features in our documents are considerably stronger and our ability to actively manage our portfolio through ongoing interaction with management and ownership is greater.
As a result, we continue to believe that the lower middle market offers the best risk-adjusted returns, and our track record of realized returns reflects this. 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. In an environment that has seen ever shifting expectations for the economy due to inflation and rising [interest] rates, among other factors, we have stayed largely focused on managing and supporting our portfolio. Our underwriting bar remains high as usual, yet we continue to find opportunities to deploy capital.
As seen on slide 14, our more recent performance has been characterized by continued asset deployment to existing portfolio companies as demonstrated with 29 follow-ons thus far this calendar year, including delayed draws. While we invested in no new platform investments this fiscal year through the end of the second quarter, subsequent to quarter end, we executed approximately $56.7 million of new originations and in two new portfolio companies and two follow-ons.
Overall, our deal flow remains solid, and our consistent ability to generate new investments over the long term despite ever-changing and increasingly competitive market dynamics is a strength of ours.
Portfolio management continues to be critically important, and we remain actively engaged with our portfolio companies and in close contact with our management teams. There remain two portfolio companies that we are actively managing as discussed in previous quarters, and I will touch on them shortly.
But in general, our portfolio companies are healthy. 70% of our portfolio is generating financial results at or above the prior quarter, and the fair value of our core BDC portfolio is 3.3% above its cost. And the issues in all our watch list or nonaccrual investments previously discussed have been at (inaudible)
85.2% of our portfolio is in first lien debt and generally supported by strong enterprise values in industries that have historically performed well in stress 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. We now only have two investments on nonaccrual namely Pepper Palace and Zollege as compared to three investments as of last quarter. We continue to hold them on nonaccrual following their restructurings but the remaining fair value is just $3.6 million or 0.3% of our total portfolio fair value.
Looking at leverage on the same slide, you can see that industry debt multiples have remained relatively unchanged from last quarter. Total leverage for our overall portfolio was 4.5 times, excluding Pepper Palace and Zollege while the industry remains around 5 times leverage.
Slide 15 provides more data on our deal flow. As you can see, the top of our deal pipeline is down from prior periods, part because we made a conscious effort to improve the quality of our deal pipeline and in part because activity is down considerably as previously discussed. We are starting to see signs of growth in deal flow again.
Overall, the significant progress we've made in building broader and deeper relationships in the marketplace is noteworthy because it strengthens the dependability of our deal flow and reinforces our ability to remain highly selective as we variously screen opportunities to execute on the best investments.
As you can see on Slide 16, our overall portfolio credit quality and returns remain solid. As demonstrated by the actions taken (inaudible) outcomes achieved on the nonaccrual and watch list credits we had over the past year.
Our team remains focused on deploying capital and strong business models where we are confident that under all reasonable scenarios, the enterprise value of the businesses will be -- will sustainably exceed the last dollar of our investment. We can't be perfect but we strive to be as perfect as possible, and we have not feared from our thorough and cautious underwriting approach.
Over the dozen years that we've been working together, we've invested $2.2 billion in 116 portfolio companies. We've had just three realized economic losses on these investments. Over that same time frame, we successfully exited 74 of those investments, achieving gross unlevered realized returns of 15.2% and on $1.0 billion of realizations.
Even taking into account the current write-downs of a few discrete credits, our combined realized and unrealized return on all capital invested equals or 13.6%. We think this performance profile is particularly attractive for a portfolio predominantly constructed with first lien senior debt.
With Netreo sold and Nolan repaid, we now only have two investments remaining on nonaccrual with both Pepper Palace and Zollege restructured but still classified as red and with a combined fair value of only $3.6 million.
During the quarter, Pepper Palace restructuring was successfully completed with us taking over majority control of the business. The turnaround specialists we have been working with who has substantial successful experience in similar situations, has invested significant equity in the business and become the EO and a Board member.
As a result of the restructuring, we recognized $34 million of realized loss this quarter and marked the investment down a further $1.7 million to $1.5 million. And following the allege restructuring of the balance sheet during the first quarter that resulted in us taking over the company and starting to actively manage this investment.
The founder and previous owner invested meaningful dollars in the business. is leading the enterprise and has reassembled some of the former key senior leadership. He and the management team are working in partnership with us with the immediate goal of returning the business to its former profitability levels. and the ultimate objective of exceeding those levels.
We still have equity in a first lien term loan in the company with a current fair value of $2.2 million. Of great value to our shareholders is that subsequent to quarter end, our Nolan investment repaid our full principle as well as all accrued and reserved interest.
In addition to making this investment up in Q2 and marking this investment up in Q2 and recognizing $7.9 million of interest income into the P&L, there remains an additional $2.7 million that will be recognized into unrealized appreciation in the third quarter to reflect the payoff at par. When taking into account the recognition of past due interest plus the write-up in fair value of investment, the total change in economic value will be over $11 million.
It's worthy to mention that the attributes that made us attracted to Nolan as a credit to begin with, including its industry leadership and the strong return on investment it produced for its customers with the same attributes that enabled it to recover from the pandemic, attract interest from several strategic acquirers and ultimately allowed us to recover all of our capital.
This investment produced a 12.5% unlevered realized return for our shareholders. In addition, we recognized $0.5 million realized gain on our Book4time Class A preferred investment resulting from the sale of the company. And the CLO and the JV had $2.7 million of unrealized depreciation this quarter, reflecting primarily markdowns due to individual credits. Our overall investment approach has yielded exceptional realized returns and recovery of our invested capital and our long-term performance remains strong as seen by our track record on this slide.
Moving on to slide 17. You can see our second SBIC license is fully funded and deployed, and we are currently up our new SBIC III license with $136 million of lower cost undrawn debentures available, allowing us to continue to support US small businesses, both new and existing.
This concludes my review of the market, and I'd like to turn the call back over to our CEO. Chris?

christian Oberbeck

Thank you, Mike. As outlined on slide 18, our latest dividend of $0.74 per share for the quarter ended August 31, 2024, with (inaudible) paid on September 26, 2024. Though unchanged from last quarter, this reflects a 4% and a 37% increase over the past one and two years, respectively.
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 current interest rate environment and on our earnings. As the Fed has begun to cut interest rates and the pace at which further cuts will come is still unclear, Saratoga's Q2 overearning of its dividend has a deleveraging effect by building NAV, providing a cushion against adverse events and potential future base rate declines.
Moving to slide 19. Our total return over the last 12 months, which includes both capital appreciation and dividends, has generated total returns of 2%. The uncharacteristically low and underperforming the BDC index of 15% for the same period. Our longer-term performance is outlined on our next slide, 20.
Our five-year return places us almost in line with the BDC index while our three-year performance is now slightly below the index, reflecting the impact of the recent latest 12 months' performance and discrete credit issues. Since over the management of the BDC in 2010, our total return has been 699% versus the industry's 274%.
On slide 21, 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, NAV per share, NII yield and dividend growth and coverage, all of which are positive and reflect the growing value our shareholders are receiving.
The lagging return on equity and NAV per share metrics this past year are primarily due to the discrete non-accruals, Zollege and Pepper Palace previously discussed. Our dividend coverage and dividend growth has been one of the strongest in the industry. We continue to be one of the few BDCs to have grown NAV over the long term, and we've done it accretively and our long-term return on equity remains 1.5 times the long-term industry average.
Moving on to slide 22. All of our initiatives discussed on this call are designed to make Saratoga Investment a leading BDC that is attracted to the capital markets community. We believe that our differentiated performance characteristics outlined in this slide will help drive the size and quality of our investor base, including adding more institutions.
These differentiating characteristics, many previously discussed include maintaining one of the highest levels of management ownership in the industry at 12.5%, ensuring we are aligned with our shareholders. (inaudible) on Slide 23.
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. And that 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 over questions.

Question and Answer Session

Operator

(Operator Instructions) Erik Zwick, Lucid Capital Markets.

Erik Zwick

I wanted to start first just on some of the commentary you gave about the, I guess, kind of the market in the most recent quarter, the investments that would have been kind of new investments for the platform that you viewed that did not meet your characteristics. I wondering if you could just add a little bit more color there. Where were they coming up short? Were there any common characteristics or more just kind of one-off issues with each of the individual credits that you have viewed decided to pass on?

Michael Grisius

Yes. This is Mike. To answer your question directly, there were more unique to the individual credits. I recall a couple of them had concentrate -- customer concentration, for example, that was above what we were comfortable with. Each of them had their own unique elements to them, but ones that we didn't feel like were suitable for our investment bar.

Erik Zwick

Thanks, Mike. I appreciate that there. And then kind of moving on to the sensitivity of the portfolio and the balance sheet to interest rates. We've obviously got 50 basis points of cuts from the Fed funds are developed so far. Markets predicting more over coming quarters.
Henri, you gave some commentary in terms of the amount of debt that you have that's callable that could be refinanced. But I guess as the balance sheet stands today, how would you quantify the impact to NII from, say, each 25 basis point reduction in short-term rates and base rates?

Henri Steenkamp

Yes, so Eric, so we actually have a table in our MD&A in the market risk section. So you can see there the sensitivity. Every 25 basis points is about $0.03 a on a quarterly basis. And that obviously is just a very static perspective, looking at it exactly as it is right now. It doesn't factor in any other variables like you said, the ability to refinance some of our debt that's -- there's definitely probably 100 basis points lower than what our current 8.5% and 8% are and then obviously, any actions that we take on utilizing some of our cash and originating new deal opportunities that might provide that might be out there.

Erik Zwick

Great. That's helpful. And I guess just a follow-up on that, trying to think about worst-case scenarios, if we went into a period where maybe we did go into a hard landing recession and the debt markets made it a little bit harder to refinance some of those notes that are callable, I guess, you feel confident kind of given your cash position that you'd be able to manage through for a quarter or two before you had the maybe opportunity to refinance again and not have the dividend at risk. Is that a fair assessment?

Henri Steenkamp

Yes. I think, Eric, one of the things to always consider with regards to rate increases or decreases is that they don't occur immediately, right? So we have assets that either reset monthly or reset quarterly. So you could have situations where the Fed change is rates by 25 basis points, but that only flows through three months later depending upon the timing of our AUM. And so the effect is not immediate.
It obviously does impact us after a period of time. But at this point in time, we still think we're overearning the dividend quite significantly at the moment.

Erik Zwick

And then just last one, looking at the amount of PIK interest on the most recent quarter, it was up quarter over quarter. I guess anything that was non-recurring there, or is that a decent rate going forward looking into the third quarter?

Henri Steenkamp

Actually, Eric, it's a good question. Most of that is nonrecurring because most of what you see there -- actually, the whole increase you see quarter over is related to our Nolan investment. Because a portion of that one-off interest reserve that was released was PIC related and then the rest was cash.

Operator

Robert Dodd, Raymond James.

Robert Dodd

On the pipeline and the market, going back to Eric's question, I mean, on slide 15, we can see that the biggest decline year over year for the first three quarters, calendar quarter to '24 is in term sheets issued right? I mean you still sourced a lot of deals, that's only down 13%. The term sheets were down 60%.
And you mentioned unique issues, and you mentioned on the slide on credit quality. But is term issuance relatively early in the (inaudible) of what you're talking about on the customer concentration and things you're seeing early? Or are some of the other issues on like the ask is too much on leverage or what is it that's stripping these things up earlier in the process rather than after deeper due diligence?

Michael Grisius

Yes. It's a good -- I mean, one thing -- it's hard for me to compare exactly how we how our processes matches up vis-a-vis other firms. But I would say, generally, we are more careful to do a lot of diligence on the front end more so than others we've seen anyways before we issue a term sheet.
And the reason being that we win a lot of deals because people feel like if we issue a term sheet and we tell them that, look, there's a -- we really like this deal. We've done a lot of work on it. There are a couple of things that we're going in on that are kind of going to be the remaining gating items.
But it's an approach that we take that gives our relationships greater certainty of execution, and we often win deals that way. So I think the way we approach it vis-a-vis some of our competitors is that we're careful, we don't just throw term sheets out on the marketing set in the process. So that might differentiate us versus other people.
But to answer your question more directly, in the cases where we were not issuing a term sheet, it was because we did a fair amount of diligence and we could see elements of the credit that didn't make us comfortable issuing an official term sheet.

Robert Dodd

Got it. Appreciate that color. On -- congratulations on recovery on Nolan and obviously, Netreo that long ago away you've got everything back. What's your level of optimism on Zollege and Pepper Palace, which (inaudible) much earlier in the process because it's only just been restructured. In terms of the potential for getting all that a meaningfully higher recovery than the current fair values, then kind of like time same and is that like 18 months if it happens or are we three to five years? Any color there?

Michael Grisius

Yes, I wish I would have a crystal ball on that. I mean it's -- I certainly commend you for asking the question. Here's the way I'd think about it. First of all, just context. I would say that our DNA is a lot different than many of our competitors.
So I would say that some of our competitors probably just would not have had the chops to try to get to where we've gotten in those deals. It took an awful lot of resources and manpower and just, I think, experience to be able to negotiate the change of control, find really good managers to come in and operate these businesses and then also structure deals with them where they are investing new capital alongside in a way where we feel like we've got a terrific alignment of interest with the new management teams.
We think we've got the right people, the very best people to try to recapture value for our shareholders. Now having said that, there were challenges that these businesses were facing clearly to get to the point that they did.
At the same time, there's elements of what we originally liked in the businesses that are intact as well. And so the management teams in both of those cases are (inaudible) with and are making some progress, but it's early to try to get those companies back on track and capitalize on the elements of those businesses that we think are really strong. But they're projects, no doubt, and it's probably going to take some time. I wouldn't want to oversell that.

Robert Dodd

Got it. One more to go on the dividend (inaudible) spillover. If I remember, I mean, at the beginning of the year -- I looked in the -- I mean, undistributed income was $46 million, I think, at that side. So that was almost $2 a share. You've obviously overearn since then. So can you give us any perspective on what -- how much undistributed spillover your balance sheet you have currently that color on how you benefit rates go down a lot, the dividend assisted.

Henri Steenkamp

Yes. No, sure. So the way spillover works, Robert, is your dividends post the year-end count towards the prior year spillover, right? So all the dividends we've paid since February has counted towards that $45 million that you've been talking about. So that's good, covering the spill, obviously, from a rig perspective.
At the same time, from March 1, then our new earnings is like building up a new spillover for the current year. And so, the way we think of it is -- and to your point about how much fill over is there that would need to be paid out at some point and could be thought about in the context of a dividend is we probably have over $3 per share currently of spillover that's been built up again that would have to be paid out at some point. And obviously, it's part of what we think about as we also think about the dividend and declining interest rates.

Operator

Mickey Schlein, Ladenburg.

Mickey Schleien

Hope all as well. Mike, I wanted to get your perspective on how you anticipate the potential reduction in base rates that the forward curve implies will impact lower middle market M&A volumes over the next several quarters?

Michael Grisius

That's really -- it's a tough question to answer. I mean I would say this, that -- there are signs that the larger middle market, the kind of standard middle market is showing some signs of recovery. Historically, we've seen that the lower middle market lags that.
Right now, if you look at lower middle market deal activity and you go back even pre-pandemic times, they're really all-time lows. And it's for some of the reasons that I outlined in my prepared remarks. All else equal, typically, with interest rates coming down, the cost of debt capital coming down generally has a positive influence on deal activity. So one would think that, that might help spur an increase in deal activity.
The one thing that I do know is that at some point, there will be a change in the amount of deals that we see in the lower middle market. It's the end of the market that's populated with the most businesses by far in our economy.
And at some point, people will transact for a lot of reasons that are driving that for businesses that are owned by baby boomers. There are a lot of reasons why there are sellers at the right price at the right time. And there are PE funds that are holding on to assets longer than they have historically.
And ultimately, those assets will trade and given all the investments that we've made in getting our name into the marketplace and really the presence that we've built in the marketplace, we're very confident in the long run that as that market comes back, our deal activity and our opportunity to deploy capital in new platforms will grow and it will outpace our payoffs as it has historically.

Mickey Schleien

That's helpful. And you talked a little bit about the broader markets. And I did notice that Saratoga decided not to reset the CLO's liabilities, and I'm sure why you decided not to do that? And what are your expectations for how the portfolio or that portfolio will run off now that it's outside of its reinvestment period?

christian Oberbeck

That's obviously a very important part of one of our investments and a good question. A couple of things are going on. On the liability side of the CLO world, there's been tremendous demand and a lot of CLOs have been raised and reset, and we explored that. The -- on the asset side, the supply of new because of the M&A, the supply of new assets is sort of not in the same sequence, right? So there's not as many primary originated syndicated loans as there is demand from a lot of the refinancing of the CLOs.
And so given the dynamics of the marketplace at that time and currently, we thought we would basically refinance part of the liability structure to take advantage of the improved rates on the liability side, but not necessarily reset the entire CLO, which also would have required a new level of equity investment in this area at this moment in time. We have a short non-call period on that.
And so we are prepared and ready should the market improve and we find it attractive to sort of reset the CLO for further investments, we're prepared and ready to do that. But in the meantime, we're operating more in sort of a runoff mode in that particular CLO.

Mickey Schleien

And Chris, given -- first of all, I completely agree with you. I mean the spread compression in the more liquid markets has been severe. Do your comments also impact your view on the senior loan fund and your willingness to continue to grow that fund?

christian Oberbeck

Again, it's -- I guess I hate to say it depends, but it depends. I mean there's just a lot of dislocations in the marketplace. And just the absence of M&A activity and the absence of primary product has just created the spread compression you referenced. And so when does that abate? When does that change?
I mean it will change a point, but it just hasn't. And so we're poised and ready. And we obviously have many years of experience in this marketplace. And so our view right now is not to make incremental equity investments into this space take advantage as best we can of improvements on the liability and the financing structure of it. And then when things change, I think we're ready to step up? Should that be what's warranted or continue our current sort of current stance?

Mickey Schleien

I understand. Chris, in terms of capital at the BDC, obviously, the stock is trading at a discount to NAV, not as much today, but still at a discount, given your liquidity, it would seem that repurchasing your stock would be one of the best uses of capital. Why haven't you done that in the last couple of quarters?

christian Oberbeck

Well, I guess there's a lot of considerations. There's short-term considerations, which is the stock trading below NAV and the opportunity to buy our own portfolio which is obviously, in our view, we're very happy with our portfolio. And so that is attractive.
On the other side, we do have leverage issues and acquiring equity would sort of increase leverage. And the question is what -- is that the right thing to do to increase our leverage in this context, even though it is for an attractive investment.
And then the other side is that we've had this -- part of the reason we have to build up in cash and we have a tremendous amount of financing over $350 million, we could grow our portfolio with. So we have a tremendous opportunity on the asset deployment side.
There's just been a real slowdown in M&A and everybody is experiencing it, but that could it might change, and we want to make sure that in the long run, right? I mean, it was like in this 6-month period or something, it might have made more sense to repurchase the stock. But if the M&A market opens up next year, we're able to deploy this capital able to build new relationships and set the stage for substantial long-term growth.
It's important to have the liquidity for that, both offensively, which is -- should things open up and the deal business gets a lot more robust, but also defensively. I mean if we have economic problems out there, having cash is -- can be important on the other side in terms of companies needing to refinance and having a more attractive refinancing situation.
So as of right now, do we have more cash and more investment capacity than we have had in the past? Yes. And the question is, what do we do with it? And I think at the moment, we think it's very prudent to maintain sort of the stance of being structured and prepared for incremental asset growth to take our assets up by another several hundred million dollars thoughtfully and carefully.
And sometimes, we've had periods of time where we can do that quickly and then there's periods of time where it takes longer. But we think that in the long run is the most important place to use of our capital is growth and improving our earnings and improving our NAV per share.

Mickey Schleien

I understand, Chris. And in terms of liquidity, just to follow-up on the undistributed taxable income question. It is over $3, which is a lot -- $2 per share, which is a lot and Henry talked about a little bit. Could you perhaps give us a little more insight in terms of what timing we can expect for the Board to take a decision on that UTI? And is a deemed distribution part of the calculus?

christian Oberbeck

Again, we haven't fully determined exactly how we're going to do that. A deemed distribution -- you're talking about it in kind. Is that your question?

Mickey Schleien

Yes. Yes.

christian Oberbeck

Look, obviously, an in-kind is an option that the industry has to do. I mean I think there's a fair amount of complication in cycles. And you'd have to figure out how large your distribution was relative to all that. I think that the magnitude of our distribution that may or may not be required has not been finally determined.
But I think that's something that's probably will be more revealing in the next quarter on precisely what that calculation is, but it's not going to be a very substantial number, and we don't believe at this time that a deemed distribution is appropriate.

Mickey Schleien

I understand. And my last question and also a follow-up on the asset sensitivity question. that market risk table that Henry alluded to shows that adjusted NII per share would decline about $0.25 per quarter with a 200 basis point decrease in interest rates, which is sort of in line with the forward curve and where base rates were at the end of your most recent quarter, and that would result in NII below the current dividend. So can you just review what tactics you plan to pursue to avoid that situation?

christian Oberbeck

Sure. I guess a couple there, not to waive anything off, but I think the forward curve has not been that accurate over the last bunch of years and --

Mickey Schleien

Agreed.

christian Oberbeck

And the exact course of interest rates. There's been a prediction of the decline for a long time that has not occurred. And we're not going to say it's not -- we're not saying it's not going to occur, but just saying the history is not that great in terms of those predictions. I think the economy is still strong and working. So the question is such a drastic cut in interest rates.
And would you have that in a robust economy or not. So I mean there's still a question where that will happen. Your question though is tactics, right? And so essentially, this is one, right? Okay. Interest rates go down 200 basis points and you look at our last quarter, what would that do? And then you have the calculation, right?
But the question is, is that if that were to happen, there's so many other dynamics that need to be taken -- they need to be -- if you have -- if you're running a model, right? You have to assume different things. And the question is, do we deploy more capital, right?
I mean we have capital delay what does something like that due to the refinancing marketplace. Maybe there's a bunch of new deals that come down that get refinanced and we can deploy our cash, which is the first most incremental investment we have, and then we could -- some of our SBIC capital.
So asset deployment is one of the mitigants, I'm not going to say that's a tactic because we're not going to deploy the capital unless we find the deals that we find attractive. But in that type of environment, there may be some very attractive investments coming.
I think Henri has discussed in the past that all of our baby bonds are callable we do have floating rate instruments, and we have access -- we can restructure some of our debt. We could call some of our fixed rate longer-term debt and we could replace that with more of the sort of friable lower spread, cheaper debt that's out there. And so we have a lot of factors at our disposal should that happen. And so I don't think -- and then the other thing that Henri mentioned is there's all sorts of lags.
In other words, some of this stuff won't take place. Even if that cuts a place, it wouldn't take place all at once, right? That would probably because of lags and because of adjustments and things like that, there's probably 6 to 12 months of adjustment before the full impact of that would hit us.
And during that period of time, we would have time to do some of these tactical things. the liability side, as we discussed, is certain -- there's a lot of targets there should we want to decrease our cost of funding. And then the deployment. So I think those are the main things that we would be focusing on.

Henri Steenkamp

The cost of funding shouldn't be understated, right? Because the 25 basis points is a very static perspective. It just views our debt structure as fixed effectively. And we structured our debt portfolio very purposefully the way we did. We think the call options have always had immense value, especially in a declining rate environment. And so we already know from what we're being revised by various banks that our baby bonds is 100 basis points plus cheaper than what it is currently now.
So there's already sort of a built-in value there at the right time. And you history has suggested as baby bond rates and private issuance mark rate move down as the Fed cuts that hopefully, our cost of financing will move with that. So that would have a meaningful impact to that $0.25 you reference. And we'd obviously act on that in the right time in the right place when it makes sense.

Operator

Thank you. I'm showing no further questions at this time. I'd now like to turn it back to Christian Oberbeck for closing remarks.

christian Oberbeck

Well, we want to thank everyone for their support and their following of our journey here at Saratoga. We appreciate all our shareholders and all our analyst coverage, and we look forward to speaking with you next quarter. Thank you.

Operator

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.