Saratoga Investment Corp. Maintains Steady Financial Performance

Overview

Saratoga Investment Corp. is a Maryland-based business development company (BDC) that has elected to be regulated as an investment company under the Investment Company Act of 1940. The company’s primary investment objective is to generate current income and long-term capital appreciation by investing primarily in senior and unitranche leveraged loans and mezzanine debt issued by private U.S. middle-market companies.

Saratoga Investment Corp. was originally founded in 2007 as GSC Investment Corp. and completed an initial public offering that year. In 2010, the company engaged Saratoga Investment Advisors as its new investment adviser and changed its name to Saratoga Investment Corp.

The company has formed two wholly-owned subsidiaries, Saratoga Investment Corp. SBIC II LP and Saratoga Investment Corp. SBIC III LP, that have received licenses from the Small Business Administration (SBA) to operate as small business investment companies (SBICs). These SBIC subsidiaries provide Saratoga Investment Corp. access to long-term capital in the form of SBA-guaranteed debentures.

Saratoga Investment Corp. has also been actively managing its Saratoga CLO, a collateralized loan obligation fund, since 2008. The company has completed several refinancings of the Saratoga CLO over the years to extend its reinvestment period and legal maturity. Saratoga Investment Corp. earns management fees for serving as the collateral manager of the Saratoga CLO.

In addition, the company has formed two special purpose entities, Saratoga Investment Funding II LLC and Saratoga Investment Funding III LLC, to enter into senior secured revolving credit facilities with Encina Lender Finance, LLC and Live Oak Banking Company, respectively. These credit facilities provide Saratoga Investment Corp. with additional sources of financing to support its investment activities.

Financial Performance

Saratoga Investment Corp.’s financial performance has remained relatively steady over the past several quarters. For the three months ended November 30, 2024, the company reported total investment income of $35.9 million, a slight decrease of 1.3% compared to the same period in the prior year.

The decrease in total investment income was primarily driven by a 5.8% decline in interest income from investments, which fell to $30.8 million from $32.7 million in the prior-year period. This was due to a 9.6% reduction in the company’s average investment portfolio size, combined with a decrease in the weighted average current yield on investments to 10.8% from 11.4%.

However, for the nine months ended November 30, 2024, total investment income increased 10.4% to $117.6 million, largely due to the recognition of $8.2 million in interest income related to the company’s Knowland investment that had previously been on non-accrual status.

On the expense side, Saratoga Investment Corp.’s total operating expenses increased 5.7% to $23.4 million for the three months ended November 30, 2024, compared to the same period in the prior year. This was primarily attributable to a 4.2% rise in interest and debt financing expenses, reflecting a 3.6% increase in average outstanding debt.

For the nine months ended November 30, 2024, total operating expenses increased 16.3% to $72.6 million, driven by a 6.8% rise in interest and debt financing expenses as well as a 132.9% jump in incentive management fees. The increase in incentive fees was due to higher net investment income and a reduction in the incentive fee liability floor during this period.

Despite the increase in expenses, Saratoga Investment Corp. reported net investment income of $12.4 million and $45.0 million for the three and nine months ended November 30, 2024, respectively. This represents a slight decrease of 12.2% and an increase of 2.0% compared to the same periods in the prior year.

The company’s net realized and unrealized gains and losses on investments have been more volatile. For the three months ended November 30, 2024, Saratoga Investment Corp. recorded net realized gains of $5.4 million and net unrealized depreciation of $9.0 million. This compares to net realized gains of $0.1 million and net unrealized depreciation of $17.9 million in the prior-year period.

For the nine months ended November 30, 2024, the company reported net realized losses of $49.2 million and net unrealized appreciation of $33.0 million, compared to net realized gains of $0.2 million and net unrealized depreciation of $40.5 million in the prior-year period. The significant net realized losses were primarily due to the restructuring of investments in Zollege PBC and Pepper Palace, Inc.

Overall, Saratoga Investment Corp. generated a net increase in net assets resulting from operations of $8.8 million, or $0.64 per share, for the three months ended November 30, 2024. For the nine months ended November 30, 2024, the company reported a net increase of $28.8 million, or $2.09 per share.

Portfolio Composition and Quality

As of November 30, 2024, Saratoga Investment Corp.’s investment portfolio consisted of 133 investments across 48 portfolio companies, with an average investment size of $7.2 million and a weighted average maturity of 2.3 years. The portfolio was predominantly composed of first lien term loans, which accounted for 86.8% of the total portfolio at fair value.

The company’s investment portfolio exhibited strong credit quality, with 89.4% of investments (by fair value) rated green on Saratoga’s internal credit and monitoring rating (CMR) system, indicating performing credits. Only 0.3% of investments were rated red, signifying investments in principal payment default or expected loss of principal.

Saratoga Investment Corp.’s investment in the subordinated notes of the Saratoga CLO, which represented 0.1% of the total portfolio at fair value, also exhibited solid credit quality, with 91.4% of the CLO’s underlying investments rated green on the CMR scale as of November 30, 2024.

The company’s portfolio was well-diversified across 40 different industries, with the largest exposures in healthcare services (8.7%), consumer services (6.2%), and HVAC services and sales (6.1%). Geographically, the portfolio was concentrated in the Midwest (34.3%), Southeast (25.1%), and West (13.7%) regions of the United States.

Liquidity and Capital Resources

Saratoga Investment Corp. has maintained a strong liquidity position, with $147.6 million in cash and cash equivalents and an additional $102.5 million in cash and cash equivalents held in reserve accounts as of November 30, 2024. The company also had $85.1 million and $86.4 million of available borrowing capacity under its Encina and Live Oak credit facilities, respectively, at that date.

In addition to its credit facilities, Saratoga Investment Corp. has access to long-term capital through its SBIC subsidiaries. As of November 30, 2024, SBIC II LP had $87.5 million in regulatory capital and $175.0 million in SBA-guaranteed debentures outstanding, while SBIC III LP had $66.7 million in regulatory capital and $39.0 million in SBA-guaranteed debentures outstanding.

The company has also issued various unsecured notes, including $175.0 million of 4.375% notes due 2026, $75.0 million of 4.35% notes due 2027, $105.5 million of 6.00% notes due 2027, and $60.4 million of 8.125% notes due 2027, among others. These unsecured notes provide Saratoga Investment Corp. with additional long-term financing to support its investment activities.

Saratoga Investment Corp.’s asset coverage ratio, a key measure of leverage, was 160.1% as of November 30, 2024, well above the 150% minimum required for BDCs. This provides the company with significant flexibility to continue growing its investment portfolio while maintaining a prudent capital structure.

Outlook and Conclusion

Saratoga Investment Corp. has demonstrated its ability to navigate the challenges of the current market environment and maintain a steady financial performance. The company’s diversified investment portfolio, strong liquidity position, and access to various sources of capital position it well to continue supporting its investment objective of generating current income and long-term capital appreciation.

However, the company’s results have been impacted by the volatility in its realized and unrealized gains and losses on investments, particularly the significant net realized losses recorded during the nine-month period ended November 30, 2024. Saratoga Investment Corp. will need to closely monitor the performance of its portfolio companies and be proactive in managing any potential credit issues to mitigate the impact of such losses going forward.

Additionally, the rising interest rate environment has led to an increase in the company’s interest and debt financing expenses, which could continue to put pressure on its net investment income if the trend persists. Saratoga Investment Corp. will need to carefully manage its cost of capital to maintain its profitability.

Overall, Saratoga Investment Corp. appears to be in a solid financial position, with a well-diversified investment portfolio, ample liquidity, and access to diverse sources of capital. As the company navigates the evolving market conditions, its ability to generate consistent investment income and effectively manage its portfolio will be key to its continued success.