Apollo Investment Corporation Earnings: Oil Problems Persist

Business development company Apollo Investment Corporation (AINV -0.07%) reported a net loss in the first calendar quarter as oil and legacy investments were written down in excess of its operating income.

This quarter by the numbers

Source: SEC filings.

Business development companies make money in two ways. First, a BDC makes money by generating earnings from interest, dividends, and fees from its investment portfolio in excess of its operating expenses. This is called net investment income. BDCs also earn money due to appreciation and depreciation in their investment portfolios, which, when added or subtracted to net investment income, results in true bottom line net income.

Depreciation of $0.30 per share outpaced operating income of $0.20 per share this quarter. In an ideal world, a BDC would generate positive operating income and gains from its investment portfolio over time.

The company's book value on a per-share basis has consistently declined since the third calendar quarter of 2014, when oil prices started sliding.

What happened this quarter?

Quiet by their nature, financial companies tend to not change all that much in just one quarter. There were, however, a few things worth highlighting:

• Net investment activity was -$86.8 million, resulting in yet another quarter where Apollo Investment's portfolio shrank on a gross basis. (This is something of an industrywide phenomenon, as deal activity is seasonal, favoring the calendar fourth quarter, and has generally slowed across the industry.)
• After logging another quarter of depreciation, its oil and gas investments now make up 11.9% of the portfolio at fair value, down from 13.9% of the portfolio at this time last year.
• Share repurchases helped stem the decline in net asset value per share, as buybacks below book value added $0.02 to per-share NAV. The significance goes behind a mere two pennies -- continued buybacks show alignment between management, who are generally paid to grow assets at all costs, and investors, who would prefer smart buybacks at prices below book value.
• Across the portfolio, 4.2% of total investments were on non-accrual status at fair value (8.4% at cost). At this time last year, only 0.1% of assets at fair value (1.3% at cost) were on non-accrual. Non-accrual means that Apollo is not accruing interest or dividend income from the investment in its earnings because it has doubts that it will actually collect the interest in cash.
• Non-accrual loans generally include resource-related companies like Magnetation, Osage Exploration & Development, Spotted Hawk Development, Venoco, and Pelican Energy. Two education credits are also on non-accrual: Delta Educational Systems and Gryphon Colleges.

What management had to say

Management noted that they continue to look for ways to improve performance on the company's conference call. The company is focused on reducing its energy exposure at attractive prices, where possible, and being proactive at restructuring losing credits when appropriate.

The company's external manager has also reduced base management fees to 1.5% of assets, and is including a performance adjustment for incentive fees for the next year. When asked, management was somewhat dismissive about the need to cut the dividend to reflect the company's earnings, but it should be noted that net investment income is only matching its dividend despite higher-than-normal leverage.

Looking ahead

Down but not yet completely out of the portfolio, oil and gas investments should remain in focus at Apollo Investment, as they continue to drive the bulk of the swings in the value of its investment portfolio. Only time can tell if the worst is over for its investments with energy exposure, which represent the biggest challenge (and, in some ways, opportunity) over the next year.