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Capital Southwest (NASDAQ:CSWC)
Q2 2021 Earnings Call
Nov 02, 2020, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Thank you for joining today's Capital Southwest second quarter fiscal-year 2021 earnings call. Participating on the call today are Bowen Diehl, CEO; Michael Sarner, CFO; and Chris Rehberger, VP, Finance. I will now turn the call over to Chris Rehberger.

Chris Rehberger -- Vice President, Finance

Thank you. I'd like to remind everyone that in the course of this call, we will be making certain forward-looking statements. These statements are based on current conditions, currently available information and management's expectations, assumptions and beliefs. They are not guarantees of future results and are subject to numerous risks, uncertainties and assumptions that could cause actual results to differ materially from such statements.

For information concerning these risks and uncertainties, see Capital Southwest's publicly available filings with the SEC. The company does not undertake any obligation to update or revise any forward-looking statements, whether as a result of new information, future events, changing circumstances or any other reason after the date of this press release, except as required by law. I will now hand the call off to our president and chief executive officer, Bowen Diehl.

Bowen Diehl -- Chief Executive Officer

Thanks, Chris, and thank you to everyone for joining us for our second quarter fiscal-year 2021 earnings call. Throughout our prepared remarks, we will refer to various slides in our earnings presentation, which can be found on our website at www.capitalsouthwest.com. We are pleased to be with you this morning to announce our results for our second fiscal quarter ended September 30, 2020. I want to first say that I hope everyone, their families and their employees continue to be safe and well.

Here at Capital Southwest, we have continued to prioritize the health and safety of our employees and of the employees of our portfolio companies. We remain in regular dialogue with our portfolio company financial sponsors and management teams and have been pleased with the overall performance of the portfolio. We have been most impressed with the management teams' and financial sponsors' ability to manage all aspects of company performance, including protecting their employees while increasing operating efficiencies during these unprecedented times. While the pandemic is not yet behind us, as we look back to where we were in March 2020, with so much uncertainty and market volatility, we are very grateful for all the work done by the team here at Capital Southwest and the teams at both our portfolio companies and financial sponsor clients.

We're also extremely pleased with the performance of our portfolio, and we remain highly confident in the quality of the assets and its earnings power. During the quarter, our portfolio performance continued to improve as evidenced by $8.4 million of net appreciation across the portfolio. For the quarter, we had two loans, which had investment rating upgrades. We had no investment rating downgrades, and we had no new loans placed on nonaccrual.

As a well-capitalized first lien lender with ample liquidity, Capital Southwest continues to be in a favorable position to seek attractive financing opportunities and to provide financial support to help our companies grow. Executing our investment strategy under our shareholder-friendly internally managed structure, closely aligns the interests of our Board and management team with that of our fellow shareholders in generating sustainable long-term value through recurring dividends, capital preservation and operating cost efficiency. On Slide 6 of the earnings presentation, we have summarized some of the key performance highlights for the quarter. During the quarter, we generated pre-tax net investment income of $0.44 per share, which more than earned our regular dividend paid for the quarter of $0.41 per share.

We also continued our supplemental dividend program, paying out an additional $0.10 per share, funded by our sizable undistributed taxable income balance. Total dividends for the quarter of $0.51 per share represented an annualized dividend yield on the quarter end stock price per share of 14.5% and the annualized yield on net asset value per share of 13.3%. I'm also pleased to announce that our Board has declared total dividends of $0.51 per share, again, for the quarter ended December 31, 2020, consisting of a regular dividend of $0.41 per share and a supplemental dividend of $0.10 per share. During the quarter, we grew our investment portfolio by over 7% to $631 million as of September 30, 2020.

Portfolio growth during the quarter was driven primarily by $66.3 million in total new commitments to four new portfolio companies and six existing portfolio companies, offset by $21 million in prepayments from two loans, which I'll review in a bit more detail in a moment. Additionally, on the capitalization front, we successfully raised $50 million in proceeds at par on our existing 5 3/8% institutional unsecured bonds, bringing the total principal outstanding of this bond issuance to $125 million. Finally, as we mentioned last quarter, we continue to work with the U.S. Small Business Administration toward becoming officially license as an SBIC.

We are pleased to report that we completed our final license submittal during the quarter and look forward to reporting developments on the status of our pending license application to our shareholders as warranted. As a reminder, final approval and issuance to Capital Southwest of an SBIC license would provide a 10-year commitment to provide Capital Southwest with up to $175 million in debt financing to be drawn to fund investments in our lower middle market strategy. We estimate that the vast majority of the deals we have reviewed over the past five years would qualify for SBIC financing, giving us a high level of confidence that we will be able to invest this capital in our existing strategy and continue to support growth and employment in small businesses across the country. As a reminder, each draw from the SBIC debenture program separately represents a new debt security in our capital structure, with a 10-year maturity from the date of draw, making this capital truly long term in nature.

From a cost perspective, if treasury rates remain close to today's level, the all-in cost of the SBIC debentures would be less than 3%. This program is clearly a perfect fit for our lower middle market focus, and we look forward to continuing to work with the SBA in completing the application process and in successfully executing the SBA's mission of supporting growth and employment in U.S. small businesses. Turning to slides 7 and 8.

We illustrate our track record of producing a strong dividend yield, consistent dividend coverage and value creation since the launch of our credit strategy. We strongly believe that the maintenance and growth of both NAV per share and dividends paid per share are paramount to creating long-term value for our shareholders. Turning to Slide 9. As a reminder, our investment strategy has remained consistent since its launch in January of 2015.

We continue to focus on our core lower middle market while also maintaining the ability to invest in the upper middle market when attractive risk-adjusted returns exist. In the lower middle market, we directly originate opportunities consisting of debt investments and equity co-investments. Building out a well-performing and granular portfolio of equity co-investments is important to driving NAV per share growth as well as aiding in the mitigation of any credit losses over time. Overall, we believe that maximizing the top end of our deal origination funnel in both markets is critical to generating strong credit performance over time as it ensures that we consider a wide array of deals, allowing us to employ our conservative underwriting standards and thoughtfully building a portfolio that will perform through any economic cycle.

Though we continue to take a cautious and extremely selective approach toward deploying new capital, taking into account the new normal of potential pandemics, among other risks, we are pleased to have the capital to invest to support acquisitions and growth across our markets. That said, we continue to find superior risk-adjusted return opportunities in the lower middle market, where we can lend at lower leverage and loan-to-value levels while maintaining tighter covenants and other terms in the loan documents. As illustrated on Slide 10, our on-balance sheet credit portfolio, excluding I-45, grew 7% during the quarter to $521 million as compared to $487 million as of the end of the prior quarter. Our credit portfolio is currently weighted 82% to the lower middle market — to lower middle market loans, down slightly from 85% last quarter as a result of two loan prepayments in the lower middle market and two originations in the upper middle market during the quarter.

We continue to heavily emphasize first lien senior secured debt lending, with 100% of the debt originations this quarter being first lien senior secured. As a result, as of the end of the quarter, 91% of the credit portfolio was in first lien senior secured debt. On Slide 11, we lay out the $66.3 million of capital invested in and committed to portfolio companies during the quarter. This included $42.2 million in first lien senior secured debt committed to four new portfolio companies and $20.9 million in additional first lien senior secured debt committed to six existing portfolio companies.

Turning to Slide 12. As I previously alluded to, we had two lower middle market exits this quarter, Danforth Advisors and Trinity 3. Our debt at Danforth was refinanced by a traditional bank, repaying our loan in full, generating proceeds of $6.7 million at an IRR of 12.4%. We continue to hold equity in Danforth alongside the sponsor, and we are excited to watch this management team and sponsor continue its stellar performance.

In the case of Trinity 3, which also appears on the new deal fundings for the quarter, we were able to participate in a much larger club deal, which refinanced our original loan and financed a large strategic acquisition for Trinity 3. We also hold an equity interest in this company and are very excited about its continued growth prospects going forward. This continues our track record of successful exits. To date, we have generated a cumulative weighted average IRR of 14.7% on 33 portfolio exits, generating approximately $308 million in proceeds.

On Slide 13, we break out our on-balance sheet portfolio as of the end of the quarter between the lower middle market and the upper middle market, excluding I-45. As of the end of the quarter, the total portfolio, including equity co-investments, was weighted approximately 84% to the lower middle market and 16% to the upper middle market on a fair value basis. We had 39 lower middle market portfolio companies with a weighted average leverage ratio measured as debt-to-EBITDA through our security of 3.9 times, down from 4.1 times weighted average leverage in the prior quarter. This reduction in leverage was primarily driven by EBITDA performance across the lower middle market portfolio during the quarter.

Within our lower middle market portfolio as of the end of the quarter, we held equity ownership in approximately two-thirds of our portfolio companies. Our on-balance sheet upper middle market portfolio, excluding I-45, consisted of 12 companies with an average leverage ratio through our security of 3.7 times, down meaningfully from the 4.4 times weighted average leverage for the prior quarter. This decrease was also driven primarily by EBITDA improvement quarter over quarter across the portfolio. Turning to Slide 14.

We have laid out the rating migration within our portfolio for the quarter. During the quarter, we had two loans upgraded while having no loans downgraded. As a reminder, all loans upon origination are initially assigned an investment rating of two on a four-point scale, with one being the highest rating and four being the lowest rating. The upgrades consisted of two loans to one portfolio company previously rated at three, which were upgraded to a two rating based on much improved performance.

As of the end of the quarter, 88% of our investment portfolio at fair value was rated in one of the top two categories, a one or two. We had seven loans representing 10% of the portfolio at fair value rated a three and only two loans representing 2% of the portfolio at fair value rated a four times. As illustrated on Slide 15, we have established a portfolio well diversified across industries with an asset mix, which provides strong security for our shareholders' capital. The portfolio remains heavily weighted toward first lien senior secured debt, with only 6% of the portfolio in second lien senior secured debt and only 2% of the portfolio in one remaining subordinated debt investment.

Turning to Slide 16. The I-45 portfolio showed meaningful improvement during the quarter, as our investment in I-45 appreciated by $4.7 million or 8%. Leverage at the I-45 fund level is now 1.39 times debt-to-equity at fair value, which has substantially improved from the March 31 quarter leverage of 2.51 times. As of the end of the quarter, 96% of the I-45 portfolio was invested in first lien senior secured debt with diversity among industries at an average hold size of 2.4% of the portfolio.

I will now hand the call over to Michael to review the specifics of our financial performance for the quarter.

Michael Sarner -- Chief Financial Officer

Thanks, Bowen. Specific to our performance for the September quarter, as summarized on Slide 17, we earned pre-tax net investment income of $8.1 million or $0.44 per share. This was a 13% increase from the $7.2 million or $0.40 per share earned during the prior quarter. We paid out $0.41 per share in regular dividends for the quarter, flat from the $0.41 regular dividend per share paid out in the prior quarter.

As mentioned earlier, our Board has also declared a further $0.41 regular dividend per share to be paid out during the December quarter. In the near and long term, we have built a consistent track record of meaningfully covering our regular dividend with pre-tax net investment income as demonstrated by our 103% regular dividend coverage over the last 12 months and 106% cumulative regular dividend coverage since the launch of our credit strategy. During the quarter, we maintained our supplemental dividend at $0.10 per share, and again, our Board has also declared a further $0.10 per share supplemental dividend to be paid out during the December quarter. As a reminder, the supplemental dividend program allows our shareholders to meaningfully participate in the successful exits of our investment portfolio through distributions from our UTI balance.

As of September 30, 2020, our estimated UTI balance was $1.19 per share. Our investment portfolio produced $16.7 million of investment income this quarter, with a weighted average yield on all investments of 10.4%. This represents an increase of approximately $1.5 million from the previous quarter. As Bowen mentioned, we had no new nonaccruals as of the end of the quarter.

Currently, three assets remain on nonaccrual with a fair value of $10.9 million, representing 1.7% of our total investment portfolio at fair value. The weighted average yield on our credit portfolio was 10.3% for the quarter. On Slide 18, we lay out our operating leverage for the quarter, which was up slightly quarter over quarter. Operating expenses were slightly elevated this quarter due mainly to a true-up to our annual bonus accrual based on improvement in our overall portfolio performance as well as an increase in share-based compensation expense relating to the annual grant to employees.

On a run rate basis, we expect operating leverage will be well within our sub-2.5% target going forward. Turning to Slide 20. The company's NAV per share as of September 30, 2020, was $15.36 as compared to $14.95 at June 30, 2020. The main driver of the NAV per share increase was $8.4 million of appreciation in the investment portfolio, much of which was in the upper middle market portfolio.

On Slide 21, we lay out our multiple pockets of capital. As we have mentioned on prior calls, a strategic priority for our company is to continually evaluate approaches to derisk the liability structure of the company, while ensuring that we have adequate investable capital throughout the economic cycle. During the quarter, we raised an additional $50 million on our 5.375% unsecured notes due 2024 and subsequently paid down $20 million on our 5.95% baby bond due 2022. We will continue to be opportunistic in paying down higher-priced debt to optimize net investment income, while also being mindful of maintaining appropriate flexibility in our liability structure.

Our debt capitalization today includes a $325 million on balance sheet revolving line of credit with 11 syndicate banks maturing in 2023, a $57 million publicly traded baby bond maturing in 2022, a $125 million institutional bond with over 25 institutional investors maturing in 2024 as well as a $150 million revolving credit facility at I-45 with four syndicate banks maturing in 2024. We are pleased to report that our liquidity is strong with approximately $151 million in cash and undrawn commitments as of the end of the quarter, with ample borrowing base capacity and covenant cushions on our senior secured revolving credit facility. Approximately 49% of our current capital structure liabilities are unsecured with the earliest debt maturity at December 2022. Our balance sheet leverage, as seen on Slide 19, ended the quarter at a debt-to-equity ratio of 1.28 to 1.

Finally, as Bowen mentioned, we continue to work actively with the SBA toward an SBIC license, which would allow us in time to access up to $175 million in attractively priced debt at our SBIC. We believe we are in the final stages of the licensing process and are hopeful of receiving our license by the end of the calendar year. We are excited to integrate the SBIC license into our capitalization strategy as the flexibility and low cost of SBIC debentures should be highly accretive to our net investment income per share, while also allowing us to continue to provide important growth and acquisition capital to U.S. small businesses.

I will now hand the call back to Bowen for some final comments.

Bowen Diehl -- Chief Executive Officer

Thanks, Michael. And thank you, everyone, for joining us today. Capital Southwest has grown and the business and portfolio have developed consistent with the vision and strategy we communicated to our shareholders almost six years ago. Our team has done an excellent job building both a robust asset base as well as a flexible capital structure that prepares us for difficult environments, like the one we have experienced over the past several months.

In fact, difficult environments like this demonstrate the investment acumen of our team at Capital Southwest and the merits of our first lien senior secured debt strategy. While we are not immune to the challenges the economy faces today, we feel good about the health of our company and the opportunities that the environment will present us as we consider places to invest capital. Everyone here at Capital Southwest is totally dedicated to being good stewards of our shareholders' capital by continuing to deliver strong performance and creating long-term sustainable value, even in challenging times such as these. This concludes our prepared remarks.

Operator, we are ready to open the lines for Q&A.

Questions & Answers:


Operator

Yes, sir. [Operator instructions] Our first question or comment comes from the line of Mike Smyth from B. Riley. Your line is open.

Mike Smyth -- B. Riley FBR, Inc. -- Analyst

Hey, guys. Congrats on a very strong quarter. So I guess my first question would be, you had a very good quarter of origination activity despite some of the COVID headwinds. So I was wondering if you can maybe size the pipeline and just talk a little bit about the quality of deals you're seeing now, just in terms of pricing, covenants, attachment points, etc.

Bowen Diehl -- Chief Executive Officer

Yes. Sure. Thanks for the question. We thought the quarter originations was very strong.

It included both new portfolio companies as well as four add-on acquisitions in our portfolio companies. And so right now, I'd say the pipeline is about average. So it's still solid, but it's about average. As far as what we're seeing in the market, we do think that the most all, if not all, of the pre-COVID premium, if you will, on a yield basis or a spread basis is disappeared.

There might be slight in certain deals. But certainly, a lot of cases, the premium of pre-COVID — or the COVID premium has decreased. With respect to leverage attachment points, I think we're still seeing leverage attachment points, slightly below pre-COVID levels. And covenants are still strong, and the EBITDA adjustments and those types of things that you see in credit docs are still really strong in the lenders favor, I should say.

And as far as quality deals, we definitely are seeing quality deals, certainly seeing low-quality deals, too, low quality being defined as companies that we still can't underwrite COVID performance. But we're seeing a fair amount of quality deals. And if you look across the business descriptions of the companies we originate this quarter, I mean, software, government services, cybersecurity, Internet marketing type companies. There's really interesting business models, especially in this environment.

So our team has done an excellent job. They've got a very wide array of a network of relationships, and they've done a fantastic job monetizing those relationships through the form of originating quality deal flow.

Mike Smyth -- B. Riley FBR, Inc. -- Analyst

Gotcha. That's helpful. That's very helpful color. So another question would be, on leverage.

You're currently sitting at 1.28 times. And if I'm not mistaken, I think the previous target was one to two. So I'm just wondering how are you kind of thinking about leverage moving forward here. And are you comfortable with it being slightly above your target?

Bowen Diehl -- Chief Executive Officer

Yes. Sure. So I'll make a macro comment and that's just with respect to leverage as it relates to economic cycles. I mean in a recessionary, challenging environment, you might be willing to go one leverage level and in a peak, everything is wonderful, marching forward like we were a year ago, you want to be at another leverage level.

And so you want to? You don't want to maximize leverage at the high end of the cycle, and you might be willing to have leverage increase at the low end of the cycle. And you want to go into the cycle with leverage low so you can manage leverage down in the cycle. So what all that means, if you think about leverage of 1.28, the answer is yes, we're comfortable with where we are. It is higher than our one to 1.2 kind of target range we gave pre COVID.

If you look at — if you just take a high-level look at the depreciation in the portfolio during COVID, retracing that kind of the COVID effect on the portfolio, we're basically back to the top end of our leverage range. And so you have to kind of keep in mind that as the portfolio reappreciates that leverage, all else equal will come down. So that's one kind of point and why I can say we're comfortable with where we are. The next thing is, we've got visibility on $30 million to $35 million of prepayments coming in from portfolio companies that are performing very well and are being sold or refinanced or what have you.

So if you kind of think about leverage, we have visibility on cash coming in. So we'll obviously be redeploying that cash in originations, but that's another point. And the third thing I would say is if you think about, we traded well above book for almost two years pre-COVID. So I believe that we've proven that our business model and our strategy in a more normal market should trade above NAV, OK? So if it's trades above NAV, as you guys know, we've got an ATM program that we're diligent about accessing a very low spreads to trade.

And so that's obviously a function. And our yield on NAV today is 13.5% or so. And on the stock price, it's north of 14%. I mean, the market will figure out the risk premium on our stock over time.

So we're comfortable just letting the market play out. But those yield levels, I mean, based on our strategy and track record really are not where we believe those yield levels will normalize out over time, which we believe will trade above NAV, and we'll be able to raise equity. So those are kind of all the points where — that are in my head, as I look at the leverage at 1.28 and am I comfortable with that or not.

Michael Sarner -- Chief Financial Officer

Yes. I was just going to say, just from a company profile perspective, our asset mix is a little different now than it was a year ago. We were probably in the mid-80s on first lien and now we're 91% first lien. We had a few, probably two to three sub-debt investments.

And today, we have one sub-debt investment. And our equity percentage of the portfolio was probably in the low 20% and now it's sub-10%. So our overall profile is a lot stronger than it was then. So we could probably take on a little more leverage based on that profile.

Bowen Diehl -- Chief Executive Officer

Yes. That's a good point. So I hope you got a great color.

Mike Smyth -- B. Riley FBR, Inc. -- Analyst

Yes. That all very helpful. And then one more kind of just high-level question for me. If I'm not mistaken, I think the $63one million is a record portfolio size.

So just given your outlook for the origination environment and kind of the potential for an SBA license, I'm wondering what kind of portfolio size can you support with your current infrastructure.

Bowen Diehl -- Chief Executive Officer

Yes. So we've kind of managed costs. We look at operating leverage. And so we think as the portfolio grows, we're looking at an operating leverage number.

So as our portfolio grows, we can invest in staff and resources, right? And so our dollar costs will go up over time, but that's what we look at as a percentage of our assets. And so as we layer in the SBIC, as we grow, continue to grow the portfolio, we will add people, but we manage it to that operating leverage number because that's really what the shareholders should care about, is that percentage drag, if you will, on the income on the portfolio from overhead that we're spending. So we look at that metric, and we absolutely add the resources as we grow the assets.

Mike Smyth -- B. Riley FBR, Inc. -- Analyst

Gotcha. Well, thanks for taking my questions. I'll let somebody else ask you.

Bowen Diehl -- Chief Executive Officer

Thanks, Mike.

Operator

Our next question or comment comes from the line of Mickey Schleien from Ladenburg. Your line is open.

Mickey Schleien -- Ladenburg Thalmann -- Analyst

Morning Bowen. Then Michael, nice to hear from you. I wanted to follow-up on the prepayment risk. I sort of think we're living in a world, obviously, of haves and have-nots in terms of the portfolio companies.

And there's a lot of private debt capital out there chasing. What I would say is still a limited deal pipeline when you consider the constraints everyone has on underwriting. Meanwhile, there's potential changes in tax rates and that could catalyze some business orders to sell now this quarter. So with those trends in mind, how high do you feel prepayment risk is in your portfolio, given the strength of some of your investments besides the two that you've already mentioned in the prepared remarks?

Bowen Diehl -- Chief Executive Officer

Yes. Mickey, thanks for the question. I mean, again, if we — just to quantify the number, I mean, it's $30 million to $35 million of prepayments that we have some visibility on. With respect to the environment and tax regime changes, theoretically, as we move into the end of the year because of potential pending capital gains treatment changes, that could definitely influence deal flow.

I would say that I don't — I'm not as certain that people are going to make, especially with the aging entrepreneurial population that are monetizing their retirement in these businesses is what's generating a lot of the sales across the lower middle market. I don't know that founder-owned business makes a rash lifetime decision 30 days here or there based on a tax change. If they were already thinking about selling their business, it could absolutely accelerate it so — and push it into this year. But — and I would also say that, I guess, we won't know until tomorrow or hopefully soon after the election change, and you would have more visible or more visibility on a theory on tax change.

It'd be hard to launch a sale process right now and get it sold by the end of the year. So long way of saying, I don't know that the tax changes necessarily were going to dramatically change certainly our prepayment risk. But look, as a lender, the strongest performers get prepaid, get refinanced, especially in the lower middle market, where traditional banks maybe aren't willing to lend to some of these companies, we are. And then the traditional banks in the case of Danforth refinance this up.

I mean that's a process. And so there's the vast majority, the majority of your portfolio companies are just kind of going along, growing, and we end up holding loans for a couple of years. Then you have the star performers, and then of course, you have a small universe of guys that underperform. So if that makes sense.

Michael Sarner -- Chief Financial Officer

Yes. And I also say that some of the deals that are set to repay were on our list of deals that this could occur. So that's kind of being taken off the register. So what we're left with is a lot of companies that we've refinanced over the last two years.

So we actually feel like we have a good sense that there's not going to be another $30 million to $50 million in the next quarter after that. So I feel like a lot of the stuff is happening right now.

Mickey Schleien -- Ladenburg Thalmann -- Analyst

That's helpful. I appreciate that. Bowen, I wanted to touch on the nonperforming loans. If I'm not mistaken, they're all in certain stages of bankruptcy.

And I think there's been some movement since our last call. So starting with American Addiction, from what I've read, and the information is a little sparse, it looks like you're going to be repaid in cash on that from asset sales, is that correct? And when will that be?

Bowen Diehl -- Chief Executive Officer

So based on what's public, it's going to emerge from bankruptcy relatively soon. It will be restructured. So the lender group, first lien lender group, which we are a part of, will end up holding a debt security, first lien debt security in the new restructured company and then ownership of the equity in the company. So it will be restructured.

It will be merchant bankruptcy, and Capital Southwest actually will have a board seat. And so that's that, and it will all be resolved relatively soon. I mean it's not in our control, but it's basically got to work through taxes and various things of structuring the recap, so the restructuring. So that's AAC.

Anyway, you want to talk about Kings and CPK as well?

Mickey Schleien -- Ladenburg Thalmann -- Analyst

Well, before we go onto those, just so you will end up with a performing piece of debt in AAC at some point, maybe next quarter.

Bowen Diehl -- Chief Executive Officer

That's correct.

Michael Sarner -- Chief Financial Officer

Yes.

Bowen Diehl -- Chief Executive Officer

That's the expectation.

Mickey Schleien -- Ladenburg Thalmann -- Analyst

And so CPK, it looks like, similarly, you're going to get equity and debt, is that correct? And when is that going to happen?

Bowen Diehl -- Chief Executive Officer

So similar story as AAC as far as what will happen from a bankruptcy perspective. So we'll end up with a performing first lien note and equity in the company. We will not have a board seat in that instance. And we think that's going to happen, that should — I think it may even be announced, but it will be relatively soon.

Mickey Schleien -- Ladenburg Thalmann -- Analyst

Right. And what's the game plan for CPK? I mean I've been reading headlines where lenders, I guess, surprisingly, are taking over some of these restaurant businesses despite everything that's going on in the world, obviously, thinking that long term, there must be value there. I think you've mentioned in the past that CPK was doing pretty well prior to the pandemic. But looking ahead, are there any major changes you expect to implement with the other owners at CPK? Or you're just going to wait for COVID to run its course and hope for things to improve?

Bowen Diehl -- Chief Executive Officer

OK. Well, yes, I appreciate the question. And obviously, I'll give you a couple of points in my view, but obviously, we want to be very careful with the confidentiality around that company. I think everybody understands that.

But I will say that this management team seems to be doing a really good job with the business. And that's one thing. And then the other thing is that the restaurants that have opened, people come eat there. And so it tells me that the brand is relevant and it's desired.

There's a demand for that brand and that concept in the market. So that's encouraging. Clearly, COVID is a bunch of noise out there. It's affecting all the restaurants.

The management team is doing some interesting creative things around that with respect to CPK. The election and any kind of unrest it may result, unrest in an area sets all the retailers, all the places, restaurants included in those areas. So there's clearly noise out there. But the things I grab on to is management team seems to be doing a great job.

We have weekly calls and the restaurants that are open, people want to eat there. And so based on those two things, that gives me a lot of encouragement as to the future of that concept once all the market noise, COVID pandemic noise phase away, which, look, this too shall pass. And so still challenges, but good team and there's some definitely some signs of relevance of that concept of brand.

Mickey Schleien -- Ladenburg Thalmann -- Analyst

I understand. That's great. And on AG Kings, obviously, there was a stalking-horse bid. I haven't seen another bid come through, unless I'm mistaken.

Is that correct? Or are there other folks sort of snooping around and potentially going to offer?

Bowen Diehl -- Chief Executive Officer

Yes. So yes, Mickey. So that's actually been announced. They signed a purchase agreement to sell to Albertsons.

That's in process of closing/documentation process, and that's pretty much all I should really say about it. But our valuation is a best guess on waterfall analysis around the proceeds on a sale.

Mickey Schleien -- Ladenburg Thalmann -- Analyst

OK. I didn't see that Albertsons' announcement. And finally, sort of just a balance sheet question. Is there any restriction on using the remaining borrowing base in the credit facility to help fund the SBIC once you get the license? And at the same time, can you contribute at least part of your positions in your existing lower middle market portfolio to capitalize it?

Michael Sarner -- Chief Financial Officer

Yes. So yes, we're able to draw on the revolver to fund the equity. And the plan going forward, we expect to get the license, as we said earlier, by the end of the year, and then we'll start originating assets, and the collateral will get allocated between the revolver and the SBIC. And we think that's important from a capital flexibility standpoint.

And I think you've seen other BDCs that are solely focused on SBIC. And when things go bad, they don't have enough collateral in a revolver to be able to draw. And that's obviously a cash flow issue. So we will be ramping up our revolver, in fact, to both pay down some of the 5.95% bonds as well as to accommodate originations that are not in the SBIC going forward.

Mickey Schleien -- Ladenburg Thalmann -- Analyst

I understand. And Michael, can you sort of warehouse lower middle market deals now and contributing to the SBIC once you get the license to move things along?

Michael Sarner -- Chief Financial Officer

The answer is, you can. But the answer is there's a process you go through. We're not going to do that. We actually expect that we're weeks away from actually having that application.

We don't want to be presumptive, but that's the kind of the guidance we've been given. So we're going to just wait until probably December and likely start allocating those assets to the SBIC probably in January.

Mickey Schleien -- Ladenburg Thalmann -- Analyst

As you originate them. And just directionally, how much? I guess you're not going to start out at 2:1 leverage in the SBIC on day one. How is leverage in the SBIC subsidiary going to progress?

Michael Sarner -- Chief Financial Officer

Sure. So you essentially get one turn of leverage out of the gate, and it's on the tech notes related to the SBIC. So essentially, the first $40 million of capital will be funded by us as equity. And then we'll be drawing from the SBIC thereafter.

Mickey Schleien -- Ladenburg Thalmann -- Analyst

You'll get — you have access immediately to $40 million of debentures then.

Michael Sarner -- Chief Financial Officer

Yes.

Mickey Schleien -- Ladenburg Thalmann -- Analyst

Yes. OK. That's it for me this morning appreciate your patience and your time. Thank you.

Operator

Our next question or comment comes from the line of Kyle Joseph from Jefferies. Your line is open.

Kyle Joseph -- Jefferies -- Analyst

Hey. Good morning, guys. Thanks for taking my questions. Let me echo on a nice quarter there.

Just most of my questions have been answered. But just, given the balance shift between the lower and upper middle market in the quarter, I think upper grew a little bit as a percentage of the portfolio, was that a one-off? Is that something we could look for to continue? Are you seeing any differences between risk-adjusted returns between those two markets?

Bowen Diehl -- Chief Executive Officer

Yes. No. We still — as a macro statement, as I try to put in my prepared remarks, we do think as a macro statement, we see a more attractive risk-adjusted returns in the lower middle market. And that's why we're really — that's our core to our strategy.

Any one quarter that can — we will look at upper middle market deals, and there are upper middle market deals that are attractive. We funded — I guess Trinity 3 technically is an upper middle market deal now because it's so much larger. And then we have one other funding on the upper middle market. So we'll fund upper middle market deals.

You also had a fair amount of appreciation in the upper middle market, too. So that's a factor as well because our metrics are all in fair value. So generally now, our position is still the same. For macro, we like the lower middle market risk adjusted returns better as a general comment, but we certainly are actively looking at upper middle market deals.

Kyle Joseph -- Jefferies -- Analyst

Got it. And then in terms of the portfolio yield, I think the consolidated portfolio yield increased in the quarter. But can you just give us — refresh us on the outlook, given where rates are, floors in your portfolio as well as spreads you're seeing on new investments versus repayments?

Michael Sarner -- Chief Financial Officer

Yes. I would tell you it's going to be stable. I mean, obviously, we're at our floors, and that's not going to change for the next, what, 18 months to two years or longer. There are some step-ups for pricing grids that might be some — you might see it go up 0.1 or down 0.1 based upon company performance that will move those grids.

But other than that, I would expect it's pretty stable where it is.

Bowen Diehl -- Chief Executive Officer

Yes. In most instances, the pre-COVID, post-COVID world, there's definitely competition out in the market. While attachment points are, I would say, generally are a little bit lower than they were pre-COVID, spreads, in most cases, are kind of back to or close to pre-COVID levels?

Kyle Joseph -- Jefferies -- Analyst

Got it. One last one for me. Just in terms of quarter-to-date origination activity, have you seen any sort of disruption given the election? Are people kind of on hold until the election? Or has origination activity remained strong?

Bowen Diehl -- Chief Executive Officer

Yes. I'd say origination activity as remained strong as far as deal looks. We've got a handful of deals that we've lost on pricing, but that's just part of the world we live in. There are definitely some people out there in certain instances for certain companies being pretty aggressive.

And so as far as the election is concerned, I wouldn't — it doesn't feel like people have shut off deals waiting for what happens tomorrow. I mean certain business models might have — or industries might have react differently to a Democratic legislator versus a Republican. But as a general, I wouldn't say that in a lot of instances, we've seen things like halting, pending the election.

Kyle Joseph -- Jefferies -- Analyst

Got it. That's it for me. Thanks very much for your answer my questions and congrats again on a good quarter.

Bowen Diehl -- Chief Executive Officer

Thank you.

Michael Sarner -- Chief Financial Officer

Thanks, Kyle.

Operator

Our next question or comment comes from the line of Bryce Rowe from National Securities. Your line is open.

Bryce Rowe -- National Securities -- Analyst

Thanks. Good morning. Bowen and Michael, just wanted to kind of follow-up on a comment you made a couple of questions ago around using the revolver to continue to redeem the baby bonds, the publicly traded baby bonds that are out there. So curious if you'll continue to redeem those at a measured pace, this $20 million, $25 million measured pace that we saw here this quarter.

And are you giving any thought to possibly extending out the unsecured bucket and doing another, maybe another five-year institutional issuance?

Michael Sarner -- Chief Financial Officer

Sure. Yes. I would tell you that we plan to increase the size of the revolver in the near term and then probably pay off the bonds over the next two to three quarters, and that will have to do with the pace of repayments. It will have to do whether we're able to raise equity or not.

But I would tell you that when we look at it, the shift between 6% bond and the revolver that's 3%, that's an uplift of when it's done. $0.02 per quarter in NII, we think that's pretty powerful. And it's risk-free to the extent we control that pay down. So we will definitely look to do that in the nearer term.

And your other question on the unsecured. I think our strategy over the next few years is going to be to grow this revolver. As I said, we're going to utilize the SBIC. And quite frankly, we're hopeful over the next year to two years as we grow our balance sheet and we get closer to investment grade, we would look to go back to the unsecured bond market and tap that market at the 4% rate or thereabouts.

If there's a need for liquidity during this coming year, 2021, we would hit the baby bond market perhaps. But that's — at this moment, that's not our baseline assumption.

Bryce Rowe -- National Securities -- Analyst

OK. That's fair. And then, Michael, you mentioned the compensation true-up for the bonus accrual. Just curious if you could quantify that for us, so we have a good run rate going forward.

Michael Sarner -- Chief Financial Officer

Sure. Sure. So last quarter, we actually brought down the bonus accrual by $200,000 based on the uncertainty in the market with COVID. So this quarter, we essentially retrenched that $200,000 into the bonus pool to bring it back to full bonus.

And so the run rate you should be looking at is usually about — on the cash compensation line is around $1.8 million. So that's going to be the run rate going forward you should expect in the next few quarters.

Bryce Rowe -- National Securities -- Analyst

OK. And then lastly, another one on the income statement. You all, in the press release, talked about nonrecurring amendment type of fees that you saw in the third quarter. So I was curious if you could quantify that.

And then No. 2, with the visibility you mentioned into prepays in this fourth quarter, do you expect any prepayment fees to come along with that?

Michael Sarner -- Chief Financial Officer

Yes. So total fees for the quarter, I would probably break it down like this. So we generally have recurring fees or admin and agent fees on our debt of about $250,000 a quarter. So that's every quarter.

We typically have between $200,000 and $300,000 in reoccurring with a portfolio of 50 companies we tend to have fees. So with this quarter, we had probably about $400,000-ish of onetime fees that are above our normal expectation or run rate. And then in terms of this quarter, repayments, right now, I think of the one to three prepayments, one of them does not have a — that may call and I think that there's maybe one small one between the other two. So I would tell you, it's like $50,000-ish.

But having said that, there's always something that comes up. So that number could be elevated by the end of the quarter.

Bryce Rowe -- National Securities -- Analyst

Yeah. OK. I think that's all I had. Thanks.

Operator

Our next question or comment comes from the line of Robert Dodd from Raymond James. Your line is open.

Robert Dodd -- Raymond James -- Analyst

Hi, guys. First, housekeeping one to kind of follow-on to both. Was there anything in terms of — anything material in terms of accelerated amortization in the interest income line rather than the fee income line? I mean it seems to me that roughly like $250,000, something like that from the two, from Trinity and Danforth?

Michael Sarner -- Chief Financial Officer

No. All of that was showed up in the fee line. There was no — all the interest income had to do with the $66 million of originations this quarter with a lot of them were early on in the quarter as well as some of the pickup in income from originations that were late stage in the previous quarter.

Robert Dodd -- Raymond James -- Analyst

Got it. Got it. Then just on the kind of the pipeline. You describe it as an average.

I mean how much — I mean this quarter, a number of add-on acquisitions, obviously, in the existing portfolio, I think four there. Trinity was effectively from how you described it [Inaudible] out because of a major add on acquisition. Can you give us any color on how much? What's the length of a cycle, close cycle for an add-on acquisition versus a normal kind of new portfolio company, i.e., can add-on acquisitions happen at a much faster pace? And of those — the appetite in the market out there right now, I mean, is there more of that given there are troubled companies that might be available to buyout that weren't before. So can you give us any color there on the outlook for more add-ons? And how quick that can happen?

Bowen Diehl -- Chief Executive Officer

Yes. So I mean generally speaking, as you can imagine, if we're — well, there's two ways to look at that. The portfolio company, financial sponsor, pace and then our pace. I mean, clearly, it can all — for an add-on acquisition, it's in the same space, same industry, more times than not the management team knows the other management team.

And there's just numbers of reasons why they tend to come together faster, to your point, I think you're — behind your question. And clearly, we have to do less figuring out the industry and the business model, right? It's more focused on what are these companies going to do together, synergies, integration risk, those types of things, which, generally speaking, don't take you as much time to generate the work and do the work to figure those things out. And so general statement, add-on acquisitions are, in some sense, easier to get done and happen faster than a new platform where both the financial sponsor and/or us are trying to figure out and verify the core business model as opposed to some of the other things. And so they do generally happen faster.

I would say that, that's one of the great things about our portfolio and other BDC portfolios, too, which is we do back companies, and we provide a capital source to help them make acquisitions. And so not every company in our portfolio or every company out there have acquisitions as our strategy. But many of them do. And so that's the nature of a portfolio like ours or other BDCs as well, that you have this kind of natural hum in the background of potential add-ons.

And so in the current environment, yes, I mean, I think there are companies that are maybe underperforming, but I think it's more often the case where it's like, OK, operating efficiencies are really important in our industry, said portfolio companies industry. And we're seeing the value of that managing things like COVID and that kind of thing. And so all else equal, two businesses appreciate maybe more the efficiency of combining after an event like we've seen maybe than they did a year ago at the margin. So does that mean deal flow tripled as a result? Probably not.

But it's definitely a positive tailwind to deal activity on the add-on front.

Robert Dodd -- Raymond James -- Analyst

Got it. Got it. Appreciate that and congrats on the quarter, guys. Thanks.

Bowen Diehl -- Chief Executive Officer

Thank you.

Operator

Our next question or comment comes from the line of Chris McCampbell from Hilltop Securities. Your line is open.

Chris McCampbell -- Hilltop Securities -- Analyst

Just quickly, do you all think we're getting to a place where factors that drove net asset value growth a part of the trend? And do you have visibility into beginning to grow the dividend again?

Bowen Diehl -- Chief Executive Officer

Yes. So as far as NAV, I think a big uplift in NAV for many BDCs, including us, will be just reappreciation of the noise that's been created by the current market environment. And so I think we certainly expect to see that. And we have a nice equity portfolio with some companies that are growing.

A couple of companies that we've had to decrease the appreciation, so write it down based on COVID, which we certainly expect that to reappreciate. So I think that clearly, from where we sit today, there are definitely tailwinds that should support NAV growth going forward. And with respect to, I don't know, Mike, if you want to talk about the NII effect of the SBIC and some other things we've talked about.

Michael Sarner -- Chief Financial Officer

Yes. I think that — I mean to your direct question, I think we do have an eye on growing the dividend, the regular dividend over time. Based upon our originations to date and sort of this transition to the 5-point — getting away from those unsecured bonds, we think our run rate in the next quarter or two is going to be in the $0.42 to $0.43 in terms of NII. And when we feel comfortable there, we'll probably inch up the dividend in turn.

When we make the full transition out of those notes and we start drawing on the revolver next year, we see quite a bit of increase in NII. I mean to quantify it long term, I think I said this on the last call, once we are fully immersed in the SBIC, fully deployed, we see that's a 20% to 25% increase relative to using bonds in the next two to three years. So we're definitely looking ahead toward increasing that dividend slowly and steadily.

Chris McCampbell -- Hilltop Securities -- Analyst

Fantastic. Great job, guys. Thank you.

Operator

Our next question or comment comes from the line of David Miyazaki from Confluence Investment. Your line is open.

David Miyazaki -- Confluence Investment -- Analyst

Good morning, guys. Just a couple of observations and questions. It seems like where the outsized returns get made tend to be where people won't go or they can't go. And I think you guys have done a really good job of being fully engaged in underwriting and managing your portfolio through the COVID crisis thus far, which is kind of how you've been able to grow the portfolio so nicely.

But I'm wondering, along those lines, when you talk about Danforth getting refinanced by the banks, obviously, there's a point in time when they were not willing to make that loan, and then something happened where they were interested in taking you guys out. So can you guys talk about, if not specifically to Danforth, but just generally, what happens with the banks that makes them change their mind that they would come into your companies and refinance them?

Bowen Diehl -- Chief Executive Officer

Yes, David. Sounds good question. I would say two things. One is just the bank's appetite for risk, and I'm not really here necessarily to quantify that.

But with respect to a certain bank and a certain company and its performance one of the things the banks will look at is the performance of the company, obviously. So these companies, part of its size, the company as it grows, gets to an EBITDA level that the banks would consider it, others are just the bank in a particular — it's not a macro market comment, but with a particular company in a particular industry with that particular financial sponsor who clearly would rather in time bring banks in because it's cheaper capital. It's just the whole story evolves. And so again, it's some market appetite, bank appetite for that particular company in that particular industry, part of it's the financial sponsors that are courting those relationships and ultimately wanting to get to a point where they can graduate from a nonbank lender to a bank lender.

So it's part of the natural dynamic within the lower middle market, is that evolution of nonbank to bank financing.

David Miyazaki -- Confluence Investment -- Analyst

And is that part of your strategic positioning? Is that your exit strategy would be to have the company grow to a point where it can be taken out by banks?

Bowen Diehl -- Chief Executive Officer

So definitely in certain situations, but it's not a macro strategy necessarily. It is a dynamic, as I described, that does exist. Some companies as we're underwriting, that might be more of a discussion than other companies. But there's other things that banks need like amortization, scheduled amortization, the things like that, that we don't necessarily need on every business that also goes into — our capital is more expensive than a bank, but it can be more flexible and especially sponsors are trying to drive growth of these companies, the next 50, 100 basis points of leverage financing, is not what moves their IRR needle.

What moves their IRR needle is the operating changes and acquisitions and various things, and they need a capital provider that is really diving into the enterprise value of the business and the cash flows of the business, which generally speaking, is not what banks necessarily are looking at as much as nonbank lenders, if that makes sense. So every deal in the industry is different. So it's hard to say macro or sitting around and saying, OK, corporate strategy is we want to do deals that we think within a couple of years are going to be taken out by banks. It's not quite that definitive, but it can be part of the conversation in certain situations.

David Miyazaki -- Confluence Investment -- Analyst

OK. Great. Thanks. If I could just shift gears and ask, there's been a lot of great discussion about the SBIC.

And I don't want to count chickens before they hatch. But congratulations on the progress thus far. I'm not sure if you talked about your targeted leverage on an economic basis versus a statutory leverage basis. And should you get the ability to participate in SBA debentures.

Can you talk a little bit about the ranges that you might work within post that SBIC?

Michael Sarner -- Chief Financial Officer

Yes. I think, overall, I would tell you, in this environment where we're may or may not be able to raise equity in the short term, we would still point you to the 1.5 times board mandated leverage. That would be — I would say that would be probably the max leverage that we feel comfortable with.

David Miyazaki -- Confluence Investment -- Analyst

Is that economic or statutory?

Michael Sarner -- Chief Financial Officer

That will be economic. Exactly. But in time, when we — actually, we look at what we'll look like, I tell you that we probably would be more focused somewhere in the 1.3 to 1.4 maybe economic with a regulatory leverage in the one to 1.1 would be where we'd be living as a target going forward.

David Miyazaki -- Confluence Investment -- Analyst

OK. OK. Great. That's very helpful.

And well, I appreciate your comments and congratulations. And I will step out of the queue. Thank you.

Operator

Our next question or comment comes from the line of Devin Ryan from JMP Securities. Your line is open.

Kevin Fultz -- JMP Securities -- Analyst

Hi. This is Kevin Fultz on for Devin. And I just have one more outstanding question, most of mine have been answered already. What is the weighted average LIBOR floor for the debt portfolio? And what percent of floating rate investments have LIBOR floors?

Michael Sarner -- Chief Financial Officer

So the weighted average LIBOR on the asset portfolio is 1.4%.

Bowen Diehl -- Chief Executive Officer

Maybe a little bit lower than that because of the new originations have lower floor...

Michael Sarner -- Chief Financial Officer

Yes, maybe 1.35%. Yes. And what was the other question? Sorry, Devin.

Kevin Fultz -- JMP Securities -- Analyst

What percent of floating rate investments have LIBOR floors?

Bowen Diehl -- Chief Executive Officer

Yes. Pretty much all of them.

Kevin Fultz -- JMP Securities -- Analyst

OK. Great. And that's my only question. Congrats on a strong quarter.

Thank you.

Michael Sarner -- Chief Financial Officer

Thank you.

Bowen Diehl -- Chief Executive Officer

Thanks, Devin.

Operator

Thank you. I'm showing no additional questions in the queue at this time. I would like to turn the conference back over to Mr. Bowen Diehl for any closing remarks.

Bowen Diehl -- Chief Executive Officer

Great. Thanks, operator. And again, thanks, everybody, for the call. Thanks for all the robust questions.

We appreciate it, and we look forward to keeping you guys posted on our progress, and if not before, we'll be talking next quarter.

Operator

[Operator signoff]

Duration: 62 minutes

Call participants:

Chris Rehberger -- Vice President, Finance

Bowen Diehl -- Chief Executive Officer

Michael Sarner -- Chief Financial Officer

Mike Smyth -- B. Riley FBR, Inc. -- Analyst

Mickey Schleien -- Ladenburg Thalmann -- Analyst

Kyle Joseph -- Jefferies -- Analyst

Bryce Rowe -- National Securities -- Analyst

Robert Dodd -- Raymond James -- Analyst

Chris McCampbell -- Hilltop Securities -- Analyst

David Miyazaki -- Confluence Investment -- Analyst

Kevin Fultz -- JMP Securities -- Analyst

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