Fidus Investment Corporation (FDUS) Q3 2021 Earnings Call Transcript

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Fidus Investment Corporation (FDUS 1.04%)
Q3 2021 Earnings Call
Nov 5, 2021, 9:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Welcome to the Fidus Third Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session [Operator Instructions] Please be advised that today's conference is being recorded.

I would now like to hand the conference over to one of your speaker today, Ms. Jody Burfening. Please go ahead.

Jody Burfening -- Investor Relations

Thank you, Vic, and good morning, everyone. And thank you for joining us for Fidus Investment Corporation's third quarter 2021 earnings conference call. With me this morning are Ed Ross, Fidus Investment Corporation's Chairman and Chief Executive Officer; and Shelby Sherard, Chief Financial Officer. Fidus Investment Corporation issued a press release yesterday afternoon with the details of the company's quarterly financial results. A copy of the press release is available on the Investor Relations page of the company's website at fdus.com.

I'd also like to call your attention to the customary Safe Harbor disclosure regarding forward-looking information included on today's call. Conference call today will contain forward-looking statements, including statements regarding the goals, strategies, beliefs, future potential, operating results and cash flows of Fidus Investment Corporation. Although management believes these statements are reasonable based on estimates, assumptions and projections as of today, November 05, 2021, these statements are not guarantees of future performance. Time sensitive information may no longer be accurate at the time of any telephonic or webcast replay. Actual results may differ materially as a result of risks, uncertainties and other factors including, but not limited to, the factors set forth in the company's filings with the Securities and Exchange Commission. Fidus undertakes no obligation to update or revise any of these forward-looking statements.

With that, I would now like to turn the call over to Ed. Good morning, Ed.

Ed Ross -- Chairman & Chief Executive Officer

Good morning, Jody, and good morning everyone. Welcome to our third quarter 2021 earnings conference call. I hope all of you, your families, friends and coworkers, are staying healthy and well. I am going to open today's call with a review of our third quarter performance and our portfolio at quarter end and then offer you an update of our views on deal activity in the lower middle markets. Shelby will cover the third quarter financial results and our liquidity position. Once we have completed our prepared remarks, we'll be happy to take your questions.

As expected, activity levels in the lower middle market from both an M&A activity and refinancings perspective were healthy and robust during the third quarter, continuing a period of heightened activity that began nearly a year ago. Against this backdrop, our portfolio performed well and we continue to see a strong flow of opportunities for investments in high quality businesses that possess resilient business models that generate strong levels of cash flow to service debt and that have positive long term outlooks. Repayments remained at high levels and outpaced originations due in part to the timing of deal closings.

Adjusted net investment income, which we defined as net investment income, excluding any capital gain incentive fee attributable to realized and unrealized gains and losses, was $9.8 million or $0.40 per share compared to $9.7 million or $0.40 per share last year. NAV grew to $447.5 million or $18.31 per share, reflecting both a solid operating performance and underlying portfolio value appreciation. In addition, we reported net realized gains of $8.4 million or $0.35 per share as we harvested several mature equity investments in conjunction with sale in excess of portfolio companies. Fidus had a base quarterly dividend of $0.32 per share, a supplemental cash dividend of $0.06 per share and a special dividend of $0.04 per share for the third quarter.

As a reminder, the board has devised a formula to calculate the supplemental dividend each quarter under which 50% of the surplus in adjusted NII over the base dividend from the prior quarter is distributed to shareholders. On November 1, 2021, Board of Directors declared a base quarterly dividend of $0.32 per share, a supplemental quarterly cash dividend of $0.04 per share and a special dividend of $0.05 per share for a total dividend of $0.41 per share for the fourth quarter. The dividends will be payable on December 17, 2021 to stockholders of record as of December 3, 2021.

In terms of originations, we invested $78.2 million in debt and equity securities, of which $39.6 million or roughly half of the total was invested in first lien debt and roughly 40% [Phonetic] was invested in second lien debt. Investments a new portfolio of companies consisted of $14.3 million in first lien debt and common and preferred equity in Cardback Intermediate, LLC, a leading provider of chargeback prevention and recovery services for e-commerce in Card Not Present businesses. $10.5 million [Phonetic] in second lien debt and common equity in PowerGrid Services Acquisition, LLC, a leading utility services business, providing repair and maintenance services for distribution, transmission and substation infrastructure.

As you can see, we continue to focus on companies with stable and diversified demand characteristics, relative insulation from the supply chain constraints and inflationary pressures currently weighing on many companies, and strong positive long-term outlooks. The remaining $53.4 million is a new $20 million second lien loan commitment in Worldwide Express and a number of follow on investments in support of M&A transactions on the part of some of our portfolio companies.

Shortly after the end of the quarter, we invested a total of $27 million in two new portfolio companies. These were $8.5 million in first lien subordinated debt and common equity of Auto CRM LLC, doing business as Dealer Holdings, a leading SaaS based provider of customer communication software to the auto repair market. $18.5 million in first lien debt, common equity and warrants of Acendre Midco, Inc., a leading provider of cloud based talent management software solutions. In addition, we committed $16 million in second lien debt to a leading technology platform for digital customer acquisition across all consumer vehicles, including financial services, home services and insurance, which we expect to fully fund in Q4.

In terms of repayments and realizations in the third quarter, we received proceeds totaling $127.5 million with the majority from second lien and subordinated debt investments and $23.4 million in proceeds from monetizing equity investments. In terms of exits, we received payment in full of $21 million on our first lien debt and converted debt to equity in Hilco Technologies and realized a net loss of approximately $1 million on our original equity investments in the company. We received payment in full of $11.4 million on our second lien debt in CRS Solutions Holdings, LLC, received payment in full of $20 million on our second lien debt in Worldwide Express LLC, and realized a gain of $3 million on our equity investment.

In conjunction with the sale of Worldwide Express, we invested $1.5 million in common equity, of which $0.8 million was rolled over from the original common equity investment and funded a $20 million second lien loan commitment. We received payment in full of $11 million on our subordinated debt investment in LNG Indy, LLC and realized a gain of $4.5 million on our equity investment. We received payment in full of $21.5 million on our subordinated debt in Allied 100 and realized a gain of $1.8 million on our equity investments. We received payment in full of $11.6 million, including a prepayment penalty on our subordinated debt in ECM industries, LLC.

In addition, we received a cash distribution of $0.8 million on our equity investment. We received payment in full of $17.3 million, including a prepayment penalty on our debt investment in Routeware, Inc. Subsequent quarter in we received payment in full of $7.1 million including a prepayment penalty on our subordinated debt in Tranzonic Companies. The fair value of the portfolio at quarter end was $719.1 million, equal to 113.9% of cost and reflecting net repayments for the quarter, partially offset by appreciation in the fair value of the portfolio. We ended the third quarter with 70 active portfolio companies and six companies that have sold their underlying operations.

Our portfolio remains well-structured, positioned to produce both high levels of recurring income and to provide us with a reasonable margin of safety, along with the opportunity to enhance returns. Given current market conditions, we remain focused on rotating mature equity investments into income producing assets. With first lien debt investments exceeding repayments and second lien and subordinated debt repayments exceeding originations, during the third quarter, the mix continued to shift in favor of first lien debt on both an absolute basis and as a percent of the total portfolio.

At quarter end, first lien debt accounted for 41.2% of the total portfolio on a fair value basis compared to 25.2% as of December 31, 2020, while second lien debt decreased to 28% of the portfolio on a fair value basis from 44.7% as of December 31st. Subordinated debt accounted for 9.7% and equity investments grew to 21.1% of the portfolio on a fair value basis.

Moving to portfolio performance. Overall, our portfolio continues to perform well and risk remains at comfortable levels. As of September 30th, we did not have any companies on non-accrual. Some of our portfolio companies continue to work their playbooks in terms of pricing and productivity measures in response to supply chain challenges created by the pandemic, including component shortages, material and freight costs inflation and labor availability. In light of these unprecedented business conditions having a well -diversified portfolio continues to serve us well.

To help us assess the overall health, stability and performance of our investment portfolio, we track several quality measures on a quarterly basis. First, we track the portfolio's weighted average investment rating based on our internal system. Under our methodology, a rating of 1 is outperform and a rating of 5 is an expected loss. At September 30th, the weighted average investment ratio for the portfolio was 2 on a fair value basis.

Another metric we track is the credit performance of our portfolio, which is measured by our portfolio company's combined ratio of total net debt to Fidus' debt investments to total EBITDA. For the third quarter, this ratio is 5x excluding equity only and ARR deals. The third measure we track is the combined ratio of our portfolio company's total EBITDA to total cash interest expense, which is indicative of the cushion our portfolio companies have in aggregate to meet their debt service obligations to us. For the third quarter, this metric was 3.1x, excluding equity only and ARR deals.

As a result of the elevated velocity of M&A activity that began in the fourth quarter last year, we have seen high levels of originations and repayments in each of the past four quarters. Because repayments outpace originations for the third quarter, we were underinvested as we started the fourth quarter. Nevertheless, we currently expect to grow the portfolio in the fourth quarter.

I mentioned earlier that we closed three deals in early October for a total of $43 million in originations, including the $16 million commitment. And strong deal flow offers us opportunity to add further to originations before the end of the year. While we are encouraged by these near term opportunities, we will continue to manage the business for the long term and not rush to grow the portfolio in a way that would have us forfeit our underwriting standards. As always, our proven underwriting discipline places greater value on quality than on quantity.

In summary, I remain confident that our relationships with deal sponsors, our experience and our strategy of selectively investing in high quality companies with defensive characteristics and positive long term outlooks positions us well for the growth over time with a long term goal of generating attractive risk adjusted returns from our debt and equity investments and on preserving capital.

Now, I'll turn the call over to Shelby to provide some details on our financials and operating results. Shelby?

Shelby Sherard -- Chief Financial Officer

Thank you, Ed and good morning, everyone. Our view our third quarter results in more detail in close with comments on our liquidity position. Please note our view of providing comparative commentary versus the prior quarter Q2 2021.

Total investment income was $21.2 million for the three months ended September 30th, a $0.6 million decrease from Q2 primarily due to $0.5 million decrease in fees and $0.4 million decrease in fee income offset by $0.3 million decrease in interest income. Total expenses, including investment tax provision, were $16.1 million for the third quarter, approximately $0.8 million higher than the prior quarter, primarily due to $0.8 million increase in the capital gains incentive fee accrual. In Q3, we accrued $4.7 million of capital gains incentive fees given meaningful appreciation in the fair value of the portfolio. Note the capital gains incentive fee is accrued for GAAP purposes but not currently payable. Excluding the accrued capital gains and incentive fees, total expenses in Q3 were $11.4 million in line with Q2.

As reminder, expenses will be higher in the fourth quarter as we will incur an annual excise tax expense, which I would estimate to be approximately $0.02 to $0.03 per share similar to prior years. As of September 30th, the weighted average interest rate on our outstanding debt was 4.2% excluding secured borrowings. In Q3, we prepaid $44.3 million of SBA debentures. We ended the quarter with $360 million of debt outstanding, comprised of $95 million of SBA debentures, $207.3 million of unsecured notes, $40 million outstanding on our line of credit and $17.7 million of secured borrowings. Our debt to equity ratio as of September 30th was 0.8x or 0.6x statutory leverage, which excludes SBA debentures.

Net investment income or NII for the three months ended September 30th was $0.21 per share versus $0.26 per share in Q2. Adjusted NII, which excludes any capital gains incentive fee accruals or reversals attributable to realized and unrealized gains and losses on investments was $0.40 per share in Q3 versus $0.42 per share in Q2. For the three months ended September 30th, we recognized approximately $8.4 million of net realized gains, primarily from the sale of our equity investments in Kinetrex Energy, Worldwide Express and Allied 100.

Turning now to portfolio statistics. As of September 30th, our total investment portfolio had $119.1 million [Phonetic]. Our average portfolio investment on a cost basis was $9 million at the end of the third quarter, which excludes investments in six portfolio companies that sold their operations and are in the process of winding down. We have equity investments in approximately 88.2% of our portfolio companies with an average fully diluted equity ownership of 5.6%. Weighted average effective yield on debt investments was 12.3% as of September 30th.

The weighted average yield is computed using the effective interest rates for debt investments at costs, including the accretion of original issue discount and loan origination fees but excluding investments on nonaccrual, if any.

Now, I'd like to briefly discuss our available liquidity. As of September 30th, our liquidity and capital resources included cash of $98.8 million, $13.5 million of available SBA debentures and $60 million of availability on our line of credit, resulting in total liquidity of approximately $172.3 million. In October, we successfully issued $125 million of unsecured notes at 3.5% interest rates. The net proceeds and available cash were used to pay down the outstanding balance on the line of credit of $40 million at closing, and to fully redeem $82.3 million of public notes due in 2024 with interest rates ranging from 5.375% to 6%. Given the notice requirements, the bond redemptions occurred on November 2nd, so we will have one month of incremental interest expense on the public notes in Q4 of approximately $0.4 million.

In conjunction with the bond redemptions, in Q4, we realized a onetime loss on extinguishment of debt of approximately $1.6 million relating to the unamortized deferred financing costs on the bonds. Taking into account subsequent events, including the debt refinancing, we currently have approximately $185.2 million of liquidity.

Now, I will turn the call back to Ed for concluding comments. Ed?

Ed Ross -- Chairman & Chief Executive Officer

Thanks, Shelby. As always, I'd like to thank our team and the Board of Directors at Fidus for their dedication and hard work and our shareholders for their continued support. I will now turn the call over to Vic for Q&A. Vic? Hello? Shelby, are you there?

Shelby Sherard -- Chief Financial Officer

I am. I'm not hearing anything on my line either. I'm not sure if we lost.

Ed Ross -- Chairman & Chief Executive Officer

Any recommendation?

Shelby Sherard -- Chief Financial Officer

It appears that the operator is having technical difficulties. So I mean, we can certainly hang on the call for a couple more minutes. But otherwise, I would suggest, unfortunately, we might need to -- well, I think they're trying to work on it. So hopefully, we'll figure it out. But Ed, we might have to adjourn the call. But we did get a message that folks are trying to work on getting the operator back to allow for Q&A.

Ed Ross -- Chairman & Chief Executive Officer

Thanks for your patience, everyone. Sorry about this.

Questions and Answers:

Operator

[Operator Instructions] First question comes from Mickey Schleien from Ladenburg.

Mickey Schleien -- Ladenburg -- Analyst

I guess patience is a virtue. Ed, there is obviously intense competition higher up in the middle market with so much private debt and equity capital available. How would you describe the effects of that competition, if any, on the lower middle market where you operate?

Ed Ross -- Chairman & Chief Executive Officer

From my perspective, competition is -- over the last 12 months, it's similar. It's not like there's a huge influx of capital but there obviously is a fair bit of capital out there. It's the same players so it's not a bunch of new entrants. And in some cases, we're seeing lenders accepting lower yields. And we've definitely seen some unnatural acts just to win business. What we're doing is focusing on the nuts and bolts of our business and sticking to what we know, again, focusing on the long term the industries we know well and situations we like. And so when I look at it from a pricing perspective, I'd say, market pricing is in line generally with where it was pre-COVID levels at times a little lower. But I think leverage is very similar to pre-COVID levels as well. So when I think about risk adjusted returns, I think about equity capitalization, which is typically much higher in this high valuation environment. I think the risk adjusted returns are quite good. And more importantly, in the lower middle market, the terms haven't changed. So terms, when I think about security, when I think about covenants, real covenants, real maintenance covenants, all those things, I think, are still in place, haven't changed and I think a real positive from our perspective regarding the market that we're playing primarily in.

Mickey Schleien -- Ladenburg -- Analyst

That's good news given that there's always a chance that those folks will start to look at the lower middle market down the road. Just one follow-up question. You had another strong quarter of unrealized appreciation. And if I'm not mistaken, the portfolio's valuation is now at a record level in terms of cost over -- fair value over costs. What are the main drivers of those valuation gains? And do you see more upside when you look at your portfolio of company's performance and market trends?

Ed Ross -- Chairman & Chief Executive Officer

I think, when I look at the drivers, so we had $23 million of appreciation this quarter in the portfolio, most of that being, large majority of it, obviously, being equity. It's driven by three things, underlying company performance that was the biggest driver by a long shot but obviously, also, we got some visibility into certain M&A processes. And so that impacted things, people are -- for great franchises, people are paying up right now and I know that you've heard talked about quite a bit. And lastly, market calibration, but that -- obviously, that's something that we take into account every quarter but it's to a very small degree, the rationale for the appreciation this quarter.

Operator

And our next question comes from Robert Dodd from Raymond James.

Robert Dodd -- Raymond James -- Analyst

On the repayment levels in the quarter. Now, I think, year-to-date your repayments have now exceeded the combined number in 2019 and 2020. I mean, when does the pace slow down? Frankly, I mean, just activity level on that side seems to be really, really high. I mean, your originations this quarter were below by historic standards, but they just obviously got swamped by new payments.

Ed Ross -- Chairman & Chief Executive Officer

I think from our perspective, and I'm hesitant to say this, because last quarter, there were some surprises, literally a couple surprise, repayments in September, we heard about in September and they happened in September. So it's hard to predict as we talked about in the past. What I would tell you is Q4 is, we at least today, feel like is going to be a limited quarter from a repayment perspective relative to last quarter. And so I don't think we'll get anywhere near last quarter. And I think what I would say is the velocity and the overall market activity has been extremely high for four quarters in a row. And obviously, we've had a fair number of M&A transactions where we've also realized equity investments but also just debt refinancings or recapitalizations where we were taken out, which tells you we had a pretty strong portfolio. So our approach has always been and we want to invest in high quality businesses that can weather the various storms that we anticipate or don't anticipate, but can weather the storms. And so we feel good about getting repaid. Obviously, it creates a challenge for us in terms of reinvesting and from that perspective, we're going to stick to our discipline. We are sticking to how we are going about our business and self-originating large-large majority of the investments we're making and sticking to the industries that we know well. So I do think this quarter it'll slow down and I do think originations will outpace repayments this quarter and the question is to what degree. And we'll be able to tell you that in February. So that's what I'm seeing, and I am seeing a slowdown in terms of --

Robert Dodd -- Raymond James -- Analyst

I appreciate that. With so many the payments, so much recycling, about roughly speaking, I think half of the capital you have at the portfolio and it's been originated, it might not be new businesses, there's follow-ons, etcetera, has been originated since COVID and to Mickey's question, that portfolio turnover doesn't seem to have impacted your portfolio yield significantly. The only thing I can think of this really changed over that period is maybe leverage has gone up a little bit. Is that indicative more of the type of businesses? I mean, obviously, you're going in firstly now with more so than second? Is it more -- would you say your loan to values or other characteristics have kind of stayed the same or even improved as that portfolio was kind of renewed? And then the other to that is with such -- what seems like a relatively new portfolio, should we expect prepayment fees and things like that to be lower, say next year or over the next 18 months with so much of that capital being newly out there?

Ed Ross -- Chairman & Chief Executive Officer

A lot of questions in there, Robert. So let me hit leverage first, and it's a little bit of an anomaly to be honest. So when I cited in our prepared remarks was a 5x net leverage, excluding ARR loans on our balance sheet, and that's an average number. And to be candid, it's distorted by several but really one in particular much larger deal that we've had in our portfolio for a very long time. It's now a very large company. And so if you excluded this name, the average leverage would be more like 4.4x, which is more indicative of the whole portfolio. And so what I would say with regard to things like leverage, I don't think that has changed materially. Loan to values only improved in this environment, quite frankly, from our perspective. And I think you touched on prepayments. Prepayments are a piece of the puzzle, I think, that will always be there. Could they go down a little bit next year? The answer to that is yes. But I don't think it's material, to be honest. I think a lot of the repayments we have were on pretty mature debt investments and many of those prepayment fees were not that sizable. But I think prepayments is part of the business and will remain part of the business, maybe it will be a little bit lower but I can't tell you it's going to be a lot lower. So fees, obviously, is an originator, first lien. We do, obviously, have a healthy fee income and that depends somewhat on activity levels, as you know. But we would expect you know -- so fees will move with activity levels. But as I look forward to next year, I expect it to be an active year. I don't know if it'll be as active as this year. I doubt it but I still think it'll be an active year. There is still a fair number of companies I know in our portfolio that we expect to be sold, and that's a good thing from our perspective.

Operator

Thank you. Our next question comes from Ryan Lynch from KBW.

Ryan Lynch -- KBW -- Analyst

Thanks for taking my questions, and really nice next quarter. And my first question has to do with, as far as your equity portfolio goes. You guys have a nice exit of $23 million of equity investments this quarter. But given the strength in that portfolio, it actually grew inside despite those exits. And my question was, I would presume that given how active the market is today that you would expect equity investments or equity monetizations to continue at a fairly consistent basis, maybe not as high as you saw in the third quarter. But I was assuming you would consider those bit to continue to happen, but please let me know if that's not the case. And so my question would be, is the thought process you just continue to monetize equity investments in the normal course like we saw in the third quarter, which again, because of the other strength in your equity portfolios, didn't actually reduced that, which is a good problem to have? Or is there any consideration being given to selling off kind of a basket or portfolio of these minority equity positions similar to what you guys had done in early 2020?

Ed Ross -- Chairman & Chief Executive Officer

I think, from a -- I mean try to hit the beginning of your comments, which is, do we expect further realizations in the equity portfolio. And what I would tell you is online to little bit of what I just finished with Robert is we do have portfolio companies that are evaluating strategic alternatives now and that meaning here in the Q4. And we also have others that have spoken specifically about first half of next year planning to also evaluate strategic alternatives. So we continue to believe that the M&A market is going to be active. And we think our equity portfolio will participate, to some degree, hopefully, a very healthy degree, but to some degree, in that activity -- in those activity levels. So I think that's a positive and I think that's your assumption is correct. With regard to selling a part of the portfolio, if you will, like we did previously. I think that idea is definitely on the table, it's been on the table. I will also tell you, it's not something that we are working actively on right now. But it is something that we do talk about and we'll consider at the appropriate time. But at the moment, it's not -- and we're not actively doing that. We like the idea that we have that as an option. But it's, again, we -- I think we feel good about the quality of our equity portfolio and we also don't want to rush things. So there's a balance, as you well know, with regard to monetizing equity investments and we're trying to strike that, but you never going to hit it perfectly. But we would -- we're trying to strike the right balance right now.

Ryan Lynch -- KBW -- Analyst

The other question I had was you discussed kind of the elevated level of prepayments with Robert, hopefully, those start to moderate a little bit. But while we're in this process of increasing activity, have you all considered or maybe you guys have actually done this, sort of trying to widen the investment funnel by moving to maybe slightly different areas, for instance, like maybe moving up to slightly larger companies, not necessarily loosening the underwriting procedures, or we've been in kind of the underwriting metrics that you guys use, but maybe just moving to like larger companies that then maybe have a little bit of a lower yield but will allow you to put capital to work a little bit quicker to kind of offset some of these repayment. Have you guys done any of that, have you guys considered any of that, why or why not?

Ed Ross -- Chairman & Chief Executive Officer

So what I would tell you is we do play in the larger lower middle market space and we have a couple of companies that I would argue are more just middle market or definitely several companies that are just more middle market investments. So we do that on an opportunistic basis, typically, where we've got good relationships and we've got, again, industry knowledge in a view that is differentiated. So we do participate there. I would also say, one of the things we've done is to widen the funnel for instances, over the last three, four years, is focused on more the software and tech enabled space and developed the real expertise there from an industry perspective and a financing perspective. And so we are doing those things. I would tell you our deal flow is extremely strong. So we feel good about the opportunity set. We feel very good about the opportunity set here in Q4 as I discussed in our prepared remarks. But at the same time, we're sticking to our knitting. We're sticking to the business that we have executed well over time. And we do see, again, growth here in the fourth quarter. Question is by how much and that's going to be dependent on both deal closings, as well as what level of repayments. But we do see that the trend of repayment slowing, and to be honest, expect that to slow as we move forward from here. So we are doing a lot of the things you just talked about but I would say in, obviously, a very disciplined and gradual manner as opposed to just switching gears, if you will.

Operator

[Operator Instructions] Our next question comes from a Sarkis Sherbetchyan from B. Riley.

Sarkis Sherbetchyan -- B. Riley -- Analyst

You guys have plenty of availability to deploy into earning assets. And in light of your comments just now that you've said that you expect the trend of repayments to slow down moving forward. I guess, as we step back, how long do you think it'll take to kind of get back to some target leverage levels? And then if you can remind us how you're thinking about target leverage in the current environments?

Ed Ross -- Chairman & Chief Executive Officer

What I would say is, over the next, I'd say, three to nine months, is where we start getting closer to more of a 1:1 leverage. And I don't think it'll happen this quarter, we won't get there this quarter but I think we'll make some progress. And so that's something we are positive about and excited about, quite frankly. With regard to, we've always talked about target leverages kind of 1:1, where obviously, and especially as our portfolio continues to migrate toward more of a first lien portfolio and we expect that trend to continue, it's cosmetically more comfortable to operate at a little more leverage than 1:1, but that's not the goal. We're comfortable doing it. And quite frankly, we're comfortable today doing it. As you know, some of our SBIC funds are levered two to one, and we went through the great recession at a 2:1 leverage point with the SBIC funds. And so leverage is not something we're concerned about but I think there's a balance as much including on a cosmetic basis. And there's we don't -- to generate good returns, we don't need to be over levered or push leverage. And so, a good number for us is 1:1 and that's how we talked about it for quite a while, and I don't think that's changed. Hopefully, that's helpful. But we do see making progress toward that number here over the next three to nine months.

Sarkis Sherbetchyan -- B. Riley -- Analyst

And just to be clear, that's 1:1 on a statutory basis, correct?

Ed Ross -- Chairman & Chief Executive Officer

More GAAP basis actually.

Sarkis Sherbetchyan -- B. Riley -- Analyst

And as we think about kind of the cadence into the next year. Clearly, closing out the year strong, but as we look at the cadence of activity expected next year. Do you think it's going to be a little bit more elevated than historic norms, just kind of given the availability of liquidity and just kind of a generally robust environment in the space you play in?

Ed Ross -- Chairman & Chief Executive Officer

Just to make sure, you're talking about here in Q4?

Sarkis Sherbetchyan -- B. Riley -- Analyst

No, moving beyond Q4, just kind of looking into 2022. It just still seems like there is a lot of liquidity out there and the pace of deals and the velocity of deals are probably going to continue. So just want to get your sense for, do you think things return to kind of a historical cadence or it will be somewhat elevated?

Ed Ross -- Chairman & Chief Executive Officer

It's a great question and a tough one to answer. But if I were to answer that question, I'm going to -- what I would say is, I think it'll be probably elevated relative to historical levels, but not what we've seen over the last four quarters. But we do just -- what we're seeing is a lot of companies performing very well today. The economy, despite all the issues we discussed, is growing nicely and it is growing slower today, and projections have come down here recently as we all know. But it is growing nicely. And there is a ton of companies out there that are performing quite well and have outlooks to continue to perform quite well. And so that sets up for a fair bit of deal activity. And so that's where I would fall out is it'll be above historical norms, but I don't think it will be where we've been in the last four quarters or so.

Operator

Thank you. And I am showing no further questions from the phone line and I'd like to turn the conference back over to Ed Ross for any closing remarks.

Ed Ross -- Chairman & Chief Executive Officer

Thank you, Vic, and thank you, everyone for joining us this morning. We look forward to speaking with you on our fourth quarter call in early March 2022. Have a great day and a great weekend.

Operator

[Operator Closing Remarks]

Duration: 47 minutes

Call participants:

Jody Burfening -- Investor Relations

Ed Ross -- Chairman & Chief Executive Officer

Shelby Sherard -- Chief Financial Officer

Mickey Schleien -- Ladenburg -- Analyst

Robert Dodd -- Raymond James -- Analyst

Ryan Lynch -- KBW -- Analyst

Sarkis Sherbetchyan -- B. Riley -- Analyst

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