U.S. Markets close in 2 hrs 45 mins

Edited Transcript of AINV earnings conference call or presentation 6-Feb-19 10:00pm GMT

Q3 2019 Apollo Investment Corp Earnings Call

NEW YORK Feb 8, 2019 (Thomson StreetEvents) -- Edited Transcript of Apollo Investment Corp earnings conference call or presentation Wednesday, February 6, 2019 at 10:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Elizabeth Besen

Apollo Investment Corporation - IR Manager

* Gregory William Hunt

Apollo Investment Corporation - CFO & Treasurer

* Howard T. Widra

Apollo Investment Corporation - CEO & Director

* Tanner Powell

Apollo Investment Corporation - President & CIO of Apollo Investment Management

================================================================================

Conference Call Participants

================================================================================

* Christopher John York

JMP Securities LLC, Research Division - MD & Senior Research Analyst

* Christopher Robert Testa

National Securities Corporation, Research Division - Equity Research Analyst

* Finian Patrick O'Shea

Wells Fargo Securities, LLC, Research Division - Associate Analyst

* Kyle M. Joseph

Jefferies LLC, Research Division - Equity Analyst

* Richard Barry Shane

JP Morgan Chase & Co, Research Division - Senior Equity Analyst

* Robert James Dodd

Raymond James & Associates, Inc., Research Division - Research Analyst

* Terry Ma

Barclays Bank PLC, Research Division - Research Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Good afternoon, and welcome to Apollo Investment Corporation's earnings conference call for the period ended December 31, 2018. (Operator Instructions) I will now turn the call over to Elizabeth Besen, Investor Relations Manager for Apollo Investment Corporation.

--------------------------------------------------------------------------------

Elizabeth Besen, Apollo Investment Corporation - IR Manager [2]

--------------------------------------------------------------------------------

Thank you, operator, and thank you, everyone, for joining us today. Speaking on today's call are: Howard Widra, Chief Executive Officer; Tanner Powell, President and Chief Investment Officer; and Greg Hunt, Chief Financial Officer.

I'd like to advise everyone that today's call and webcast are being recorded. Please note that they are the property of Apollo Investment Corporation, and that any unauthorized broadcast in any form is strictly prohibited. Information about the audio replay of this call is available in our earnings press release. I'd also like to call your attention to the customary safe harbor disclosure in our press release regarding forward-looking information. Today's conference call and webcast may include forward-looking statements. Forward-looking statements involve risks and uncertainties, including, but not limited to, statements as to our future results, our business prospects and the prospects of our portfolio companies. You should refer to our registration statement and shareholder reports for risks that apply to our business and that may adversely affect any forward-looking statements we make. We do not undertake to update our forward-looking statements or projections unless required by law. To obtain copies of our SEC filings, please visit our website at www.apolloic.com.

I'd also like to remind everyone that we've posted a supplemental financial information package on our website, which contains information about the portfolio as well as the company's financial performance.

Please note that all share and per share data discussed on today's call have been adjusted for the 1 for 3 reverse stock split which was completed during the quarter. At this time, I'd like to turn the call over to Howard Widra.

--------------------------------------------------------------------------------

Howard T. Widra, Apollo Investment Corporation - CEO & Director [3]

--------------------------------------------------------------------------------

Thanks, Elizabeth. I will begin today's call by providing a brief overview of our financial results for the quarter followed by an update on the execution of our derisking investment strategy. I will then discuss a couple of business highlights. Following my remarks, Tanner will discuss the market environment, our third quarter investment activity and will provide an update on credit quality. Greg will then review our financial results in greater detail. We will then open the call to questions.

Let me begin with an overview of our financial results for the quarter. Net investment income for the quarter was $0.45 per share. Net asset value was $19.03 at the end of the period, a decrease of 1.9% quarter-over-quarter. The decline in NAV was primarily attributable to certain noncore assets and our quoted positions given the selloff in the liquid credit markets in December, partially offset by the accretive impact of stock buybacks.

Moving to an update on the execution of our investment strategy, we continued to de-risk and reposition the portfolio through active management and opportunistic sales, reducing our exposure to concentrated positions and noncore assets and shifting the portfolio into higher quality, lower risk, true first lien diversified corporate loans sourced by the Apollo Direct Origination Platform. We continue to proactively manage position size and concentration risk as evidenced by the downward trend in our average position size. Our ability to co-invest with other Apollo entities continues to be an advantage allowing us to compete with other major market participants. The Apollo platform is able to win deals based on size and certainty of execution while at the same time allowing AINV to maintain its desired hold size. In addition, we continue to deploy capital in life sciences, asset-based lending and lender finance, areas with significant barriers to entry and in which MidCap Financial has expertise. Since receiving our co-investment order in 2016, the platform has made over $8 billion of commitments, of which AINV committed to 22% or $1.8 billion of this amount. During the quarter, we invested $221 million, excluding revolver activity, across 28 companies; $162 million or 73% in 12 new portfolio companies; $58 million or 27% in 16 existing companies. Consistent with our strategy, new investment activity focused on first lien term loans backing sponsors with proven track records. 100% of deployment was floating rate, 94% was first lien and 84% was in investments made pursuant to the co-investment order. Sales and repayments totaled $213 million excluding revolver activity, resulting in net investment activity of $8 million. In addition, net revolver funding totaled approximately $8 million, and we had a net repayment from Merx of $1 million during the quarter. We ended the quarter with core assets representing 80% of the portfolio, up from 78% at the end of September and compared to 74% a year ago. Noncore assets decreased to 16.7% of the portfolio at the end of December, down from 18.3% at the end of September, driven in part by a receipt of $17.6 million of cash from the return of capital from 2 of our oil and gas investments and the partial sale of one of our remaining structured credit investments. In addition, at the end of December, investments made pursuant to our co-investment order represented 35% of the total portfolio and 59% of the corporate lending portfolio.

Moving to other topics, we completed the 1 for 3 reverse stock split during the quarter. The reverse stock split took effect at the close of business on November 30, and AINV began trading on a split-adjusted basis on December 3. The sell-off in the equity market did present us with what we believe was an attractive opportunity to repurchase our stock. We consider stock buybacks below NAV to be a component of our plan to deliver value to our shareholders. Since the inception of our share repurchase program and through the end of December, we have repurchased $166.1 million or 12.3% of the initial shares outstanding, which has added approximately $0.56 to NAV per share, which is again adjusted for the reverse stock split. As you've seen in today's press release, we are pleased to announce that our Board has approved another $50 million share repurchase plan, which brings the total authorization since 2015 to $250 million, of which $83.9 million remains available. We intend to continue to repurchase our stocks so they continue to trade at a meaningful discount to NAV.

Turning to other announcements, as you have seen, in mid-January, we filed an 8-K announcing that Gary Rothschild, the President and Chief Executive Officer of Merx, our aircraft leasing portfolio company, became an employee of Apollo Global Management while retaining his roles as President and CEO of Merx. Let me provide some color regarding this move and the benefits to AINV.

As you are aware, given AINV's large concentration in aircraft leasing, we have been selectively recycling our capital within Merx and building out our servicing capabilities over the last couple of years. During this time, Merx has also successfully sourced transactions for other Apollo funds which generate servicing fee income for Merx. In order to maximize our value in Merx, we believed it was necessary to improve the connectivity between Merx and Apollo, thereby enhancing Merx's ability to source transactions for the entire Apollo platform and availing itself of the opportunity to access Apollo's fundraising capabilities. AINV will benefit from a fee offset against fees due to the company's investment adviser under the investment advisory management agreement. The fee offset agreement is included as an exhibit in the Form 10-Q we filed today. The amount of the fee offset will be 20% of all fees earned by Apollo in connection with managing new investments in aviation assets covered by the agreement. We do not expect any fee offset from this agreement in the near or medium term as no capital has been raised. Over time, we believe this arrangement will allow us to reduce the concentration of aviation assets on AINV's balance sheet while retaining earnings through increased servicing income and the fee offset.

Turning to our distribution. The Board has approved a $0.45 per share distribution to shareholders of record as of March 21, 2019. With that, I'll turn the call over to Tanner.

--------------------------------------------------------------------------------

Tanner Powell, Apollo Investment Corporation - President & CIO of Apollo Investment Management [4]

--------------------------------------------------------------------------------

Thank you, Howard. Beginning with the current market environment. As you are aware, during the quarter, the leveraged loan market was negatively impacted by record-breaking retail fund outflows and an increase in risk aversion. The middle market, while not immune, is generally insulated from broader credit market volatility and typically reacts with a lag to the changes in the liquid credit markets. Accordingly, we saw little to no impact of this dislocation in the private debt market, which remains highly competitive primarily due to the tremendous amount of capital being raised for direct lending, which is estimated to be a record $85 billion in 2018 according to data from Refinitiv.

This capital formation has led to the continuation of a highly competitive borrower-friendly market where most deals continue to have aggressive structures in pricing. Against this competitive market backdrop, we are focused on opportunities that capitalize on Apollo's scale and areas of expertise and that can also take advantage of our ability to co-invest with other capital managed by Apollo.

Turning to our investment activity, we funded approximately $221 million during the quarter, excluding revolver activity. Although the reduction in our minimum asset coverage ratio will become effective in early April, the investments that were made in our core strategies during the quarter were consistent with the reduced risk profile we are targeting for incremental assets. The weighted average yield on funded debt investments made was 9.3% and the weighted average spread of new debt investments was 647 basis points, within our target range of 500 to 700 basis points for incremental assets. The weighted average net leverage of investments made during the quarter was 4.9x, within our target range of 4 to 5.5x for incremental assets. Co-investment activity accounted for 84% of funded activity in our core strategies during the quarter, including U.S. Legal Support, TNT Crust, and Micom, among other investments. Sales totaled $16 million and repayments, excluding revolver paydowns, totaled $197 million. Sales included half of our investment in Craft 2015-2, our only remaining structured credit investment. Repayments include our $80 million investment in a U.S. security, which eliminate our exposure to unsecured debt and our $30 million second lien investment in Smokey Merger Sub, a.k.a. Smart Bear. As previously mentioned, we also saw partial repayments from some of our noncore investments, including Pelican Energy and Glacier Oil and Gas as well as some of our second lien investments, including Grocery Outlet and DigiCert, and the full exit of our investment in [kaficeros]. The weighted average yield on debt sales and repayments was 10.4%. In addition, net funding on revolvers for the quarter was $8 million.

Now let me spend a few minutes discussing overall credit quality. Our first lien debt investment in Crowne Automotive was placed on nonaccrual status. As mentioned on our last call, AINV's participation in the credit was part of a larger commitment made by the Apollo Opportunistic Group. The company is in the process of selling its various businesses and our mark based on the expected recovery -- and our mark is based on the expected recovery from E6. At the end of December, investments on nonaccrual status represented 2.8% of the portfolio fair value, up from 2.6% last quarter and 3.4% at cost up from 3.2% last quarter.

Moving on, the risk profile of our portfolio as measured by weighted average leverage and interest coverage, were unchanged quarter-over-quarter. The current weighted average net leverage of the portfolio remained at 5.5x, and the current weighted average interest coverage remained at 2.3x. Let me provide some additional data which we believe shows the health of our portfolio companies. The corporate lending portfolio saw revenue growth of 7.7% and 8.5% quarter-over-quarter and year-over-year, respectively. Similarly, median adjusted EBITDA growth was 7.5% and 7.2% quarter-over-quarter and year-over-year, respectively. As you can see, revenue growth is outpacing EBITDA growth which is partially due to acquisitions.

With that, I will now turn the call over to Greg, who will discuss the financial performance for the quarter.

--------------------------------------------------------------------------------

Gregory William Hunt, Apollo Investment Corporation - CFO & Treasurer [5]

--------------------------------------------------------------------------------

Thank you, Tanner. Revenue for the quarter was $64 million, down 3% quarter-over-quarter primarily due to lower recurring interest income and lower prepayment income, partially offset by higher dividend and fee income. Recurring interest income declined due to a lower average portfolio given the timing of investment activity in the quarter, as well as the placement of one of our investments on nonaccrual. Dividend income increased quarter-over-quarter due to a higher dividend from both Merx and MSEA. Prepayment income was approximately $2.9 million in the quarter compared to $3.6 million in the September quarter and fee income was $3.8 million, double the prior quarter.

Expenses for the quarter were $32.6 million, down 4% quarter-over-quarter, primarily due to lower management fees, lower interest expense and lower G&A. Management fees decreased due to the lower average portfolio balance. Interest expense decreased due to a decrease in the average debt outstanding balance partially offset by the movement in LIBOR. Incentive fees increased slightly quarter-over-quarter as the prior period included the reversal of $1 million of incentive fees related to PIK income. The incentive fee rate for the quarter was 15%.

Moving on, net investment income was $31.5 million or $0.45 per share for the quarter. This compares to $32.2 million or $0.45 per share for the September quarter. The net loss on the portfolio for the quarter was $32.7 million or $0.47 per share compared to a net loss of $4.1 million or $0.06 per share during the September quarter. Negative contributors for the quarter included oil and gas investments and our renewable energy investments. The impact to NAV per share from the net loss on the portfolio was partially offset by the accretive impact from stock repurchases during the quarter, which totaled $0.10 per share. Net asset value per share was $19.03 at the end of the quarter, down 1.9% quarter-over-quarter.

Turning to the portfolio composition. At the end of December, our portfolio had a fair value of $2.3 billion and consisted of 103 companies across 24 industries. First lien debt represented 64% of the portfolio; second lien debt represented 24%; structured products, 3%; preferred and common equity, approximately 9%. As previously mentioned, we exited our exposure to unsecured debt during the period. The weighted average yield on our portfolio at cost remained at 10.7% as the impact from rising LIBOR was partially offset by lower yields on new investments.

On the liability side of the balance sheet, we had approximately $994 million of debt outstanding at the end of the quarter. Our net leverage stood at 0.74x at the end of December compared to 0.68x at the end of September. As previously announced, we amended, extended and upsized our senior secured revolving credit facility in November. The amended facility lowered the asset coverage requirement from 200% to 150%. This amendment follows the passage of the Small Business Credit Availability Act in March, and our Board's approval of the modified asset coverage requirement for the company in April 2018. Our reduced asset cover requirement will become effective on April 4, 2019.

In addition, we extended the final maturity of the credit facility by approximately 2 years and increased commitment by $400 million to $1.59 billion for both new -- from both new and existing lenders. There is no change to the borrowing cost in connection with the amendment. We greatly appreciate the support from our lending community in this important amendment to our facility, which allows us to continue to shift our portfolio mix to more senior, first lien floating rate loans sourced by the Apollo Direct Origination Platform.

Lastly, regarding stock buybacks, we repurchased approximately 1.5 million shares at an average price of $14.73, adjusted for the reverse stock split, for a total cost of $22 million during the quarter. Since the inception of the stock repurchase program, we have repurchased 9.7 million shares or 12.3% of our initial shares outstanding adjusted for the stock split, for a total cost of $166 million. The company now has approximately $83 million available for stock repurchases, which includes the recent $50 million increase announced today.

This concludes our prepared remarks, and I will open the call to questions.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) Your first question comes from the line of Rick Shane with JPMorgan.

--------------------------------------------------------------------------------

Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [2]

--------------------------------------------------------------------------------

Look, you guys described an environment -- a market environment that was pretty stable for middle-market loans during the fourth quarter. I am curious as you sort of enter 2019, and we've seen the volatility but we're also in an environment as you point out where there's a lot of capital inflows and there is going to be a turn of leverage to -- toward the BDC industry. How do you think about the competitive framework or should we expect further spread compression? And is there more room for sort of compression of deal terms as well?

--------------------------------------------------------------------------------

Howard T. Widra, Apollo Investment Corporation - CEO & Director [3]

--------------------------------------------------------------------------------

I think we had reached a point, putting aside the couple of weeks at the end of December, which actually really didn't sort of strike the illiquid market all that much, where things had compressed pretty far and deal terms had widened a reasonable amount. And I would not expect that to improve from a lender's perspective. But I don't know if I would expect it to get meaningfully worse, for a few reasons, in that a significant amount of capital has already come in, including the BDCs that are investing either because their leverage has been approved to go up or they expect it to go up. And there's just been enough capital formation to meet most of the needs already. And more so, there is sort of a natural end to how aggressive they can get, because companies have to be able to service their debt. So I don't know if I expect it to get meaningfully worse for lenders, but I don't necessarily expect it to get better until there is a longer-term disconnect in the market than a couple of weeks at the end of December.

--------------------------------------------------------------------------------

Gregory William Hunt, Apollo Investment Corporation - CFO & Treasurer [4]

--------------------------------------------------------------------------------

I'd add one thing to that, Howard. And if you think about, while the volatility perhaps did not percolate to the deals that we were competing on, we are hopeful -- if you think about it in the context of the middle market in particular, the upper middle market where opportunities had been crowded out to a certain extent by banks underwriting, and we're hopeful that some of this volatility will influence banks and make them more reticent to underwrite the $200 million to $500 million term loans, which were otherwise getting syndicated to CLO buyers and the like, but on a go forward basis, have the opportunity to be taken down by private lenders such as ourselves, enhance our opportunity that way. But other than that, I would echo Howard's comments that we did see some amount of stabilization in terms of spreads in 2018. Things remain competitive and we don't forecast a material change, tightening or widening, as it relates to our core middle market business.

--------------------------------------------------------------------------------

Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [5]

--------------------------------------------------------------------------------

Got it. Okay. That's helpful. And look, you can make bad loans in good environments, you can make good loans in bad environments. You are in a position over the next 12 to 24 months where you have, you will have a great deal of capital to deploy. Talk about sort of strategically how you will approach that, because again in the spirit of you can make good loans in tough environments.

--------------------------------------------------------------------------------

Howard T. Widra, Apollo Investment Corporation - CEO & Director [6]

--------------------------------------------------------------------------------

Yes. So let's talk about portfolio composition first. So the first thing we focus on is obviously, as we said being much more granular, and -- from a portfolio construction basis, and not you have concentrated positions in any sort of given industry or something like that. So let's assume we continue on that path so we then -- we've taken out sort of single credit event risk for our performance. I think our focus is, and the way we think about projecting our performance going forward outside our noncore assets is, we have a certain set of loans that are more proprietary, asset-based loans, life sciences loans, lender finance loans which, over our long history of doing those loans, have very low loss given default. And so for us, we don't feel like this market has changed that. It may be more competitive. There may be some price pressure at times, but credit terms don't really flex all that much in those product areas. And so to the extent we have those loans, we would expect credit losses to stay about the same. So then the next thing is, well, what does the rest of the portfolio look like? What are we doing today to try to ensure that our losses are within a band? And if you looked at what we were doing today, almost -- not all, but almost all of our first lien loans that we've done over the last 3 quarters have covenants. And so -- but the average leverage on a senior debt basis is on the higher end of where it is in the continuum over a cycle. Both because there's more senior stretch getting done and also because leverage is pushed up. So if you looked historically at middle-market loan loss given default rates, it's in the -- I don't know, 20% to 25% range. And I think now it's more realistic to sort of think those will be 30% to 35%. So if you model that. So assume we're no better or worse than the market, we hope and think we're better. Our track record has been better, but we need to prove that. But assume we're at market levels we -- and assume default rates go up like they do in a normal recession to something like 5% or 6%. If you have 30% losses, you're talking about 1.8% of those assets over an extended period of time, and you blend that with our proprietary assets that don't have a whole lot of losses. That's how you get into sort of very measured loss rates that we've guided people to. Hopefully that wasn't too much math.

--------------------------------------------------------------------------------

Operator [7]

--------------------------------------------------------------------------------

Your next question comes from the line of Kyle Joseph with Jefferies.

--------------------------------------------------------------------------------

Kyle M. Joseph, Jefferies LLC, Research Division - Equity Analyst [8]

--------------------------------------------------------------------------------

Just related to the unrealized depreciation in the quarter. How much of -- can you give us a sense for how much of that was just 12/31 marks versus company-specific issues. And just trying to essentially see how much of that you would've gotten back already.

--------------------------------------------------------------------------------

Howard T. Widra, Apollo Investment Corporation - CEO & Director [9]

--------------------------------------------------------------------------------

Well, so I would say -- I mean yes -- so I'm trying to clear out the numbers. We had a 10% positive impact from buybacks, right? So if you clear that out and you say there's a $0.40 negative impact from marks, about 3/4 of that was from volatility, either in the liquid marks as you're asking, or in the oil and gas which is a result of the value of the commodity, which was also down. I can't say even though the market is fully recovered all those marks have fully recovered, because oil's a little bit different and it's based on sort of certain curve. But basically 3/4 of the write down was attributable to things that have to do with the change in the value of the assets based on short-term volatility. I just don't know if they're all going to return exactly at the same levels they went down, because obviously it's hard to predict and obviously we don't know where we'll be March 30. But it's about 3/4 of everything was related to noncredit related, unrealized loss.

--------------------------------------------------------------------------------

Kyle M. Joseph, Jefferies LLC, Research Division - Equity Analyst [10]

--------------------------------------------------------------------------------

Got it, that's helpful. And then just one other one, Greg. I know you touched on this a little bit, but just looking for a little bit more color on the interest income decline, Q-on-Q. How much of that was related to the sale of, I think you guys sold an $80 million sub debt piece. How much of it was timing? And then, I think the other thing was the nonaccrual. If you can give us a sense for how each of those...

--------------------------------------------------------------------------------

Gregory William Hunt, Apollo Investment Corporation - CFO & Treasurer [11]

--------------------------------------------------------------------------------

Right, so the nonaccrual was very, relatively minor for the quarter. It was just the investment activity. We had -- basically, the $80 million was a U.S. security, it was basically repaid in October. If you think about our average position size, which is less than 20, that meant you had to replace it with 4 other positions. And a lot of that activity ended up being after Thanksgiving, between Thanksgiving and December 15. So it was kind of really barbelled in the quarter, the activity, and that just drove. So it literally is just a function of that, nothing more.

--------------------------------------------------------------------------------

Operator [12]

--------------------------------------------------------------------------------

Your next question comes from the line of Chris York with JMP Securities.

--------------------------------------------------------------------------------

Christopher John York, JMP Securities LLC, Research Division - MD & Senior Research Analyst [13]

--------------------------------------------------------------------------------

So the question's on valuation. So in reviewing the valuation inputs in your first and second lien loans for Level 3 investments in the Q, it appears the discount rate for both the yield and DCF valuations were unchanged despite the spread widening. So the question is, I'm curious, how are you viewing the spread widening in the liquid credit markets? Are you viewing it almost entirely as liquidity-driven and then not applicable to the valuation of the middle-market loans?

--------------------------------------------------------------------------------

Gregory William Hunt, Apollo Investment Corporation - CFO & Treasurer [14]

--------------------------------------------------------------------------------

Yes. So thanks for the question. A couple of comments there. The first would be when -- those inputs, when we look at the illiquid market, certainly, we did not tighten things down as things were compressing over the last 18 or so months. And so it -- there would not be the same volatility on the widening side, owing to the fact that, that was not fully calibrated in our valuations. And then the second point, we'd draw on some of the comments that I made in the prepared remarks, with respect to the illiquid private debt, senior loans don't have that same amount of volatility. And while we are cognizant of the moves in the liquid markets, it is not as influential in how we think about valuation. And then the other point I think that you reference in your question is, we agree, and I think some of the recovery that you've seen, not a full recovery in the year-to-date period, bears out that at least a portion of the decline was a function of the liquidity of the market and hence, to some extent, temporary.

--------------------------------------------------------------------------------

Christopher John York, JMP Securities LLC, Research Division - MD & Senior Research Analyst [15]

--------------------------------------------------------------------------------

Got it. Okay, that makes a lot of sense. And then just a couple of other questions. Is the new buyback program a 10b5-1 or is it more of a self-directed open-market purchase program?

--------------------------------------------------------------------------------

Howard T. Widra, Apollo Investment Corporation - CEO & Director [16]

--------------------------------------------------------------------------------

It would -- it depends on what portion of the quarter, right? We basically have both of them. We have a 10b5-1 plan in place for when we don't have the window open. Or the window closes.

--------------------------------------------------------------------------------

Christopher John York, JMP Securities LLC, Research Division - MD & Senior Research Analyst [17]

--------------------------------------------------------------------------------

Okay. And then, when the liquid markets froze throughout the quarter, did sponsors increasingly turn to you? As Howard, you said in your prepared remarks as a result of your certainty of close and essentially kind of reinforce the franchise value in your direct lending platform?

--------------------------------------------------------------------------------

Howard T. Widra, Apollo Investment Corporation - CEO & Director [18]

--------------------------------------------------------------------------------

Yes, I mean, it was a pretty narrow window, it was towards the end of the year, when a lot of people weren't. So I think it was hard to see that yet. You certainly saw on deals that needed to get executed right then, people looking for a little bit more certainty. But the sort of the sales cycle for middle-market loans, it's different then when a big underwriter's coming to market, the price changes immediately when -- if you've committed to a sponsor to do a certain deal on December 5, you can't say the market's changed and not do that if you want to stay in the market. By the same token, if you say on December 20, here's the pricing because the market's widened out, by January 15 then the market's back, they'll sort of call 7 other lenders and move you back. And so it was just too short a window.

--------------------------------------------------------------------------------

Christopher John York, JMP Securities LLC, Research Division - MD & Senior Research Analyst [19]

--------------------------------------------------------------------------------

Yes, so did it -- yes, did that change at all in January or anything? Lingo...

--------------------------------------------------------------------------------

Howard T. Widra, Apollo Investment Corporation - CEO & Director [20]

--------------------------------------------------------------------------------

Well, somebody -- so I would say, our pipeline's good right now. I do think that there are a few more opportunities in that pipeline that are related to deals that could be executed broadly. So that would be my indication. They don't come from sponsors indicating clearly that they feel concerned about things, because that's not what they do. They always come from strength, even when they're not strong. But we have seen a few more of those deals. So I think people are still a little bit aware, especially if they have like an HSR filing or something that's going to extend their time frame so they're taking more market risk. They are still I think, a little more skittish than they were in November.

--------------------------------------------------------------------------------

Operator [21]

--------------------------------------------------------------------------------

Your next question comes from the line of Finian O'Shea with Wells Fargo Securities.

--------------------------------------------------------------------------------

Finian Patrick O'Shea, Wells Fargo Securities, LLC, Research Division - Associate Analyst [22]

--------------------------------------------------------------------------------

Can you first just kind of walk us through the logic on the new arrangement with Merx, appreciating that you're constructing those economics on balance sheet. Given they may be a bit volatile going forward, why not set up just sort of an adviser, an RIA and have that perhaps grow in -- or ebb and flow in value over time?

--------------------------------------------------------------------------------

Howard T. Widra, Apollo Investment Corporation - CEO & Director [23]

--------------------------------------------------------------------------------

So we look at every alternative in terms of sort of what are the options. There are some potential, sort of regulatory hoops you'd have to jump through to set up an RIA, but let's just put that aside for a second. The question is, do you want to set up an RIA, or do you want to set up an asset management function at Merx and raise money, and have the costs and -- the costs and the infrastructure and the challenge related to that, and what are the economics to that, versus doing it in sort of effectively like a JV-like way, where we did with Apollo, where we take advantage of not only the reach, which we sort of have anyway as part of Merx, but more directly as well as all the cost being absorbed by them. So if you look at the amount of assets you'd have to raise in order to make as much money as we would make by just having a gross revenue share from dollar 1, it was a relatively no-brainer on the asset management side. And that doesn't even include the fact that, if we raise more money in that way, and there's a bigger platform, we generate a lot more servicing income, too. So it was actually sort of a win-win. We don't have to put any money out, and we're totally aligned with somebody who can really raise money and is directly focused on that.

--------------------------------------------------------------------------------

Finian Patrick O'Shea, Wells Fargo Securities, LLC, Research Division - Associate Analyst [24]

--------------------------------------------------------------------------------

That's very helpful. Next question, for Greg. Looking at the pretty impressive commitments on the facility, especially during this quarter, can you kind of talk about the sort of breadth of new entrants or was this increasing commit from your existing bank base? Or did you kind of expand, say, with non-U.S. banks abroad, et cetera? Any color you could provide there?

--------------------------------------------------------------------------------

Gregory William Hunt, Apollo Investment Corporation - CFO & Treasurer [25]

--------------------------------------------------------------------------------

It was actually very successful. Not only did we get increased commitments from existing lenders but like, within a facility that probably has 15, 16 lenders, we added another 5 lenders onto it. So it was very broad, broadly marketed. I would say to you that it really shows the power of the Apollo platform, in that people wanting to participate not only in our facility, they participate in the mid-cap facilities, but also part of Apollo, and Apollo in raising their own capital. So it's really a reflection of being part of a larger platform, where we can take advantage of the relationships that we have there.

--------------------------------------------------------------------------------

Finian Patrick O'Shea, Wells Fargo Securities, LLC, Research Division - Associate Analyst [26]

--------------------------------------------------------------------------------

And one more small one, if I may. Just going through the Q, it looks like you may have allowed the energy puts to roll off, correct me if I'm wrong, and why the change in approach there? Are these positions small now, or is it a market call?

--------------------------------------------------------------------------------

Howard T. Widra, Apollo Investment Corporation - CEO & Director [27]

--------------------------------------------------------------------------------

Sort of neither. They were small, they were winding down and fading off. And I think we had all been sort of -- there had been a mismatch between how they performed and the way the underlying investments performed. And so, over the time with which we had those hedges, we have sort of increased our -- increased the pressure that we've put on the companies, to make sure they were hedged appropriate at their level. And so when oil dropped down we just -- we decided to exit it at a time when we could sort of mitigate some of the loss in this quarter, and just have the hedges done at the really, the 2 company level, the 2 companies that we have remaining, other than the small, other one.

--------------------------------------------------------------------------------

Operator [28]

--------------------------------------------------------------------------------

Your next question comes from the line of Terry Ma with Barclays.

--------------------------------------------------------------------------------

Terry Ma, Barclays Bank PLC, Research Division - Research Analyst [29]

--------------------------------------------------------------------------------

I just wanted to follow up on Merx and make sure I understand correctly, but it sounds like you want to grow your servicing revenue for Merx, while over time decreasing leasing revenue and exposure to just leased aircraft. Is that correct?

--------------------------------------------------------------------------------

Howard T. Widra, Apollo Investment Corporation - CEO & Director [30]

--------------------------------------------------------------------------------

Yes, I mean we like our lease exposure. We would like Merx to be about 10% over the long term of our overall portfolio. Some of that will happen by virtue of our portfolio growing as we increase leverage, and some of that will happen by having sort of more money that we can utilize to invest in these planes while we generate good income off them. So the servicing income really allows us to sort of move that portfolio down, while retaining sort of the outsized earnings from that, from the capital involved there. So it -- but again, we're not deemphasizing leasing, and we still will have, as an important pool of capital for Apollo, access to do whatever transactions we like. So we expect to continue to invest in the aircraft space with what -- but we have an overall view, as do I think a lot of the investors in our platform, that it's more appropriate for this to be closer to 10% than closer to 20%.

--------------------------------------------------------------------------------

Terry Ma, Barclays Bank PLC, Research Division - Research Analyst [31]

--------------------------------------------------------------------------------

Got it. And so, just in terms of the return profile of Merx longer term, is a servicing plus leasing mix comparable to what you're earning just leasing out of Merx right now?

--------------------------------------------------------------------------------

Howard T. Widra, Apollo Investment Corporation - CEO & Director [32]

--------------------------------------------------------------------------------

Well, right, it depends on how much servicing we get. Servicing has an unlimited return on capital, right, because it's just so -- the answer is, if we raise a -- if we are successful in building out this third-party asset management platform in a way we believe we can be, but which will take some time and work, we will have a servicing platform that will replace the earnings that we're losing by shrinking our leases. So in other words, we'll be earning as much money on less capital. That's sort of the ultimate goal, but there's execution to be done, and that doesn't mean that there isn't a gap in timing, when we're building up the servicing we've shrunk the leasing. But the goal would be -- I mean, you could think about it differently. You could just say, okay, you're going to have a leasing platform that's 3 quarters as big, and that's going to earn the same returns on a percentage basis it's earned before, and you're separately going to own a servicing company that just makes money. That's sort of probably more how we think about it.

--------------------------------------------------------------------------------

Operator [33]

--------------------------------------------------------------------------------

(Operator Instructions) Your next question comes from the line of Robert Dodd with Raymond James.

--------------------------------------------------------------------------------

Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [34]

--------------------------------------------------------------------------------

Kind of almost following up to Rick's question at the beginning, where it was a lot of information you gave us about the market environment. My question is what, how much embedded excess spread remains in your portfolio today? Obviously your current market spread's very flat now. But when we look at your deployments at 9/3 versus repayments at 10/4, right, some of your older assets on the books are higher spread and they're coming off and the market's competitively tighter, plus the fact, obviously that your first lien's still rising. A year ago it was 50%, today it's 64%. So there's some excess spread embedded in the core earnings today, maybe from a question of older vintage and portfolio mix. So when that all normalizes out, how much would you -- you think not necessarily on a like-for-like versus the market spreads today being stable, but how much excess spread is there embedded in the portfolio today, given the vintage and mix dynamics of the last several years?

--------------------------------------------------------------------------------

Tanner Powell, Apollo Investment Corporation - President & CIO of Apollo Investment Management [35]

--------------------------------------------------------------------------------

I think one way we can answer the question, and I'll refer to our earnings presentation. But an important piece of our strategy as we get the increase in leverage, is to overemphasize or deploy in a more pronounced way into first lien versus second lien. And on that page, it's actually Page 12, we quote within our corporate book, what the average spread is for second lien versus first lien, and first lien being 650 and second lien being roughly 850. And so if you think about, as we replace assets, and in fact this happened quite a bit in the current quarter, where deployments were disproportionately first lien, I think the number was 94%, and the exits were -- a sizable portion of which was second lien, that's one I think directional -- that's as changeable of data as we can give you, with the assumption that we're originating at kind of that same 650 and the rolloff will disproportionately be the second lien as we choose not to -- or choose to deploy less into second lien on a go-forward basis.

--------------------------------------------------------------------------------

Howard T. Widra, Apollo Investment Corporation - CEO & Director [36]

--------------------------------------------------------------------------------

Just -- just to put a little math on it, I mean, we have continually sort of guided, I think for the past 18 months to say we, as we ramp up our portfolio, we'll go to 10% yield, and we believe that we can have the type of coverage that people want to see at a ramped portfolio at 10% yield. We are still now at 10.7% or between 10.6% and 10.7%. And if you looked at our portfolio, you would say we have -- we don't have that much excess yield in there. So there's some cushion. The reason why there's some cushion is because LIBOR has moved. So we continue to believe that we can have this rotation with more current things and remain above the 10 that we've guided. That's sort of I think, how we think about it long term.

--------------------------------------------------------------------------------

Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [37]

--------------------------------------------------------------------------------

Got it, got it. And on just the second question, tied to exactly that LIBOR move. If we look, a quarter ago the forward LIBOR curve went into the mid-3s -- well, low 3s by the end of this year. The forward curve now is barely above mid-2s, 2.5, 2.6. Is that, a, affecting your target of 10%? b, having any effect on market dynamics? So if I'd be much more willing to compress spreads a little bit, if I thought I was going to pick up 50 basis points in LIBOR, versus if I think I'm not going to pick up 50 basis points in LIBOR. So any impact on you, and/or the market from the shift in the curve?

--------------------------------------------------------------------------------

Howard T. Widra, Apollo Investment Corporation - CEO & Director [38]

--------------------------------------------------------------------------------

It's hard to say, because there's lots of inputs, right, in the market than just this. What I would say is, I don't personally feel like spreads have changed as much versus LIBOR versus sort of liquidity being built in the market. In fact, spreads have held up better than leverage and terms, if you put those in categories. The increase in LIBOR helps everybody. Most people have spent that -- or not -- I shouldn't say most people -- a lot of people have spent that by moving more to first lien. That's sort of how we've spent it. And so it's sort of -- it basically subsidizes that strategy in a way that's pretty meaningful and that's how I would sort of view it as what it's done. It's moved more money into first lien, so really if you look at the market and say, there's a lot more stuff getting done senior stretch by BDCs, if you will, than first lien from a bank and second lien by BDCs. Basically people have sort of moved into sort of taking dollar 1 risk.

--------------------------------------------------------------------------------

Operator [39]

--------------------------------------------------------------------------------

Your last question comes from the line of Christopher Testa with National Securities.

--------------------------------------------------------------------------------

Christopher Robert Testa, National Securities Corporation, Research Division - Equity Research Analyst [40]

--------------------------------------------------------------------------------

Just Howard, if you could comment on Mr. Rothschild joining from Merx, whether we should expect potentially more total aviation exposure, but a greater diversification of maybe aviation companies? And if you don't mind a bit on Terry's questions, too. Could you just provide a breakdown generally on Merx and servicing for his first leasing income there?

--------------------------------------------------------------------------------

Howard T. Widra, Apollo Investment Corporation - CEO & Director [41]

--------------------------------------------------------------------------------

I'll answer the first part and then I'll have Tanner answer the second part. We don't think there's any change with regard to how Merx operates and runs. Gary continues to be the CEO of Merx. We expect to try to augment our activity over time in the aviation space, with [regging] with third-party money. And then over time, therefore probably have less invested there, it may be spread over more planes because we'll take more pieces of more transactions, but it's pretty diversified already. So I think we just view it as enhancing the income streams. We now have leasing income. We have asset management income, we'll share it over time, and we'll have increased servicing income. I mean, in terms of where we are today...

--------------------------------------------------------------------------------

Tanner Powell, Apollo Investment Corporation - President & CIO of Apollo Investment Management [42]

--------------------------------------------------------------------------------

Yes. I'd say, I'd make 2 comments there. The first of which is, the servicing revenue doesn't drop all the way to the bottom line. We've had to invest heavily in the platform to build up technical resources to actually perform those services. So there's a cost component to it in any event. Secondly, the second point I'd make is that we are in the early stages of transitioning. And in fact, there's a portion of our existing book where we are not the servicer. And so over time, what we do in the existing Merx balance sheet and/or by taking over those servicing responsibilities, we would expect that to be accretive. In a given transaction, it could be a handful of, percent-low, kind of 2% to 3%, and at current juncture owing to the fact that we are in the process of hiring -- we've hired the infrastructure to perform such services, and we are not servicer on the -- all our planes. And at this juncture, not-for-trades or investments that are done at the Apollo balance sheet it is relatively modest, in the handful of million per year.

--------------------------------------------------------------------------------

Christopher Robert Testa, National Securities Corporation, Research Division - Equity Research Analyst [43]

--------------------------------------------------------------------------------

Got it, okay. That's really good color, Tanner. And would you say, so the vast majority of the existing book you're not the servicer, so there's a really good runway for growth there?

--------------------------------------------------------------------------------

Tanner Powell, Apollo Investment Corporation - President & CIO of Apollo Investment Management [44]

--------------------------------------------------------------------------------

I'd say it's probably above 50% at this juncture. So it's not a huge opportunity. But again, I would calibrate everyone to that it's early and as I alluded to, and so at the risk of being redundant, there have been costs assumed as we've built up the expertise in order to perform such services.

--------------------------------------------------------------------------------

Christopher Robert Testa, National Securities Corporation, Research Division - Equity Research Analyst [45]

--------------------------------------------------------------------------------

And obviously this was a big quarter for originations, not just for you guys but generally via the direct lending market across the board. Just wondering, do you think that any borrowers were kind of rushing to get things in before the new year and pulled any volume forward from the 3/31 quarter? Or are you still seeing the same sort of amount of activities so far in the quarter?

--------------------------------------------------------------------------------

Howard T. Widra, Apollo Investment Corporation - CEO & Director [46]

--------------------------------------------------------------------------------

Yes, we -- I mean, I think it's anecdotal for us, we had a few significant transactions spill over. So we didn't have the opposite. So I -- no, we did not see that.

--------------------------------------------------------------------------------

Christopher Robert Testa, National Securities Corporation, Research Division - Equity Research Analyst [47]

--------------------------------------------------------------------------------

Got it. And how did the technical marks from spreads widening impact your mid-cap assets versus the more legacy, higher-yielding assets? Kind of what was the differential in marks there?

--------------------------------------------------------------------------------

Howard T. Widra, Apollo Investment Corporation - CEO & Director [48]

--------------------------------------------------------------------------------

Yes, well so that was sort of what somebody asked before, I mean those are all the level 3 assets. And basically, that market didn't change. It didn't change on the ground and it didn't change with regard to what those assets would've traded by. Put differently, if we would've said those assets, marked at 99, and now we're at 98.5 and asked people to buy them, everybody we compete with would have bought them all. And we would have bought them from them. It just wasn't what drove values for that short period of time. So obviously the totally liquid names are marked in a different way, they're just marked by a quote. The truth is, you couldn't buy them at those quotes either. Like the one -- they were quoted there, but there wasn't a lot of volume there. So the level 3 names didn't change in value much. I think you'll see that -- I would be surprised if you don't see that throughout the BDC universe. Not a whole bunch of movement.

--------------------------------------------------------------------------------

Operator [49]

--------------------------------------------------------------------------------

At this time, I would like to turn the call back over to Howard Widra.

--------------------------------------------------------------------------------

Howard T. Widra, Apollo Investment Corporation - CEO & Director [50]

--------------------------------------------------------------------------------

Thank you. On behalf of our team, we thank you for your time today and your continued support. Please feel free to reach out to any of us if you have any other questions. Have a good night.

--------------------------------------------------------------------------------

Operator [51]

--------------------------------------------------------------------------------

This concludes today's call. You may now disconnect.