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Edited Transcript of AINV earnings conference call or presentation 16-May-19 9:00pm GMT

Q4 2019 Apollo Investment Corp Earnings Call

NEW YORK May 31, 2019 (Thomson StreetEvents) -- Edited Transcript of Apollo Investment Corp earnings conference call or presentation Thursday, May 16, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* 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

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Conference Call Participants

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* Casey Jay Alexander

Compass Point Research & Trading, LLC, Research Division - Senior VP & Research Analyst

* 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

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Presentation

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Operator [1]

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Good afternoon, and welcome to Apollo Investment Corporation's earnings conference call for the period ended March 31, 2019. (Operator Instructions)

I will now turn the call over to Elizabeth Besen, Investor Relations Manager for Apollo Investment Corporation.

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

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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 also 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.

At this time, I'd like to turn the call over to Howard Widra.

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

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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 investment strategy. I will then discuss a couple of business highlights. Following my remarks, Tanner will discuss the market environment, our fourth quarter investment activity and will provide an update on credit quality. Greg will then review our financial results in greater detail. We'll then open the call to questions.

Let me begin with an overview of our financial results for the March quarter. Net investment income for the quarter was $0.47 per share. Net investment income benefited from strong net origination activity and the impacts of the change in our incentive fee structure, which now incorporates realized and unrealized losses incurred since April 1, 2018. We believe the change in our fee structure enhances the alignment of interest of the manager with the interest of the shareholders. Greg will discuss the incentive fee calculation in greater detail later during the call.

Net asset value per share was $19.06 at the end of the period, a $0.03 increase quarter-over-quarter. The increase in NAV per share was driven by earnings in excess of the dividend as well as the accretive impact of stock buybacks, partially offset by a slight depreciation of the portfolio.

As a reminder, a year ago in April 2018, the company's Board of Directors approved the reduction in our asset coverage requirement pursuant to the Small Business Credit Availability Act. Accordingly, effective April 4, 2019, our minimum asset coverage ratio was reduced from 200% to 150%, which essentially allows us to increase our leverage above 1x equity. As discussed in the past, we are targeting during periods of normal market conditions a debt to equity range of 1.25x to 1.4x.

We believe the ability to increase our leverage provides a unique opportunity for AINV given the robust volume of senior first lien floating rate loans originated by Apollo Direct Origination Platform.

We intend to generally use the incremental investment capacity to invest in first lien floating rate loans with leverage of 4x to 5.5x and with spreads of 500 to 700 basis points. Because the reduction in our minimum asset coverage ratio became effective last month, we've accelerated the origination of new loans with this target profile.

On that note, I'd like to make -- take a moment to briefly highlight some of the progress we've made over the past year, which we believe shows the improvement in the risk profile of the portfolio.

On the origination front, investment activity has focused on first lien floating rate loans sourced by the Apollo Direct Origination Platform. At the end of March, first lien loans represented 65% of the corporate lending portfolio, up from 41% a year ago. The weighted average assets spread in the corporate lending portfolio decreased to 713 basis points, down from 814 basis points a year ago. The floating rate portion of the portfolio increased to 100% compared to 92% a year ago.

We also continue to take advantage of our ability to coinvest with other funds and entities managed by Apollo, which allows us to participate in larger deals, which are typically less competitive, which allows us to maintain relatively small hold sizes on our balance sheet. Our ability to coinvest with other Apollo entities continues to be an advantage, allowing us to compete with other major market participants.

Investments made pursuant to our coinvestment order increased to 63% of the corporate lending portfolio at the end of March, up from 38% a year ago.

We continue to deploy capital in life sciences asset-based lending and lender finance, areas with significant barriers to entry in which mid-cap financial has expertise. These 3 niches represents 13.5% of the portfolio at the end of March, up from 7.7% a year ago.

We also continue to proactively manage position size and concentration risk. The average corporate borrower exposure has decreased to $15.5 million, down from $18.5 million a year ago.

Regarding Merx, as we outlined on previous calls, our plan includes reducing our exposure to Merx to 10% to 15% of the total portfolio. During the quarter, Merx priced its second aircraft securitization, allowing it to repay AINV approximately $31 million on a net basis, reducing AINV's investment in Merx from $456 million to $425 million, bringing it from 19.7% of the portfolio down to 17.7% of the portfolio.

Additionally, we continue to make progress reducing our exposure to noncore assets, including exiting all of our structured credit exposure. We remain focused on prudently exiting our remaining noncore positions. Noncore and legacy assets represent 19% of the portfolio at the end of March, down from 23% a year ago. In short, we believe the portfolio today is much better positioned than it was a year ago.

Moving on, 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. We typically repurchase shares during both open window periods, and we generally allocate a portion of our authorization to a 10b5-1 plan, which allows us to repurchase stock during blackout periods.

Since the inception of our share repurchase program and through the end of March, we have repurchased 170.9 million or 12.7% of initial shares outstanding, which has added approximately $0.57 to NAV per share. Since the end of the quarter, we have continued to repurchase stock. The company currently has approximately $78.4 million available for stock repurchases under the current authorization. We intend to continue to repurchase our stock should it continue to trade at a meaningful discount to NAV.

Turning to our distribution. The Board has approved a $0.45 per share distribution to shareholders of record as of June 20, 2019.

With that, I'll turn the call over to Tanner to discuss the market environment and our investment activity for the quarter.

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

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Thanks, Howard. Beginning with the current market environment, the credit markets have largely recovered from the volatility seen in December. Secondary prices in the broadly syndicated loan market have recovered despite a continuation of retail loan outflows. The private debt lending market remains highly competitive due to the tremendous amount of capital raised over the last few years as well as the significant decrease in new loan issuance during the quarter.

Away from the traditional sponsored-by-corporate lending or specialty areas, life sciences, asset-based lending and lender finance are generally less competitive and accounted for 13.5% of the portfolio at the end of March.

During the quarter, investment activity focused on senior first lien floating rate corporate loans sourced by the Apollo Direct Origination Platform. New investment commitments and fundings were $228 million and $164 million, respectively. New commitments were comprised entirely of first lien floating rate loans. These new commitments were across 19 portfolio companies for an average commitment size of $12 million.

The weighted average spread over LIBOR of these new commitments was 585 basis points, which is within our target range of 500 to 700 basis points for the incremental asset. The net leverage to the new commitment was 3.9x, just below our target range of 4x to 5.5x. Lastly, 94% of these new commitments were made pursuant to our coinvestment order.

Following the volatility in the December quarter, repayment and exits were more modest. Sales totaled $11 million and repayments totaled $34 million for total exits of $45 million, resulting in net funded investment activity of $120 million. Sales included the exit of our remaining investment in Craft 2015-2, eliminating our exposure to the structured credit investment, one of our noncore strategies.

We also received a partial repayment from Crowne Automotive during the period, an investment on nonaccrual. In addition, net fundings on revolvers totaled $9 million, and we received a net repayment of $31 million from Merx.

Let me provide a brief update on our post-quarter and investment activity. Since the end of the quarter, net portfolio growth has been in excess of $100 million, increasing our net leverage ratio to over 0.9x as of today. And with our current pipeline, we expect to be in the mid-90s by the end of the quarter.

Now let me spend a few minutes discussing overall credit quality. No investments were placed on nonaccrual status during the period. Investments on nonaccrual decreased due to the partial repayment from Crowne Automotive.

At the end of March, investments on nonaccrual status represented 2.4% of the portfolio at fair value, down from 2.8% last quarter and 2.9% at cost, down from 3.4% the last quarter. Our continued efforts to reduce the risk profile of our portfolio are borne out by the improvement in our credit metrics. The weighted average net leverage of our investments decreased to 5.4x, down from 5.5x. But as I mentioned earlier, net leverage on new commitments was 3.9x during the quarter. The average interest coverage increased from 2.3x to 2.4x. The weighted average attachment point decreased to 1.9x, down from 2.1x.

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

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

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Thank you, Tanner. Before I discuss our financial performance, I'd like to mention that we provided our quarterly financial supplement to provide you with more detail about the corporate lending portfolio, which we think will help you better evaluate the performance and execution of our plan to reduce risk within our portfolio. I'd also like to remind you that Merx financial statements are included in an exhibit to our 10-K. You will note that Merx's financial statements include the consolidation of the assets from 2 securitizations that were previously held as investments on the balance sheet.

Moving on, our core portfolio grew by approximately $100 million or 6% quarter-over-quarter and by approximately $216 million or 12% year-over-year as we continue to execute on our portfolio repositioning strategy with the passage of the Small Credit Availability Act. Our core portfolio, which includes corporate lending positions and Merx, represented 81% of the total portfolio at the end of March, 63% in corporate lending and 18% in Merx. 65% of the corporate lending portfolio is first lien, up from 41% a year ago. 100% of the corporate lending book is floating rate. The weighted average yields on the corporate lending portfolio is 10.3, down slightly quarter-over-quarter.

Our net investment income was $0.47 per share for the quarter compared to $0.45 per share for the December quarter. The increase was reflective of our investment cadence during the quarter. Net leverage at the end of March was 0.83x compared to 0.74x at the end of December. Our average leverage during the quarter was 0.78x, up from 0.71x during the December quarter.

NAV for the quarter rose to $19.06 versus $19.03 at the end of December as we added $0.47 of net investment income against a dividend of $0.45 per share, plus a $0.01 per share increase for the impact of our share repurchase activity, offset slightly by portfolio depreciation.

Turning to the income statement. Total investment income was $61.4 million compared to $64 million for the December quarter as prepayment and fee income were down quarter-over-quarter. Fee income, which includes bridge fees, declined by $2.6 million, and prepayment income declined by $2 million.

Net expenses were $28.9 million, down from $32.6 million in the prior quarter due primarily to lower incentive fees, offset partially by an increase in interest expense as a result of the growth in the portfolio to over $2.4 billion at the end of March.

As a reminder, a year ago, we announced that the calculation of the incentive fee -- our incentive fee had been revised to include a total return requirement with a rolling 12-quarter look-back beginning April 1, 2018. The incentive fee calculation with a total return provision became effective on January 1, 2019. For the period between April 1, 2018 through December 31, 2018, the incentive fee was a flat 15% and did not include the total return feature. As a result of net losses, both realized and unrealized, incurred since April 1, 2018, no incentive fees were paid during the March quarter.

Our weighted average interest rate on the average debt was 5.4%, flat quarter-over-quarter. Going forward, as we grow our portfolio, we expect the weighted average cost of debt to decrease given the higher utilization of our lower cost revolving credit facility.

Regarding our liquidity and liability structure. We added an additional $50 million to our revolving credit facility during the quarter, which now is one of the industry's largest at $1.6 billion, up $450 million as our existing lender group expanded their commitment to our facility, while at the same time, we have added 5 new banks to the bank group. With the additional funding commitments, we now have enough capital to operate at the higher end of our leverage range. The additional leverage capacity is reflective of the benefit AINV received from being part of the Apollo platform.

Lastly, regarding stock buybacks. During the quarter, we repurchased 311,000 shares at an average price of $15.38 for a total cost of $4.8 million. And since quarter end and through yesterday, we have repurchased an additional 45,000 shares at an average price of $15.23 for a total cost of $700,000. Since the inception of the share repurchase program, which began in 2015, we have purchased 10 million shares or 12.8% of our shares outstanding for a total cost of $172 million. The company now has approximately $78 million available for stock repurchases.

This concludes our prepared remarks, operator, and please open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from the line of Kyle Joseph from Jefferies.

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Kyle M. Joseph, Jefferies LLC, Research Division - Equity Analyst [2]

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Just wanted to talk about sort of quarter-to-date. It sounds like the investment activity has remained strong, and you guys have a solid pipeline. Can you give us an update on sort of repayment activity subsequent to quarter end? Is that sort of normalized after the volatility, I guess, at the end of last year?

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

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Well, we -- I mean we have -- we ended the quarter around 0.82x, 0.83x, and we're around 0.9x right now, and expect to be about in the mid-90s by the end of the quarter. So that's net. Our origination levels are good, probably a little bit higher than this quarter. And so the repayments are still probably lower than they will be on average to the whole cycle, but it's more than this past quarter. So it's still probably a little bit muted.

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Kyle M. Joseph, Jefferies LLC, Research Division - Equity Analyst [4]

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Got it. And I think since you last spoke, people's expectations for interest rates have changed a bit. Could you give us a sense in terms of how you're thinking about that, both from an asset and liability perspective? Any changes to your strategy?

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Howard T. Widra, Apollo Investment Corporation - CEO & Director [5]

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No. I mean at this point, our loans are all floating rate. All our incremental debt is going to be floating rate. And so we're going to be -- we do have fixed-rate debt. And over time, obviously, it changes the calculus each time interest rates may go down with regard to any of our fixed-rate debt that may be callable. So that's sort of the only place. But it doesn't -- it won't change our strategy. I mean we're trying to sort of eliminate the interest rate risk. Obviously, when interest rates go down, the return on equity goes down a little bit. But as we lever up more, that gets muted as well.

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Gregory William Hunt, Apollo Investment Corporation - CFO & Treasurer [6]

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Yes. And I'd add one thing there, Kyle. Where possible, we try to add back LIBOR floors to our loans, which would help to mitigate some of that decline, a feature that had started to lead the market as LIBOR had rallied or increased, but something we're trying to add back to help as a mitigant to the potential interest rate declines.

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Kyle M. Joseph, Jefferies LLC, Research Division - Equity Analyst [7]

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Sure. That's helpful. Then last one from me. Just in terms of credit, obviously, you guys -- NPAs were stable in the quarter. But can you give us an update on sort of revenue and EBITDA trends you're seeing from your portfolio of companies? And any changes you've seen this year?

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Gregory William Hunt, Apollo Investment Corporation - CFO & Treasurer [8]

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Yes. Sure. So we try to take a sample size. And I think as we've discussed in the past, we do our best to try to get at an organic number. But realistically, with the level of acquisition activity and the underlying obligors, sometimes it's tough to disaggregate.

I think the holistic comment is that on an absolute basis, revenue and EBITDA growth were high single digits. If we disaggregate -- on kind of a median adjusted basis -- if we try to disaggregate to what is organic, that's certainly less than that number, but still firmly positive. I think one takeaway, and it might have to do with the fact that maybe we're lapping some of these cost issues from a year-on-year basis, is we saw less margin pressure than we had in more recent quarters. Relatively speaking still tough, whether it be wages, commodity costs, but the level of pressure at certain of those -- of our underlying investments, some moderation there, which I think has to do with, if I'm to speculate, some lapping of the more difficult comps.

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Operator [9]

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And our next question from the line of Chris York from JMP Securities.

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Christopher John York, JMP Securities LLC, Research Division - MD & Senior Research Analyst [10]

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So I just want to begin with a couple of questions on life sciences lending. So Howard, it does seem that mid-cap has been quite active in the origination of life sciences loans year-to-date and that the opportunity set, as you said in the prepared marks, appears healthy and attractive because of your barriers. So the question I have is about portfolio management and maybe the max size today you would want life sciences loans to represent as a percentage of the total portfolio.

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Howard T. Widra, Apollo Investment Corporation - CEO & Director [11]

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Well, I mean our view of sort of life sciences space is that the key to keeping the credit performance pristine in that asset category, which it has been for us over time and for some people we would describe as our most sort of direct competitors, is to be circumspect about going too aggressively into the capital structure, which means that the market's only so big, right? So the opportunity to add loans in this space is probably not even as large as the percentage of the portfolio that we would be comfortable with it being.

In addition to the fact that obviously, whatever loan we do, mid-cap is doing a portion of and if there are bigger loans, other parts of Apollo could potentially be part of them as well. So what that all leads to is what we have sort of said before is for the BDC, for AINV, we'd like the asset base products and the life sciences' products to be 25% to 32% of our portfolio.

If we broke that down, we would think that life sciences would be 10% to probably 12% to 15%. We'd be very happy if we got there. We're moving towards a $3 billion portfolio, so that would be $300 million life sciences portfolio. That it would be -- I'd be hard-pressed to see the market being big enough for us to be able to get much more than that anyway. Does that all put together?

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Christopher John York, JMP Securities LLC, Research Division - MD & Senior Research Analyst [12]

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Very great color. Yes, yes. So I knew you had the 20 to 25 on an asset base kind of portfolio percentage basis, so the 10 to 12 is helpful and then the $300 million is very helpful as well.

And then I mean I guess kind of following up on that from the competitive environment for life sciences, there have been 2 newer entrants, and I'm -- "newer" in that area. Has that affected your business or maybe your opportunity set? Because you did partner with one of those lenders recently.

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Howard T. Widra, Apollo Investment Corporation - CEO & Director [13]

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Well, first of all, I'm not even sure who the 2 newer entrants are because our competition for these deals is not always just the people we're directly competing with on debt. We're sometimes competing with additional equity rounds, and we're certainly competing with like very aggressive debt lenders in lieu of equity. So if someone comes to us and they're either going to do debt or they're going to do a preferred, and so it's part of a broader capital raise. So there are more new entrants in terms of providing capital, these types of companies, than just ones that are doing venture debt as we describe it.

That said, if you look at the market today versus the market 3 or 4 years ago, there are more people in the market. And so there is some more competition. The combination, I think, of having been in the market for a long time, so having established sort of a really, really good set of relationship so we see our share of flow, combined with the fact that we have a couple arrows in our quiver, which other people don't have, which is one, we can do large commitments because of the combined balance sheets of Apollo available; and two, probably more importantly, we can provide revolvers to companies which have some revenue even if they're not profitable, which allows us to sort of grow with these companies as a revenue base grows, which a lot of people can't do, provides us with a little bit of protection versus that competition.

But for sure, I mean people in the market -- and if they're good -- and well, if they're good, it's actually not as bad as if they're not good. Because if they're not good early, they often do things that don't make sense and move to market. But there is more competition there, but it hasn't -- I wouldn't say it's changed things night and day.

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Christopher John York, JMP Securities LLC, Research Division - MD & Senior Research Analyst [14]

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Got it. Great, great color. Just to be clear from my side, I was speaking to Blackstone and then [SVP] as what I call newer entrants.

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Howard T. Widra, Apollo Investment Corporation - CEO & Director [15]

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Actually, we beat them there forever, right? I mean we do a lot of business with them. So...

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Christopher John York, JMP Securities LLC, Research Division - MD & Senior Research Analyst [16]

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Or the new Genesis is one. Okay. So -- and then the last one is a little bit different, it's on fundraising. So are you guys currently fundraising or considering fundraising in any complementary direct lending strategies, either SMAs or private funds today at the manager that could help benefit AINV via coinvestment?

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Howard T. Widra, Apollo Investment Corporation - CEO & Director [17]

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Well, Yes. Not only are we -- we have been. I mean -- and we haven't sort of done -- been very aggressive about sort of publicizing sort of the size of our direct origination platform across the board, but -- and we actually probably will release something soon. But we've raised billions of dollars of SMAs. That invest in the same type of assets that are in -- that are type of investment that AINV is coinvesting in. So it enables them continue to sort of take whatever size makes sense, $15 million, $20 million, $25 million of something that we are speaking for as a team for $200 million, $250 million and keep it diversified across the board. So we have raised over the past 18 months significant SMAs and intend to continue to be able to increase our servability to execute on larger transactions.

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Christopher John York, JMP Securities LLC, Research Division - MD & Senior Research Analyst [18]

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Got it. Very helpful and you got [ahead] of my question. I had heard some SMAs were being raised and I just hadn't seen any press releases like some other direct lenders did. So...

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Howard T. Widra, Apollo Investment Corporation - CEO & Director [19]

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Yes. I mean we've talked about it because we've seen so much -- press releases we haven't, we just figured we'd be in business and do our stuff. And mid-cap's big, Right? So mid-cap has $11 billion of commitments under management itself. So people know we have this large presence, but we haven't done as good a job of sort of publicizing that. But we will improve that in the near future.

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Operator [20]

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And our next question is from the line of Rick Shane from JPMorgan.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [21]

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Just want to talk about nonaccruals a little bit. They were down quarter-over-quarter on a fair value on cost basis. Curious what moved there and how you feel about the migration of the nonaccruals over the next 3 to 6 months.

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Tanner Powell, Apollo Investment Corporation - President & CIO of Apollo Investment Management [22]

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Yes. So that movement down -- obviously the denominator is changing a little bit. But in terms of absolute levels, we've just -- the partial repayments that we received on Crowne Automotive. As it relates to continued movement, tough to speculate. Still a pretty -- like we talked about, a pretty benign economic environment, but difficult to speculate there. Obviously, it will go without saying that these are the names that we're the most focused on and trying to bring to a resolution such that we can reinvest in yielding assets.

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Operator [23]

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And our next question is from the line of Robert Dodd from Raymond James.

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Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [24]

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If I can ask a question kind of about competition. When we look at the incremental spreads on first lien, I mean, obviously, 585 this quarter, I mean it's 599 last, and 639 the one before that. Can you give us any color on how much of that downtrend is competition versus maybe incremental derisking? Obviously, the attachment point is below 4 this quarter, which is the lower than your average and certainly the last couple quarters of incremental asset add-on even on the first lien side. So I mean how much of that spreads movement is deliberate derisking versus market competition?

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Howard T. Widra, Apollo Investment Corporation - CEO & Director [25]

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So it's probably not either. This is basically the dynamic. It's -- until April -- just April 4 of this year, we were not able to go over 1 to 1 leverage. So the screen with which -- we have a long-term view of sort of our level of assets that we're -- they're willing to do between 500 and 700. As we got closer to April, I knew that we were not going to sort of run up right against the limit. We basically increased the origination funnel to include all the things in that range as opposed to just sort of the higher end of the range, if you will. So all that is, is just more of the origination was slightly lower under the range, which is to say that you would expect over the next quarters for that to level off in this area -- in this level. So wasn't really the result -- the market really hasn't changed with regard to what we're doing. What we're choosing to do at the BDC is a little different, but it's actually not different than what the platform was doing overall. If that all makes sense. That's why you're seeing -- that's why you saw good growth this quarter. That's why we're telling you that already in this current quarter, we're seeing good growth, and we expect to continue to see it because now we're not as worried about the ceiling.

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Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [26]

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Got it. Got it. When -- and just kind of to tie onto that, I mean with the attachment point then if that was -- when you're weighing towards the lower end, will you open up to more lower end in that 500 to 700 range? Would it be fair to say that obviously is opening up potentially a lower attachment point as one would see on average and there's a lot of other dynamics, I realize, the attachment may be -- drift lower, and obviously, that implies incremental derisking of the portfolio as well.

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

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For sure. That's what you should see. You should see that obviously, the average hold size, you have already seen. That's derisking portfolio because that's granularity. But also, the credit metrics -- putting interest rates aside in terms of interest coverage, the average leverage, the percent of first lien, all of those should get incrementally better.

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Operator [28]

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And our next question is from the line of Christopher Testa from National Securities.

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Christopher Robert Testa, National Securities Corporation, Research Division - Equity Research Analyst [29]

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Last quarter, I know that the quoted prices and volatility in the liquid market had led NAV to decline. And NAV was up just very modestly, although your nonaccruals didn't increase. So were there some companies that had some idiosyncratic issues that you marked down in a significant way during the quarter?

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

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No. Last quarter. Most of our down last quarter was not from the liquid market.

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Christopher Robert Testa, National Securities Corporation, Research Division - Equity Research Analyst [31]

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It was not.

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

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Right. We probably have a book of -- in second lien -- primarily second liens, okay? So that $300 million of our book that basically was impacted by the drop on -- in the syndicated market -- syndicated market was probably off 500 bps. We were off less than 200 bps in our kind of a closed market per se. That rebounded somewhat this quarter, but not to the extent that you would see. And that's really because of those second liens. And there was one investment in there that was marked down from, let's say, 94 to 91 during the quarter that impacted the quarter-over-quarter comps. And then if you go back, you have to remember that the September quarter was also very strong in valuations. So -- and we have not recovered to that extent.

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Christopher Robert Testa, National Securities Corporation, Research Division - Equity Research Analyst [33]

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Got it. Okay. No, that is helpful. And given that you guys now obviously have the ability to go towards your target close to almost 1.5x, if you look at the portfolio today, is the current composition where you'd be comfortable at that level? Or should we assume that sort of the L+500 to 700 paper comprised of at least, I don't know, call it, 75% of the portfolio before you get towards the top end of the leverage range?

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Howard T. Widra, Apollo Investment Corporation - CEO & Director [34]

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No. Right. Okay. So the simple thing is to say to go from 90 to 140 would be all in similar assets to what you're seeing new this quarter. So that takes us from whatever it is 2 6 today to something like 3 1 or 3 2. $600 million of incremental assets, all in that number. In addition, though, we would hope as we're climbing that ladder, we're getting another sort of -- we're getting our core assets to shrink on an absolute basis and Merx to modestly shrink on an absolute basis. And so then there's also that. So then when the picture came through at the end of the day, you'd have 10% to 15% Merx. You'd have markedly less core assets, and then you had this corporate portfolio look like it looks today in terms of metrics and things like that, but it's obviously much bigger percentage as a whole.

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Christopher Robert Testa, National Securities Corporation, Research Division - Equity Research Analyst [35]

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Got it. Okay. That's helpful. And just a little bit on Merx. You guys have done a great job with diversifying the portfolio more. And in response to Chris York's questions earlier, said you're raising more money in SMAs. You're increasing your coinvest ability. But then you have Merx, you have a single name that's you're targeting 10%, 15% of the portfolio. And I understand it's a good company, and it's done great. But I mean just optically, do you think that, that's something that could potentially weigh on valuation? And is it something that you might revisit to maybe have as a smaller portion of the portfolio going forward?

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

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Well, so as we talked about at last call, right, we just -- we made a couple changes in order to sort of to be able to take advantage of a value that's been created there, but also address your question because there's no question that once we've moved off our noncore assets, that's the next question. Okay, you have this one concentrated position. How do I assess that risk. And so we're aware of that. It was at 20%. We targeted 10% to 15%, but ultimately, it could be less, but we don't want to throw the baby out with the bathwater. So for us, what we focused on is using the power of that platform to raise third-party money, build the servicing capabilities at Merx, which hopefully will retain a reasonable portion of the income but shrink the capital there.

So I think the answer is yes -- but we're not so focused on valuation. We're focused first on sort of the quality and we'll see -- we'll have the luxury of worrying about sort of what Merx does to valuation when we improve some of the other things. But ultimately, in the long-term, we have our eye on it. And so our hope is to monetize the value of Merx through raising third-party money in combination with Apollo getting fees off that, creating a stronger servicing platform getting fees off that, and then having the asset level there be small enough so nobody asks that question again.

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Christopher Robert Testa, National Securities Corporation, Research Division - Equity Research Analyst [37]

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Got it. No, that's really helpful. And last one, if I may. Just -- I know you have mentioned that going forward, you guys were looking to really only do floating rate debt to just basically not take interest rate risk, only credit risk. Aside from the obvious on the revolver, is doing middle-market securitization something you guys are evaluating given the largely first lien focus and obviously, the brand naming that the platform has?

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

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Yes. I mean we're certainly aware -- I mean we are one of sort of the larger issuers of CLOs at mid-cap and it's these exact assets that go in there. So we definitely have exactly the benchmark for what would work in terms of what the alternatives are. So it's definitely something we're aware of. I wouldn't necessarily expect in the short-term only because we have undrawn debt capacity, which is not vastly different in cost. And certainly, we would have unused line cost related to it. It's nominally cheaper to do the CLO with a little higher leverage but it doesn't drive all that much earnings power, if any, because of our unused commitments we have.

So we are -- it sort of something we have. We do issue CLOs at -- off the mid-cap platform, which is sort of people can look at and see what they could expect us to execute at and then it executes basically at the best execution of middle-market CLOs. So we feel like we have that available to us.

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Operator [39]

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(Operator Instructions) Our next question comes from the line of Casey Alexander from Compass Point.

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Casey Jay Alexander, Compass Point Research & Trading, LLC, Research Division - Senior VP & Research Analyst [40]

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Based upon your known prior losses, just looking straightforward, how long would the total return requirement eliminate incentive fees going forward from this quarter?

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Gregory William Hunt, Apollo Investment Corporation - CFO & Treasurer [41]

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Well, I think we -- at the current -- you just take a look at where we are. I mean you can kind of take a look at this, Casey, looking from 4 1 forward. You can look at the accumulated losses from that. I think there are about $55 million. You can multiply that X the incentive rate. You can get a sense of what our run rate is. So you know our earnings are at about $30 million a quarter. So that's without any losses. So if you kind of take that versus a $55 million number that, that's kind of carrying forward, we will kind of in effect -- our next quarter have some benefit from that carryover of the incentive fee credit essentially because of the losses, but then probably move out of that into the third quarter.

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Howard T. Widra, Apollo Investment Corporation - CEO & Director [42]

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So we have the $55 million, and 20% of that is $11 million, $6 million or $7 million of that was credited in the first quarter. So there's still -- it's tough -- if performance -- if nothing else changes this quarter, there's another 4, I don't know what it is, $4 million, $4.5 million of benefit in the second quarter.

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Casey Jay Alexander, Compass Point Research & Trading, LLC, Research Division - Senior VP & Research Analyst [43]

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Okay. That's what I was looking for. If I'm hearing right, as it relates to the oil, energy and tanker assets, there was no movement in those other than regular mark-to-market. There were no exits of any of those noncore assets.

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Howard T. Widra, Apollo Investment Corporation - CEO & Director [44]

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There's a very small dividend on one of them, that's correct. We hope to have more meaningful progress in the next few quarters. We're still very focused on it and feel like -- I mean we're hopeful to make real progress over the next couple of quarters.

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Operator [45]

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And our next question is from the line of Finian O'Shea from Wells Fargo.

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Finian Patrick O'Shea, Wells Fargo Securities, LLC, Research Division - Associate Analyst [46]

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Just first one on now we have a more accelerated shift into more senior assets, seemingly pretty straightforward lower spread, lower leverage. Can you kind of talk about the opposite, the higher spread market or segment? Are you completely kind of moving on for the time being? Or are you maintaining some form of presence in those higher risk areas?

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Howard T. Widra, Apollo Investment Corporation - CEO & Director [47]

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Yes. Look, I mean we are not out of it forever. We think there is an investment strategy for AINV that requires this type of execution for an extended period of time so investors get a sense of the stability. The risk/reward proposition in that market is not appealing to us right now because even though yield might even held up there, the credit metrics are just so out of whack. So we see those deals all the time definitely on the platform. There are occasionally times when we make choices, and there are even sort of some that we would do at the BDC if we decided to win them and do them and do a bought second lien on a really stable company that looks really solid. So I wouldn't say we would never do it. But there isn't that much of a need in a sponsor world to sort of be really active in that space in order to sort of continue to see those opportunities because in almost every case where someone is contemplating a second lien, they're also contemplating a unit tranche. And so they're looking at financing options across those deals.

So you should expect to not see very much of it, but you -- I wouldn't be shocked if you saw one at some point. And then as we stabilize and as the market changes, we certainly think it could potentially fit the opportunity. But first, we want to sort of set the table very solidly before we get to that point.

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Finian Patrick O'Shea, Wells Fargo Securities, LLC, Research Division - Associate Analyst [48]

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Got it. And then just one more on the BDC and the platform. So you have a pretty good array of vehicles under -- in the direct lending platform. And we can all see the world's going -- you and many of your peers are going toward permanent capital. So is it something to think about as to your hopes or intentions to bring any private fund vehicles into Apollo, into the BDC? Should we kind of think of -- look to something like that down the line?

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Howard T. Widra, Apollo Investment Corporation - CEO & Director [49]

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You mean as part -- as like a JV of the BDC?

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Finian Patrick O'Shea, Wells Fargo Securities, LLC, Research Division - Associate Analyst [50]

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To merge into the BDC.

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Howard T. Widra, Apollo Investment Corporation - CEO & Director [51]

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Yes. No, I mean I don't think so. Obviously, anything that may make sense down the road that's opportunistic, we would potentially do, but nothing that seems imminent certainly or even sort of medium-term. I mean never say never.

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Operator [52]

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And your last question is a follow-up from Robert Dodd from Raymond James.

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Robert James Dodd, Raymond James & Associates, Inc., Research Division - Research Analyst [53]

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Yes. Just actually, literally a follow-up on the last one. Howard, obviously, you mentioned the average borrower's exposure [damage is], your average on the corporate debt side now, it's about a 1% position, it was about 1.5% a year ago. With the SMA capital, et cetera, you've got more pockets you can put that into as well. So potentially bringing down EBIT even further and adding more diversity, and as you said, another layer -- another level to derisk. So what's your target, if you have one, on kind of average position size long term for AINV?

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Tanner Powell, Apollo Investment Corporation - President & CIO of Apollo Investment Management [54]

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Yes. And so you alluded to the 1.5% going to the 1%. I think the 1% is a good operating assumption. Clearly, as we hopefully continue to post positive net origination and we approach that $3 billion number that Howard alluded to earlier that naturally will mean slightly bigger hold sizes, but same kind of percentage. And I think directionally, that's right. The other thing just to expand on for a second is, as you could probably appreciate in this type of market, certainty to the counter-party that you're interfacing with is of paramount importance. So we don't look at the incremental capital raised as necessarily cannibalizing the AIC opportunity. We more broadly look to that gives us the opportunity to commit to bigger deals, provide that much more certainty and are comfortable, especially because AIC at that 1% level is not a number that would overwhelm the type of availability such that we think of it as additive.

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Operator [55]

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And I'll now turn the call back over to management for closing remarks.

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Howard T. Widra, Apollo Investment Corporation - CEO & Director [56]

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Thank you. On behalf of the 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 questions. Have a good night.

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Operator [57]

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Ladies and gentlemen, this does conclude our conference call for today. We thank you greatly for it. You may now disconnect.