Saratoga Investment Corp.: Navigating the Middle-Market with Diversified Investments

Saratoga Investment Corp. is a Maryland-based business development company (BDC) that has elected to be regulated as an investment company under the Investment Company Act of 1940. The company’s primary investment objective is to generate current income and long-term capital appreciation through investments in senior and unitranche leveraged loans and mezzanine debt issued by private U.S. middle-market companies.

Corporate History and Structure

Saratoga Investment Corp. commenced operations in 2007 and completed an initial public offering the same year. In 2010, the company engaged Saratoga Investment Advisors as its new investment adviser and changed its name from GSC Investment Corp.

The company has formed two wholly-owned subsidiaries, Saratoga Investment Corp. SBIC II LP and Saratoga Investment Corp. SBIC III LP, which have received licenses from the Small Business Administration (SBA) to operate as Small Business Investment Companies (SBICs). These SBIC subsidiaries provide up to $175 million each in long-term capital in the form of SBA-guaranteed debentures.

Saratoga Investment Corp. has also formed special purpose entities, Saratoga Investment Funding II LLC and Saratoga Investment Funding III LLC, to enter into senior secured revolving credit facilities with Encina Lender Finance, LLC and Live Oak Banking Company, respectively. These credit facilities provide additional sources of financing to support the company’s investment activities.

Furthermore, Saratoga Investment Corp. has a joint venture, Saratoga Senior Loan Fund I JV LLC, with TJHA JV I LLC, which invests in a diversified portfolio of broadly syndicated first lien and second lien term loans or bonds.

Investment Portfolio and Composition

As of August 31, 2024, Saratoga Investment Corp.’s investment portfolio consisted of 133 investments across 50 portfolio companies, with an average investment size of $7.8 million and a weighted average maturity of 2.2 years. The portfolio is primarily composed of first lien term loans (85.2%), with smaller allocations to second lien term loans (2.5%), unsecured term loans (1.6%), structured finance securities (2.2%), and equity interests (8.5%).

The company’s investment portfolio is well-diversified across 41 different industries, with the top sectors being Healthcare Software (11.9%), Healthcare Services (6.6%), Consumer Services (5.8%), HVAC Services and Sales (5.7%), and Real Estate Services (5.0%).

Geographically, the portfolio is concentrated in the Midwest (30.2%), Southeast (29.6%), and West (16.7%) regions of the United States.

Financial Performance

Saratoga Investment Corp.’s total investment income for the three months ended August 31, 2024 was $43.0 million, up 21.1% from $35.5 million in the same period the previous year. This increase was primarily driven by a 21.7% rise in interest income from investments, which reached $39.4 million. The weighted average current yield on the company’s investments increased to 11.5% as of August 31, 2024, up from 11.3% a year earlier.

For the six months ended August 31, 2024, total investment income grew 16.4% to $81.7 million, with interest income from investments increasing 19.0% to $73.7 million. The higher investment income was largely due to the recognition of $7.9 million in interest income related to the Knowland investment, which was previously on non-accrual status.

On the expense side, total operating expenses for the three and six months ended August 31, 2024 increased by 15.1% and 22.2%, respectively, compared to the same periods in the prior year. The primary drivers were higher interest and debt financing expenses, as well as an increase in incentive management fees.

Saratoga Investment Corp. reported a net increase in net assets resulting from operations of $13.3 million, or $0.97 per share, for the three months ended August 31, 2024, compared to a net increase of $7.9 million, or $0.65 per share, in the same period a year earlier. For the six-month period, the net increase was $19.9 million, or $1.45 per share, compared to $7.7 million, or $0.64 per share, in the prior-year period.

Portfolio Performance and Credit Quality

The company’s investment portfolio continues to demonstrate strong credit quality, with 89.6% of investments at fair value rated “green” (performing) as of August 31, 2024, compared to 87.8% as of February 29, 2024. Investments rated “yellow” (underperforming) decreased from 1.1% to 0.0%, while those rated “red” (in default) decreased from 0.6% to 0.2% over the same period.

Saratoga Investment Corp.’s investment in the subordinated notes of the Saratoga CLO, a collateralized loan obligation fund, had a fair value of $5.8 million as of August 31, 2024, representing 0.6% of the total portfolio. This investment constitutes a first-loss position in a portfolio of predominantly senior secured first lien term loans.

Liquidity and Capital Resources

Saratoga Investment Corp. intends to continue generating cash primarily from operations, including interest income, as well as through the Encina Credit Facility, the Live Oak Credit Facility, and future issuances of debt and equity securities. The company’s asset coverage ratio, a measure of leverage, was 159.6% as of August 31, 2024, providing ample room for additional borrowings.

The Encina Credit Facility, with a current borrowing capacity of up to $65.0 million, and the Live Oak Credit Facility, with a current borrowing capacity of up to $75.0 million, provide the company with flexible and cost-effective sources of financing to support its investment activities.

In addition, Saratoga Investment Corp.’s SBIC subsidiaries have access to up to $175.0 million each in long-term, low-cost capital in the form of SBA-guaranteed debentures, further enhancing the company’s liquidity and funding capabilities.

The company has also been active in the unsecured debt markets, issuing a variety of notes with maturities ranging from 2025 to 2028 and interest rates between 4.35% and 8.75%. As of August 31, 2024, the company had a total of $458.9 million in unsecured notes outstanding.

To fund future growth, Saratoga Investment Corp. may raise additional capital through various sources, including the equity markets and other public and private debt-related markets, subject to market conditions and regulatory constraints.

Dividend Distributions and Equity Capital Activities

Saratoga Investment Corp. has a history of providing consistent dividend distributions to its shareholders. Since its inception, the company has paid a total of $106.91 per share in dividends. For the tax year ended February 28, 2025, the company has declared dividends totaling $2.21 per share.

The company has also been active in repurchasing its own shares, having purchased 1,035,203 shares at an average price of $22.05 per share under its Share Repurchase Plan as of August 31, 2024.

Additionally, Saratoga Investment Corp. has an active Equity ATM Program, under which it has sold 6,543,878 shares for gross proceeds of $172.5 million as of August 31, 2024, providing a flexible source of equity capital to support the company’s growth initiatives.

Outlook and Conclusion

Saratoga Investment Corp. has demonstrated its ability to navigate the middle-market investment landscape, delivering consistent financial performance and maintaining a well-diversified portfolio of high-quality investments. The company’s access to a variety of financing sources, including credit facilities, SBA-guaranteed debentures, and the unsecured debt markets, provides it with ample liquidity to support its investment activities and growth plans.

Looking ahead, Saratoga Investment Corp. is well-positioned to continue capitalizing on opportunities in the middle-market, leveraging its experienced management team, robust investment pipeline, and disciplined underwriting approach. The company’s focus on generating current income and long-term capital appreciation, combined with its commitment to shareholder value creation, makes it an attractive investment proposition for investors seeking exposure to the middle-market lending space.