Saratoga's Q2 2026 Earnings Call: Contradictions Emerge on Dividend Coverage, AI Impact, Liquidity Strategy, and CLO Investments

The above is the analysis of the conflicting points in this earnings call

Guidance:

• Declared Q3 FY26 dividend of $0.75 ($0.25/month) for the quarter ending November 30, 2025.
• Subsequent to quarter end, about $42.7M of new originations in three new portfolio companies and two follow-ons are closed or in closing.
• Liquidity/capacity totals $406.8M (incl. $201M cash), enabling ~41% AUM growth without external financing.
• Expect lower middle market M&A to eventually revert; deal flow increasing; will deploy capital prudently and remain disciplined on underwriting.
• Anticipate BBB (and some BB) CLO debt to play an increased role in the portfolio.
• All $296M of baby bonds (6%+) are callable, providing flexibility if rates decline.

Business Commentary:

• Portfolio Performance and NAV Growth:
• Saratoga Investment Corp's core non-CLO portfolio increased by $3.9 million in fair value, with the overall total portfolio fair value increasing by $3.8 million during the quarter.

• The growth was driven by improvements in the financial performance of portfolio companies and strategic investments in new BBB and BB CLO debt securities.

• Net Interest Margin and Originations:

• The company's net interest margin decreased from $15.1 million to $13.1 million, primarily due to a decrease in non-CLO interest income and lower yielding new originations.

• Despite this, the company originated $52.2 million, including $26.3 million in BBB and BB CLO debt investments, reflecting continued investment activity in attractive opportunities.

• Credit Quality and Non-Accrual Investments:

• The overall portfolio non-accrual status improved, with only one investment, Pepper Palace, representing 0.2% of fair value and 0.3% of cost.

• The improved credit quality is attributed to the successful restructuring of ZOLLEG, which returned to accrual status, and active management of portfolio investments.

• Dividend and Shareholder Returns:

• Saratoga declared a $0.75 per share dividend for the quarter, representing a 12.3% yield based on its stock price of $24.41.
• The company's long-term realized and unrealized returns on all capital invested equal 13.5%, indicating the strong performance of its investment strategy despite macroeconomic challenges.

Sentiment Analysis:

• Adjusted NII per share was $0.58, down 56.4% YOY and 12.1% QOQ; dividend under-earned by $0.17. Net interest income fell as assets and base rates declined. Offsetting positives: NAV rose to $410.5M (up 10.3% YOY, 3.6% QOQ), LTM ROE 9.1% above industry, and non-accruals reduced to 0.2% of fair value after ZOLLEG returned to accrual. Management cites $406.8M of liquidity and increasing pipeline, with ~$42.7M of post-quarter originations in process.

Q&A:

• Question from Erik Zwick (Lucid Capital Markets): What levers will improve dividend coverage amid lower short-term rates, and how big a priority is it?
  Response: Maintain strict underwriting while deploying substantial dry powder as M&A recovers; increased originations should close the NII–dividend gap without compromising credit.

• Question from Erik Zwick (Lucid Capital Markets): Are larger competitors moving down-market a temporary phenomenon?
  Response: Likely temporary; their scale doesn’t fit $20–$30M deals, and they should move back up-market as activity returns.

• Question from Erik Zwick (Lucid Capital Markets): Any near-term equity realization opportunities?
  Response: Marks reflect fair value; expect steady, portfolio-wide equity gains via co-investments rather than near-term outsized realizations.

• Question from Casey Alexander (Compass Point Research): Term sheets up but deals executed down—are competitors winning on price/terms?
  Response: Yes; spreads compressed and covenants loosened; Saratoga is avoiding weak structures, focusing on relationship-driven, non-commoditized deals and expanding business development.

• Question from Casey Alexander (Compass Point Research): Why invest in CLO structured debt when investor history is mixed?
  Response: They are BBB/BB debt tranches (not equity), across top managers, offering comparable portfolio returns with diversification and liquidity; used opportunistically and sized prudently.

• Question from Casey Alexander (Compass Point Research): Why not reset the dividend given under-earning?
  Response: Prefer to maintain dividend while deployment ramps; have spillover income and see improving pipeline to close the coverage gap.

• Question from Robert Dodd (Raymond James): How large could CLO debt positions become over 12 months?
  Response: Currently ~5% of portfolio; comfortable being larger (potentially ~2x) but no hard target—allocations will be opportunistic.

• Question from Robert Dodd (Raymond James): Risk that covenant-light terms persist even if large players leave?
  Response: Will hold the line; aggressive structures typically underperform in this segment, and competitors usually retreat after setbacks.

• Question from Christopher Nolan (Latimer Thalmann & Company): What is the current spillover income?
  Response: Approximately $2.00–$2.50 per share remains.

• Question from Christopher Nolan (Latimer Thalmann & Company): Is the ~12.2% CLO yield GAAP, and what’s included?
  Response: It’s the blended effective yield across all CLO-related instruments (BDC CLO F note, JV E note, and BBB/BB CLO debts).

• Question from Christopher Nolan (Latimer Thalmann & Company): Is AI a threat to your software borrowers?
  Response: Underwriting emphasizes high-retention, workflow-critical, system-of-record software; AI is evaluated as both risk and enhancer on each deal.

• Question from Christopher Nolan (Latimer Thalmann & Company): How will you handle upcoming debt maturities amid rate uncertainty?
  Response: Multiple internal options and ample liquidity; can refinance or repay without accessing external markets.

• Question from Mickey Schlein (Clear Street, LLC): How can you extract cash from SBICs?
  Response: Can take undistributed reserves and draw undrawn debentures to reimburse prefunded assets; SBIC dividends are also an option.

• Question from Mickey Schlein (Clear Street, LLC): Why increase exposure to Comfort Care?
  Response: Business has strong tailwinds and franchisor economics; low LTV with robust performance and close monitoring justify the upsizing.

• Question from Mickey Schlein (Clear Street, LLC): What was the third follow-on last quarter?
  Response: A small equity follow-on in Modus Dental.

• Question from Mickey Schlein (Clear Street, LLC): What drove the non-CLO portfolio markup—multiples or performance?
  Response: Roughly half market multiples and half company performance.

• Question from Mickey Schlein (Clear Street, LLC): Why continue raising equity given high liquidity?
  Response: Long-term strategy to scale, improve trading liquidity, and invest when possible; insider ownership aligns incentives.

• Question from Mickey Schlein (Clear Street, LLC): Would you acquire another BDC for growth?
  Response: Prefer organic growth; would consider quality portfolios, but avoid acquiring problematic books that demand long, resource-heavy workouts.