Owl Rock Capital Corporation (NYSE:ORCC) Q3 2020 Earnings Conference Call November 5, 2020 10:00 AM ET


Dana Sclafani – Head of IR

Craig Packer – CEO

Alan Kirshenbaum – CFO, COO


Robert Dodd – Raymond James

Ryan Lynch – Keefe, Bruyette & Woods

Mickey Schleien – Ladenburg

Casey Alexander – Compass Point

Kenneth Lee – RBC Capital

Derek Hewett – Bank of America


Good morning, and welcome to Owl Rock Capital Corporation’s Third Quarter 2020 Earnings Call. I would like to remind our listeners that remarks made during the call may contain forward-looking statements. Forward-looking statements are not guarantees of future performance or results and involve a number of risks and uncertainties that are outside the company’s control.

Actual results may differ materially from those in forward-looking statements as a result of a number of factors, including those described from time to time in Owl Rock Capital Corporation’s filings with the Securities and Exchange Commission. The company assumes no obligation to update any forward-looking statements. [Operator Instructions]

Yesterday, the company issued its earnings press release and posted an earnings presentation for the third quarter ended September 30, 2020. This presentation should be reviewed in conjunction with the company’s Form 10-Q filed on November four with the SEC. The company will refer to the earnings presentation throughout the call today.

So, please have that presentation available to you. As a reminder, the earnings presentation is available on the company’s website.

I will now turn the call over to Craig Packer, Chief Executive Officer of Owl Rock Capital Corporation.

Craig Packer

Thank you, operator. Good morning, everyone, and thank you for joining us today for our third quarter earnings call. This is Craig Packer, and I’m CEO of Owl Rock Capital Corporation and a co-founder of Owl Rock Capital Partners. Joining me today is Alan Kirshenbaum, our CFO and COO; and Dana Sclafani, our Head of Investor Relations.

Welcome to everyone who is joining us on the call today. We hope you and your families remain safe and well. I will start today’s call by briefly discussing our financial highlights for the third quarter before providing an update on our portfolio and deal activity in the quarter. Then after Alan covers our financial results, I will discuss our outlook and make some closing remarks.

Getting into the third quarter financial highlights. Net investment income per share was $0.33. We ended the quarter with net asset value per share of $14.67, up $0.15 from the second quarter. We are pleased to report the second consecutive quarterly increase in the fair value of the portfolio since the end of March.

Looking forward for the fourth quarter, our Board has declared a dividend of $0.31 per share, the same amount we have paid each quarter since our IPO and which is in addition to the previously declared special dividend of $0.08 per share. As planned, the fourth quarter special dividend will be the final of our previously declared special dividends that were put in place as part of our IPO in 2019.

Regarding our balance sheet, we remain very well capitalized with $1.8 billion of liquidity. We ended this quarter with leverage of 0.72 times, reflecting an increased pace of originations in the quarter. We are seeing improving levels of deal activity and continue to expect to achieve leverage within our targeted range of 0.9 to 1.25 times by the second half of 2021.

As announced in our earnings release yesterday, our Board has authorized a new share repurchase program for up to $100 million of our stock over the next 12 months, which we may purchase in the open market on an opportunistic basis. We believe this is a valuable tool for us to have going forward. Turning to the portfolio. We are pleased with the overall credit performance to date which, by and large, has come in toward the higher end of potential outcomes we could have hoped for given the economic environment.

This quarter, many of our borrowers saw improved operating metrics and revenues in line with the broader economic reopening. We also implemented cost savings measures, which improved profitability. Broadly speaking, we are seeing economic activity return to a more normalized pace, approaching pre-COVID levels. Our internal credit ratings metrics are consistent with last quarter.

Names in our one or two rating categories, which are names performing in line with or exceeding our expectations at the time of underwriting, continued to comprise approximately 88% of the fair value of the portfolio. The vast majority of our portfolio continues to demonstrate solid financial performance and has proved to be resilient in the face of a challenging economy.

The percentage of our lower-rated names, rated 3, four or 5, which are underperforming expectations, is 12% of fair value, largely unchanged from last quarter. While there is always some natural movement between ratings categories, we are pleased that the number of underperforming credits has stabilized.

Most of our credits are seeing improving results and many are exceeding their revised COVID budgets while there certainly — there are certainly a few which will have a longer road to recovery. As of quarter end, 109 of our 110 portfolio companies were current on their interest. We currently have two names on nonaccrual status.

Swipe Acquisition Corp., which we added to nonaccrual status this quarter is not current on its interest. We are finalizing discussions with Swipe regarding a long term solution, which, if completed, would include Owl Rock becoming the controlling shareholder and providing the company with the necessary support to execute its operational plan and growth strategy.

CIBT Global, which was added in the second quarter, remains current on its interest with a portion paid in cash and a portion in PIK. These two investments represent less than 1.5% of the total fair value of the portfolio, which is consistent with our nonaccruals last quarter. One name I’d like to spend a minute on is National Dentex, which was placed on nonaccrual status in the second quarter but was placed back on accrual status this quarter.

As this is one of the first challenged credits we’ve had in our portfolio, I’d like to walk through the situation and ultimate outcome. National Dentex, which shows as GeoDigm Corporation on our schedule of investments, is a leading dental lab business that serves dentists across the U.S. The company was significantly impacted by the shutdown of dentist offices, and the subsequent financial impact resulted in it being placed on nonaccrual.

However, it has rebounded nicely in recent months as dentist offices have reopened. We worked very closely with the sponsor and the Dentex management team to embark on a sale process of the company, which I’m pleased to announce has had a successful outcome. In October, National Dentex agreed to be sold to a new private equity firm. This transaction closed last week, and our loan was repaid at par, which will result in the full reversal of the unrealized loss we had taken.

We are pleased with the outcome of this process. We believe it reflects the underlying strength of our portfolio of companies, even those which underperform. While every situation is unique, we believe National Dentex demonstrates the downside protection we strive for when we invest.

In addition, as we’ve continued to grow the team over the last year, we have invested in our portfolio management and workout resources and believe that this outcome reflects the strength of our team and our ability to work through challenging situations. After heightened amendment activity in the second quarter, we saw a reduction in the number of amendment requests with three material amendments this quarter down from eight in the second quarter.

Similar to the themes we discussed last quarter, we saw a limited number of requests for covenant relief for a defined period of time in exchange for higher economics representative of the borrower’s current risk profile. No additional borrowers were moved to PIK interest in the quarter, and PIK interest continues to represent less than 5% of total investment income.

Looking forward, we may see some amendment requests from additional borrowers. But largely, we feel that we have addressed those situations in which borrowers were most impacted by the economic shutdown and that we provided we have provided sufficient runway for those businesses to operate and recover. While we remain cautious given the broader economic uncertainty, we have been pleased with the pace of recovery our borrowers have experienced to date.

Moving on to investment activity. We entered the quarter with a very cautious posture. But at the period we’re on, we saw both an economic rebound and an increase in deal activity. We were able to capitalize on this activity, and we’re pleased to close on a number of attractive new investments. Gross originations for the quarter were $844 million with net funded originations of $599 million, which was up from net funded activity of $142 million in the second quarter.

We had $48 million of repayments, noting there were no full repayments this quarter. We do expect to see an increase in repayments over time. Certainly, COVID and the economic disruption has impacted repayment catalysts for the near term. Overall, we added eight new portfolio companies and serve as the administrative agent on the majority of the origination volume this quarter.

Largely all of our origination volume was for new borrowers as we saw less add-on at volume for existing portfolio companies. We do expect to see add-on volumes increase in the next few quarters as we are seeing many of our portfolio companies return to more normal operating levels, and strategic discussions are picking back up.

We are pleased with the investments we closed this quarter, which we believe offer compelling economic and structural terms for businesses, which have proven to be resilient in the current economic climate. I’d note that the weighted average spread of new investments this quarter was roughly 720 basis points. I’d like to highlight two of the investments which closed this quarter.

Across the Owl Rock platform, we committed as the sole lender to a $410 million first lien facility to support the acquisition of Sonny’s Enterprises by Genstar Capital. Sonny’s is a leading provider of equipment and supplies to conveyor car wash operators in the U.S., a sector which has continued to demonstrate strong performance during the COVID crisis.

The facilities are attractively priced at L plus 700 with a 1% LIBOR floor and benefit from strong call protection. We are pleased to once again demonstrate our ability to provide sizable commitments and serve as a one-stop financing provider.

Another name worth highlighting was our investment in the $250 million second lien term loan for Shearer’s Foods, the company, which is owned by the Ontario Teachers’ Pension Plan, is a leading contract manufacturer of snack foods in the U.S. Consistent with our approach to second lien investments, we believe Shearer’s was an attractive investment due to significant EBITDA and low loan to values.

While second liens have been a more modest portion of our portfolio to date, in the current market, we are seeing increased demand from private equity firms in directly placing second liens. We believe these opportunities were done for the right credit profile, can offer attractive risk-adjusted returns.

Our portfolio at quarter end now stands at $9.9 billion across 110 portfolio companies. We feel that the performance of the portfolio during COVID has validated where we have focused, primarily first lien investments in upper middle market, recession-resistant sponsor-backed businesses.

Now I’ll turn it over to Alan to discuss our financial results in more detail.

Alan Kirshenbaum

Thank you, Craig. Good morning, everyone. It’s great to be speaking with everyone again, and I’d like to wish everyone the best in these continued unusual times. Thank you very much for your partnership and support of our business. To start off, I’ll refer to our earnings presentation, starting with slide seven. You can see that we ended the third quarter with total portfolio investments of $9.9 billion, outstanding debt of $4.3 billion and total net assets of $5.7 billion.

Our net asset value per share increased to $14.67 as of September 30 compared to $14.52 as of June 30. We ended the quarter with leverage of 0.72 times debt-to-equity and $1.8 billion in liquidity. Our dividend for the third quarter was $0.31 per share plus an $0.08 per share special dividend, and our net investment income was $0.33 per share.

On the next slide, slide eight, I’m going to talk through in a bit of detail the results of our revenues and expenses for the third quarter. You can see total investment income for the third quarter was $187 million, down slightly from $190 million last quarter. This $3 million decline was driven by three items. We saw a $4 million decline in other income and other fees during the third quarter largely driven by fewer amendments and repayments, as Craig touched on earlier.

The next item is in connection with us putting Swipe Acquisition Corp. to on accrual this quarter. As of June 30, Swipe was operating in forbearance as we were in constructive negotiations with the sponsor on a comprehensive amendment. We had Swipe on accrual status as of June 30 as we were awaiting the receipt of our interest payment. Because this was on accrual, we recognized income in the second quarter.

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As of September 30, the amendment had not closed, and as a result, we placed Swipe on nonaccrual status. Due to this, we did not recognize any income associated with this portfolio company in the third quarter. And in addition, we reversed the income we had recognized in the second quarter.

The income for each quarter represented a little over $3.5 million or $0.01 per share per quarter. So this reduced third quarter NII by a little over $7 million or approximately $0.02 per share.

Lastly, we only saw an increase of approximately $8 million in interest income from our investments. Although our portfolio increased in size this quarter, almost half of our originations were toward the end of September, so not driving interest income up as much as if the originations were weighted throughout the quarter.

In 4Q, we’ll see a pickup of interest income driven in part by now having a full quarter of interest income for our 3Q originations. So as you can see, the net of all this is the $3 million decline in investment income this quarter. To hit the expense side briefly, net expenses were roughly flat quarter-over-quarter.

In 2Q, we had a onetime noncash item that increased interest expense. Stripping that out, interest expense is up quarter-over-quarter driven by increasing leverage in the third quarter. These two items basically net out. Hence, expenses are roughly flat quarter-over-quarter.

So, pulling the lens back a bit. We continue to make good progress toward earning our dividend and are on track to achieve our target leverage by the second half of 2021. We expect to continue to pay our regular dividend of $0.31 per share and would anticipate returning a modest amount of capital in the interim.

So, to wrap up our financial results discussion, I’ll mention a few other quick items. As a result of the fair value of our portfolio increasing from 95.1% to 96%, we had $88 million of net unrealized gains during the third quarter. Our other operating expense ratio continues to be among the lowest in the industry at 22 basis points on a trailing 12-month basis, and our undistributed distributions as of September 30 is $0.05 per share.

A few final closing comments before handing back over to Craig. We continue to be well positioned in the industry given the strength of our balance sheet. Our three structural pillars of low leverage, significant liquidity and unsecured debt, continue to provide us and our stakeholders comfort in the strength of our balance sheet.

We very intentionally have built a well-diversified financing landscape, diversifying the number of facilities we have, the types of facilities and number of lenders we partner with. Matching duration between the left and right sides of our balance sheet is another important aspect of our landscape. Our weighted average debt maturity is over six years, and we do not have any debt maturities until June of 2023.

We continue to have one of the lowest leverage levels in the industry at 0.72 times debt to equity. As of September 30, we had $1.8 billion of liquidity. In total now, we have issued $2 billion of unsecured debt, which brings us to a current funding mix of 45% unsecured debt. Because of this, we continue to have a meaningful amount of excess collateral for our secured facilities, and we continue to have a significant cushion to our new regulatory asset coverage of 150%.

As we have previously mentioned, our updated target leverage ratio is 0.9 to 1.25 times debt to equity. Overall, our funding profile continues to be very sound, and we continue to be in a very good position. Thank you all very much for your support and for joining us on today’s call. Craig, back to you.

Craig Packer

Thanks, Alan. I will close with some thoughts on the current market and competitive landscape and touch on some of the earnings levers we have in the business. The increased level of deal activity we experienced in the third quarter has carried into the fourth quarter so far. Improving economic conditions and strong markets have stimulated M&A activity for private equity firms.

We are seeing private equity firms commence sale processes for portfolio companies, resume acquisition plans and seek financing solutions for refinancings and liquidity needs. As a result, we are pleased with the current opportunity set and are having significant dialogue around new lending opportunities.

We believe borrowers and sponsors continue to appreciate the value of execution certainty, which is provided by a direct lending solution, especially with the continued economic uncertainty. In particular, our ability to provide large-scale and flexible solutions is a significant competitive advantage. Our strong balance sheet and liquidity make us a preferred lending partner.

Certainly, over the last several months, syndicated market conditions have strengthened as a result of the Fed monetary stimulus which can impact terms for larger companies. The terms we are seeing on new opportunities are more attractive than those of the pre-COVID market. However, we have seen some spread compression from the widest levels we saw during the height of COVID.

We remain disciplined and are excited by the pipeline of opportunities we’re seeing, which we believe will allow us to prudently deploy capital into compelling opportunities at attractive yields. Before I close, I wanted to discuss some of the levers we have to drive higher earnings over the next several quarters. Many of these were on display this quarter.

The biggest driver is the continued growth in our portfolio.

This quarter, we again demonstrated our origination strength, and continued portfolio growth will allow us to achieve our target leverage by the second half of 2021. We were able to originate loans at higher spreads over the past two quarters and hope to continue to lift our overall portfolio spread as we continue to deploy capital into new investments.

As existing higher quality but lower-yielding investments get repaid, we expect to redeploy that capital into higher yields, also increasing the portfolio spread. As we amend loans, we typically receive additional economics often from increased spread on the loans. Lastly, as the markets recover, we expect to have increased repayments, resulting in increased income and prepayment fees.

Taking all these factors into consideration, we feel confident that there are a number of levers in our portfolio that will allow us to achieve our full earnings potential in 2021. Of course, along with that, our core focus remains on the credit quality of our portfolio, which remains quite strong. We are very pleased with where our portfolio sits at this point in the economic recovery, which is at the upper end of what we could have hoped for.

We believe we are well positioned to be a direct lender of choice and to continue to deliver attractive risk-adjusted returns to our investors. In closing, thank you for joining us today. We appreciate your continued interest and support and look forward to keeping you apprised of our progress. On behalf of the entire Owl Rock team, we hope each of you and your families remain safe and well.

Operator, please open the line for questions.

Question-and-Answer Session


[Operator Instructions] Your first question comes from the line of Robert Dodd of Raymond James.

Robert Dodd

Hi, guys. Just looking at those drivers that you talked about, Craig, can you give us obviously, you’ve given us an outlook on portfolio growth when you can get to target leverage and the capacity to cover the dividend essentially relies on that plus basically prepayment activity.

Obviously, it was essentially negligible this quarter. Typically, if M&A is picking up and there’s a lot of private equity activity, somebody’s origination is somebody else’s repayment. What’s your outlook for repayment I mean how fast can that ramp back up to kind of a normalized level?

Because obviously, that’s a significant delta in earnings power from quarter-to-quarter. And to the point where you can cover the dividend is largely contingent on repayment activity, not just portfolio growth.

Craig Packer

Sure, Robert. I’ll try to hit a few things you said in there. Just in terms of, generally, what are we seeing in terms of repayments. We’ve commented on this pretty consistently over the last few quarters that we’ve been surprised at the low level of repayments that we’ve had, even pre COVID, and certainly COVID depressed them further.

I attribute some of that to just the relative use of our portfolio, and it’s going to pick up. I mean it just is, given how long some of these investments have been in the sponsor’s portfolio. It typically will pick up when a sponsor sells a company. I would quibble a little bit with your comments, someone’s repayment in someone else’s origination.

I think often the case is that the incumbent lender is oftentimes financing the new buyer because we have an advantage in doing so. That was an advantage we didn’t have for the first couple of years of Owl Rock, and it’s an advantage we do have now. So with our large portfolio, what I would expect to happen is we will have companies get sold.

We will get a repayment, and we’ll have the opportunity to finance the new buyers. We are seeing dialogue right now that could very well result in repayment activity picking up as soon as this quarter or next quarter, but it’s hard to know for sure if it will consummate and what the timing will be.

But as you know, and we talked about, we assume a three-year like we’ve got about a $10 billion portfolio, that should average $750 million of repayments a year — excuse me, a quarter, $750 million a quarter.

And the last couple of quarters, we’ve had, as you said, almost minimal. Even a modest pickup in repayments will enhance our earnings. The way I would think about it, I just — I tend to think about it net. Obviously, this is not something we can easily model.

It’s idiosyncratic to individual credits. But if you think we’re sitting at about a $10 billion portfolio, a fully levered portfolio for us is about $11.4 billion. That’s about $1.4 billion of growth. So if you think $400 million net originations a quarter, that’s about 3.5 quarters to get to target leverage. So that’s where you get the middle — the back half of next year comments that we made.

Could be a little faster, could be a little slower. We’ve been — we were pleased with the origination activity this quarter. I do think we’ll see a pickup. This was unusually light quarter. Just COVID, I think, kept some of the repayments away. When they come, they’re chunky. We have position — our position sizes are, on average, $100 million.

So, two or three repayments could easily increase repayments to $200 million to $300 million in a quarter. So, hopefully, I covered the gist of what you’re asking.

Robert Dodd

You did. I appreciate that and I recognize that encompass does not necessarily mean repayments and then yes, exactly. Just one more follow-on, if I can, real quick. On Swipe, you’re going to be the control equity holder. This would be the first kind of equity position for this company that came from the restructuring.

Can you give us any color on kind of how long you would expect to hold an equity type position before potentially slipping isn’t the right word, but turning it back into an income-producing piece of capital rather than the adequate piece of capital?

Craig Packer

Sure. So, as we commented, we are finalizing discussions with Swipe. So we’re not an equity holder yet, but we clearly are signaling that if we consummate the discussions, that would become one. I just want to go back to Dentex, though, before we talk about Swipe. Because I really want to make sure we’re clear on this.

We could have if things had played out differently, we could have wound up being an equity holder at Dentex. But instead, we work cooperatively with the existing sponsor to commence a sale of the company, whereby we got our entire debt repaid. And so I just want to emphasize how proactive we are at managing these situations.

That’s a tricky balance to strike, and I think it worked out well for the company. And the previous sponsor, the new sponsor at us really pleased with that. In the case of PLI, we don’t anticipate the kind of timing that Dentex had, in part, because, as I mentioned in my comments, Dentex was a business that was particularly impacted by COVID.

And as the economy opened back up, that business snapped back quickly. In the case of PLI, it’s a manufacturer of gift cards and hotel key cards. And so the end markets they serve are clearly going to have a longer road back. And so we go into it expecting a longer time frame.

I don’t want to speculate how long that could be, but it’s we don’t anticipate an immediate sale of the company in the case we had with Dentex. I will say we have tremendous resources. We’re very supportive of PLI. We’re working very closely with our management team and the existing sponsor to make sure it’s a smooth transition.

We have balance sheet to support their growth. We believe in their business. And in terms of how long, it really just depends on all the logical factors you would expect, how the company is doing, what’s going on in the market and what we think is best for our shareholders.

We generally would prefer generally, I don’t think we view our equity positions as something that we want to hold longer than needed. If there’s an opportunity, and the company does better, there’s an opportunity to exit the position, of course, we’ll actively look for that.

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But I would imagine it’s going to take a little while for debt — for PLI to be in a position where that’s the case, but we’ll have to see.

Robert Dodd

Got it, thank you. I appreciate the response, the answers.

Craig Packer

Great. Thanks, Robert.

Alan Kirshenbaum

Thanks, Robert.


Your next question comes from the line of Ryan Lynch.

Ryan Lynch

Good morning. Thanks for taking my questions. Just a quick follow-up on your discussion with Swipe and PLI. As you guys are looking to do a restructuring or take over part of this business as the controlling shareholder, is it the anticipation that you guys will, as part of that restructuring, inject additional capital into that business?

Craig Packer

We’re providing additional capital now. I mean, we’re supporting the company. And we I would expect, if they need it, we work very closely with the management team to make sure the business is well positioned to be successful. The amount of capital that Swipe might need in the context of our $1.8 billion of liquidity is quite, quite modest.

But we are, absolutely we feel it’s incumbent upon us if we do wind up taking ownership of the company to make sure it has the capital it needs to thrive. And so we will do that working closely with the company.

Ryan Lynch

Okay. And then you mentioned in your prepared comments that you guys are seeing some increased demand for second lien debt out there, and you guys would only look to do so if it’s really the right credit profile. I guess, how does the bar move for your guys underwriting process when you guys are looking to structure a first lien versus second lien debt?

What do you need to see in that borrower profile that, that would get you guys comfortable with being in a subordinated debt position?

Craig Packer

Sure. We for obvious reasons, if we’re going to be a second lien lender, the bar is that much higher in terms of the risk profile we’re wanting to take on. For our second lien businesses, they tend to be materially bigger, probably double the amount of EBITDA. They our typical borrower.

We want to see a very substantial equity cushion from a very strong financial sponsor. And most importantly, we want to do second liens in companies that we think are very stable and won’t be cyclical, won’t be volatile, won’t have concentrations that could result in our second lien loan potentially being at risk.

We think our second liens are oftentimes the very best companies in our portfolio. We do them extremely — in extremely limited amounts. It’s been about 20% on a pretty consistent basis. But the companies themselves are upper middle market businesses, I think on average, directionally EBITDA close to $200 million.

The loan-to-value is actually very comparable to our first lien. So very significant equity checks, and the performance has been quite strong in our second liens. But nothing I’ve said there is different than what we said for the last 4.5 years.

We’ve been very disciplined. We get shown given our scale on our ability to do second liens, which not all lenders will do, we get shown most opportunities in the market, and we are incredibly selective, I would say, most selective on our second lien opportunities. We’re not trying to do more mezzanine light loans. We will not trade-off.

I do see our second lien, if it entails more credit risk. We’re really trying to do very stable up or middle market businesses where a sponsor values having Owl Rock as a lender and prefer that having a direct lender like us versus trying to do a deal in the syndicated markets where they’re not sure who the lender will be.

Ryan Lynch

Okay, that’s good color on that. And then just one last one, if I can. On the new newly approved share repurchase program that said, your — discretion for opportunistic purposes. Your guys’ stock price has been in the call right around 80%, 85% of book value over the last several months. Is that a level where you guys would feel like that’s an opportunistic type of purchase for your guys’ stock?

Or is the share repurchase more reserve in case there’s more volatility like we saw in the March and April time frame, where your stock price and all BDC stock price dropped pretty meaningfully from these current levels?

Craig Packer

Sure. Look, we — I’m glad you brought this up. We’re disappointed with where our stock is. The only thing we can control is our performance but we believe our performance has been very strong and consistent with what we’ve said we would do. Since the beginning, the credit performance has been excellent.

We think among the best in the space. We continue to grow the portfolio at attractive terms. You can see that this quarter. Balance sheet has been strong. We continue to grow NAV. And I have to say, and I’ll come back to your question, but it’s just very interesting to us.

We look at market data since COVID has hit. You’ve seen all the credit markets rally. The high-yield markets rallied. Leverage loan markets rallied, and the assets in BDCs have rallied, as evidenced by increased NAV pretty much across the board we’re seeing, and most BDCs report that now. Yet despite all that, BDC equities are traded down, not up.

And it’s hard for us to reconcile. Pre COVID, we’ve traded above NAV. We would expect over time for us to get back to NAV or above. Our portfolio is very visible. Every investor can go look at every single investment on our schedule of investments. 80% of its first lien. We hire a valuation firm to value every name every quarter.

And we look at the return profile for our BDC. Just taking our dividends, assuming we continue to pay our dividend, which we’ve said we strongly intend to do and are going to be able to do, at current levels, it’s an 11.5% cash-on-cash return at the current stock price. The stock gets back to NAV. We’re trading at 80, as you said.

You can do the math if you’re getting 11.5% and the 20 points of appreciation. Obviously, there’s no guarantees to any of that. But clearly, the return opportunity is there. We would hope, if we continue to perform, the market will recognize that. In light of where the stock was trading, we thought — we talked to our Board, and we thought it was appropriate and important for us to have a stock buyback.

I’m not going to share exactly how we think about where we would purchase, but we’re clearly disappointed with where the stock is trading today. We’re going to watch it very carefully and decide how we deploy that capital. But we think the stock clearly warrants consideration for trading where it is and certainly, if it were to trade off all the more so.

Ryan Lynch

That’s good color, Craig. Those are all my questions. I appreciate the time today.

Craig Packer

Great. Thanks, Ryan.

Alan Kirshenbaum

Thanks, Ryan.


Your next question comes from the line of Mickey Schleien of Ladenburg.

Mickey Schleien

Yes. Good morning, everyone. Craig, I wanted to follow up a little bit on the prepayment expectations given that you operate at the very high end of the middle market. I’m curious as to your opinion about how much competition you’re seeing from banks.

I have seen banks starting to take out some of the more attractive deals at other BDCs, and obviously, their cost of funds is extremely low. So are you seeing them as being more aggressive?

Craig Packer

Well, I’m not sure. Well, when you say banks taking it out in their cost of funds, you’re almost describing something where a commercial bank or regional bank might be taking out on a very low levered company and a term loan A type financing.

Where we typically compete, the size of companies we lend to. They oftentimes were too big and the companies have a little more leverage than what a regional bank would be comfortable doing a loan on their balance sheet, too. We tend to compete more with the syndicated market.

So, it’s less a regional bank doing a refinancing at a low rate, although that’s certainly possible but more that the banks might try to do a syndicated term loan and distribute that to the market at potentially better pricing.

The answer is, I — no, we’re not seeing although it’s possible and maybe we’ll have a couple, I’m not seeing any significant uptick in companies talking to regional banks or even the investment banks about refinancing just for cost of capital purposes. Companies choose direct lending solutions for a lot of reasons, not just pure rate.

They like having a lender they know, one that can grow with them, the flexibility that we can offer. So it’s not simply trying to say 25 basis points.

The biggest driver for us on when we get refinanced is the company gets sold. Occasionally, we’ll lend to a more modest-sized business, and it will grow through acquisition and that will be a catalyst for refinancing into the syndicated market, and we may see some of that.

But look, as I commented a couple of minutes ago, discussions are picking up. So, we will see I expect we will see increased repayments. I mean, while it’s just part of the model, we’re going to see it. We’ve seen really very little. And even with an increase, it will still be sort of an average amount of what we would expect.

But I don’t see any regional banks coming in, in any material way in refinancing our debt. Our sponsors typically are not working with the regional banks. The leverage profile is a little too high. The bite-size is frankly way too big for them.

Mickey Schleien

That’s really helpful, Craig. Let me follow up by asking about portfolio allocation. I think part of the investment thesis for Owl Rock is, over the medium term, a rotation from pure first liens to more unitranche. And I’d like to understand, are you trying to do that proactively into what is currently a pretty healthy market?

Or are you just going to wait to let the portfolio run its course and rotate repayments into unitranche as they come?

Craig Packer

So, as we’re looking at new opportunities now, new deals, we very much would like to fund more unitranches and I would say have pretty limited appetite for additional first lien — traditional first lien, high quality but lower spread.

So, for new deals, we’re absolutely preferring unitranche versus the lower spread. And we have the luxury and flexibility to be able to do that now that we’re closing in our target leverage. We have our capital working. And the marginal deal, absolutely, we prefer unitranche.

It carries higher spread. And you saw that this quarter because our average spread on new investments was 720 basis points. We’re given an opportunity in the portfolio, if it presents itself, for whatever reason, where we can get refinanced or sell down a little piece of a first lien that has lower spread, we will consider that strongly and do it, and do it if it’s appropriate.

In other words, we would like to migrate the portfolio. There’s — we can’t control that. It’s not something that’s easily controlled. We can’t turn on a dime. But over the course of the quarter, over the course of the year, you’re going to find opportunities where maybe there is a refinancing and we decline to participate or participate in a small amount and migrate that first lien into something a little bit higher return.

We’re going to be judicious about it. We’re not going to do anything to undermine the overall quality of the portfolio. But we’ve tried to balance getting invested with risk and picking our spots on unitranches, and that’s played well for us, and we’re going to continue to do it.

But I would say, going forward, really focused on additional higher spread opportunities versus the high-quality lower spread opportunities.

Mickey Schleien

And in terms of higher spread opportunities, you touched a bit on second liens. They’re about 700 basis points wide of first lien. Notwithstanding your underwriting requirements for individual investments, do you think that’s a good risk-adjusted return today on average in the market for second liens? Or your preference would be unitranche deals?

Craig Packer

Well, I’m not sure where you’re getting the 700. But I’ll tell you where I think of second liens. Second liens today, depending upon the credit, are clustered around Ls 800, 825. A couple of syndicated ones have gone in the high L 750, 775 or a few exceptions, but that’s about where it is.

But let’s call it L 825 for the purpose of this discussion. With a LIBOR floor and some fees, it’s about a 10% return opportunity. Unitranche, today, is around L 650 to 700. So, that’s only 150 basis points inside of that. So now true first lien, today, in the syndicated market, is L 400 in that zip code.

So there’s about typically about a 400 basis point relative value between first lien and second lien in the syndicated markets. When we do a second lien, we will typically insist on having at least 400 basis points of spread on the second lien versus the first lien. And I’m showing a lot of statistics at you. So stop me if this is not helpful.

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We find second liens attractive for the right situations. I think they’re attractive risk-reward for the right situations. The hardest part is just finding credits that we’re willing to be a second lien lender on. If we chose to, we could do a lot more second liens, but we really are quite disciplined about it, and we say no to most of them.

But where we see ones we like, we’ll do them, and we think they enhance the yield in the portfolio, and they’re just — they’re good credits and a good risk reward. But we’ve been running at this 20% for a long time. I wouldn’t, it’d be averse to taking that up modestly depending upon the opportunity set.

But it has on its own natural flow has been at about 20%. And if we see some good ones, then we consider taking it higher.

Mickey Schleien

I understand. My last question on a different note. I noticed the unsecured facility to Hg Genesis. And curious whether that’s to support sort of an overall relationship with that sponsor. Or was that just an interesting investment opportunity for you and sort of a one-off?

Craig Packer

I don’t want to go into too much detail on that facility. We don’t extend as much as we have wonderful relationships with financial sponsors and their incredible part of our business, we’re not in the business of extending relationship loans to support their relationship.

That’s not the nature of what we do and certainly not what our shareholders would want us to do. So any investment we’re going to put on our portfolio is going to be one that we think is an attractive risk-adjusted return.

That was a bit of an unusual structure and that it was being done at a fund level, but it had very high-quality assets, a very attractive spread, a very attractive loan-to-value. It was a sponsor that does a lot in the technology arena, which is obviously one of our sweet spots.

And so it checked all the boxes of everything we like in an investment. It was a bit of a complicated structure, which I’m not going to go into because it’s private, but it’s an absolutely attractive loan, just like every other loan on our book.

Mickey Schleien

That makes sense and that’s really helpful. Those are all my questions for this morning. I appreciate your time, as always.

Craig Packer

Great, thank you.

Alan Kirshenbaum

Thanks, Mickey.


Your next question comes from the line of Casey Alexander of Compass Point.

Casey Alexander

Yes, Good morning. My questions have been asked and answered, so I’ll step back out. Thank you.

A – Alan Kirshenbaum

Thanks, Casey.


Your next question comes from the line of Devin Ryan of JMP Securities.

Unidentified Analyst

Good morning. This is Kevin Fultz on for Devin. First, you scaled up portfolio at a strong pace over the last few years and it currently stands at $10 billion. Can you discuss the portfolio size that you think the platform can support, both in terms of dollar value and the number of portfolio companies?

And also, how has that changed at all after the pandemic-driven challenges that you had to navigate this year?

Craig Packer

Sure. Our equity is about $5.7 billion today. We put out a target leverage profile of about 0.9 to 1.25 times. To keep the math simple, let’s just call that one times debt to equity, and so that would imply about $11.4 billion portfolio versus where it stands today, about $10 billion. In terms of number of names, today, we’re at 110 names.

So, it’s about $90 million per name. I don’t see that average bite-size changing. And so maybe we’ll round it up to 100, just to keep the math simple. So probably it’s for another $1.4 billion. It’s probably another 14 [indiscernible] so call it 124. We don’t, it’s not programmed that way, but that’s what it’s been running at.

And that’s, I think, a reasonable assumption. The last question was does COVID impact that, I believe, is that the last part of your question?

Unidentified Analyst

That’s correct.

Craig Packer

Yes, no. No change to portfolio construction for COVID. I would say just generally, we think our models work quite well. I think for those of you who have followed us since the beginning, it may sound a bit redundant because we’ve been saying the same thing for 4.5 years, upper middle market sponsor back, first lien.

We’ve been very consistent in what we like, and we’ve been executing on that. We’re very pleased with the portfolio build and the credit performance. And I really, really — just the credit performance has been quite strong. And I know one of the questions that we’ve been asked, as we’ve been investing over the last three years is you’re investing a lot, what about credit, what about credit quality.

And here we are, and our nonaccruals are among the lowest in the space and half many of the peers. We just had one of our first two nonaccruals get repaid at par. Our NAV is growing. The portfolio is in quite good shape. So there’s no — not only no reason to change our strategy, but we feel very validated by our strategy.

Unidentified Analyst

Great, that’s very helpful. And then looking at the portfolio, the fair value of Mindbody, first lien loan, and that’s just above 91 this quarter. I know in the past, you’ve mentioned that the sponsor is very supportive of the business. But can you give a high-level overview of how the company has been performing recently, given the risk of the current environment in this business?

Craig Packer

There’s probably not a lot I’m going to go in detail on Mindbody. Mindbody is software sold to gyms and spas. Obviously, that’s a business that was impacted by COVID-driven shutdowns.

It was a take product by Vista, one of the premier technology sponsors. Technology is a sweet spot for us. And as we commented in the past, we’re very confident in the Mindbody credit. Vista is very confident in the Mindbody credit.

We’ve worked very closely with them to continue to support the business. Obviously, without getting into nonpublic information regarding the company, obviously, as the economy reopens and gyms reopen, that’s obviously positive for Mindbody.

They’ve also adjusted, as you would expect, to remote fitness, and their software helps with that. So, we marked it appropriately. It’s not a name that I have an undue level of concern about, but certainly, it was impacted by COVID.

Unidentified Analyst

Okay, thank you, that’s helpful. And then lastly, looking at the expectation that the low interest rate environment will persist for quite some time, how has that changed how you view your liability structure?

Alan Kirshenbaum

I apologize, Kevin. I heard the last part, the liability structure. What was the first part?

Unidentified Analyst

Yes. I said, with the expectation that the low interest rate environment will persist for quite some time, how has that changed how you view your liability structure going forward?

Alan Kirshenbaum

Look, we’ve — I guess, I sound like a broken record similar to Craig. We’ve been, I think, really consistent in the road map that we followed here from the beginning. We’ve built a very diverse funding landscape. We’re going to continue to build out and do CLO financing.

We’re going to continue to do unsecured financing, and we have a very big senior secured revolver. So over time, I’ve mentioned in the past, over time, we will pay down the drop-down financing facilities we have and turn those into either, again, CLO financing or unsecured notes, but we have a significant amount of liquidity sitting here today.

So, we’re sitting in a very good position. So, nothing has changed from our perspective.

Unidentified Analyst

Okay, that’s helpful. And that’s just me. Thank you for taking my questions.

Alan Kirshenbaum

Of course. Thank you, Kevin.


Your next question comes from the line of Kenneth Lee of RBC Capital.

Kenneth Lee

Hi, thanks for taking my question. Wondering if you could just provide a little bit more color on the outlook for originations. I think in the past, you mentioned that origination volumes could skew toward existing borrowers versus new borrowers. But wondering with the pickup in sponsor activity, whether you could see a lot more origination on that new borrower front. Thanks.

Craig Packer

Sure. So, this quarter was really mostly new names. We had very little add-ons for existing portfolios this quarter, which I think reflected sponsor that since evolved since the quarter has ended. And we are seeing now sponsors resume their acquisition plans for their portfolio companies.

And I think many of them view the economic climate, the uncertainty as potentially being conducive to doing buy-and-build acquisitions. And so that will be a benefit we hope to get in terms of financing our existing portfolio company. Obviously, that’s the easiest underwriting we do is when we’re extending capital.

And so I think that will help us grow our portfolio over the next this fourth quarter and into early next year. So again, third quarter, mostly new investments. Fourth quarter, I expect more of a mix between add-ons and new investments.

The new investments tend to be chunkier because it’s a new buyout and whereas the add-ons tend to be a little more modest in terms of their size. So I don’t know if that helps give a little bit of color around it.

Kenneth Lee

Right. That was very helpful, that’s all I have. Thank you, very much.

Craig Packer

Thanks, Ken.


Our next question comes from the line of Derek Hewett of Bank of America.

Derek Hewett

Good morning, everyone. Craig, assuming that unitranche opportunities kind of more emerge over the next few quarters or so, are there opportunities to maybe migrate some of that first lien into the JV to manage overall capital and optimize the portfolio yield?

Craig Packer

We, I mean I’m going to give you a short answer, but it’s a more complicated question. We have as a BDC, there are we have strict limitations on how we manage our funds. We don’t manage the JV. The JV, we’re an investor in the JV. We have a partner in that JV. And so under our exempt to three quarters and the rules on which the JV is governed, there are limitations in what we can do.

I’m not going to go into all the detail, but it’s definitely not as simple as us just moving it in there or not. So I don’t want to set your expectation that, that’s something that we would do. Although I do appreciate why you’re asking the question, it’s sort of a logical question.

But it’s they’re given the way the joint venture is set up and the partnership that we have with the University of California, which is an incredibly warm and constructive partnership but the way it’s set up, it doesn’t allow for easy movement of assets from an Owl Rock managed fund into a joint venture that we’re an investor in. So I don’t expect that in any meaningful way.

Derek Hewett

Okay, thank you. And then kind of circling back to an earlier question in terms of leverage, you were using the kind of the simple math of one times or $11 billion — roughly $11.5 billion optimal portfolio. That being said, what would it take for you to want to go toward the upper end of the leverage target? What would you need to see?

Craig Packer

Well, it’s refreshing to be asked that question. We’ve been really focused on just getting to our one times, and we’re not quite there yet. And I hope we’re there — we expect to be there by the second half of the year. I think that, that’s where you should expect us to be.

I don’t think we expect to be in excess of that. We have, we try to be very balanced in the use of leverage. We care deeply about our lenders and our bondholders and the rating agencies, and they obviously want to make sure we’re being prudent with leverage. Obviously, there, we trade off on those considerations versus returns.

We feel really good that at one times leverage, with the type of return profile that we’re seeing with investments, that, that can be a really good place in terms of balancing returns, dividend coverage, return to our shareholders as well as maintaining a very strong balance sheet and cost of capital.

And obviously, that gives us a tremendous amount of cushion versus regulatory cap.

Derek Hewett

Great, thanks. That’s all for me.

Alan Kirshenbaum

Great, thank you.

Craig Packer

Thank you, Derek.


At this time, I’m showing no further questions. I will now turn the call over to Craig Packer.

Craig Packer

Great. Well, thanks, everyone. Thanks for the questions. I appreciate the interest. Really pleased with the quarter. Look forward to catching up with many of you individually. I really hope everybody’s families stay safe and well, and we will talk with you again very soon.


Thank you. This concludes today’s conference call. You may now disconnect.

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