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Apollo Investment: IIIQ 2021 Conference Call – ANNOTATED

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Q2 2022 Apollo Investment Corp Earnings Call

NEW YORK Nov 5, 2021 (Thomson StreetEvents) — Preliminary Transcript of Apollo Investment Corp earnings conference call or presentation Thursday, November 4, 2021 at 9:00:00pm GMT

Corporate Participants

Elizabeth BesenApollo Investment Corporation – IR ManagerGregory William HuntApollo Investment Corporation – CFO & TreasurerHoward T. WidraApollo Investment Corporation – CEO & DirectorTanner PowellApollo Investment Corporation – President

Conference Call Participants

Kyle M. JosephJefferies LLC, Research Division – Equity AnalystMelissa Marie WedelJPMorgan Chase & Co, Research Division – AnalystRobert James DoddRaymond James & Associates, Inc., Research Division – Research Analyst

Presentation

Howard T. Widra Apollo Investment Corporation – CEO & Director

… I’ll begin today’s call by providing an update on our ongoing progress repositioning the portfolio, followed by a review of our results by the quarter. Following my remarks, Tanner will discuss the market environment, review our investment activity for the quarter and provide an update on credit quality. Greg will then review our financial results in greater detail. We will then open the call to questions.

During today’s call, we will be referring to some of the slides in our investor presentation, which is posted on our website. Beginning with an update on our portfolio repositioning. We continue to successfully execute our strategy of increasing our exposure to first lien floating rate corporate loans and reducing our exposure to junior capital and noncore positions. We have constructed what we believe to be a well-diversified portfolio of high-quality senior corporate loans as evidenced by improving credit metrics, including lower leverage, lower attachment point and higher interest coverage.

BDC Reporter Notes: With all due respect, AINV’s “repositioning” program has been going on for years and seems more akin to “waiting around for something good to happen”. Just for fun, we entered the word “repositioning” in our BAM.sec.com database of all filings and conference call transcripts and found the earliest AINV use of the word back in 2007. Every quarter investors are updated on the progress, which mostly appears to consist of either write-offs or the occasional repayment – as well as unrealized write-downs – rather than any concerted effort to get rid of the “non-core” assets. This is an important issue as AINV’s Net Asset Value Per Share has dropped (18.8%) since the end of 2017 – a starting point we’ve used for all BDCs to measure this metric. We believe the bulk of this red ink can be attributed to these non-core assets and the delayed resolution of their fate.

Regarding our aircraft leasing portfolio company, we believe Merx has successfully navigated this challenging period. As a result, AI and earned more income from Merx during the September quarter compared to recent quarters.

BDC Reporter Notes: As far as we can tell, AINV has converted some of its equity in Merx back into debt at a 10% yield (used to be 12%). At the end of the IIQ 2021, there was $120mn of equity in Merx at cost. Now there is $36mn. The difference has been turned into more senior debt. The total value of the BDC’s largest investment, though, is unchanged. That suggests the improvement in Merx remains flattish from quarter to quarter. On the other hand, AINV has clearly increased its income from Merx substantially, which is every important as the BDC seeks to increases earnings to make up for paying out more in incentive fees.

Repayments during the quarter included the exit of 2 2nd lien investments [???]. Post quarter end and MC, one of our shipping investments, sold a vessel, which will result in a small paydown to AINV in the December quarter.

BDC Reporter Notes: The shipping investment is a “non-core” asset.

Moving to our results for the quarter. After market closed today, we reported net investment income for the September quarter of $0.33 per share, $0.02 above our quarterly base distribution of $0.31. As mentioned on our last conference call, given the total return feature in our fee structure and the strong performance of our corporate lending portfolio, we resumed paying incentive fees during the quarter.

BDC Reporter Notes: The resumption of incentive fees added ($5.3)mn to AINV’s costs. Without that expense burden we calculate that AINV would have earned NIIPS of $0.41. Even if AINV had chosen to reduce its management fee to the same level as that charged by Goldman Sachs BDC (GSBD), NIIPS would have been $0.37. Clearly, the BDC’s manager has the tools necessary to generate Net Investment Income sufficient to pay out a combined $0.36 per quarter. Lest we forget, AINV was paying out $0.45 per quarter before the pandemic and as much as $1.56 during its best days. Till last quarter AINV was receiving one quarter of all income received after interest expense and other costs. This quarter, that share of the pie has become one-third.

Net investment income for the quarter reflects a full incentive. We ended the quarter with net asset value per share of $16.07, up $0.05 or 0.3%, driven by our corporate lending portfolio, which continues to perform well as well as the accretive impact of stock buyback.

BDC Reporter Notes: We read the numbers a little differently. Yes, there were $69mn in unrealized gains in the portfolio in the quarter, but there were also net realized losses (mostly consisting of two “non-core” energy investments) of ($64.5mn). Much of the unrealized gains was the write-back of realized losses to the unrealized category. After netting out other unrealized depreciation of assets, the real net gain in this category seems to have been only a few million dollars. Effectively we’d say AINV’s assets were flat in value in the period.

Regarding investment activity, the Apollo direct origination platform, which includes AINV, was very active, closing $4.6 billion in new commitments during the quarter. AINV’s new investment commitments were strong totaling $222 million all first lien floating rate senior corporate loans. Given the solid level of activity, our investment portfolio grew and our net leverage ratio increased to 1.5x at the end of September, right in the middle of our target leverage range. We remain focused on increasing AINV’s earnings power.

BDC Reporter Notes: Given that some of AINV’s investments consist of non-income producing assets of dubious value, AINV is pushing the envelope at a 1.50 : 1.00 debt to equity, let alone at the high end of the range of 1.6x. This is higher than most of its peers and by a substantial margin. This seems to demonstrate that the BDC is pulling out all the stops – short of reducing its fees – to earn enough to maintain its dividends.

Let me discuss how we think about our baseline earnings and the embedded upside in our portfolio. First, as a result of the stability we expect to continue to see from Merx. During the quarter, we recast the capital structure and received $6.9 million of interest income from Merx during the September quarter, $2.1 million more than last quarter. Second, although net leverage was 1.15x at the end of the quarter, average leverage for the quarter was 1.46x, a good baseline for projecting earnings going forward. Third, fee and prepayment income totaled $1.7 million for the quarter. Although these sources of income can fluctuate from quarter-to-quarter, we expect to generate approximately $3.5 million of fee and prepayment income per quarter on average. As an illustration, in the March 2021 and June 2021 quarters, fee and prepayment income totaled $3.9 million and $5.9 million, respectively. Conversely, although we earned a $2 million dividend from MC during the September quarter, we expect to earn approximately $1 million on average going forward, a level consistent with prior periods.

Taking these items in aggregate would produce a baseline of approximately $0.34 per share. From that $0.34 baseline, there are a number of items we are focusing on to grow earnings in the near term. First, we continue to generate incremental cash proceeds from the portion of our noncore assets that are not generating income. For every $10 million of cash we generate from these nonincome-producing assets, we can generate approximately $650,000 of annual net investment income or approximately $0.01 per share. In this regard, we have generated incremental cash each quarter and are very focused on executing some more significant progress in the coming quarters; second, we continue to make progress with Merx. Prior to COVID, Merx generated a 13% return on average over a number of years. The current payment level, as recently adjusted this quarter is approximately 9% and although we don’t expect to close this gap completely, we do believe that we can improve the return by either reducing capital in Merx with the same gross dollar return or increasing the cash return by improving the capital structure. Third, we continue to focus on monetizing under-yielding assets, specifically Spotted Hawk, Dynamic MC and Kyron. Taken together, these assets and a few others account for approximately $230 million of fair value and generate only $16 million of annual income. — redeploying those assets that are approximate all-in yield should generate an incremental $2 million to $3 million of annual net investment income. And last, we continue to buy back our stock when the price dictates. We obviously hope these opportunities become more and more infrequent. But when they occur, the buybacks are both accretive to book value and moderately accretive to EPS. We believe these items provide additional support to our baseline earnings and also provide a path to generating the earnings above the baseline.

Turning to our distribution for the quarter. The Board has declared a base distribution of $0.31 per share and a supplemental distribution of $0.05 per share. Both distributions are payable on January 6, 2022, to shareholders as of record on December 20, 2021. I’d like to remind everyone that as we’ve indicated previously, we intend to declare a quarterly base distribution of $0.31 per share and a quarterly supplemental distribution of $0.05 per share for at least 1 more quarter.

BDC Reporter Notes: AINV has given the analysts what amounts to a road map of potential future earnings. We won’t dissect each element in turn because there are a host of assumptions built into each source of higher income. However, something is going to have to give. The BDC is currently paying out more than it’s bringing in and that could continue through the end of 2022. When 2022 rolls round, AINV will either be earning its way or not and a decision will have to be made about the distribution. Management has already given themselves a way way by splitting the distribution between a $0.31 regular and a $0.05 special. The latter could be jettisoned, leaving AINV paying out $1.24 annually ($0.31 x 4). If that were to occur, though, shareholders will be receiving one-third less than before the pandemic – one of the biggest dividend cuts BDC shareholders have been asked to absorb. This is proving to be a very interesting test of whether AINV’s management can deliver decent earnings and whether the advisor and Board will be “shareholder friendly” or prioritize its own compensation even as shareholders absorb another cut in their payout. At the end of the day, a BDC’s net earnings are like a pie, and the manager has to decide how big a piece to take for itself. Given that BDC corporate governance is all but non-existent shareholders cannot look to the Board to negotiate favorable terms on their behalf.

Tanner Powell Apollo Investment Corporation – President

Thanks, Howard. Beginning with the market environment, the broader market sentiment remains mostly positive with the continued rollout of the vaccine and the reopening of the economy. While the post-pandemic recovery continues, concerns about inflation due to supply chain problems, higher energy prices and labor shortages could create periods of volatility. Specific to our business, competition for attractive middle market loans remains intense as the syndicated loan market and private credit providers vie for new opportunities, particularly as private credit providers make increasingly larger commitments. As a result, terms and covenants are becoming increasingly borrower friendly. That said, we continue to see more companies financed through private credit.

Moving to AINV’s investment activity. New corporate lending commitments for the quarter totaled $222 million, across 18 companies for an average new commitment of $12.3 million. 88% of the new commitments were leveraged lending 5 lender finance, 5 asset-based and 2% Life Sciences. Consistent with our strategy, all new commitments were first lien floating rate loans with a weighted average spread of 13 basis points { ???] and a weighted average net leverage of 4.4x and 95% were made pursuant to our co-investment order. Gross fundings for the quarter totaled $211 million, excluding revolvers. Sales and repayments totaled $107 million, excluding revolvers. The strength in the market enabled us to continue to reduce our exposure to second liens.

During the quarter, repayments included $35 million of second liens, including the full exit of 2 positions. Net fundings for revolvers totaled $10 million. In aggregate, net fundings for the quarter were $114 million.

Moving to Merx, the overall air traffic environment appears to be improving, particularly in the U.S. we are optimistic that demand for air traffic will continue to grow with the ongoing rollout of the vaccine and the lifting of travel restrictions. Furthermore, the aircraft leasing market will continue to be an important and growing percentage of the world fleet as airlines will increasingly look at third-party balance sheets to finance their operating assets. Specific to our investment, as Howard mentioned, we believe Merx has successfully navigated the significant disruption caused by the COVID-19 pandemic. The level of lease revenue generated from our fleet has stabilized.

We have worked through our exposure to airlines that have undergone restructurings. We have been able to remarket aircraft during the period with long-term leases or sales. And Merx continues to benefit from a growing servicing business, which has increased in value over time.

Given the stabilization of Merx during the quarter, we recast $84.5 million of Merx’ equity into debt. And as Howard mentioned, AINV received $6.9 million of interest income from Merx during the September quarter, $2.1 million more than last quarter. Merx remains focused on remarketing aircraft that are due to come off lease via extensions with existing lessees, re-leasing to other airlines on long-term leases or sales.

During the September quarter, Merx sold 2 aircraft and signed lease extensions for 6 aircraft. Our lease maturity schedule is well staggered. We believe Merx’s portfolio compares favorably with other major lessors in terms of asset, geography, age, maturity and lessee diversification. Merx’s portfolio is skewed towards the most widely used types of aircraft, which means demand for Merx’s fleet is anticipated to be resilient.

Merx’s fleet primarily consists of narrow-body aircraft serving both U.S. and foreign markets. The poly Aviation platform will continue to seek to opportunistically deploy capital to be clear, Merx is focused on its existing portfolio and is not seeking to materially grow its balance sheet portfolio. However, growth in the overall Apollo aviation platform will inure to the benefit of Merx as the exclusive servicer for aircraft owned by other Apollo funds.

Turning to the overall AINV portfolio. Our investment portfolio had a fair value of $2.61 billion at the end of September across 144 companies in 26 different industries. We ended the quarter with core assets representing 93% of the portfolio and noncore assets representing 7%. First lien assets represented 92% of the corporate lending portfolio, up from 90% last quarter. At the end of September, the weighted average spread on the corporate lending portfolio was 602 basis points.

As a reminder, the weighted average LIBOR floor on our floating rate investments is approximately 1%, well above today’s current LIBOR. As Howard mentioned, we continue to see ongoing improvement in our credit metrics as we reposition the portfolio. The weighted average net leverage of the corporate lending portfolio declined to 5.1x, down from 5.22x last quarter. The weighted average attachment point declined to 0.3x, down from 0.4x last quarter. Our low attachment point is a clear indication of the seniority of our corporate lending portfolio compared to loans, which are classified as senior but have much deeper attachment points. The weighted average interest coverage improved to 3x, up from 2.9x last quarter. The improvement in these metrics, not just this quarter but over the last several quarters, clearly demonstrate the improved quality of our investment portfolio. Investments made pursuant to our co-investment order represent 84% of the corporate lending portfolio at the end of the quarter.

Although overall quality of our portfolio remains strong, our second lien position in Sequential Brands was placed on nonaccrual status during the quarter. Sequential Brands owns, manages and licenses a portfolio of consumer brands in the active and lifestyle categories. The company filed for Chapter 11 bankruptcy in August and is seeking an orderly liquidation of the brands in its portfolio. Our second lien position was marked at 91 at the end of September compared to 82 at the end of June. The mark at the end of September reflects the liquidation process and the resolution of our current position, which is expected to occur in the December quarter. At the end of September, investments on nonaccrual status totaled $28 million or 1.1% of the total portfolio at fair value.

BDC Reporter Notes: As the BDC Credit Table shows, the value of non performing assets remains close to the level of the prior quarter and is non-material.

During the quarter, Spotted Hawk completed a restructuring of its balance sheet, our second lien position, Tranche A, was converted to equity in our third lien position in Tranche B was canceled. Both of these positions were previously on nonaccrual status. The valuation of our investment in Spotted Hawk was not impacted by this restructuring.

Gregory William Hunt Apollo Investment Corporation – CFO & Treasurer

.Beginning with AINV’s statement of operations. Total investment income was $52.9 million for the quarter, up 4.6% quarter-over-quarter, reflecting higher interest income and higher dividend income, partially offset by a decline in prepayment and fee income. The quarter-over-quarter increase in interest income was attributable to higher earnings from Merx as well as a larger average investment portfolio.

Dividend income was $2.7 million for the quarter, an increase of $2.3 million, driven by a dividend from MC, one of our shipping investments. Fee income was $1 million compared to $1.2 million last quarter. Prepayment income was $700,000, down from $4.1 million last quarter, which is below normal levels.

As Howard mentioned, fee and prepayment income can fluctuate quarter-over-quarter, but we expect to generate approximately $3.5 million of fee and prepayment income per quarter on average. The weighted average yield at cost of our corporate lending portfolio was 7.6% at the end of September, down from 7.7% last quarter. The weighted average spread of our corporate lending portfolio declined from 616 basis points to 602 basis points decline in yield and spread reflects the continued shift of the portfolio into first lien investments and away from second lien investments.

Expenses for the quarter were $31.7 million, an increase of $6.5 million quarter-over-quarter, driven by our incentive as well as slightly higher interest expense.

Prior to the September quarter, AINV had not paid any incentive fee since the quarter ended December 2019. As a reminder, AINV’s incentive fee on income includes a total return hurdle with a rolling 12-quarter look back. Given the reversal of unrealized losses during the look back period, the manager earned a full 20% incentive during the quarter.

The total return requirement closely aligns the incentives of our manager with the interest of our shareholders. In addition, during the quarter, AINV received a slight fee offset from our Navigator Fund I, which is Apollo’s Globe, which is Apollo’s flagship commercial aircraft leasing fund. Not only did Merx receive income in servicing in this fund, AINV benefits from a direct fee offset equal to 20% of fees earned by Apollo global injection with managing aviation assets for Apollo, including Navigator.

The increase in interest expense reflects both the growth in the portfolio as well as an increase in our funding cost. As a reminder, in July, we issued $125 million of 5-year 4.5% unsecured notes, which drove the increase in our weighted average cost of funding from 3.08% to 3.2% quarter-over-quarter. Importantly, unsecured debt increased to 30% of our outstanding debt at the end of September, up from 24% last quarter.

Net investment income per share for the September quarter was $0.33. Net leverage at the end of September was 1.1 — 1.51x up from 1.39x at the end of June. And our average net leverage for the September quarter was 1.46x. On Page 16 in the earnings supplement, we disclosed the net gains or losses by strategy over the past 5 quarters. As Howard mentioned, our corporate lending portfolio continues to perform well.

During the September quarter, our corporate lending portfolio had a gain of $5 million or $0.08 per share, partially offset by $1.3 million or $0.02 per share on noncore and legacy assets. The net loss on noncore and legacy assets reflects net losses on oil and gas, renewables and shipping investments, partially offset by a gain on carbon-free and legacy investments.

Regarding Carbon-Free, as a reminder, our investment in Carbon-Free consists of an investment in the company’s proprietary carbon capture technologies and an investment in the company’s chemical plant. Carbon Free is benefiting from strong interest in carbon capture, utilization and storage as part of broader ESG trends. We believe Carbon-Free is a leader in this space as evidenced by partnerships announced during the quarter, which demonstrate market acceptance for its technology.

NAV per share at the end of September was $16.07, a $0.05 increase quarter-over-quarter. The $0.05 increase is attributable to a $0.06 per share gain on the portfolio, $0.02 from buybacks, partially offset by $0.03 from the distribution in excess of net investment income.

Regarding liquidity, given the continued improvement in the quality of our investment portfolio and our recent unsecured debt issuance, our liquidity position continues to strengthen. Moving to stock buybacks. During the quarter, AINV purchased 450,953 shares at an average price of $13.09 for a total cost of $5.9 million. Since the end of the quarter, AINV has purchased an additional 308,000 shares at an average price of $13.30 for a total cost of $4.1 million leaving $14.9 million of authorized authorization for future purchases under the board’s current authorization.

Questions and Answers

Operator

(Operator Instructions) And we’ll take our first question today from Kyle Joseph with Jefferies.

Kyle M. Joseph Jefferies LLC, Research Division – Equity Analyst

Just want to make sure I got the moving parts of — on non accruals. So Spotted Hawk came off and Sequential was added, that was the only movement in terms of non accruals?

Howard T. Widra Apollo Investment Corporation – CEO & Director

Yes, yes. Yes.

Kyle M. Joseph Jefferies LLC, Research Division – Equity Analyst

And then how are you guys thinking about credit at this point? Obviously, we are kind of through the pandemic at this point, but obviously, there’s some inflationary pressures and wage pressures. What’s the biggest risk economically you guys are thinking about as you’re deploying capital?

Howard T. Widra Apollo Investment Corporation – CEO & Director

Well, I mean, right now, the performance has been great, right? And so that’s terrific sort of shows in the sort of the corporate debt portfolio, but it also means it there’s nowhere to go but down from there, right? And so as you think like through cycles and part of that, I think you mentioned a few other things, inflation, wage pressure, supply change constraints. And so obviously, like as we’ve talked about over an extended period of time, the best offense to that is sort of granularity and diversity. So that like any of these risks don’t expose you across the portfolio. We’re, of course, looking at sort of for example, supply chain constraints and how they affect individual borrowers and might impact them and feel relatively comfortable where we are on the capital structure that, that’s — that in and of itself is not a tremendous risk to our portfolio. But it’s sort of like the combination of all of these pressures combined with a very aggressive debt market, which means you have to retain your humility — and not everyone in the market is. And so that’s a concern.

Again, it’s why we’ve always said like one of the key aspects is to have a very wide funnel have a diversity of products and be able to be as selective as you can be in a market like this. So I know I didn’t give you look at specific answer, but that’s really — it’s a very benign environment this minute. But you can see all sorts of things that could potentially come your way. So we take a very — we take portfolio construction very seriously. And then on individual credits, try to look out at these specific risks we see coming to see how they can absorb them.

Kyle M. Joseph Jefferies LLC, Research Division – Equity Analyst

Got it. And very helpful. I appreciate it. And one follow-up for me. Repayments have been, I don’t know, for lack of a better term, lower than feared, I’d say, not just you guys, but what are your thoughts there? You talked about how active the debt markets have been and are. And I know it’s hard to predict, but just give us a sense for how you see repayments trending over the remainder of the year.

Howard T. Widra Apollo Investment Corporation – CEO & Director

Yes. I mean repayments in the first 2 quarters of the year were really high, right? And so you saw as we mentioned, our fee income, you saw that everywhere. And that it just sort of seemed to sort of all of the low and medium hanging fruit has sort of dissipated on repayments, yet like new issuance was high, and so you saw that this quarter. I think you’ll see in the December quarter, some return to maybe not the levels it was at the beginning of the year, but sort of a return back to some normalized levels of repayments. There was a real sense, I think, in September of people thinking that there was a major tax change coming. It was going to drive behavior, so that would drive sales. So it will drive new business and payoffs. I think obviously, that’s changed some and so changes some people’s focus. But end of the year still always drives a bunch of activity. So that’s both on the repayment side of the new deal side. So I think it will pick back up to normalized levels in the fourth quarter.

Tanner Powell Apollo Investment Corporation – President

Yes. I would add to Howard’s comments and the overall takeaways are still the same. If I would hazard one guess for maybe why across our space, maybe seem a little bit less despite record M&A volume. Is there some auto correlation, Kyle, to the type of companies that want a private debt solution. And because of that, you see less of our companies graduating and more specifically, those type of companies that need heavy delayed draws are active in their own M&A pipelines within the companies. And as a result, the private credit players, and this kind of goes to power of incumbency, which we beat the drum on within our institution, I know others do the same. You see a longer duration on those assets and maybe the margin, perhaps less of the syndicated market is really, really hot, and we’re seeing — as you might have seen in the past and names that graduate and leave our market and go to the syndicated market. Maybe that’s happening a little bit less on the margin. But overall, would that go what Howard was saying as well.

Operator

And we will move next to Melissa Wedel with JPMorgan.

Melissa Marie Wedel JPMorgan Chase & Co, Research Division – Analyst

Thank you. Appreciate you taking my questions. I’m curious how or we are really there has been any conversation amongst the board and the management team about any fee waivers in the context of NII not covering the dividend?

Howard T. Widra Apollo Investment Corporation – CEO & Director

I mean, what we’ve been focused on with the Board is the same thing we focused on in these calls is effectively establishing with like a very sort of, hopefully, like a tight bender [???] long-term earnings power — so we try to go through that and set that up. And then once that’s set up, I think sort of, obviously, the major expense for all BDCs is the manager fees, and that has to basically take into account how we deliver on that and what the return the investors have. So the answer is, it’s always there sometimes in the foreground, sometimes in the background. But right now, it’s let’s deliver on where we think we can deliver and then we can assess what’s appropriate there given how — what our portfolio is and what the yield is.

Operator

Okay. And one hone on sort of on that point, you’ve talked about a few of the areas where you believe you can rotate some assets and sort of boost the baseline earnings power of the portfolio. One of the things we recognize is that the timing of that portfolio rotation can be uncertain, and it’s not always entirely within the manager’s control. Can you talk us through how you’re assessing that time line for rotation?

Howard T. Widra Apollo Investment Corporation – CEO & Director

Yes. We’re approaching it very aggressively right now. We have talked a long time about sort of working that portfolio down and we did from a very high number, but it’s been sort of dribs and drabs over the past whatever a year or 18 months. And now we’re very focused both because the market is welcoming, there’s some positive tailwinds on some of these investments. And because we feel like the corporate portfolio is so strong and steady that sort of have its opportunity to shine, if you will. So the answer is — you’re right, we can’t say definitively what’s going to happen with the liquid positions. But we think that there is a pathway for all of our liquid positions to be able to do something sort of strategic. Whether that fully monetizes them or partially does, we’re very focused on the next — within the next year to have something strategic done with all of them. And hopefully, that will happen linearly, not like meaning some each quarter some each but we’re very focused to have that sort of done and completed. So we can sort of tell what we thought — what we’ve always thought is the core story of this without any other noise.

And Melissa, actually that really goes to your other questions like, well, how do you look at the fees. Well, the fees and the appropriate level of the fees will depend on what sort of the solid clean portfolio looks like and what its yield is and what it’s delivering to shareholders. And so we need to sort of prove the NAV of these investments and make them earn the right return.

Operator

(Operator Instructions) We will go next to Robert Dodd with Raymond James.

Robert James Dodd Raymond James & Associates, Inc., Research Division – Research Analyst

On Merx, if I can. I mean, obviously, this quarter, you be cash reallocated recent equity to debt. At the margin, would be your preference to do that kind of going forward to rotate more of the remaining equity into debt, get the ROIC over the total committed capital that way? Or I mean, obviously, you could reduce the amount as well. I mean you talked about that. Or should we expect dividend income from Merx the equity might stay the same and you just collect the excess cash flow or earnings from Merx and that would flow to maybe dividend income? Or would you prefer to convert it essentially to interest income?

Tanner Powell Apollo Investment Corporation – President

Yes. Thanks, Robert. Thanks for the question. And I appreciate there is some complexity here. As a reminder, this is our investment in the business. And on the margin, as you asked the question, Robert, our preference would be to characterize it as debt. It creates more predictability. It takes away what is, as I acknowledged, a complex investment or at least characterization of investment and makes it a little bit less complex. And so — on the margin, we would prefer to do — to characterize it as debt. I would also state that and you would hopefully expect us to do this as well, we would only be doing that to the extent that we had the confidence that we could support it. So that would obviously be the counter to that or how we balance that decision-making process for — within the management team.

Robert James Dodd Raymond James & Associates, Inc., Research Division – Research Analyst

Understood. I appreciate that. One more, if I can. On the broader corporate lending platform. Obviously, Apollo has now got the debt solutions product that’s about to launch, which could have a large pool of capital behind it. I presume, obviously, the plan would be to co-invest. And would — do you think the launch of that product or where that product is, say, a year from now, do you think that would have any impact on the available — or if not necessarily even available, but target bite sizes for the AINV BDC?

Howard T. Widra Apollo Investment Corporation – CEO & Director

No. Good question. But no, I’d say 2 things. First of all, the core strategy of that vehicle is to do sort of like the large market origination, which you’ve seen some deals power in $1.5 billion, $2 billion sort of proprietary origination where they take a portion of those deals that to do that and whatever sort of other bespoke really large origination is done. And then a smaller portion of that vehicle would potentially overlap with what we’re doing in sort of our base origination.

So we do expect there to be some co-investing, but not a huge amount of co-investing. But the same token, for us, we don’t expect it to take part in their deals unless we feel like they’re particularly aligned with what our strategy overall is. The fact that, that vehicle will raise capital and grow should be helpful to our overall origination effort because like everybody else in our market, the key to originating is having scale. We have quite a bit of scale that’s why we’re able to originate, but it’s like you always need more.

There’s like an arms race. And so having a vehicle like this with permanent capital that has appetite for the deals and actually has appetite for the deals on the larger end of our spectrum because that fits our strategy is also where we need more capital, obviously, because those are bigger deals. And so we would not — we do not expect it to affect AINV’s bite size, and that’s because AINV gets its full bite size on all these deals. It doesn’t get cut back. There’s always enough. It’s always — and so it’s always about having more capital than it is the asset.

So we don’t expect it. Now if it became a $40 billion vehicle, would my answer start to change maybe, but it’s only going to become a $40 billion vehicle that does a lot of those large deals anyway. So hopefully, that answers the question.

CONCLUSION

More than most BDCs, AINV remains caught betwixt and between, unable to fully “earn” its dividend because its non-core portfolio remains a drag on profits and management’s time, and its compensation costs are rising.

Moreover – and less discussed by the advisor – earnings are handicapped by the lower yields available in the BDC’s mainstream corporate lending strategy.

Admittedly, the credit results of these loans – principally generated by the mid-market Apollo platform – has been excellent but the yields are low and getting lower.

Management has been taking a very long time to get to this inflection point and continues to keep all options open – as demonstrated in the Q&A session – to how they may choose to resolve this conundrum.

The good news in all this is that AINV seems to have dodged a bullet with Merx, and the “non-core” assets – thanks to ever more permanent write-offs – may become almost immaterial by 2022.

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