Owl Rock Capital Corporation (NYSE:ORCC) Q4 2022 Earnings Call Transcript

Owl Rock Capital Corporation (NYSE:ORCC) Q4 2022 Earnings Call Transcript February 23, 2023

Operator: Greetings. Welcome to Owl Rock Capital Corp.’s Fourth Quarter 2022 Earnings Call. At this time, all participants are in listen-only mode. A question and answer session will follow the formal presentation. Please note this conference is being recorded. At this time, I’ll now turn the conference over to Dana Sclafani, Head of Investor Relations. Dana, you may now begin.

Dana Sclafani: Thank you, operator. Good morning, everyone, and welcome to Owl Rock Capital Corporation’s fourth quarter earnings call. Joining me this morning are Chief Executive Officer, Craig Packer, our Chief Financial Officer and Chief Operating Officer, Jonathan Lamm; and other members of our senior management team. I’d like to remind our listeners that remarks made during today’s call may contain forward-looking statements, which are not a guarantee 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 in ORCC’s filings with the SEC.

The company assumes no obligation to update any forward-looking statements. Certain information discussed on this call and in our earnings materials, including information related to portfolio companies, was derived from third-party sources and has not been independently verified. The company makes no such representations or warranties with respect to this information. ORCC’s earnings release, 10-K and supplemental earnings presentation are available on the Investor Relations section of our website at owlrockcapitalcorporation.com. With that, I’ll turn the call over to Craig.

Craig Packer: Thanks, Dana. Good morning, everyone and thank you all for joining us today. We are pleased to once again report another quarter of very strong results with earnings momentum that reflects the continued pull-through of higher rates the ongoing strong performance of our portfolio. Our net investment income in the fourth quarter was $0.41 per share, capping off a record year since we went public. To put this in perspective, NII increased 18% versus the fourth quarter of last year and over 30% in the second half of the year as we have seen the benefit of rising rates and stable credit performance. On our call last quarter, we highlighted that we expected to earn at least $0.39 of NII in the fourth quarter based on our visibility at the time.

We are pleased to report even stronger results. As a reminder, we also announced several capital actions with our third quarter results, including a $0.02 increase in our base dividend to $0.33 and the introduction of a supplemental dividend component going forward. The supplemental dividend is equal to 50% of earnings in excess of our base dividend and given our increase in NII, our supplemental dividend increased to $0.04 for the fourth quarter. As a result of this new dividend structure, investors will receive $0.37 in total dividends for the fourth quarter. At our current share price, this dividend level generates what we believe is a very compelling annualized dividend yield of over 11%. Based on the visibility of higher rates flowing through the portfolio, we expect to see continued growth in NII and corresponding growth in the supplemental dividend throughout 2023.

Our NII ROE for the fourth quarter was 11% up from 9.3% a year ago. For the full year 2022, we generated a 9.5% ROE, up 100 basis points from 2021. Looking forward, we expect to see runrate ROEs of 11% or higher, great steady current levels, which we think is an attractive risk-adjusted return for a primarily first lien portfolio. Last quarter, we also announced that our Board had authorized a $150 million repurchase program, which was in addition to a $25 million Blue Owl employee investment vehicle and the intention to purchase up to $75 million of stock in the near term through the combined buying power from these programs. We are pleased to have made significant progress on this goal to-date, in part by utilizing a programmatic repurchase plan.

As of February 17th, a total of $52 million of ORCC stock was purchased, of which $35 million was bought by the company at an average price of $12.05 per share or 81% of net asset value. We believe these capital actions underscore our alignment with shareholders, while providing comfortable coverage of our base dividend. In addition to our strong earnings, net asset value per share also increased this quarter to $14.99, up $0.14 from the third quarter. Our non-accrual rate remains low at 1.3% of the fair value of the portfolio with one name added to nonaccrual this quarter. Since inception, we have deployed roughly $25 billion across 400 borrowers, of which only six names have been placed on non-accrual in our history, and our annualized loss ratio remains at less than 15 basis points.

We believe our continued strong portfolio performance reflects our conservative underwriting standards and credit selection process. While we are pleased with the strong earnings of the fourth quarter, we are also cognizant that there will likely be new challenges for the economy as we look ahead. We expect broader economic headwinds and the potential for a recession later this year. We believe our portfolio is well positioned for this environment and our borrowers are already demonstrating resilience. Our borrowers continue to report low-single-digit growth quarter-over-quarter on a revenue and EBITDA basis, although we note that the pace of growth has slowed versus prior quarters. Many of our borrowers have experienced relief from supply chain disruptions and saw a moderation in input costs, which has helped to offset the impact of rising rates and to support EBITDA growth.

Despite this, we have not seen any pickup in the early indicators of stress across the portfolio. Our portfolio marks and internal ratings remained stable quarter-over-quarter. Anecdotally, we have not seen an increase from requests from borrowers for covenant lease or additional liquidity. We continue to utilize a rigorous monitoring process with our investment and portfolio management team of over 100 people. We have significant resources in place to proactively identify early signs of stress and mitigate potential challenges. Given the current market backdrop, we have a heightened focus on projected liquidity needs, and our continuously reunderwriting credits in evaluating downside and liquidation scenarios. As we expected, interest coverage declined to 2.3x in the fourth quarter and 2.5x the prior quarter.

This is a reflection of higher rates. This metric is reported LTM coverage. However, we also monitor the forecasted peak rate environment based on current market expectations and have found that the vast majority of our borrowers are expected to maintain adequate coverage levels over the course of the year with average coverage remaining between 1.5 and 2x. We have a monthly watchlist session in which we evaluate both existing and newly identified situations where operating results are deviated from our expectations. Across our 184 portfolio companies, the vast majority continue to perform in line with expectations. Based on our heightened monitoring, we identified less than 5% of the total portfolio on a fair value basis that we currently believe may experience more significant challenges over the next year or so.

To be clear, we are not saying these 5% will have problems, but rather that our current view, is the area of potential concern at this point is in this 5%, which we believe is an encouraging statement about the overall health of the portfolio. We continue to come away from our investment monitoring process, confidence in the portfolio and the strength of our underlying borrowers. This confidence is bolstered by our belief that large sponsor-backed companies in recession-resistant sectors will fare better in a tougher environment. Even in situations with weaker credit performance, sponsors will employ operational initiatives, such as cutting costs, for providing additional liquidity, for strategic initiatives, such as selling assets or making accretive acquisitions.

In our experience, we have found that these actions can be impactful in extending the runway to realize value for sponsors and enhance the credit profile of the business to provide additional downside protection for us as a lender. Looking forward, we are prepared for a more challenging economic environment. We believe any defaults or potential losses in our portfolio will be very manageable and offset by the continued strength of our earnings. We’ve built our portfolio to be resilient across varying environments and believe that it will fare well in the face of an economic downturn. We have deliberately built a highly diversified portfolio, focused on primarily first lien investments with low loan-to-value ratios in non-cyclical sectors and believe this is a highly defensible strategy and a slowing economy.

With that, I’ll turn it over to Jonathan to provide more detail on our financial results.

Jonathan Lamm: Thanks, Craig. We ended the fourth quarter with total portfolio investments of $13 billion, outstanding debt of $7.4 billion, and total net assets of $5.9 billion. Our NAV per share was $14.99, an increase from our third quarter NAV of $14.85. This increase was driven by over-earning the regular dividend and strong credit performance. Additionally, we saw a meaningful increase in the value of some of our strategic equity positions, which benefited NAV in the fourth quarter. Funded activity in the quarter was modest at approximately $200 million, as we match new deployments to our repayment activity, which remains muted in line with the broader slowdown in M&A and refinancing activity. Turning to the income statement, our continued strong fourth quarter performance drove record investment income for 2022, up 18% from the prior year.

This increase was driven by higher base rates and from higher average spread in the portfolio. While we have benefited from higher rates, we have also been diligently working to increase the spread in the portfolio, while maintaining the majority of our portfolio in first lien investments. As a result, the average asset yield in the portfolio increased over 300 basis points to 11% in 2022. From an earnings perspective, we expect the average base rate of our portfolio will continue to increase over the first half of the year as borrowers reset to current rates. Our average base rate for the fourth quarter was 3.7% and the average base rate elected at the end of the fourth quarter was 4.3%. This implies a pull-through of an additional 60 basis points in the first quarter.

As a reminder, holding all else equal, we expect each additional 100 basis points increase in our effective base rate to generate approximately $0.04 per share in quarterly NII after considering the impact of income-based fees. For the first quarter of 2023, our Board declared a $0.33 per share regular dividend, which will be paid on or before April 14 to shareholders of record as of March 31. For the fourth quarter of 2022, our Board declared a supplemental dividend of $0.04per share, which is 50% of the difference between the $0.41 fourth quarter NII and our previously declared $0.33 per share fourth quarter dividend. This supplemental dividend will be paid on March 17th to shareholders of record on March 3rd. Turning to the balance sheet.

We continue to have a flexible balance sheet with a well-diversified financing structure. At quarter end, our net leverage remains within our target range at 1.19x net debt to equity largely unchanged from where we ended the third quarter. We also had liquidity of $1.8 billion, well in excess of our unfunded commitments of approximately $1 billion, roughly half of which are revolvers. With only 50% of our liabilities exposed to rising rates, our weighted average total cost of debt remains low at 5.2%, and we have no near-term maturities. With that, I’ll turn it back to Craig for closing comments.

Craig Packer: Thanks, Jonathan. I’ll close with some thoughts on how ORCC is positioned today and what we’re expecting for the year ahead. We are seeing the earnings power of the business and we expect to see further earnings growth over the year as we benefit from higher base rates. The portfolio is generating very attractive risk-adjusted asset yields and we have worked hard to position it for success entering this environment, not just through careful credit selection, but also by identifying and exercising multiple strategic levers, which have allowed us to optimize earnings. We increased the overall portfolio spread by roughly 20 basis points over the last year, in part by opportunistically rotating out of investments with spreads less than 550 basis points.

And more recently, we’ve been able to take advantage of the market backdrop to re-underwrite investments and increase spreads to add on an amendment requests, which we negotiate to reflect current market terms. We have also made prudent investments in strategic opportunities, including Wingspire and the senior loan fund, which are each diversified portfolios of loans that generate over 10% ROEs and provide differentiated returns to the portfolio. More recently, we have also made select equity investments in businesses like Amergin and Fifth Season that we expect to enhance earnings and provide strong returns over time. We have locked in low-cost liabilities through our proactive approach to financing the portfolio. As Jonathan noted earlier, half of our liabilities are fixed rate.

As a result, we believe ORCC is well-positioned to continue generating outsized returns in today’s environment. Earnings continue to expand and we expect to see the benefit of higher rates play out more in the first half of the year. It’s also worth noting that this is a period of very low repayment activity, resulting in minimal repayment income. When rates eventually normalize, we expect to see a pickup in repayment activity and an increase in repayment income. The company is performing well and we are confident in the portfolio’s resiliency even in a more challenging economic environment. We are excited about the future of ORCC and the ways in which we are delivering differentiated returns to shareholders. We are pleased to announce we are hosting our first Investor Day in May and look forward to sharing more detail with investors on why we are confident that ORCC will deliver attractive returns across evolving market environments.

Dana will be sharing more details in the coming weeks and we hope that many of you on the call will be able to join us. With that, as always, thank you for your time today and we will now open the line for questions.

Q&A Session

Operator: Thank you. And our first question is from the line of Casey Alexander with Compass Point. Please proceed with your questions.

Casey Alexander: Yeah, hi, good morning. I have two questions. First of all, in your press release, it shows that you break down the asset structure of the portfolio between preferred equity and common equity over 10% of the investments dedicated to equity investments. I think that a novice investor picking this up might say that, that’s a fairly high level. But I think a lot of that is covered by asset-backed lending and off-balance sheet vehicles. If you were to carve those out, how much of the portfolio would you characterize as being true equity as opposed to being equity that’s actually fronting for interest-earning investments?

Craig Packer: Sure. Good morning, Casey, I’ll start and Jonathan can fill in what I’ve missed. I’m glad that you asked the question because I agree that if you weren’t close to our company, it could create the wrong impression. The largest pieces of those investments are investments in portfolios of secured loans, just like sit on our balance sheet today. As you know, we’ve got a large investment in a business called Wingspire which does asset-based lending, very conservative asset-based lending. And so we €“ ORCC owns almost 90% of Wingspire so that shows up as an equity investment. But what you’re getting is a highly diversified portfolio of asset-based loans that generate very consistent dividends. Similarly, and that’s about a $400 million investment, give or take.

The next biggest piece is our senior loan fund. We used to call it Sebago Lake a couple of years ago, we changed the names. Similarly, that investment is in a large portfolio of first lien senior secured term loans with really terrific credit performance and we own about 90% of that as well. And so, those portfolios generate income, just like everything else in our book, and we €“ ORCC gets 90% of that income essentially through dividends. Those are by far the biggest pieces. We have very little what you might consider like pure equity investment. On the preferreds we do are also, we think, very predictable and high quality €“ they tend to be very large sponsor-backed companies where we are being — given the opportunity and we like the opportunity to structure a preferred typically through about 50% loan-to-value.

So significant equity beneath this from the sponsor for very large companies, $200 million, $300 million, $400 million of EBITDA, if not more, that generate very consistent dividend streams. So those are the biggest components and it’s a part of the book that I think is very accretive to our overall earnings and our performance and the underliers have been very consistent.

Jonathan Lamm: Casey, if you were to just strip those items out and just look at what’s remaining in common equity, it’s about 4%. So it’s a much lower number.

Casey Alexander: All right. Great. Thank you. That’s very helpful. Secondly, we know that Applied Cleveland went on nonaccrual this quarter. And yet the mark on it quarter-over-quarter changed very little. Could you contour your confidence in that, Mark, given the fact that you’ve taken it on nonaccrual and kind of give investors an update as to what your plans are there?

Craig Packer: Sure. So Applied Cleveland, it shows up on our schedule of investments with a different name, FR Arsenal Holdings. It’s a business that provides inspection services and consulting services to energy and infrastructure companies. It’s been in our portfolio for a handful of years. We know the company quite well. It is €“ it was impacted by COVID, which reduced demand for their services, given the energy price declines. It was current in its interest payment to us during the quarter, but there was a maturity coming up and we made a judgment that we did see an easy path for us to get refinanced. As a consequence, we put it on non-accrual. We €“ you may have seen or if you haven’t seen, you’ll see some public disclosure, a subsidiary of the company.

So one of their businesses, not the whole company filed for bankruptcy for some particular technical reasons. But the overall company is solvent, if you will. We’re working closely with the company and the sponsor to take actions for us to generate repayment. And so the mark reflects our confidence in our ability to get a very high recovery, if you will, if not par, hopefully, very close to par despite the fact that we have it on nonaccrual. Just as a reminder, for folks that are newer to us, we mark every name, every quarter. We use a third-party Duffel to do that. Same process since inception. Duff has marked this name probably in our history, and we work extremely closely with them. And I think that it’s a fair observation to wonder why the market is not lower despite the nonaccrual but we believe even in situations where there is a non-accrual that we will get very high recovery levels and we are working closely with the management team here and I don’t want to overpromise, but I think over the next 6 to 9 months, you’ll see how this plays out and I think it will land in a reasonable place for us.

Casey Alexander: All right. Great. Thank you. And lastly, the senior lending fund, the JV is kind of much smaller as a percentage of assets than we typically see in BDCs that use JV vehicle. Is there room to grow that? Do you plan to grow that? Or are you simply comfortable with the size of that particular sleeve as we sit today.

Craig Packer: It’s a great question. I €“ we’ve committed $500 million. We have funded about $320 million of that. So in the short term, we certainly expect to continue to invest the remainder of our commitment I would be very open, and I think you should expect that over time, we will continue to grow this investment. It generates really attractive returns for ORCC north of 10%. As I mentioned, it’s just a portfolio of senior secured loans. And so I expect us to grow it over time. Just to make reference back to it, we commented we’re going to have our first Investor Day this May and this is a topic that you should expect us to spend a lot of time on. I think that we have the ability to drive returns higher in the portfolio, not only by growing the senior loan fund, but also by growing our exposure to Wingspire and a couple of our other more structured investments.

I think they’re very accretive. I think we’re very deliberate about how we do it. I think it’s worked out extremely well, and we will continue to add to it. Collectively, those investments today are about 6% of the portfolio. Over time, I don’t see any reason why that couldn’t get to be 10% plus. Again, we’ll talk more about that at our Investor Day. But it just shows our ability to continue to drive returns higher in the portfolio.

Casey Alexander: All right. I had still one more question then I should have. So, I’ll step out in the queue. But thanks for taking my questions.

Craig Packer: Okay. Thanks a lot.

Operator: Our next question comes from the line of Robert Dodd with Raymond James. Please proceed with your questions.

Robert Dodd: Hi guys. On Wingspire. I mean, obviously, it’s been very successful for you so far. When you did invest a little bit more capital in it this quarter, the tell-you vote the fair value up a little bit, but the dividend did drop. So can you give us any color on what do you expect the long-term return on invested capital to be from that asset given it is 400 million of assets equity, but it’s income-producing equity as you’ve already discussed. I mean what’s the long-term ROIC that can be sustained from that business?

Craig Packer: So look, Wingspire has been really pleased with our investment in Wingspire and what we’ve created there and the quality of the loans that they are writing, the quality of the team. As you will recall, we did an acquisition in that business for an equipment finance business, which got integrated very nicely. This should be a €“ and certainly north of 10%, 11-plus percent, 12% return on equity investment. In any one quarter, the dividend might be $1 million or $2 million higher or lower. We did do the Liberty acquisition there. But I wouldn’t read anything into 1 quarter. So dividend being down by $1 million or $2 million. I would expect over the course of the year that, that dividend will increase and will generate certainly north of 10%, but hopefully more like 11% or 12% return.

And I think we’re creating real enterprise value by the business we’ve created. Organically, and I think David Wisen and the team at Wingspire deserve a lot of credit. We built this from scratch with a clean sheet of paper, a business that we think is valuable today, and we’ll have more value over time and we’ll generate a very consistent income stream to ORCC.

Robert Dodd: Got it. Thank you. I mean, to your point, you did say last quarter, you said $0.39 or at least $0.39. My guess is you probably thought prepayment income was actually going to be a little higher than this quarter being $0.41 with very prepay income is a very strong NII quarter. So what — was there anything that surprised you, so to speak, because we’re 41, obviously, well above 39, at least 39, despite the fact that prepay income was so low. So what were the €“ what were the uptick drivers that kind of pushed it into the above 40?

Craig Packer: So, I don’t think there are any significant surprises, Robert. What I hope is, those that watch us closely now for seven years, we try to under promise and over deliver. I was very deliberate that we said at least $0.39. I know most of the estimates were at 40, I think that this portfolio has tremendous operating momentum. The rates are going through. It’s driving earnings. And in our script earlier today, we talked about further increases in the first quarter and that’s all despite no repayment. So I €“ we are not naturally disposed to give out guidance, I think given where our stock is traded, I think that instinctively, we want to make sure our investors understand the strength of what we’ve built. So we put out the guidance we did.

We certainly wanted to make sure if we did that, that we would deliver on what we said. So, no big surprises. Portfolio continues to do well. I expect NII to be up in the first quarter, just based on rolling through the higher rates that we’ve already €“ the company have already experienced our continued strong credit performance.

Robert Dodd: Got it. Thank you.

Craig Packer: Thanks. Robert.

Operator: Next question is from the line of Ryan Lynch with KBW. Please proceed with your question.

Ryan Lynch: Hey, good morning, Craig. Good morning, Jonathan. First question I had was you mentioned in your prepared comments, less than 5% of your current portfolio may experience problems in the future. And again, that’s not a guarantee or anything like that, but those are kind of the investments you may be monitoring closely. I’m just curious, can you maybe help clarify €“ are those businesses experiencing problems with the fundamentals of their business weakening potentially? Or is it more a combination of higher leverage and pressure in their earnings profile from higher rates or some combination of those two fundamentals and higher rates that are having you more concerned with that small subset of your portfolio?

Craig Packer: Sure. Thanks, Ryan. Look, we know probably topic 1 on investors’ minds is how the portfolio is going to hold up in a world where rates are much higher and potential weakening of the economy later this year. We are all over our portfolio and just €“ that’s just the way we operate since inception. And so scrubbing our portfolio happens every quarter since inception, watch what happens every month and so, and we very consistently have had a watch list of about 10% of the portfolio. Those are companies that generally have underperformed for various credit specific reasons. But in this environment, given that heightened concern from investors about what might happen with higher rates in a weakening economy, we wanted to offer further insight that within that 10%, there’s only about half of it that we would say we’re really concerned about.

And why is that to the guts of your question, I’d say it tends to be just challenges in the business themselves, operational issues that might come from all the factors you might expect labor costs or material costs or weakening demand specific to a company, not any broader themes, coupled with higher debt service. And so the higher debt service obviously is going to take a weaker business that was potentially struggling now and really put pressure on it. And so we’re acknowledging that we would expect to see some pickup in stress in the portfolio, but hopefully, folks take comfort that we’re really only talking about less than two handfuls of companies. So it’s credit specific, coupled with higher debt service is the underlying theme for those businesses.

I really don’t sit here €“ I am not sitting here thinking like we’re going to have a problem of every single one. They each have their own plans to address their concerns. But I’d rather just share some context so investors can make decisions about the portfolio overall and hopefully take some comfort with a relatively small low number.

Ryan Lynch: I appreciate you shared that information and it’s helpful to kind of frame things regarding your portfolio. The other question I had, focusing on the credit theme, because that’s very important in this environment. I believe you said that you’re not really seeing a pickup in early indicators of stress in your portfolio thus far. I’d love to just hear what sort of metrics or indicators that you all monitor as those early signs of stress.

Craig Packer: Sure. I mean it’s a handful of things. Obviously, companies that come to us that are — in a violate covenants in a material way that are going to result in a difficult negotiation. I think that’s not happening now in a meaningful way. But when that happens, that’s certainly 1 factor. Companies that — companies are drawing on their revolvers because they need the liquidity in a meaningful way. Obviously, COVID, we saw that very dramatically. We’re not seeing any change in behavior whatsoever for companies drawing revolvers, request for to take our cash pay interest and make it pick because of liquidity pressures. We’re not seeing any pickup in that. I mean, obviously, defaults for sure, but those are the tangible things, but I’d say more broadly, we’re not €“ not only we’ve not had those things, but we’re not having a lot of elevated conversations around the potential for them, there is always some, there is always some discussion in the portfolio.

But the amendments we’re doing, for the most part are garden variety amendments. And there is not these like deep drawn out, hard conversations with a company that’s suffering where we’re grinding out something that might result in a bad credit outcome. I’m just not seeing it yet. And again, I expect some pickup in the course of the year. It’d be unrealistic to think not, but I think folks should take some comfort that there really isn’t much right now. And I don’t expect any next week either, but those are some of the factors that we look at. I don’t know if that helps.

Ryan Lynch: I appreciate that, Craig. That’s all for me.

Craig Packer: Thanks, Ryan.

Operator: Next question is from the line of Kevin Fultz with JMP. Please proceed with your question.

Kevin Fultz: Hi, good morning and thank you for taking my questions. So on Slide 3 of the presentation to comes about 46% of funding activity in the fourth quarter.

Craig Packer: Kevin, sorry, Kevin, sorry to interrupt, it’s really €“ it’s a little hard to make out hear you. Is there any way you could tweak your microphone or something?

Kevin Fultz: Sure. Can you hear me better now?

Craig Packer: Yeah, it’s way better. Thanks a lot.

Kevin Fultz: Okay, okay. No problem. I believe that, that was driven by an increased investment from interest in Fifth Season investments, could you provide a high-level overview of Fifth Season investments.

Craig Packer: So Kevin, that part where we could hear you, that part of the front, we kind of need that again. Sorry about that.

Kevin Fultz: Sure. Sure, no problem. I was saying Slide 10 in the presentation shows the asset funding. And I see your common equity was about 46% of funding activity in the fourth quarter. I believe that was driven by increased investment improvement to Fifth Season investments. I was just curious if you could provide a high level overview of Fifth Season’s business as well as the opportunity that led you to invest in the company.

Craig Packer: Sure. So, we had €“ we’ve been talking about some of these structured investment opportunities. A couple of quarters ago, we made an investment in an in Fifth Season with a very experienced management team Fifth Season, it’s a life settlements business. Essentially, they offer consumers who have life insurance policies who don’t have an easy way to get liquidity from €“ on those policies from their insurance companies. They offer to €“ a way to get liquidity on those policies. So it’s a business that consumers like we don’t originate direct from consumers, we work with middleman. But it’s a non-correlated asset class that we think can generate very nice returns to our portfolio, working with a very experienced management team.

They had €“ it’s a little bit complicated and I am not sure worth going into a great amount of detail. We were working with them. There was a potential acquisition they are looking to make in the space early in their life and that not happening, but subsequent to that, essentially, we funded additional purchases of portfolio assets to build out that business. You should expect to see us continue to grow Fifth Season. Again, it’s a very actuarial, predictable as long as we have good underwriting practices, non-correlated returns that we think could generate comparable low double-digit rates of returns similar to our other structured investment vehicles.

Kevin Fultz: Okay. I appreciate your comments there. And then, I also see that the season paid a small dividend ORCC in the fourth quarter. I’m just curious if that dividend is considered recurring and if you expect the size of the dividend of scale over the next few quarters with the increased investment improves in October and November?

Jonathan Lamm: It was a repayment of the dip loan. We made a dip loan on a …

Craig Packer: It wasn’t a dividend. It may be showing up in a way that’s confusing. But essentially, I mentioned this potential acquisition that didn’t wind up happening and the payment that you are seeing essentially was repaying some financing we had offered in connection with that acquisition. Over time, we will see dividends from Fifth Season, but that is not representative of that. But over time, you will see it and we’ll call that out when it happens.

Kevin Fultz: Okay. Got it. That’s helpful. Very congratulations on a very nice quarter.

Craig Packer: Thanks, Kevin.

Operator: Our next question is from the line of Mark Hughes with Truist. Please proceed with your question.

Mark Hughes: Thanks. Good morning. You talked about the NAV getting a boost from increased value and the strategic investments presumably maybe offset by wider spreads. I wonder if you could break out those two effects, if possible?

Craig Packer: Sure. So, for this quarter, our secured loans basically were flat for the quarter. Our first liens were slightly negative. Our second liens were slightly positive, less than 50 basis points. But essentially, they were flat for the quarter. The slightly positive because we had one particular second lien that is part of a publicly traded capital structure that traded up for the quarter. So it was a very observable increase. So the growth in NAV this quarter was driven by our out earning our dividend and through an increase in value in our equity investments, which is not just the structured equity investments that we’ve been talking about. Our equity investments were up about 3% for the quarter. The biggest driver of that was a company called Windows, which is a business we’ve owned for a while, has very little leverage on it.

It’s performed extremely well. Folks that have followed us will know we’ve taken really nice dividends out of this. The company has performed very well and so there was a markup in that part of the portfolio. Wingspire was up a little bit, those were the 2 biggest pieces of the increase, $25 million out of the $30 million. So, that drove a slight increase in NAV for the quarter.

Mark Hughes: Appreciate that. And then is there a point estimate? You talked about the interest coverage, 2.3x on a trailing basis. I think you said on a forward, if you look at the curve, they should be between 1.5 to 2. Where does it stand now if you use current interest rates on the leverage on the interest coverage?

Craig Packer: So, I think that if you take rates at the end of the year to roll those through, as we said, we’ll get to a 1.5 to 2. If rates stayed where they are like this afternoon and just ran that for 12 months, it’s probably more towards the 1.5 part of the range than the 2 part of the range, 1.5 to 1.7, somewhere in there. Obviously, there is a tremendous number of variables in there, EBITDA and the like. But that gives you a sense. I still €“ that’s the right range. But I think if you take today’s spot rates and just rolled it forward, for 12 months, you’ll get something towards the lower half of the range of 1.5 to 2.

Mark Hughes: Appreciate that. Thank you.

Craig Packer: Thank you.

Operator: The next question is from the line of Mickey Schleien with Ladenburg Thalmann. Please proceed with your questions.

Mickey Schleien: Yes, good morning, everyone. Craig, just one question from me more about capital allocation. Just curious what your thoughts are on the likelihood of continuing to retain some undistributed taxable income in this market environment, which can help bolster the balance sheet versus potentially reducing excise taxes by distributing more of the UTI beyond the supplemental dividends that you have according to the formula?

Jonathan Lamm: Yes. Mickey, it’s Jonathan. The number right now is still relatively small. We had about $13 million of undistributed NII and maybe like $7 million on the cap gain side. So it’s not a significant number, not driving a lot of excise tax. So, based on the way our structured dividend policy works, we would anticipate that we’re going to continue to spill over a little bit more and we have no plans for doing anything with that spillover at this point.

Mickey Schleien: No, thanks, Jonathan. That’s it for me this morning.

Jonathan Lamm: Thanks, Mickey.

Operator: Next question comes from the line of Kenneth Lee with RBC Capital Markets. Please proceed with your question.

Kenneth Lee: Hey, good morning and thanks for taking the question. Just one on the expectation for a run rate ROE of about 11%. I think you mentioned assuming if rates aren’t changed, does that mean that there could be some upside if rates were to continue increasing. And just wondering what other assumptions are embedded there in terms of leverage and things of that like?

Craig Packer: Sure. We said 11% or higher, at least 11%. I think we’re clearly signaling it could be higher even if rates stay where they are, portfolio continues to perform extremely well. We have the carryover effect from higher rates in the fourth quarter that will roll through in the first quarter and ROE will benefit from that and we continue to have really excellent credit performance. So we’re not €“ we are assuming we’re staying within our target leverage range. That’s extremely important strategically to ORCC to stay within our target range. Investment-grade ratings are strategic imperatives. So we’re not assuming anything unusual there. We are just assuming continued strong earnings from the higher rate environment, I do think that we’ll continue to grind higher on these equity investments, which are also €“ generate high returns.

And we’ve got really nice visibility that earnings will be €“ continue to be very good in this environment, if you think rates are going to stay where they are or they go higher, then I think there’s further upside from there. Again, just to call it out, to make an effort to participate in our Investor Day that we’re going to have in May because I think that’s the kind of topic I’d like to go through. We think we have a very powerful return story and while it’s nice that the stock is up today, it continues to puzzle us why the stock has not traded better given the strong predictable earnings that we’re continuing to demonstrate and I think that ROE north of 11% on an ongoing basis, hopefully will address that.

Kenneth Lee: Got you. Very helpful there. And just one follow-up, if I may. Wondering if you could just talk about what you’re seeing around either sponsored deal flow? Any other €“ what could be key drivers for potential originations over the near term, just given the level of M&A activity? Thanks

Craig Packer: Overall, M&A activity remains quite modest. And I think M&A was down about 40% last year. We are not seeing any significant pickup in that activity. But the positive for direct lenders like Owl Rock is while overall activity is lower. It’s all going to direct lenders. Direct lenders market share has never been higher. I’d say any transaction of size is primarily being done in the direct lending universe and we are fortunate here at Owl Rock that we have extremely deep relationships with financial sponsors and see everything that’s out there and are in a fortunate position to be selective on the deals that we do. And the deals we’re doing are some €“amongst the best we’ve seen in our history with great spreads, credit leverage levels, covenants and the like.

So there is a lot to like for the new loans that we’re doing. I recognize for ORCC, the challenge is not deal flow. The challenge is age repayments. We’re sticking to our leverage target. We’re having almost no repayments and as a consequence, really matching origination to repayment levels. So we really need repayment levels to pick up for us to take advantage of that. I should say, we are able to take advantage of the environment and we have been doing this in situations where we asked for additional capital or amendments. We have had nice success at repricing as much as 10% of the portfolio in those cases with good performing credits that we like and essentially marking them in the market in the context of amendments and acquisitions. So we are benefiting there.

But at some point, if you think that the market will improve to the point that M&A returns, which I think will happen at some point this year, we should see a significant pickup in repayments at some point, and that will allow us to redeploy capital. So again, I think it’s €“ I think we’ve said it probably 3x today, but all the earnings and the significant earnings performance that we generated in the fourth quarter and that we expect it to continue to generate the first quarter is without barely any benefit from repayments whatsoever. And so there’s another lever down the line at some point that will return. But it’s a great environment to be a lender if you’ve got the deal flow and we’re fortunate to have that.

Kenneth Lee: Got you. Very helpful there. Thanks again.

Craig Packer: Thanks, Kenneth.

Operator: Our next question is from the line of Derek Hewett with Bank of America. Please proceed with your question.

Derek Hewett : Good morning, everyone. Craig, maybe you can take this one. So, credit trends, looks like they continue to look good, although PIK income has increased. So I think it’s a little under 9.5% of total revenue in 2022 versus I think it was roughly a little above 5% of the prior year. So at what level of PIK income would it start to become worrisome?

Craig Packer: With the vast majority of our PIK income is not from credit problems, it’s from specific deals where we were asked to structure our investment with either a portion or all PIK at the get-go, and we thought it was reasonable to do so for credit specific reasons. It’s like 85%, 90% of our PIK income. We have very little PIK income from credit problems. So, it’s just not €“ it’s just not €“ it’s not an indicator of stress in the portfolio. If you’re asking me, I think about where we are low double-digits, it’s about the right level of PIK. So I don’t think we expect to take that number higher. As I mentioned before, we’re not seeing request for PIK from troubled credit situations, but we are in a very comfortable place there and there is nothing €“ there is no so you should not look at as a cause of concern of the portfolio because that’s not what it’s an indicator of.

Derek Hewett : Okay, great. Thank you

Operator: Thank you. At this time, we’ve reached the end of the question-and-answer session. I’ll now turn the call over to Craig Packer for closing remarks.

Craig Packer: All right. Thank you, everyone. I really appreciate it. Thanks for your time today. We’re very accessible. If you have more questions, please reach out to Dana Sclafani, look forward to seeing everyone at our first Investor Day in May and enjoy the day. Thank you.

Operator: This will conclude today’s conference. You may disconnect your lines at this time. Thank you for your participation.