Henri Steenkamp: Yes, Robert. And I think just the nice thing about the RIC rules and you know how they constructed is, it allows you to plan really well sort of looking ahead more longer term and to manage the payment and to manage the spillover. So as you mentioned, yes, as rates go up, our earnings, i.e., our taxable income that we need to distribute will increase quickly. But that doesn’t mean that we will have to pay it out quickly based on the payment rules of the rig structure. So that allows us to sort of — if you manage your spillover well, which we think we have. It allows you to really plan more long term how you want to pay it out, especially in an economic environment. As Chris was talking about, that is more uncertain. So although the accretion maybe happens quickly, the payment doesn’t necessarily happen quickly, which is the nice thing about the sort of the planning mechanism of the RIC rules.
Christian Oberbeck: One for the point — I’m sorry, just one further point on this. And I think that we have been very careful. And I think as you may recall from our very, very long conference call in April of 2020, we’ve been very careful with our spillover. And we’ve used our spillover as sort of like a rainy day fund, if you will, or something like that. And some other BDCs are kind of max on their spillover. They view it as a source of capital, perhaps. And so they don’t really have a lot of room. And if they have an increase, they kind of have to pay it out immediately. But we’ve created this flexibility for ourselves utilizable in this environment to give us the time to consider an optimal approach to sort of permanent dividends versus temporary dividends.
And as we said before, we’re trying to come up with a sustainable, dependable dividend rate and that our shareholders can expect and then look behind all this question and our thinking, right, is what levels of dividend increase are we going to have next quarter and the quarters and the quarters after that? And obviously, I think the balance of consideration is that’s going to be relatively more available than in sequential quarters, certainly in the very near term than there has been in the past.
Robert Dodd: Understood. I really appreciate the color and to your point you’ve managed spillover such that it’s not going to force your hand by being near a cap. So that’s a good spot to be in as well. So, thank you for the color.
Operator: Thank you. Our next question will come from Erik Zwick of Hovde Group. Your line is open.
Erik Zwick: Thanks. Good morning. Most of my questions have been asked and answered at this point. And I guess the one I still have is a bit of a follow-up in some terms. So I guess thinking about the health of the borrowers in your current portfolio? And what could impact them certainly based on the outlook for the Fed funds curve, there’s another 50 basis points, maybe 75 that would happened here at the beginning of the year in LIBOR would likely follow suit higher to a similar magnitude. There’s also a concern about the trajectory of the economy and whether we dip into a mild recession or something more moderate or severe. As you think about the potential for credit and the health of your borrowers. At this point, what would be a larger risk if the Fed had to continue hiking further beyond current expectations, which would put a higher debt burden on your companies or material slowdown in the economy that would materially impact EBITDA and the cash flow of those companies.
Just curious how you think about that and weigh those risk factors today?
Christian Oberbeck: Well, let me try and answer it first from a high level, and then Mike can speak very specifically to our portfolio. So at a high level, we have the good fortune of investing in the smaller middle market. And so each of our companies has its own destiny, its own marketplace, its own universe. And a lot of these macro considerations, they kind of affect the broader economy in sort of broader ways and there’s a lot of cyclicality in the economy. I mean we were just — in our last investment meetings, we have one of our portfolio companies, we’re actually talking about decreasing their rate because they’re earning so much money, they want to pay us back, like no, don’t do that. I mean they’re having surging increase in revenues.
And so — the U.S. market is such a huge, huge place, and there’s so many opportunities and efficiencies and all of the Software as a Service companies that we invest in they’re creating efficiencies to their products. And so there’s a growth dynamic that’s going to persist even in a negative — in a recession. I mean if we have a mild recession, it may not affect a lot of our companies really much at all. And if we have a severe recession, there’s a bunch of our companies that will still continue to do well, can continue to do well. So I don’t mean to paint an overly rosy picture of everything for everybody. But what I would say is that each of our companies is not necessarily as affected by these macro trends on a current basis and then it partly has to do with the nature of our portfolio and also they’re the smaller companies.
I mean if you’re Walmart, if you’re McDonald’s, if you’re Procter & Gamble, I mean they’re much more exposed to the very broad gauge what’s going on in the big economy. But our companies have very specific niches in very specific markets and market opportunities. When you add them all up, they aren’t necessarily as correlated to the broader economy.
Michael Grisius: Yes. Let me add to that a little bit, Chris, because it’s a good question and an interesting observation you make. We spend a lot of time thinking about that at the front end when we’re underwriting deals, and there’s so many things that we think about. But first and foremost, at the end of the day, all of the work that we’re doing is centered around trying to get a comfort level that the business that we’re lending to is at a minimum going to be in a position where under almost all reasonable circumstances we feel comfortable they’re going to sustain their cash flow level. And we do that by looking at the end markets that they’re in. We look at the value proposition that they offer their customers. We try to think about all the vulnerabilities they may have in the future and reach an assessment as to whether they’re going to be able to continue to offer that value proposition to the customer in a way that’s very profitable for them.
And that underwriting is the most important component to what we do. It makes us — it draws us to certain industries. It draws us to industries that are less cyclical. It draws us to companies that have wide margins that produce lots of cash flow, why do they have wide margins because they can price their products at a level that allows them to have strong margins because people want their products, they see our services. They see the value in them. And the most important thing in the underwriting and the capital structure, therefore, tends to be the persistency of the cash flow. Now when we underwrite, and I should say before I move into the interest rate part of your question, when we underwrite as I said, we’re thinking about all the downside scenarios, but the cash flow is — and the persistency of that cash flow is the most important thing.
As you get into another component that we look at, which is what is the capital structure, how much leverage is reasonable for the business relative to all the things I discussed that we think about in terms of the business fundamentals that factors in as well. And as we look at our portfolio, generally, and this is just true in credit in general, the businesses are going to be affected more if their cash flow were to go down much more than if their interest rates go up. So we construct our businesses and the capital structures that we lend to in a way where as I said, we, first and foremost, get comfortable that the cash flow is persistent and usually it’s going to grow, that we feel comfortable it’s going to grow quite considerably. But in the downside scenarios that we run, we’re looking at things like interest rate sensitivity, et cetera.
And while there’s some effect that, that can have on free cash flow of the business, that has a much more marginal impact than the fundamentals of the business itself. We feel comfortable. I want to make this point that when we look at our portfolio construction right now that we are in really good businesses in really good end markets in companies that are well positioned to continue to offer that same value proposition that I mentioned to their customers in a way that will allow them to continue to be solidly profitable.
