BCP Investment Corp (BCIC) 2010 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen and welcome to the Kohlberg Capital Corporation 2009 annual and first quarter 2010 earnings conference call. An earnings press release was distributed earlier today. If you did not receive a copy, the release is available on the Company's website at www.kohlbergcapital.com in the Investor Relations section. A PowerPoint presentation with additional information related to this conference call is also available on our website under Event. At this time all participants are in a listen-only mode. Following today's presentation, instructions will be given for the question-and-answer session. (Operator Instructions). As a reminder this conference is being recorded today, Tuesday, June 1st, 2010. This call is being hosted on the live webcast which can be accessed at our Company's website www.kohlbergcapital.com in the Investor Relations section under Event. In addition, if you would like to be added to the Company's distribution list for news events including earnings release, please contact Denise Rodriguez at 212-455-8300.

At this time Management would like me to inform you that certain statements made during this conference call which are not historical may be deemed forward-looking statement within the meaning of the Private Securities Litigation Reform Act of 1995. Although Kohlberg Capital Corporation believes the expectations reflected in any forward-looking statements are based on reasonable assumptions, it can give no assurance that its expectations will be attained. Factors and risks such as those described in the risk factor section of our 10-K and sections of our Forms 10-Q and other SEC documents filed during the course of the year could cause actual results to differ materially from expectations.

And now at this time for opening remarks, I'd like to introduce Chris Lacovara, Chairman. Chris, please go ahead.

Thank you. And thank you all for joining Kohlberg Capital for a review of the Company's financial results for the 2009 fiscal year and for the first quarter of 2010. We will also comment on the restatement of the fair values of certain investments for the quarterly periods of 2008 and the first half of 2009. I will open the call with some general comments about the financial performance of our middle market lending and asset management businesses. I will then turn the call over to Dayl Pearson, our Chief Executive Officer, who will discuss our investment portfolio and comment on the restatements in more detail. After that, our Chief Financial Officer, Mike Wirth will provide a recap of our fiscal 2009 and first quarter 2010 financial results and performance. We will then open the line up for your questions at the end of the call.

On December 31st, 2009, net asset value per share was $9.56 and as of March 31st, 2010 our NAV per share was $9.62. For 2009 net investment income was $0.83 per share compared to $1.50 per share for 2008. For the first quarter of 2010, net investment income was $0.11 per common share as compared to $0.30 per common share for the first quarter of 2009. The Company's net investment income includes the impact of higher interest cost on our credit facility being paid under protest due to a decision by our lenders to charge default interest from which we are currently seeking judicial relief.

We have been paying this higher rate of interest since June 2009 and estimate that our net investment income for 2009 would have been approximately $0.20 per share higher for fiscal 2009 and $0.08 per share higher for the first quarter of 2010 had the interest rate on our borrowing facility not reflected the higher default interest rate. The remainder of the reduction in net investment income in 2009 and for the first quarter of 2010 resulted primarily from the reduction in the size of our loan portfolio as loans prepaid or were sold as well as from the temporary suspension of distributions on some of the junior securities of collateralized loan obligation funds, or CLO fund securities, held by the Company. I will comment further on the performance of our CLO fund investments in a moment.

Kohlberg Capital declared and paid in cash dividends for 2009 of $0.92 per share. The Company declared and paid in cash a dividend of $0.17 per share for the first quarter of 2010. Realized losses of approximately $16 million or $0.71 per share were recognized during 2009 primarily due to the sale of certain assets below their original cost. These losses are primarily as a result of the sale of defaulted or distressed assets at or above their prior quarter fair value marks.

We have restated the fair values of certain investments for quarterly and annual periods in 2008 and for the first half of 2009, and have also restated our financial statements for the first two quarters of 2009 to correct an error related to revenue recognition with respect to certain payment-in-kind interest income.

The fair value restatements related to 2008 did not impact our net investment income for that year but did impact our net asset value which was restated to $9.03 per share as of December 31st, 2008. The fair value restatements in the first and second quarters of 2009 reduced our net asset value per share to $9.41 and $9.73 respectively. The PIK-related restatements related to the first and second quarters of 2009 reduced our net investment income per share by $0.02 and $0.03 per share respectively.

Trading values in the loan market have improved in recent months and we believe that the downward pressure on our net asset value as a result of the distressed market conditions we saw in 2008 and through the first half of 2009 have moderated significantly. These trends also impact our investments in CLO fund securities.

With regard to our portfolio investments in the subordinated debt and preferred stock of collateralized loan obligation, or CLO funds, we faced some challenges in 2009 that are now beginning to moderate, which we believe validates Katonah Debt Advisor strategy of managing its CLO funds through the downturn by managing underlying credit as opposed to reacting to rating downgrades. Although all of the CLO funds in which we invested continue to experience manageable default rates and strong net interest cash flows throughout 2009, beginning in early 2009 we saw a significant number of rating downgrades in the underlying loan assets particularly in the older CLO funds.

These rating downgrades resulted in a temporary suspension of cash payments to the junior fund securities which KCAP holds in three CLO funds temporarily reducing KCAPs related investment income and reducing the fair value of some CLO fund investments. Fortunately these challenges related primarily to investments in CLO funds raised and invested prior to the onset of the credit crisis in late 2007, which currently represent approximately 19% of our total CLO investment portfolio and approximately 2% of total assets.

In the second half of 2009 and the first quarter of 2010 we have seen a substantial improvement in the performance of the CLOs that curtailed payments during 2009, and two of these funds have resumed distributions to their junior securities during the second quarter of 2010. This improvement is due in part to careful management of these funds by our wholly-owned portfolio Company, Katonah Debt Advisors, or KDA, in particular superior credit selection and the avoidance of asset sales at the stressed prices during the financial crisis. We believe that all funds which had suspended distribution will resume distributions by the end of 2010 or in early 2011 absent some dramatic downturn in the credit markets.

Our investments in the Katonah X and Katonah 2007-1 CLO funds, which represents 80% of our CLO investments, fortunately experienced much less significant ratings downgrades and never suspended distributions. These funds continue to make cash distributions to KCAP on a quarterly basis.

Turning to our asset management business, KDA, as of March 31st, 2010, KDA had $2.1 billion of assets under management. Our 100% ownership with KDA was valued at $56 million based on its assets under management and perspective cash flows at March 31st, 2010. KDA has also been impacted negatively by the performance of its managed CLOs as three of its managed funds began to defer payments of a portion of their management fees during 2009 due to the ratings downgrades on underlying assets previously mentioned. These unpaid management fees continue to accrue and remain payable to KDA as these funds come back into compliance with certain financial tests. Accrued fee income available for future release to KDA, and thus available to distribute to KCAP in the form of a distribution or return of capital, was approximately $6 million at the end of March 2010. Two of the CLO funds began to pay past accrued subordinated fees along with their current payment of subordinated fees to KDA during the second quarter of 2010 and we believe that all unpaid fees will be recovered over the balance of 2010 or by early 2011 absent a dramatic downturn in the credit markets.

Moving on to our balance sheet leverage. At the end of the first quarter of 2010, we had debt outstanding of $199 million under our secured credit facility. The credit facility is non-recourse to KCAP and is secured by approximately $273 million of assets at fair value consisting primarily of senior secured loans and representing approximately 62% of our investment income as of March 31st, 2010. The remaining $144 million of our assets, representing 38% of our gross investment income, are unpledged and outside of the credit facility.

In August 2008 the Company was notified by the lenders that the liquidity banks providing the underlying funding for the facility did not intend to renew the liquidity facility to the lenders. The lenders accelerated the maturity of this facility from September 2012 to September 2010 and began to sweep all interest and principal collections on pledged assets in excess of interest due against the loan balance. Because we have substantial earning assets not pledged as facility collateral, we believe that we have sufficient cash and liquid assets to fund normal operations and continuing dividend distributions through the accelerated maturity of the facility in September 2010.

After the Company and the facility lenders failed to reach agreement on an amendment and restoration of the 2012 maturity, in June of 2009 the facility lenders asserted that the Company was in technical violation of certain terms of the facility. At that time, the facility lenders unilaterally imposed an increase in the interest rate and an acceleration of the amortization period. On August 2009 we filed a complaint against the lenders to clarify our rights and obligations under the facility documents. We also stated our belief that the lenders assertion that the Company was in breach of its obligations was without merit and that the facility should not have been accelerated from 2012 to 2010. This case is still pending in New York State Court. And with that I'd like to turn the call over to Dayl Pearson, our President and Chief Executive Officer. Dayl?

Thank you, Chris. I'll first address our investment portfolio and recent restatements to our financials. As already noted by Chris, our year end 2008 NAV was $9.03 per share from a previously reported $11.68 per share. Our valuation process, as it always had, focuses first on the attributes of the subject asset, the credit quality, performance, industry and other unique characteristics of each investment. In addition we now use a present value technique that discounts contractual cash flows based upon bond spreads in the yields for comparable issuers for the specific asset and then adjust those yields using two market indices to adjust for priority of the asset. The comparable issues are chosen based upon their industry and credit considerations and similarly to the underlying asset value-- the underlying Company rather. We also further adjust those discount rates to reflect any amendments or prepayments during the valuation period. In addition we have also engaged valuation research to provide positive assurance on a significant portion of our portfolio annually, and they did this for both 2008 and 2009.

We retroactively applied these revised valuation procedures for our portfolio for the year ended December 31st, 2008 and the quarterly periods included in 2008 as well as the quarterly periods ended March 31st, 2009 and June 30th, 2009. As a result, the restated fair value of our portfolio more closely tracked the broader market yields for high yield and levered loans.

At this point I would like to refer to the slides that we posted on our website earlier today. We'll start with slide one, which we think gives a better graphic representation of what happened. Slide one compares the yields on certain market indices for bonds and loans. As you can see at 12/31/08, the spread between loans and bonds reached its highest point ever at 12.5%. Investors clearly were focusing on reducing risk by investing in more senior securities.

Slide two shows the impact on the restatement of our loan portfolio in dollar terms. As you can see the impact was less than 5% for all periods except for the fourth quarter of 2008 and the first quarter of 2009, and even then it was less than 10%.

Slide three shows the trend in our loan marks and compares those to the original marks while slide four shows the trend in our overall NAV per share, which has a similar pattern. As a result of the-- of this approach to fair value, our previously weighted average mark on our debt securities portfolio of 89 dropped to 82 at year end 2008 as you can see. But by June of 2009 the difference between those marks had narrowed significantly to 86 and 83. By year end 2009 our weighted average mark on our debt securities portfolio was 86 and remains 86 at March 31st, 2010.

As for our CLO portfolio, we adjusted fair values downward as of December 30th, 2008 from a weighted average mark originally reported of 75 to 46. The fair value for the CLO portfolio at year end 2008 anticipated market expectations of substantially higher defaults and non-performance in the CLO market. Expectations that have not come to pass based upon the fact that over 80% of our CLOs continued to perform during the course of 2009 and have continued to perform through the first quarter of 2010. The CLO fund securities that continued to perform through 2009 and annual cash returns ranging from 15% to 97% based upon the fair value at December 31st, 2009.

I will now move on to our current portfolio results. As of March 31st, 2010, our NAV per share was $9.62 and our total investment securities were $410 million. Our debt securities portfolio has decreased relative to prior periods as we continue to de-lever using principal repayments on our investments and also make selective cash, I'm sorry, selective sales for cash management purposes. Looking at the composition of our investment portfolio, our portfolio quality continues to hold up relatively well. At the year end and the first quarter our debt securities totaled approximately $276 million and represented about 68% of our investment portfolio. As in the past, first lien loans represent the largest percentage of our debt securities portfolio at 52%. At March 31st, 2010 our ten largest portfolio companies account for approximately 39% of our loan portfolio fair value.

Excluding our investments in Katonah Debt Advisors and CLO fund securities, our ten largest portfolio companies represent approximately14% of portfolio fair value. As you know it has been our strategy to be diversified by borrowed industry in an effort to mitigate the effects of the recession. At March 31st, 2010, the weighted average yield on our loan in the bond portfolio was approximately 5.5%, approximately 5% of our investments are fixed rate and the approximate average fixed rate is 11%.

As we noted earlier, credit quality in our portfolio remains relatively strong. At the end of March 31st, 2010, our hard watchlist consisted of six issuers, four of which currently are in non-accrual status. We continue to see prepayment at or above par which supports our belief that the unrealized losses currently reflected in our portfolio will not necessarily result in realized losses in respect to those investments.

From January 1, 2009 through May 31st, 2010, we received approximately $111.7 million of unscheduled payments in our loan portfolio. These payments were on approximately $126.2 million of par loans with a cost basis of approximately $123.3 million. This represents a loss compared to our cost of $11.7 million but a gain compared to the previous quarter mark of $2.8 million. As a result of the sales and pay downs that have occurred and those that we expect will occur in the remaining of the first half of this year we expect to be able to reduce our debt facility outstanding balance below $150 million by the end of the second quarter. And now I'll ask Mike to walk you through the details of our financial performance. Mike?

Thank you, Dayl, good afternoon, everyone. Since we've already discussed our recent restated results, I will start with comments about our full year 2009 results and then I will focus on our first quarter 2010 results before commenting on some qualitative aspects of our performance. For the year ended December 31st, 2009, we reported net investment income of approximately $18 million or $0.83 per share as compared to approximately $31 million or $1.50 per share in 2008. Our total investment income for 2009 was approximately $34 million as compared to approximately $49 million in 2008.

The most significant driver impacting the decline in investment income is a reduction of approximately $9 million in interest from investment and debt securities. This reduction is primarily due to lower average investment balances on which interest is earned and to some degree an increase in non-accrual assets. The reduction is also impacted by restatement to correct an error in the accrual of approximately $1 million of noncash PIK income on assets that were placed a non-accrual status in the first half of 2009.

Our CLO fund securities dividend income decreased to approximately $9 million in 2009 from $13 million in 2008. The reduction in CLO fund income is primarily due to the suspension of distributions to junior securities from certain CLO fund investments in order to de-lever those CLO funds primarily as a result of writing downgrades and the underlying assets of the affected CLO funds.

Expenses for 2009 totaled approximately $16 million as compared to approximately $19 million in 2008. Our largest expense during 2009 was interest expense at approximately $9 million. Most of the decrease in expenses was due to an approximate $2 million increase, I'm sorry, decrease in interest expense resulting from approximately $6 million in reduced interest expense due to lower outstanding balances but offset by over $4 million of additional interest expense resulting from the higher interest rate, which we are paying under protest on the Company's debt facility beginning in June 2009 which is the subject of a dispute with our lenders. If the Company were not paying the higher default interest rate, interest expense would have been approximately $5 million or approximately $0.20 to $0.21 per share. Realized losses in 2009 were approximately $16 million as compared to realized losses of approximately $575,000 in 2008. Net investment income for 2009 was approximately $18 million or $0.83 per share compared to approximately $31 million or $1.50 per share in 2008. If we were to eliminate the additional interest expense resulting from the default rate of interest on our credit facility, our net investment income would have been $1.03 per share for 2009.

Moving on to our most recent quarters performance for the three months ended March 31st, 2010, we reported net investment income of approximately $3 million or $0.11 per share as compared to approximately $6 million or $0.30 per share in the first quarter of 2009. Our total investment income for the first quarter was approximately $7 million as compared to $9 million for the same 2009 period. The most significant driver impacting the decline investment income was a reduction of approximately $2 million in interest from investments in debt securities. This reduction is primarily due to lower average investment balances on which interest is earned.

Expenses for the three months ended March 31st, 2010 totaled approximately $4 million as compared to approximately $3 million for the same quarter in 2009. Such increase is primarily attributable to interest expense of-- had approximately $3 million for the quarter. And as I previously noted, we are currently paying under protest a default rate of interest. For the three months ended March 31st, 2010, we estimate that this additional default rate of interest added approximately $2 million or $0.08 a share to our interest expense for the first quarter of 2010.

Realized losses in the first quarter of 2010 were approximately $2 million which was approximately the same of the realized losses in the first quarter of 2009. Net investment income for the three months ended March 31st, 2010 was approximately $3 million or $0.11 per share compared to approximately $6 million or $0.30 per share in 2009. Again, if we were to eliminate the additional interest expense resulting from the default rate of interest on our credit facility, our net interest-- our net investment income would have been $0.19 per share for the three months ended March 31st, 2010.

I will now move on to a qualitative discussion about our balance sheet and income statement, will add a little more color to some of the previous comments made by Chris and Dayl. Our largest CLO fund investment, the equity tranch of Katonah 2007-1, is yielding a current annual return on fair value of approximately 15% and our investment in the BB rated securities of that CLO currently has an IRR of over 55% based on the amount of original investment. Our second largest CLO fund investment, Katonah X, is yielding an annual return on fair value of approximately 30% and our investment in the Katonah three CLO is yielding a current annual return on fair value of 97%.

The other CLO funds in our portfolio, approximately $10 million at fair value, which represent less than 2.5% of our investment portfolio, have currently suspended cash payments to the junior securities which KCAP holds due to ratings and credit downgrades on the underlying loans held by these CLO funds. Again, fortunately these CLO funds represent less than 2.5% of our investment portfolio. Of that $10 million of non-performing CLO fund securities, 30% of such amount has resumed making equity distributions during the second quarter of 2010 and another 30% of such amount is expected to resume their equity distributions in the third quarter. By year end we believe that nearly all of our CLO fund investments will resume their equity distributions.

With regard to our wholly-owned asset manager, Katonah Debt Advisors, its assets under management, or AUM, has remained fairly constant during 2009 and through year-to-date. As noted previously, KDA continues to receive 100% of its quarterly senior management fees on it's AUM. The older CLO funds that are managed by Katonah-- by KDA, known as seven, eight and nine, are among those who suspended cash payments to the junior fund securities due to ratings and credit downgrades and the underlying loans held by those CLO funds.

As a result, these funds during the course of 2009 deferred the payment to KDA of those quarterly subordinate management fees. By the year end 2009, the accrued and unpaid subordinate management fees due to KDA by these CLO funds totaled approximately $5 million to $6 million. In the quarter, second quarter of 2010, Katonah's eight and nine resumed their normal distributions to bondholders and to KDA for full payment of KDA's quarterly senior and subordinate management fees.

In addition, these CLO funds paid KDA approximately $2 million of the accrued and unpaid subordinate management fees with the remaining balance of approximately $1 million to be paid in the third quarter along with residual cash flows being paid to the CLO fund equity investors. Similarly we believe that Katonah seven will resume its normal distribution to bond holders in the KDA of its subordinate management fees depending on the third or fourth quarter of 2010 and will begin to pay accrued and unpaid management fees from the prior periods.

From the liability side of our balance sheet, as of March 31st, 2010 our debt facility had a balance of approximately $199 million. At the end of March, our leverage was 92% and our asset coverage was 209%, above the minimum required by the Investment Company Act of 1940. As of today's call, our debt facility has a balance of approximately $162 million and by the end of the second quarter we are projecting such balance to be further reduced to less than $150 million. The significant decline in the facility balance is mostly due to pay offs and redemptions at par during the first half of the year.

The weighted average interest rate on weight average outstanding borrowings during the first quarter of 2010 was approximately 5% during the first quarter compared to 2% for the same quarter last year before the imposition of the default rate of interest. The credit facility is non-recourse to KCAP and is secured by approximately $273 million of assets at current fair value consisting primarily of senior secured loans and representing approximately 62% of our gross investment income as of March 31st, 2010. The remaining $144 million of assets representing 38% of our gross investment income is not [plus] the security payment of amounts outstanding under the credit facility.

A brief history of recent events regarding our debt facility is as follows. In August 2008, the Company was notified by lenders that the liquidity banks providing the underlying funding for the facility did not intend to renew their liquidity facility to the lenders. As a result, the lenders terminated our ability to obtain revolving advances, commence the two-year amortization period for the facility, which we believe has been wrongly commenced. During the amortization period, all principal and net interest collected from the assets pledged as collateral for the facility are used to amortize the facility through a termination date of September 29, 2010. There are no fixed required amortization payments during this two-year amortization period. Because our debt balance continues to amortize in future quarters through principal and net interest collections on pledged loans, we expect our leverage ratio to continue to improve.

In June 2009, the lenders under our facility asserted that we are in breach of certain terms of the facility. Specifically they alleged that we failed to determine rating- properly determine ratings on certain pledged loans which resulted in multiple incorrect calculations under the terms of the facility. We disagree with this assertion and are seeking judiciary to clarify our and our lenders obligations under the facility.

Lenders also stated that as a result of such default they were entitled to interest payable at a higher default rate equal to 85 basis points above the prime rate plus 75 basis points. Again we have been paying such higher interest rate under protest. We intend to vigorously pursue the claims set forth in our complaint against the lenders, neither the outcome of this litigation nor the amount and range of potential damages recoverable by the Company and the borrower or our exposure associated with this litigation can be determined at this time. For more information regarding the litigation please refer to our recently filed financial reports on Forms 10-K and 10-Q.

For the first quarter, we declared a $0.17 dividend which was paid in cash on April 29th, 2010 to holders of record as of April 7th, 2010. In determining the dividend for the first quarter, considerations included the estimated current quarter net income, anticipated net income for the year, the impact of increased legal, accounting and valuation professional fees associated with our restatement, and the related legal and governmental proceedings and impact and timing of the resolution of our dispute with the lenders. Between cash on hand, liquid investments and net income on (inaudible) that's not secured by the facility, we anticipate that we will have sufficient cash and liquid assets which could be sold as needed potentially at a loss to fund normal operations and continue dividend distributions over the next 12 months. The aforementioned discussions in 2009 and first quarter 2010 results are also discussed in our recently filed annual report on Form 10-K and quarterly reports on Form 10-Q, which are available at our website, www.kohlbergcapital. com or at www.sec.gov. And with that, I'd like to turn the call back to the Operator to start the question-and-answer session. Operator?

Thank you, sir. (Operator Instructions) Our first question in queue comes from Greg Mason with Stifel Nicolaus. Please go ahead with your question.

Great good afternoon, gentlemen. Could you tell us, when do you expect the court to hold a hearing and a decision on your credit facility?

Well, we really don't know at this point Greg. We really can't comment any further. Obviously we're hoping to get this resolved as quickly as possible, but it's really unclear when that's going to happen.

So what happens in September of this year when the bank say it's due and you guys say it's not, if it's not resolved by then what happens? Do you get to keep your assets or are they turned over to the bank even if this is still outstanding?

Well they're not turned over to the bank. I mean the banks could choose to foreclose on the assets. They could have chosen to foreclose previous to that as well based upon their assertions that they've made. So nothing -- we obviously still maintain that that's not the correct maturity date, so--

And there'll probably be some clarification between now and then.

So there'll be clarification between now and then. I think things-- I don't think we'll be going up to the last minute on that. But can't really comment on when that's going to happen, because we just don't know.

And then have you been in discussions with any other lenders to potentially replace the Deutsche Bank facility?

Yes, we have.

And can you comment on how those discussions are progressing?

I guess the only thing I can really say is we've had numerous discussions with numerous parties. Obviously as the balance on the loan goes down, it becomes a much more realistic possibility.

Does the restatement of NAV and your assets affect at all the relationship with Deutsche? Was there a one to one or 200% asset coverage test that was now violated by the restatement of these assets? Does that have any bearing?

Well it was-- there was a leverage test. It was not the traditional BDC leverage test, but again as of today, as opposed to the restatement as of March 31st we're in compliance with that covenant.

Okay. And then on the CLO subordinated debt fees I think you said there's $6 million outstanding and $4 million a year are being accrued. Is that actually accrued into income, GAAP income to day or when you receive those in cash will they hit the income statement?

A couple of point there is. Keep in mind that goes to Katonah Debt Advisors. So it is accrued to Katonah Debt Advisors for GAAP purposes. That's not necessarily going up to the company since that's at the Katonah Debt Advisors, it [coats] to Katonah Debt Advisors level. If Katonah decides to distribute-- make a distribution of cash up to the KCAP level in the form of a dividend, that would then be reflected on KCAPs P&L.

Just to be clear, none of those fees are reflected in the KCAP income.

That's right.

Okay. And then is there a requirement with, I believe at Katonah Debt Advisors you had a $6 million charge related to the Bear Stearns warehouse facility. Is there some amount down at Katonah Debt Advisors that has to be made up before you're able to distribute anything up?

No, all that is past history. Katonah Debt Advisors paid off that $6 million during the course of 2009.

Okay. So any future income is free and clear with whatever Katonah decides to do with it?

That's correct.

Okay. And then could you talk about your $0.17 dividend? Does that kind of reflect where you believe the earnings are going to go after the facility is complete?

Well, it's-- I mean it's really an attempt to smooth out the dividend to where we think we will be but there are a bunch of factors in that as Mike commented. First on the one hand with all the extraordinary costs that we've had in terms of the extra audit fees and some of the legal fees, that is not reflected in the $0.17 for the first quarter. On the other hand, neither is the recovery and potential distribution up to KCAP of the KDA fees that you asked about. So in a sense we feel like those numbers should offset and therefore the $0.17 should be closer to what is an ordinary income rate or run rate.

Now again the $0.17 does not reflect or sort of backs out the extraordinary interest costs which we don't think we actually owe. And in addition if we refinance at a higher rate, that would push the dividend below that $0.17 rate. So we're trying to get to a number of factors, or look at a number of factors in establishing that, but consistent with our past history of dividending what we currently earn or think we'll earn over the course of the year. But there's just obviously a lot of moving parts.

Okay and then one last question. Can you talk about, you said there was a change in PIK accrual in the first and second quarter that took out $0.02. Can you discuss that change?

Sure. We were-- in the past we were recording PIK income as income and then it would accrete to the cost basis of in par of that similar security. In the first two quarters of 2009 we reversed some of that PIK income because the credit of those underlying securities was-- first of all the NAV, or sorry not the NAV, but the fair value of those securities was impacted but we also thought the credit may be impaired as well. So as a result of that we effectively put that PIK income on non-accrual and so we reversed the PIK income that we recorded in the first two quarters and-- accordingly.

Great. Thank you.

Thank you, sir. Our next question in queue comes from [Jonathan Feldman] with Vance Hall Capital. Your line is now open.

Thank you, couple questions. First would be how we should think about the long-term earnings power of the Company in terms of how you're looking at net investment income going forward? And-- or put differently, want to better understand what your current ability is to redeploy assets in terms of reinvesting some of the first lien investments that you hold that are currently at low LIBOR spreads into higher yielding assets.

Sure. I mean that's something we're certainly-- we are looking at right now, and we mentioned we are getting a lot of prepayments not only as first lien assets but other assets outside the facility. Obviously anything within the facility has to go to pay down the debt, and we are going to be redeploying some of that over the course of the second half of this year in higher yielding opportunities. But to be honest with you, there haven't been a tremendous amount of high-quality high yielding opportunities over the course, certainly in the middle market space over the course of the last six months or actually 18 months, but we are starting to see those opportunities now and we do have some cash to redeploy.

And then maybe a follow up to that is if I look at your portfolio for the most part you've been investors in what I'd call broadly syndicated deals or at least club deals as opposed to self-originating loans. Would you expect that to stay the same or would you expect to--

Well I don't think that's really accurate. Most of the club deals are really self-originated deals. These are very small--

Okay.

Very small club deals where we are invited in because of our relationship with the sponsor, and I think we'll continue to do that. We're also to look at opportunistically at self-originated things as we have in the past. We are not going to be doing a lot of broadly syndicated going forward and I don't think other than some second lien assets, which we haven't probably syndicated deals we do not have a lot other than for some things we put in first lien and broadly syndicated and it was really more for liquidity purposes for temporary investing.

Also to the extent by self-originated you mean a direct loan to a small company where we're the only lender? That has never been a big part of our strategy.

Nor will it be. Our strategy is always to focus on sponsored transactions.

That sort of micro capped direct lending in our view as a-- can be a riskier business just because the companies tend to be somewhat smaller and it's also a lot more labor intensive and costly to have a large origination network of the kind that some of the BDCs used to have.

Got you. And just in terms of the CLO securities that you earned, can you provide a little bit more color around those in terms of what the ranking is in terms of relative seniority or subordination (inaudible) fit within the waterfall of the securities?

Well all of the CLO securities with the exception of the BB tranch in Katonah's 2007-1 are the equity, or the junior tranches. So those are the unrated junior tranches essentially the equity, which as-- the manager was rally sort of the "sponsor equity" that we put in.

Okay, that's what I would have thought. What have you seen in terms of pricing of CLO equity in recent months in terms of where your equity and your peers equity is trading?

Well the equity doesn't really trade to be honest with you and we've had those discussions with underwriters, serial discussions with underwriters of our own-- of the tranches we own. There's rally no trading activity, there's some synthetic trade that happens but there really is no trading activity. And I think in terms of returns, then there's no original issue market right now for CLOs, so there's no real way of gauging what somebody would demand on an original return base. And by and large I think people are looking very carefully as we would at the CLO securities and the underlying loans and the performance of the underlying CLOs to determine what sort of discount rate is appropriate for looking at the equity. Clearly ones that have substantially impaired due to the fact that they sold assets in order to try to make certain covenants in the first quarter of 2009 at very low levels and therefore incurred significant losses, those equity tranches people would demand a much higher return for.

So is it fair to say that if you wanted to buy back your equity, you'd find it difficult to do so?

In most cases you don't even know who owns the equity other than the pieces that we own. You mean buying other, buying other equity holders?

Yes. I've heard of some CLO managers buying back their equity in the market.

Haven't seen a lot of that. It would be very difficult to even find them. A lot of these are-- we don't know again who the holders are and others are strategic partners of ours who really wouldn't want to sell.

Okay. Let's also just in terms of that change in the valuation methodology, I guess I understand how you're doing so presently, can you speak to what had been the prior valuation methodology and what accounts for in terms of the changes that were made as part of the restatement and basically what accounts for the reductions in NAVs as reported?

Well I think as the charts indicate, the new method is much more sensitive to changes in spreads and interest rates and we factored those in more significantly than we had in the past. So it's really almost exclusively due to changing in-- changes in spread and interest rates particularly in the fourth quarter of 2008 and the first quarter of 2009.

Okay. One final question, as I look at your portfolio and the current valuation on the stock, the stocks at about a 45% discount to NAV based on today's closing price. In terms of narrowing that discount to NAV, can you talk to what the Management team is focused on and working on in terms of driving shareholder value? And I guess one comment to that effect would be, I think it'd be helpful to have some portfolio average portfolio metrics in terms of leverage interest coverage, et cetera, that some of your peers provide. My view is the portfolio quality is substantially similar, if not better, to some of your peers and in light of the delayed release of financials and disagreement with your lenders, I think that's been obscured in the marketplace. So that's my comment I guess, wondered kind of what your thoughts are on that topic?

I think that we also believe that it is a portfolio of high quality and a portfolio that has actually come through the downturn quite well. And we-- it's always hard to say what drives a stock price particularly given all the volatility in the financial stocks generally over the last few years, but I think it's fair to say that for Kohlberg Capital there are a number of external factors that probably contribute to the greater discount and those are many of the things we've talk about on this call. The fact that we don't have a resolution with our lenders.

And I think more importantly, and you've heard this from many of our stockholders, that we need to establish a clear path where we can return to growth. And some of that is going to require a resolution of the situation with our balance sheet leverage and some of it is going to require us to go back into a pattern of raising additional equity capital. So I think to your question, what Management is doing is trying to clear up as many of these things as we can, and I think to the extent that we're able to do that and obviously getting these statements out is the first step in that, that we hope would start to chip away at the discount NAV that we currently trade at.

Maybe one final question because you mentioned potential equity raise. Is that something that we should anticipate or expect in the near term because at least from this view, selling equity is such a huge discount to NAV at anything close to or at today's prices to me would be selling stock very cheaply?

We agree. I mean and as you may recall, insiders own a significant block of stock. So the Company is very sensitive to the dilutive effect of raising equity at these prices, and that's something we have to weigh against what those proceeds could be used for. But the Company is certainly aware and we've had this dialogue with many of our shareholders about the disadvantages and the dilutive impact of raising equity at these level. So I think it's fair to say we would only do it if the use of proceeds was such that it really would contribute to a recovery in the overall share price.

That's all I have. Thanks so much for your time [today].

Thank you. Our next question in queue comes from David Chiaverini with BMO Capital Markets. Your line is now open.

Good afternoon, guys. Thanks for taking my questions. So far in the second quarter you've had a strong level of excess to about $40 million and you anticipate it sounds like a few more exits in the quarter to bring the facility down to less than $150 million, so it's implying a healthy exit environment. Who really are the buyers out there of these assets?

Well there's been a number of different sources of that for a long period of time, the high-yield market was-- people were refinancing, bank debt with high yield debt, several of the companies were sold and M&A transactions primarily to strategic buyers. One company was sold to IBM, another was sold to another strategic buyer and those were significant positions we had that happened in the late first and early second quarter. It's been-- there's no real single factor.

And do you expect the favorable environment to continue?

Well, clearly credit markets have backed up a bit in the past few weeks. The high-yield market is not as attractive as it was, but we do think that strategic buyers are still going to be out there, and I think sponsors by and large, one of the other advantages of focusing on sponsors, loans to sponsors are incentivize to turn over capital and so therefore I think it's particular those who have a strategic angle, and there are several in our portfolio, we wouldn't be surprised if those companies were sold in the next three to six months.

Okay. And do you have a goal to get the facility down to a certain amount by the end of September before that-- it matures?

Well the irony is we don't really have any ability to--

Well I mean we don't really have a specific dollar goal, no is the answer.

It's really just as pay downs come in.

Yes.

As pay downs come in and-- well you've sold some stuff as well right?

Not a lot recently other than we did sell some distressed assets and we sold them not necessarily because we thought we want just to get out but we just thought things traded up so significantly particularly in the second half of last year and first half of this year that they were trading above what we thought the final value was. And so we had one that we were holding at $0.19 and we sold at $0.39 and we had another one we're holding at $0.40 and we sold at $0.50 or $0.48. So we just thought that we're trying to manage our risk in what we think is still a very challenging economic environment particularly with very cyclical businesses. So there aren't going to be a lot of asset sales going forward.

I see, got it. Got it. So as the increase in repayments has more to do with M&A environment increasing in just--

Yes, correct.

And then switching gears back to the dividend of $0.17 versus the $0.11 of NOI. You mentioned perhaps selling some assets to fund the dividend, have you considered as opposed to selling assets if you aren't willing to sell or not wanting to sell the assets, have you considered paying the dividend in a combination of stock and cash as opposed to all cash?

We considered that at points last year, we ultimately didn't do it. Right now though because we have had some prepayments that have been both inside and outside the facility, of course if it's inside the facility it's used to pay down the facility, but those for assets that have been sold outside the facility, not sold but prepayments outside the facility, we do have a fair amount of cash on hand at this point.

At this point we do not anticipate selling any asset to pay the dividend over the next 12 months.

Yes.

And could you talk about how you arrived at KDAs valuation of $56 million? And it didn't change too much after following the restatement, so I was just curious.

Yes, we-- there's two metrics that we used to value KDA. The first one is as a percentage of AUM, and as AUM has been relatively static, it goes up and down a little bit, but it doesn't move the needle that much. And then we also look at KDA's, most importantly we look at KDA's perspective cash flows. So that's really driving, and that present value of those cash flows is what really drives KDA's valuation from quarter to quarter.

Do you have at your fingertips what the annual cash flows are, and assuming all the management fees are paid, and what the remaining average life is of those vehicles?

We reflect all of that. It's very easy to come up with accurate numbers because again the cash flows on an annual basis don't fluctuate with the asset values because they're paid based on par, and the par is a locked number for each fund. And similarly we know when the reinvestment periods expire for each fund and we have quite a few years in a number of those funds. So it's-- the cash flows are-- there are a series of inputs that are relatively fixed.

The one thing I would say about KDA that I think people have not focused on is with loan assets still trading below par, these funds with the management contracts are actually likely to have longer lives than they-- than in the good old days when it was very easy to call a fund at the end of it's reinvestment life, sell the assets at above par and do a new fund. Now we don't really reflect that in our cash flows, but if anything, management contracts for old legacy funds you could argue actually probably have longer lives than before the downturn. But we basically make assumptions about a line down under the terms of the fund agreement after the end of the reinvestment period.

Are you able to disclose what the annual cash flow coming into KDA is?

We typically don't, but you can kind of back into it because most of the funds earn an annual fee of 50 bips on AUM. And so you can see-- I mean you can generally look at the disclosure and kind of piece together what a gross amount would be.

We also-- Mike we make assumptions about the receipt of deferred fees because remember all of these--

That's right.

All of these funds accrue a deferred incentive fee that would be payable at some future date, now it's out a number of years.

We don't actually accrue it though, but it's--

Exactly--

It's back ended.

We don't accrue it on an annual basis but we do reflect that in the cash flows although we discount it at a higher rate as well because there are metrics that need to be met.

But it's very back ended.

It's very back ended, so it's not a huge, it's not a huge input into the valuation, but there could be some upside in the out years.

Thank you.

Thank you. Our next question in queue comes from [Nick Hutton] with [Black Diamond]. Your line is now open.

Thank you. Could you-- I noticed there's an SEC investigation I saw for the first time in your 10-Q but didn't see anything in the press release, is that resolved now?

No, that's still ongoing and it has everything to do with the restatement process that we've gone through.

Is that-- it's a valuation issue? Does it relate just to the items that you've restated? Just-- if you could just provide some color, I--

Yes, again it's primarily related to the restatement and the fair value issues that were raised between us and (inaudible) back in I guess November.

November and December .

December of last year.

How do you see this playing out?

Well we're cooperating with the SEC, and I'm certainly not going to speak for the SEC in terms of how it plays out, but we're providing any information they ask for and obviously we'll provide them in the future with any additional information they ask for.

And the informal invest-- you said I guess you got a letter from them on April 30th, is that-- I'm reading it now, is that the last communication?

I don't think we can really comment on it. I mean our lawyers talk to the SEC counsel periodically, I don't know the last time they spoke to them.

And could you just-- also I guess the Cyrus, is there any update on that?

Yes. We've had a number of discussions with them over the last few weeks, and we have discussed that it's more appropriate to have additional strategic discussions once the financial statements were completed. So I expect we'll have a continuing dialogue with them. That said, and I think we put this, we noted this that there are pluses and minuses to the proposal that they publicized that really need to be explored in more detail, but it was really-- it was very difficult to have those discussions while we were completing the restatements.

Do you have the ability to announce issue stock below NAV? Would you need approval for that?

We would need approval for that.

Other than through a rights offering.

Right, okay.

Thank you.

Thank you.

Thank you. There are no other questions in the queue at this time. I'd like to turn the program back over to our speakers for any closing remarks.

I think we would just say in closing we thank you all for joining us on today's call and obviously we appreciate your patience during this period when we are working to get our delayed financials out and we feel now that we have this behind us, we can start to look to the future and hopefully increase shareholder value.

Thank you.

Thank you. Ladies and gentlemen, this does conclude today's program. Thank you for your participation and have a wonderful day. Attendees, you may now disconnect.