Gladstone Capital Corp (GLAD) 2004 Q3 法說會逐字稿

Please stand by for Gladstone Capital Corporation conference call. Ladies and gentlemen, Good day and welcome to the Gladstone Capital third quarter earnings release conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. If anyone should require assistance during the conference, please press star, then zero on your touch-tone telephone. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's' conference, Mr. David Gladstone. Mr. Gladstone, you may begin your conference.

Thank you Melanie. This is the quarterly report and I need to read the obligatory warning about forward-looking statements. This report I'm about to give may include statements that may constitute, quote, forward-looking statements, within the meaning of the Securities Act of 1933, and the Security and Exchange Act of 1934. Including statements with regard to the future performance of the company. These forward-looking statements inherently involve certain risks and uncertainties and although that he based on the company's current plans that we believe to be reasonable as of today, no assurances can be given. There are many factors that may cause the company's actual results to be materially different from any future results expressed or implied, by such forward-looking statements including those factors listed under the caption risk factors in the company's 10-K filings as filed with the Security and Exchange Commission, and those 10-Ks can be found on our website as well under www.gladstonecapital.com. The company's undertakes no obligations to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

The quarter ending June 30th, 2004 was a good quarter. We hope we can keep it up. New loans were, a good number of new loans. We had Benetech, which is a dust management company for coal and electric utilities. We had 3.2 million there. We increased our investment in MedAssets by a couple million dollars. New investment, Maidenform, well known name of manufacturing of women's intimate apparel, or as my uncle would call it, lady's unmentionables, we put in about $10 million in that. We also added $1 million to Mistras, which is one of our portfolio companies, because they're expanding and we put $12.25 million in a loon to All style or A&G, which is a production company that makes T-shirts and sweats. And that one unfortunately is going so well and so strong that it's conceivable we could get paid off early on that one, just as a warning. We also made a loan of $8 million to MD Beauty, a manufacturer of cosmetics and $6 million loan to Bear Creek. Bear Creek is better known by it's two brand names, Harry and David's foods and gifts, and Jackson and Perkins is in the flower world. It was a good quarter. After the quarter ended, we closed on Allied Extruders, a manufacturer of polyurethane bags and that was $4 million and there were some reductions during the quarter.

We sold about $4.6 million of Gammill in order to make it fit into our securitization pool. Wingstop restaurant paid off. We got back our $5.3 million, plus we picked up about $360,000 in conditional interest. That pushed the all in return for that over 15%. Home Care Supply paid back its $18 million and we got about $1.1 million of conditional interest on that. That also pushed its return over 15%, probably closer to 20. I viewed the payoff with mixed emotions on home care. Nice company. Good company, good management, but the changing landscape there gave us some reason to think about getting paid off. As you know, the government continues to, what I call, play around with the reimbursements on these kind of companies, so it's probably a good time to exit.

New people, we did not add any new people during the quarter. However, we are interviewing and hope to have a couple more people on board during the next few months. The numbers were good for this quarter and we hope to repeat them in the future. Net investment income, which is before any changes, that is appreciation or depreciation in the portfolio, for the third quarter were up substantially, about 45 cents a share. It was really driven up by the extra interest we received from some of our loans when they paid off. Net investment income for the nine months was about 105. Is that right, Harry? Yeah. Okay.

Net investment income is the number that we pay taxes. It's very close to the one that we pay taxes from. The tax number is what we declare our dividend from. However, you have to adjust the net investment income for the hedge that we have in place. It's a derivative. You'll see it there in the P&L. We put that in place of course to cover the fixed rate loans that we have in place and that derivative depreciated by about $114,000 for the quarter. That's really not for taxes. So we can't deduct that for taxes. It's more like an appreciation depreciation but unfortunately it has to be above the net investment income line. So if you're trying to get to -- trying to compute that number that would be our taxable income, which is what we pay our dividends from, you would really need it add that back to net investment income. And this hedge is meant to make sure that Mr. Greenspan, as he continues to move interest rates up, doesn't have a big impact on our ability to pay out dividends.

Now I'm turning to unrealized appreciation and depreciation. That was up by $1 million over the quarter because of appreciation in several investments for the quarter. Net increase in shareholder's equity from operations which is the real bottom line of the company, was 54 cents a share. And for the nine months net increase in shareholder's equity was about 95 cents a share. This was reduced and make note of it here, we did accrue $800,000 for bonuses at year-end for our folks here. We just wanted to plan for year-end and make sure everybody knew that that was coming. We felt we should make that accrual and just to send the signal to everybody that that's in the pipeline. It doesn't mean we'll pay it all out, but it does mean it's accrued for book purposes. So that adjustment went through our P&L for the quarter ending June 30.

Our portfolio company evaluations pretty much stayed as we expected. We did have about $1 million as I mentioned increase in value. That's about 10 cents a share. Loan ratings, you may have noticed that we had some 5s in there. We're normally about about 7. Those are not our old deals going down but rather we put two new existing -- two new loans, two of our new loans that we put on board were at 5s, rather than 7s or 8s or 9s, as they often are. And we deemed both of these loans, the risk there worth taking because they're very large companies and they are syndicated loans. They have very large equity investment it's by with a we consider some of the premiere leverage buyout funds. And so when we do our risk rating, these investments all fall in the range on our qualitative criteria. In fact, they were strong there. But based on the ratios of the balance sheet and the income statement, they are a bit lower on that quantitative standard. But that quantitative standard that we have doesn't take into effect the fact that the leverage buyout funds has a significant amount of equity in there, and since they own the company, we believe they would step up in any kind of downturn or any kind of problem in the company. So they numerically had to get a lower rating, but we think they're relatively strong compared to our portfolio. Anyway we are quite happy with our portfolio as it exists today. Our loans, they are paying as agreed and so we're continuing to churn along and put more of the same on the books. Well, the marketplace has changed a bit since I last talked to you.

Senior and sub debt marketplace for large middle market companies has continued to move up. It's stronger. And rates have perhaps come down a little bit. There are pretty sizeable inflows of money into the debt marketplace. There is some reluctance by most of them to do fixed rate loans and we're included in that, just to avoid what could happen if Greenspan continues to increase interest rates. So most of us are avoiding fixed rates where is we can and putting variables in place when we can. As you know, we put a hedge in place to cover our fixed rate loans and we did that last quarter. So we think we've hedged out most of our fixed rate loans. So you might say we don't feel what Alan Greenspan is doing although I might say I'm not quite sure what in the world he's doing there. I just -- I respect the man a great deal, but I wonder what tea leaves he's reading as he continues to increase interest rates. But the market does continue to get better for smaller companies. The debt portion of the capital marketplace on Wall Street is certainly flying, and I think that bodes well for the smaller businesses. Money pouring into that marketplace will trickle down to some of the smaller businesses as they continue to grow. So for senior syndicated loans, we're still seeing rates go in at about LIBOR plus 2.50 to 3.50, probably closer to 2.50 today. And with LIBOR being around 1/8 or wherever it is, that means you're paying at about 4.5%. That is an all-time low for interest rate. And LIBOR has traditionally been 5%. No doubt we'll move back to that position over time and I don't think people should worry about that too much.

We are worried here about the cost of oil. It has a tremendous ripple effect in the economy. Also other commodities like copper and steel continue to increase and have an impact on the marketplace. Inflation, I don't any is going to be too strong until sometime next year, but that really depends on what's happening with the war in Iraq, if they can start scaling it back, I think inflation will be reduced and if they continue to pour money in, it certainly will continue to push inflation up.

I don't think investors should fear the fact that rates are going back to their norm. We've been at 40-year lows and so I don't think going back to a traditional amount of 6 or 7% for the big companies paying that rate for their money and more for the smaller businesses is going to make things change much in terms of their growth. We don't see Wall Street or the banks looking to lend a lot of money to the smaller businesses, so we don't see competition there. Most of the banks are sticking to say 2.5 times free cash flow or as they call it adjusted EBITDA. And they must have collateral. So banks are still pretty strong in terms of their requirements with regard to getting a loan. And we don't see the government or the OCC that regulates banks doing anything to change that in the near term. They may somewhere down the road.

So demand for loans like ours is still pretty heavy. The hedge funds and the bond funds are out there looking for good loans and so at the senior paper level, I'd say demand is exceedingly high. However, the more subordinated paper or second lien loans that we do, there's still not a huge demand for that. It depends on the company, obviously, but mostly that marketplace is not very strong. No doubt as the -- as the market, the capital markets change, there will be more liberal lending standards but as of today, we're not seeing it, so I think the opportunities for us going forward are still quite good. The industrial base that we look at every day, the smaller businesses that we see coming across our shop are still getting stronger. They are hiring people. They have back logs. They're building the backlog. Neither of those existed even a year ago and hardly begun to change even six months ago.

I had -- I think in my last call expected the summer to be strong. It's not as strong as I had projected. Even though we're doing well, it's still growing, the businesses are growing at a relatively small pace. But it is getting stronger every day. We see better and better companies coming through here. Our credit line, we are about 35, $36 million I think into our credit line. We're 33 at six months. Where are we now, Harry, do you know? About the same, 35, 36. We also set up a revolving line of credit since we last talked to you at BB&T. We have a $15 million line there. We just thought it was good to have an extra lender. So we have $15 million there. It will help us close some of our loans faster because the other lines are inside our securitization entity and so it is a little more cumbersome to get to that money. With BB&T and we can close loans and then dump them into that securitization line.

You may have heard our shelf offering for common stock has been declared effective by the SEC. So should we have a need to go to the capital marketplace, and assuming that people wanted to buy our stock, we are ready to go, as of today and so if we need to go to the marketplace, we have the mechanism in place to do it. Don't plan to do it today, but we'll have to look at the fall and winter to see where we are in terms of drawing down our line of credit before we go back to that marketplace.

There are been a rash of new filings for business development companies like us in our format. Most of them have been put on hold, as you know, one got through called Apollo, it's a $1 billion fund. One smaller one did get through for $105 million. They have confessed that they're going to be in the energy investment area. So we probably won't see them in the things that we look at. But we've talked to them and would like to co-invest with them.

We wish all of them well and I am very sorry that so many of these BDCs that announced got put on hold. It would be much better for us and our industry if we had more well-run BDCs, and I think most of those who filed had really great management teams that could have added a lot to the BDC world.

Anyway, that's the end of my presentation. I would like you all to go to our website and sign up for e-mail notifications. We don't send out junk mail, just business news and it will be good to have you on that list so we can update you when something happens here. At this point in time, Melanie, if you will come back on and lead us through the question and answers, that would be great.

Thank you, Mr. Gladstone. If have you a question at this time, please press the one key on your touch-tone telephone. If your question has been answered or you wish to remove your self from the queue, please press the pound key. If you're using a speaker phone, please lift the handset. One moment, please. Our first question comes from Joel Houck from Wachovia.

Thanks. Good morning, David.

Good morning, Joel.

I was wondering if you could talk a little bit about the backlog of deals -- this is I think probably your strongest quarter since you went public -- and then also any help in the sense of modeling fee income with respect to both prepayment fees, the conditional interest incoming. I mean, it seems like the uptick in portfolio activity, that that source of income, while tough to predict, may be more reoccurring in nature than in the past.

Okay. Our backlog is about the same as it always is. I don't see much of a change, so some quarters we're going to have great quarters like we just had in terms of closings and others I suspect will be slow. We've got sort of the average backlog today and I'm hopeful of closing a lot of those. So we just have to see, Joel. As far as fee income, I don't know how you model that. We don't count on it coming in but when it comes, it's great. And I think the bigger the portfolio gets, the more frequently that will occur. And that's about all you can say about it. Most of these loans were put on the books with the idea that they were going to be there for four to six years and some of them are coming obviously a lot quicker. And, you know, there's just not much you can say about how to model that. I remember years ago one of the teams at Fidelity kept asking me about how do they modeling triggering capital gains and appreciation, depreciation and there's not much I can say there, Joel. It's one of the enigmas for our industry.

Okay. Thanks, David.

Other questions?

Our next question comes from Senghita Mafitsia of UBS.

Hi, good quarter. I had a couple of just questions on -- I know you mentioned in your opening remarks that you invested 4 million in Allied, and then one of the investments was either paid off or you sold, was it Gammill. If you could just repeat that?

Allied Extruders after the close of the quarter, we put $4 million.

Right.

Is that the one you missed?

That one I got. And then you had a repayment I I thought you said you had to sell something.

Gammill. Gammill, we -- you know, we have to fit these things in to our securitization portfolio and when they're too large for the portfolio, that is they throw you out of the securitization model that they have, which doesn't like large loans, we sold down a piece of that to a group that we know and -- $4.6 million was sold out.

Okay. And on the bonus amounts, is that all we should -- would you think you will have additional accruals in the fourth quarter because that's really year-end?

If he with have a great fourth quarter I would certainly like to accrue a little bit more. So it's sort of dependant on how well the company does. As you probably know, we didn't pay people much last year because we didn't do as well, and I think we had to $200,000 that we used for the whole year. So a little bit of catch up here now that we've done well and have a good portfolio and it's strong. All of our loans are paying as agreed. And these exits, that we're exiting, are giving us returns into the high teens and sometimes we're breaking 20%. So our program that we've put together is working and working well and we're just going to try to continue to do that, so maybe put a little something in there and hope it's a good quarter.

Thank you.

Next question.

Our next question comes from Eric Swargothe of Gruber & McBain.

Good morning, David and congrats on a very solid quarter in a tough environment.

Thanks, Eric.

Certainly as usual you seem to outperform in the bare markets. The question I've got for you is balancing both the investment opportunities and the workload between GLAD and Good. Obviously, GLAD had a very good quarter this quarter and Good's quarter you weren't able to put as much to work. Is that because of the opportunity sets presented to both companies, because of the workload, because of the competition in one sector versus another? If you could kind of walk through that, that would be helpful:

I think predicting for both of those is unusually difficult, especially commercial at this point in its growth. Commercial really hasn't gotten its name out there as well as we thought we were going to get it, so it's been a little slow getting there. The loans that we're seeing in capital now are just the standard vanilla flavor loans. So we're seeing lots of stuff. The add on opportunities of doing the real estate is there, but it's just not occurring as quick. I don't know that -- I'm absolutely sure it's not workload related because we've got three people that do the real estate and then the underwriters of the tenants are the same people that underwrite the subordinated debt deals and we just haven't had any problem with that to date. I would like to had a couple more associates so we're out looking for associates to do some more modeling of some of these. Other than that, I think it's just timing, it's the way things flow. And we have not a lot of control over the flow.

All right. Thanks much.

Next question.

Our next question comes from Vernon Plack of BB&T Capital Markets.

Hi, David. I was looking for a little more color, any of your thoughts from on industry perspective. In other words, are there certain sectors or industries that you view as extremely favorable right now versus are there some industries and sectors that are you avoiding for whatever reason?

Yeah, I don't know that we have any list that's changed, you know,. We kind of wax and wane every time we see something. We were very negative on the auto industry for the longest time and that's proved us wrong. We should have done a couple of those loans that that we turned down in the automotive business. We've always been hot on the automotive aftermarket, just not the tier one/tier two suppliers to General Motors and Ford and those. Which felt there was a bubble in that marketplace. We have also avoided the housing market and that's cost us probably one loan I can remember that was a good loan. Still haven't changed our tune there. We think interest rates going up are going to have an impact on that. So we haven't hit that marketplace hard.

The commercial and industrial side that, is the manufacturing side with smaller businesses , I still think is exceedingly good for us right now and we're seeing a lot of good opportunities, take a little company like Allied Extruders that makes this special purpose polyurethane bag stock, that's sold to the companies that actually make the bags. It's just a great little company and they're growing. They've got opportunities and a new LBO group came in and brought it from a family group. They're going to put more money in it. They're going to grow it. I just think that sector, for example like that of commercial and industrial things are doing nothing but picking up and I think that's exceedingly good for us.

I do think when a loan gets, or a transaction size gets over $25 million, you have a lot of people looking at it, so when you see a $25 million or $30 million second lien or subordinated debt piece, there are a lot of people who look at those, Vernon, and I think that business is very competitive. When you get down to the 5, 10 and $15 million range, it's not nearly as competitive and while there are competitors, and we see them in the marketplace, I just think we're going to get our pro rata share of those an it's not nearly as competitive nor are people paying as much for businesses as they are for big businesses.

The multiple of EBITDA or adjusted EBITDA that people are paying at the LBO world for larger deals has gone up by at least one time in the last six months. And is probably going to go another turn before the end of the year. They're really paying up and they're not loading it up with debt. They haven't been able to load up with debt as much as they had in the past. I can remember the days when people would borrow six times and pay eight times. They're not doing that yet. But for the larger transactions, they are definitely paying up and we are back to normal in the LBO world for larger deals.

For the smaller world, it's still a relatively low multiple of earnings, 4,5, not more than 6. And they're putting up 2 turns in equity and borrowing 3 times EBITDA would be sort of a standard in the lower end. So we're not really going after any particular industry per se. We have a very large net that we use and we look at lots of things as you can see from all the different pieces that we we've put on the books. It's more opportunistic. I'm not really hot on healthcare right now. I know there are a lot of folks that like healthcare. I do think the area like telecom is coming back, and communications, all of that area is coming back. We haven't done anything there, but I think we'd be -- we'd look very intently at anything that came in in that sector, whereas probably a year ago we were still not looking at it. I've kind of rambled on. I hit the points that you want?

That's actually right on target of what I was looking for, just some thoughts from a sector perspective. One other question that's unrelated. Are you still on track to I guess engage Gladstone management from an advisory fee standpoint come October 1st is it?

Yeah, we are. The cut over will be on October 1st and some of that was driven by trying to get healthcare plans and 401-Ks and all that have crazy stuff converted over during a very busy period. But we also looked at it and said it would be from capital standpoint a very -- a very nice way to do the cutoff at year-end rather than trying to do it in sort of a partial year. So that's how we got there.

Just one other question that relates back to the first question. Can I assume that the debt to EBITDA for your portfolio right now is somewhere around 3?

Yeah, I would say it's lower than that, but I haven't done the ratios. Terry Brubaker would know better than I. We maybe could -- let's see if we can get something out on that. We'll take a look and see if we can publish something on what our portfolio statistics are.

Great. Okay. Thank you.

Next question.

Our next question comes from Jeff Foisey of Shaw Brooks.

Hello, David.

Hi, Jeff.

I am new to learn being your company and actually it seems as if at least part of the question that I am asking you've already just referred to. Basically I was a little bit confused about your initial remarks saying both that the -- there were sizeable inflows of money into the debt marketplace, but at the same time you said you didn't see Wall Street or banks competing lending to small and midsize businesses. And you did kind of get to that perhaps talking about the different sizes of the loans. Maybe if you could just talk a little bit more if there is anything else to say in the area of the $5 million to $10 million loans, who else do you see, is it only business development companies, is there -- has there been much change in the amount of money or the kinds of players seeking to make those financings?

Sure. There is a two-tier marketplace, Jeff, as I guess there is in the stock market. If you looked at the debt marketplace, there are people that raise $200 million and there are people who raise $20 million, and the big transactions can get a rating from S & P or Moody's or both, and then can go to the standard marketplace in which somebody like UBS or some other Wall Street firm might do the transaction that would take it out and syndicate the loan, and it's a big marketplace. And there's lots of companies coming to that marketplace and they're huge inflows of dollars into that marketplace. So the hedge fund, the pension funds, insurance companies are all pouring dollars into that, as are the mutual funds that buy securitized debt and senior debt and syndicated debt. So that marketplace is booming. It couldn't be better. The rates that people are getting are unheard of. It's every day is a new day on that marketplace.

Down below that is another tier of companies that can't possibly qualify for a rating from S & P or Moody's, and as a result, can't tap that marketplace and as further results of that, end up going to a -- maybe even a UBS, but certainly a different part of UBS but most likely a sort of financial broker, or coming being direct to us or some others and as a result, they can't get the same kind of low rate that you would expect to see in a big deal. So the difference is size and ratings and money flow is very different. In our size of the marketplace, there are about 100 -- what I'd call sub debt players. There's some small business investment companies, most of them are private and then there are a few, a handful of smaller business development companies.

There are three really large business development companies, American capital is one. Allied capital is another and now Apollo, which just came into the marketplace, are three very large business development companies that I think play more in the larger end. They do 25, 30, $40 million transactions. We don't see them, don't compete with them. We compete more with the smaller, small business investment companies and the smaller BDCs. But quite frankly, the marketplace is so fragmented that we play in, we rarely see them. We may see one of them in a transaction that we're looking at. So that's kind of an overview of the marketplace, Jeff. I hope that answers your question.

It certainly helps me out quite a bit. I appreciate you taking the time.

All right. Next question.

Our next question comes from Matt Schultfeis of Ferris Baker.

Hi, David. How are you?

Just fine, Matt.

That's good. I wanted to ask you a question about your derivative. It sounds like you've -- you're paying fixed on it received floating. Do you see more need in the future to continue with that type of swap arrangement or because of the loans you're putting on, is it pretty much going to be it for the foreseeable future?

We're trying to avoid fixed rates, so most of the deals that we've announced are variable. We do have a couple of fixed that we put on. And some of the ones that were paid off were fixed. So as a result we're trying to keep our fixed within the bounds so that we don't need another hedge. In essence, we spent a little over $300,000 for the hedge, and as I mentioned, it's down by $115,000. Now the good news is our -- the other side of that is we're protected. So I -- you know, Matt, I just don't know. Right now, I would say we won't need one. You may hear me six months from now saying we had to do another hedge because we had so many fixed rate loans and they were so attractive we went ahead and did them and then did the hedge.

Do you have a sort of a dollar figure of exposure for fixed rate where you would consider swapping out?

I think we try to -- I'm trying to remember the numbers now. We had a ratio that we used and I don't remember. Let's see if I can get that information and put it up on the web page under questions and answers.

Okay.

I don't have it at my fingertips.

All right. And I know you've already been asked about your backlog or your pipeline. And you said it's pretty much at a historical normal. Can you give us sort of a ballpark figure, dollar figure?

Yeah, you know, the -- we count our backlog different from other places I've been. We don't put down everything that sort of comes across the transom, as things that we're looking at. So as a result, the only time it gets to backlog is when we have a commitment letter that we've worked on, and put out and are working on. And usually even if it's sort of one of those indications of interest, we don't put it down as well because who knows where that's going to go. So as a result, when I say backlog, I'm talking about things that have pretty high probability of closing and, you know, I think there's four or five loans that have that characteristics to it today.

Okay. That's it for me. Thanks.

Okay. Next question.

Our next question comes from Lee Carter of Oppenheimer.

Good morning, David.

Good morning, Lee.

You said you had a lumpy quarter. This is a beauty.

Well, you know what Warren Buffet said about lumpiness. He said given the choice between a constant 3% increase and 8% increases but very lumpy, he said he would take lumpy any day.

Any day. Right on. What is your -- you know, you use a scale of 1 to 10. What is your average of the total loans now running about?

It's in there, Lee and I don't know what it is. 7.2 -- 7.8 Harry?-- 7.8. It's somewhere in the Q.

Because 8 is almost perfection.

Oh man, if -- we're in good shape, Lee.

Securitization, are you doing it with recourse or without?

Without.

Without?

Yeah, we wouldn't do securitization with recourse back to the company. They have recourse to the equity that you have in the pool. For example, if you had $100 million and you securitized and sold off 80%, you would have 20% at risk but that pool doesn't have a shot back to your company. It stays within the pool.

Okay. You know, you've got I think it shows up as 1.9 million in prepaid that you I think that have you to pay out. Have you a made a decision is that going to come as an extra?

That's what the board will have to decide at the next meeting whether they want to do a little bonus dividend or not or find some place to bury it.

Okay.

I don't have anyplace to bury it right now.

You got nothing to hide yet. No baggage.

I don't have any baggage yet. It's going to be hard to hide. I can't promise you that it's going to be paid out. I don't know. We have to do the calculation. You know how this system works, the problem is we will have to make that decision, you know, at our next meeting, which is first or second week of September, and when we make that decision, we have to guess what our earnings are going to be for the year-ending September, and then declare the bonus dividend and hope we've met the 90%.

Okay. .

It is the -- it's the stupidest thing the government's ever invented but that's what they say we have to do.

That's what you got to do. Okay. Last question. What is your management of Gladstone Capital doing that competition isn't?

What are we doing for what? What are doing to find loans?

Yeah, for your business what are you doing that's making you better than competition?

It has to go back to the pure formula that we came up with, which is we're not doing these deeply subordinated loans, as some of our competition is. So I would say that the portfolio is akin to if you were looking at a bond fund, you would find one bond fund that's doing triple A funds only, and another bond fund that's doing junk bonds. I'm not accusing our competition of doing junk bonds, but I'm trying to make a point. We have a higher quality loan portfolio because we're doing senior and subordinated -- where they're doing mostly subordinated and what I call, mezzanine, or deeply discounted. So I think that is the difference, is the quality of the portfolio, I think is better and we have that verified by S & P, and they've been pretty good and rigorous going through all of our loans. So I think the portfolio is stronger.

I think the second thing that we do different from the competition for our shareholders, is that we don't have a lot of paid in kind or original issue discount, or as I call it phantom income, that has to be paid out because we have a small amount. I think the total accrual for that is around $998,000, is that right? About 998 on the balance sheet. So it's not big at all. And it's most of it's one loan, which right now if they get -- get what they're doing, what they're trying to do, it will be paid off. So I think those are really the only two things, the quality the earnings, not having any phantom income in it, the quality of earnings from the standpoint that we're not dependent on capital gains, and the quality of portfolio from a standpoint of we're doing senior and subordinated loans.

I think that's -- and it cuts against you of course, Lee, because we don't have the kind of returns that other companies will have. They're higher risk and higher return gives them bigger dividends and you just have to decide, do you want something that is more secure, sort of -- I'll use the example again, triple A , or do you want junk bonds in your portfolio, and I think while that's that's an extreme and I don't mean to say that we have triple A and somebody else has junk, there's a big difference in the quality of portfolio. Sure, sure.

Well, the market liked your trade. It's up a buck.

Good. Thank you.

Super. Appreciate it. Thanks, David. Keep it going.

Okay, Lee. Next question.

Thank you. Again, ladies and gentlemen, if you have a question at this time, please press the one key. One moment please. Our next question comes from David Miazaki of AG Edwards Asset Management.

Good morning, David.

Good morning. How are you?

Doing very well, thanks. Had a follow-up question on the hedging expense item. Is that a -- that's a non cash adjustment to your hedge isn't it?

It's non cash. I sort of went through that when I talked about the taxable bottom line.

Sure.

Forgot to add that back. Why in the world that doesn't go down in the portfolio, I don't know. But you -- some day somebody who knows a lot about GAAP accounting will explain that to me. But it's up there above the line and it distorts the net investment income. So if you want it get to a number that's closer to the actual tax income that we have, you have to add that 117 I think it is, back to the bottom line to get that number.

But that potentially has a -- it could disrupt your cash flow versus --

$300,000, you can only depreciate another two. It's not going to do much to us.

Okay. I was just kind of think being that going forward. If you is had more fix rated loans on the books.

That's true. If you put a lot of them on, there would you have that one line item. I think one of the BDCs, I can't remember which one now, had a hedge on theirs and they were negative $35 million on their balance sheet. So you're right, if you become a big BDC, you could -- and you're hedging a lot, you could have -- some confusion in your balance sheet, as well as your income statement. What we try to point it out in these calls is not much we can do in the financial statements because GAAP is with a we have to report and --

Sure.

The SEC is so adamant that you use only GAAP in your statements that it's kind of hard to fix that other than on a call like this.

Okay.

Other questions, David?

Yeah, the -- do have you any sort of general guidance as to how large you think you're get the securitization pool?

You know, that's really dependent on the marketplace. When we did the first one over at American capital, I think it was like $130 million. It was tiny. We had 9 or maybe it was 11 buyers. So it was almost a story book deal, I think you got to be about 200 million in my own mind today to do a decent securitization. And we may or may not do it at that level. We may try to get bigger to do it.

Okay.

I don't want to make that decision at this point in tile. I want to make it when we need to do the next financing and decide, do I want to go out and do a securitization or do I want to borrow more money from a bank or do I want to raise equity. There's sort of three decisions to make there.

Okay.

You make it -- for example, at the stock market got hot and the stock moved to 32, we would probably do an equity offering.

Okay. Last question, just wondering if you had any comments, you know, one of the -- you mentioned earlier in your comments regarding the inability to come out with more BDCs, and I think one of the criticisms that has been high on the list has been sort of the fee structure that a lot of these have, do you have any comments on the fee structure --

Yeah, I really don't see that. Most of the hedge funds run on fee structures similar to that and certainly when we ran Allied capital, we had a 2% fee structure as well, and I just don't see it as a big deal. The question you have to ask is, what kind of return are they giving me if they're giving me a 30% return, do I really mind that they have 2% fee and 20% of the gains? I don't think you would care. You'd feel pretty good about that. So have you to sort of measure -- these BDCs that come out by what you think they're going to return. And if they're going to return, you know, 10%, sure, that would be an outrageous fee, but if they're going to return something up in the teens, I don't think that's a bad fee structure. So I didn't fault any of them for their fee structures.

I was a little bit disturbed by the fact that most of them were raising huge amounts of money with not much in the way of opportunity to put it to work, which would mean that it would take many years to get it to work. When we did our funds in the past, we've had huge commitments. I think when we did the road show on American capital, we had a billion dollars or $900 million worth of commitments and we took down 150. When we did Gladstone capital, I think it was in $600 million or 700 million, and we took down 130. To me, discretion on how much money you raise is the better part of dealing with your shareholders, because I -- I just don't know that there are that many opportunities out there to get it invested. It's great for the management company obviously and I think that more than anything else is what the marketplace was reacting to. For example, if one of the little companies I'm trying to remember, Ferris, Baker Watts took one out --

Prospect.

Yeah. Prospect and they raised 105 or whatever it was. That seemed to be very appropriate in my way of thinking as opposed to the Prospect could have -- I know they couldn't probably given the market climate -- raised $300 million or $400 million. It would just have seemed to be -- I don't know, greedy is not the word. Not a good thing to do to your shareholders. So I think the marketplace was reacting to the fact that most of these people who were coming in were not giving them any indication of where the money was going to go and how quickly it was going to get out and no assurances that even if they made that promise they could live up to it. So the end of the day, I think that killed it more than anything because you were going to have 24 months of sort of not making money before you finally got to break even or something like that.

So I'm really not against the fee structure per se, as I am about raising so much money that you can't put to work and hurting your shareholders in the near term.

Okay. Very good. Thank you.

All right. Any other questions?

Thank you. Our next question comes from Charles Hissler, a private investor.

Yes, Mr. Gladstone, many of the BDCs have yields that are greater than your company's. Is that due to the fact that their quality -- the quality of their portfolio is not as good as yours, which you alluded to earlier, or is it because the fact that you have only become fully invested lately?

Yeah, I think it's a combination of the two things that you mentioned, but I don't think it's quality per se, the way that you're -- you may be implying. It's quality in terms of, we're doing senior and senior subordinated and many of those other companies are doing junior sub debt and preferred stock. So they've just chosen a different part of the balance sheet to make their investments and we're higher in the balance sheet in most cases than they are. So as a result, they have a higher return as is justified by them taking more risk, and that's -- leaves you as the investor with a choice of do I want to be in a sort of senior sub debt fund, or do I want to be in an LBO or junior debt fund, which is what you would see in some of the other portfolios, and again, I don't think it's a question of quality per se. It's a question of what kind of loan or portfolio do you want.

The second thing is we're just not leveraged much right now. And if you looked at bond funds and you looked at bond funds that were leveraged and they can't leverage very much because of the 40 act. But when you leverage up a bond fund, the buying public looks at you quite differently from an unleveraged bond fund, and so as a result, the leveraged bond fund has to pay a higher return to keep its shareholders, and as conversely, it does have a higher income because it's leveraged, borrowing usually short and lending long. And while the -- we're -- 30 some million dollars worth of borrowings today, we're not nearly as highly leveraged as some of the other funds and I don't -- I don't cast aspersions at them for that. It's just, again, how you run your company. I think that as well as we're just getting to the point where we're leveraging up and just fully invested, so all of those sort of come together to give us a better PE than some of the others.

Thank you.

Other questions?

At this time, Mr. Gladstone, I'm not showing any further questions.

All right. Well, we'll cut it off now and thank you very much, Melanie, and thanks all for participating. It's been a good call. Good-bye.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may all disconnect. Everyone have a great day.