Gladstone Capital Corp (GLAD) 2009 Q2 法說會逐字稿

Greetings and welcome to the Gladstone Capital Corporation second quarter 2009 earnings conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. David Gladstone, Chairman for Gladstone Capital Corporation. Thank you. Mr. Gladstone, you may begin.

Thank you, Claudia, for that introduction. This is the quarterly conference call for shareholders and analysts of Gladstone Capital, NASDAQ trading symbol GLAD. Thank you all for calling in. We are always happy to talk to shareholders about our Company. I wish we could do it more often. We just do it once a quarter.

I hope you will all sign up for our email notices so you can get information directly from the Company. And please remember that if you are ever in the Washington, DC area, you all have an open invitation to visit us here in McClain, Virginia, just outside of Washington, DC. Please stop by, say hello; you will see a lot of fine people working for you.

And I need to read the statement of forward-looking statements. This conference call may include statements that may constitute forward-looking statements within the meaning of the Securities Act of 1993, the Security 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. Even though they are based on our current plans, we believe those plans to be reasonable. There are many factors that may cause our actual results to be materially different from the future results that are expressed or implied by the forward-looking statements, including those factors listed under the caption Risk Factors in our 10-K and 10-Q filings and in our prospectuses as filed with the Securities and Exchange Commission.

And those can be found on our website at www.gladstonecapital.com and also on the SEC website. The Company undertakes no obligations to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Well, we will start with our President of the Fund, Chip Stelljes. Chip is also the Chief Investment Officer of all the Gladstone companies. He will cover a lot of ground here. Chip, please give us your report.

Thanks, David. As most of you know we continue to operate in a very difficult environment. Through the quarter ended 3/31, 2009 the environment did not worsen but it did not improve much either. While the longer term prospects for making new investments are more encouraging, the continued instability of the financial and the lending markets and then combined with significant downturn in the economy and the lack of any real visibility into the rest of 2009 has made us cautious in the near-term. As a result we did not close any new investments during the quarter and the investment production during the quarter of $8.4 million went into existing portfolio companies in the form of additional investments or draws on revolver facilities.

During the quarter we received repayments of approximately $13.1 million due to loan payoffs, investment sales and normal amortization and paydown of revolvers. This resulted in a net production decrease of $4.7 million for the quarter.

Since the end of the quarter we made about $4.7 million in additional investments in existing portfolio companies. Additionally after the end of the quarter we sold 13 of the 24 syndicated loans that were held in our portfolio of investments at March 31st. The loans had an aggregate fair value of $22.5 million, of which all the proceeds were received as of May 5th. We sold these loans to further reduce our line of credit as a precursor to the maturity of our line on May 21st. We intend to sell our remaining syndicated loans, fair valued at about $33 million, over time.

Our pipeline is still good in that we are still seeing new investment opportunities. We are being contacted aggressively. So many other lenders or so many lenders in general are not in the marketplace and not lending. Pricing structure are attractive. Unfortunately, companies that have a positive projection for 2009 are few and far between. If we can find them, we can make some strong loans provided we have the capital.

The net decrease of investments this quarter was $4.7 million from prepayments and repayments. This allows us to further deleverage the balance sheet. We continue to look at ways to increase the yield on the existing portfolio, by refinancing lower yielding senior loans with third party lenders, while trying to maintain the higher yielding junior debt. Our deal flow of investments is solid, but we will need to be confident that we understand the economic cycle ahead of us and have the capital to pursue the pipeline opportunities. At the end of the March quarter our investment portfolio was valued at approximately $385 million versus a cost basis of $445 million. So our portfolio was fair valued at approximately 87% of cost. The appreciation for the quarter was about 1.3%. This is logical to us. We are seeing some strengthening in the senior loan market, although loans continue to trade at significant discounts to face value.

We remain concerned that the use of fair value becomes suspect when there are four sellers and few buyers, or in some cases no sellers or buyers. Even though the value stabilized this quarter, we still believe the valuations are more reflective of the overall poor market for loans rather than our specific portfolio. That being said, we continue to closely monitor our portfolio companies' revenues and backlogs to judge where we think the underlying companies are headed.

At the end of the quarter we had loans with three companies on non-accrual and a number of companies experiencing problems that may prevent them from making timely payments in the future. We are at operating control of several of these companies and are working aggressively to fix the problems and improve their profitability. On a dollar basis the loans classified as non-accruing have a cost basis of $10.7 million or about 2.4% of the cost basis of all loans in our portfolio.

Loans with two additional companies totaling $6.6 million are past due, but were not classified as non-accruing at quarter end. Our portfolio of companies are not immune to the current economic climate, so we expect to have some additional nonperforming loans before this recession is over. But we are working very hard to keep them to a minimum. We continue to have a high concentration in variable rate loans so that we participate when rates eventually increase. And while our rates are variable, they often have a minimum rate or a floor attached so that declining interest rates are somewhat mitigated. About 70% of our loans have floors. However, 26% of our loans do not have floors and with floating rates having fallen, we have been generating less income. At March 31, 2009 we had five fixed rate loans with a cost basis of $18 million or approximately 4% of the cost basis of our total portfolio of loans and investments.

Another measure of the quality of our assets is that our average loan rating for the quarter that just ended remained relatively unchanged. Our risk rating system gives you a probability of default rating for the portfolio with a scale of 0 to 10, with 0 representing a high probability of default and 10 a low probability. Our risk rating system for our nonsyndicated loans showed an average of 7.3 for this quarter and 7.5 for the same prior year quarter.

The average risk rating for unrated syndicated loans was 6.8 for this quarter versus an average of 6.3 for the prior year's quarter. As for our weighted syndicated loans, they had an average rating of CCC Plus or CAA1 for both this quarter and the prior year quarter. Overall the risk profile has remained constant according to our risk rating model. This is a good sign and we are satisfied with our current portfolio mix.

In addition to the solid quality of the assets, the quality of our income continues to be good. As we have discussed before, some companies' structure investments were paid in kind or original issue discount structures. This generates noncash income which has to be accrued for book purposes and taxed, but is not received until much later, sometimes not at all. This income is subject to our 90% payout requirement, so the Company does not receive the cash but would have to pay out the income, so we avoid these structures for this reason.

From inception through 3/31 2009, we have made loans to 126 companies, we have been repaid or exited from 66, the average return of the exits has been about 12% for syndicated loans and 15% for nonsyndicated loans. This will drop some as we book the syndicated loans we sold below cost after quarter end.

Since last quarter, the senior and second lien debt marketplace for larger middle market companies continued to have liquidity problems. As I mentioned, we have seen some improvement in the senior loan market. The second lien market remains very weak. For the most part the second lien market was closed during the quarter -- that is, there were very few buyers. At March 31, we had about $70 million at our cost basis in senior and second lien syndicated loans. And this is where we have most of our variability rate loans without floors and these loans have seen their values decline more than others. Again, after quarter end we sold a number of these syndicated loans.

The market pricing for the larger middle market loans continues to change. For senior syndicated loans of $200 million or more rates prior to the credit crunch were at about 2.5% over LIBOR. Of course, LIBOR is the London Interbank Offering Rate, which is recognized as the leading indicator of short-term corporate rates.

Now the spreads seem to be closer to 6% over or more. Because these new loans are at a higher spread, the old loans commmand a lower market price. In light of this market we intended to hold our syndicated loans until they matured, because we believe that ultimately we would recover most of our capital if we did not sell them. But we did choose to sell the ones that we did at a discount in order to reduce our outstanding indebtedness under the line of credit. Of the remaining syndicated loans all but two of these loans are paying as agreed.

In addition to widening spreads over LIBOR, the norm for LIBOR has traditionally been about 5% or 6% and was approximately 0.5% at March 31, 2009. LIBOR is unnaturally low, given the emphasis on lowering rates worldwide to spur lending, and a drop in LIBOR, unfortunately, lowers our income.

The small loan market in which we invest most of our capital is not seeing much competition from banks. Many banks have tightened up their credit standards. The only activity we see from the banks is a willingness to make purely asset-based loans. Now we normally compete with other BDCs, private lenders, like the mezzanine loan funds, a few hedge funds and some of the small business investment companies.

Again, our loan request pipeline is still good. And if we can access capital and get comfortable with the risk in the economic cycle, it may materialize into more new investments for us as the year proceeds. Our goal is to be a strong profitable company, not the biggest company.

And with that, I will turn it back over to David.

Thank you very much. Now we will hear from our -- on the financial side, we will hear from Gresford Gray, our Chief Financial Officer. Gresford, go ahead.

Thanks, David. We will begin with our balance sheet. Our balance sheet continues to remain strong and at the end of the March quarter we had approximately $411 million in assets, consisting of $385 million in investments at fair value and $26 million in cash and other assets. We had about $153 million borrowed on the line of credit and had about $255 million in net assets. So we are less than 1 to 1 leverage. This is a very conservative balance sheet for a company like ours and we believe that our overall risk profile is low.

For the March quarter, net investment income was about $5.6 million versus $6.4 million for the same quarter last year, a decrease of about 14%. The decrease was primarily due to the lower transaction fees credited against our base management fees and the amortization of deferred financing fees incurred in connection with some amendments we made to the credit facility.

Note that we have also seen LIBOR fall, as Chip mentioned earlier, and for our syndicated loans, that has hurt our earnings as well. As rates go back up, we expect that our income will also increase, all other things being equal. On a per share basis, net investment income was $0.26 per share for the quarter, as compared to $0.33 for the same quarter last year. This was a per share decrease of about 21% due to the dilution from share issuances during the year, or in other words, an additional 1.4 million weighted average shares outstanding as compared to the same period of the prior year.

As all of you know, net investment income is the most important number to us because it is the number that is closest to our taxable income. And that taxable income is what we use to pay our dividends.

Now let's turn to unrealized and realized gains and losses. This is a mixture of appreciation, depreciation gains and losses.

We like to talk about two categories in this section. First, gains and losses because they are cash items, and second, we talk about appreciation and depreciation, which are non-cash items.

For the quarter ended March 31st, we had a realized loss of about $2 million from the writeoff of a syndicated loan. And for the same quarter, we had a net unrealized appreciation of approximately $6.7 million. This represents the net change in the fair value of our investment portfolio, including the reversal of previously recorded unrealized appreciation or depreciation when gains and losses are realized.

During the quarter, the unrealized appreciation included $1.960 million in previously unrealized appreciation from the syndicated loan that was written off. As such, the $2 million realized loss we incurred this quarter, as I explained earlier, was almost completely offset by the reversal of the previously unrealized depreciation, resulting in a net $40,000 loss for the March quarter.

As Chip mentioned earlier, the appreciation for the quarter is logical to us and is indicative of the strengthening in the senior loan market, although loans continue to trade at significant discounts to face value. As of March 31st, our entire portfolio was fair valued at 87% of cost. The unrealized appreciation of our investments does not have an impact on our current ability to pay distributions to stockholders; however, it may be a indication of future realized losses, which could ultimately reduce our income available for distribution.

As explained in our previous 10-Q, we made a change in our valuation procedures to value our syndicated loans using a discounted cash flow method versus relying on third party indicative bids. The marketplace from which we historically obtain indicative bids for purposes of determining fair value for our syndicated loan investments continue to show attributes of illiquidity.

Historically, our valuation procedures specify the use of third party indicative bid quotes for valuing syndicated loans where there is a liquid public market for those loans and market price -- pricing quotes are readily available. When there was an active market, the use of these agent desk nonbinding indicative bid quotes was deemed to be appropriate and acceptable in accordance with FAS 157. However, due to the market illiquidity and the lack of transactions during the quarter ended March 31st, we determined the current nonbinding indicative bids for our syndicated loans were based on transactions within an active or liquid market and could not be relied upon and alternate -- alternative procedures would need to be performed until liquidity returned to the marketplace.

As such, we have valued our syndicated loans using a discounted cash flow methods for the quarter ended March 31, 2009. Except for the loans we sold after quarter end, we used their sale prices and not the discounted cash flow values.

Now let's turn to net increase or decrease in net assets resulting from operations. This term is a combination of net investment income, appreciation, depreciation, gains and losses. Please note that we are talking about weighted average, fully diluted common shares when we use the per share numbers. This is the most conservative way of stating earnings per share.

For the March quarter, we had a net increase in net assets resulting from operations of about $10.3 million versus a net decrease of about $11.9 million last year this time. This March quarter we are at about $0.49 per share versus last year this time at negative $0.61 per share. While we believe our overall investment portfolio is stable and continues to meet expectations, with the continued uncertainty in the current economy and credit markets, investors should expect continued volatility in the aggregate value of our portfolio.

And now I'll turn the program back over to David.

Okay. Thank you, Gresford. That was a very good presentation. I hope all of you listeners out there read our press releases and also obtain a copy of our quarterly reports, that report is called a 10-Q, which has been filed with the SEC and can be accessed on our website at www.gladstonecapital.com, and also on the SEC website.

As I mentioned before, our biggest worries today are the debt marketplace for our funds. That's the right hand side of our balance sheet where all our liabilities are. And we also worry about our portfolio companies. With respect to our balance sheet, we worry that our banks' ability to provide our line of credit going forward and for the banks to provide a line of credit to our portfolio companies as well, both of those have an impact on us. Right now we have indications that our lenders will issue new lines of credit, obviously, at a smaller amount than the $300 million we have. It will be a higher rate and probably more restrictive terms.

Just like everyone else in the business right now and just like we announced in Gladstone Investment, we believe that we will have our new lines of credit out soon. Obviously, there is no guarantee, but we have been told by the two banks that are working on this that we have commitments by them and that we are drafting legal documents now and going -- trying to get to closing. So I'm hopeful that we can have a press release on this soon and alleviate that uncertainty that's out there right now.

As I mentioned, we also worry a lot about the credit marketplaces and how they impact our portfolio companies. There are a fair number of regional banks that are making new loans based on assets of the business. These are what we call the asset based lenders. They are certainly much more plentiful today than they were last quarter and the quarter ending December, there were very few, now we have probably 20 or so in -- that we deal with and are working with.

I think there is hope that the credit marketplace is beginning to free up. This is certainly the first sign that short-term asset-based loans are available to the best of the companies out there.

We continue to worry about oil prices. I know they are low today, but we know that when the economy starts back up again, there will be demand for oil and oil prices will have to go back up again. We are not currently worried about inflation, except that I fear that it will be a concern come 2010. There is just too much money out there not to expect inflation to come.

The amount of money being spent on the war in Iraq and Afghanistan is certainly hurting our economy. All your team here at this Company support our troops. They are certainly our true heroes in this period of history. They are risking their lives for us and we hope they will all come home safe. One of our big worries is the pork barrel spending by federal, state and local governments. The federal spending is just off the charts, just out of control.

I hope the new administration can cut back on the pork barrel spending, but looking at the so called, quote stimulus package, end quote, they are filled with spending of goodies for many of the supporters of the new administration and the new Congress that's in there. It's a shame that we are wasting so much money.

Stimulus spending is dislocating a lot of the markets. I'm not sure how all of this will turn out. It looks like it's partly nationalizing a lot of the banks, insurance companies and auto businesses. Over time these partially nationalized businesses will have to raise equity to take out the government or remain part of the government, which seems to be a shame if that's going to happen. All this spending will mean more taxes on our people and I'm just not sure how people can handle any more taxes. It will just continue to cause more and more dislocation in the economy.

There are many in Congress that call for increased taxes on the so called rich, but the definition of rich continues to include the middle class and this is clearly just a bad idea that's going to continue to be implemented by the folks that are running our government today.

Trade deficits with China and some of the other nations are just terrible. China continues to subsidize their industries to the disadvantage of our businesses so that they can take manufacturing away from us. They subsidize their oil prices for example, drastically. The government buys oil and gas on the open marketplace at a high price, turns around and sells it at a low price to the businesses in China.

The downturn in housing industry and the related disaster in the home mortgage defaults are going to continue to hurt our economy, no one knows how many home mortgages will fail. We had originally put the thought, as well as some others, as upward of $400 billion. There are some estimates now that put the number up as much as $1 trillion.

That is the main cause of the recession today. The housing problem is likely to turn around this year, because housing prices are falling and of course the government is subsidizing a lot of the mortgage rates that are out there. So that should bring the qualified buyers back into the marketplace to buy some of the houses that have dropped in price.

In spite of all the negatives that I have mentioned in the housing and those above, the US industrial base is not in a depression. The only thing that's hurting us now is the lack of banks lending money to companies for long-term needs. Short-term loans by asset-based lenders are certainly helping. However, most of the banks have stopped making long-term loans. This is just like it was in 1990, '91, except in this situation, the government's pouring money into the banking system rather than taking them over.

So we are propping up these large banks much the way the Japanese did and that didn't turn out so well, so I am somewhat skeptical of the system we are using today to prop up these banks rather than taking them over and selling off the assets.

We are guessing that the downturn that began in 2008 will continue for at least the first half of 2009 and we think there will be some stabilization and turnaround in the second half of 2009. And certainly that -- if that's true, we can take advantage of it; and if we can take advantage of it, it will be a great time for us over the next two years.

Our plans today are to seek some long-term loans from our funds and to seek long-term loans because we are using our money to make long-term investments. So we are making the rounds of some of the long-term lenders like insurance companies to see if we can get some long-term debt.

We have applied for a SBIC license at the SBA. If we are granted a license then we would be able to borrow up to $120 million on very attractive terms. The terms are 10-year loans to us, interest only and the rates are very good at today's market at a few percentage points over long-term treasuries. So it would be a very attractive opportunity for us.

We are looking at issuing some preferred stock, but it would be very expensive today so I'm not sure where that will go. And we've considered but put on the shelf the idea of issuing any common stock, the stock price is just too low for that. So as a result we are sitting with our distributions at $0.07 for the month of April. We are earning more than that, but not much more than that, so we got a little bit of room there. We're hopeful that the shares will make room for dividends to come up if we can make new investments and put up the earnings. Our goal is to put new loans on the books and grow that dividend back up again.

In our projections we did not assume making new investments, so hopefully this $0.07 per share per month is the bottom. And we should be able to exceed those as we go forward and make new investments. Certainly there is no guarantee on that one, but that's our projection.

As soon as our new line of credit is in place, the Board will meet and consider the dividend for May and June. We are working on some changes that I hope will let us build the earnings and our payouts even more. At the distribution rate for April, the dividend with the stock price at about $6.35, as it closed yesterday, the yield is about 13.2%, so nice yield if you believe this is the bottom, which is where we believe we are.

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In summary, as far as we can see, conditions look okay today. We think the economy is reaching a bottom. It will start to gain strength, but we can only see a couple of quarters out so we want to be careful. We are stewards of your money and we are going to stay the course and continue to be conservative in our investment approach.

Just let me summarize again. The plan is to get our new revolving line of credit in place, which we think will happen soon. Then once we do that, we are going to continue to refinance some of our senior debt of our portfolio companies using banks that provide asset-based loans. So we will move away from those loans that are low yielding, hopefully into some higher yielding. We will use the money from the refinancing to pay down our bank line and to do some new loans at higher rates.

We are going to seek the SBIC license, hopefully, and borrow some money from SBA and we are going to seek some long-term capital to match our long-term investments that we are making. We will have probably some more losses if we sell off some of our loans in order to make room for cash to do new deals. So don't be alarmed when you see some of that come through.

At this point, we will stop and we will take some questions. So let's open up the lines. Claudia, if you will come back on and handle that, please.

(Operator Instructions) Our first question is coming from Troy Ward with Stifel Nicolaus. Please state your question.

Thank you and good morning, David.

Good morning, Troy.

Just real quick on the credit facility, in your conversations with the potential renewal, can you just give us a little bit of color potentially on, not specifics, but what -- are the lenders looking for any scheduled amortization, what kind of covenant package or covenants still based on mark-to-market, that type of thing with a potential new -- with a new facility.

It's really not too different from the package that is out there today. In fact, they are just marking up that package. Obviously the rate is going to be higher. But other than that, there is not a lot of change in the facility. We are going to have a smaller facility. We are not quite ready to announce what the number is, but we should, hopefully, within the next two weeks have all of that completed and finished and out to everybody.

Right. Okay, that's great. And as you think about -- you said the amortization of loans and selling additional loans used to pay down debt, what is kind of the -- what's the right debt level do you believe in this environment going forward?

Oh, that's one that we agonize over. Right now we don't want to have a lot in short-term debt. The problem with all of the BDC industries, and the reason people keep saying the industry is broken and can't work, is that all of us had long-term visions in terms of what we were going to do, but we financed it with short-term debt. That is, we all believed that if we borrowed short, we could turn it into long-term debt and the marketplace was all set up to do that. We had the securitizations were out there and people were using that.

So we all had long -- large short-term debt facilities. I think ours was $300 million in this Company and we were up around $150 million some at some point in time when the, in essence, the game stopped. Right now we don't believe that we need a large short-term line of credit. This line of credit will be the typical 364 day or less than one year commitment on the part of the banks and the goal will be to keep that at a relatively low amount.

My guess is we will probably need only $75 million of that at some point in time. But right now we will have more than that and our goal is to use that very, very carefully, because we just don't know what might happen to some of the banks that are lending to us, and they might pull up short next quarter or next year and not be able to fulfill going forward on their line of credit.

So the goal here, Troy, is to make sure that we have a line of credit, and that should happen soon, but then turn around and look for long-term ways of financing ourselves. SBIC is one, some long-term debt perhaps from some insurance companies if we can do it, perhaps some preferred stock, but we are looking for long-term ways of financing ourselves. And as I mentioned, we do want to get out of some of the revolving lines of credit, as well as senior debt pieces that we have to some of our portfolio companies for the simple reason that when we did those, we had low cost money and expected to continue with low cost money, so those loans are not making us a lot of money.

We want to get out of those. We still have about $32 million of senior -- of syndicated loans that we will probably sell out over the next six months or so. That's the goal. No guarantee, but that's what we are thinking about.

And using that money that we free up from the senior and subordinated syndicated loans, as well as refinancing the lines of credit we have to portfolio companies and the senior debt to portfolio companies, all of that will go first to pay down our revolving line of credit and then we will use some of that revolving line of credit, don't have a number in mind yet, to do new transactions at much higher rates than today. Today, you can do a second lien at 12% to 15% current pay with a little bit on the back as well. We want to get back into that marketplace, that's how we built all of our companies in the past. So that's the goal. Next question?

Yes, just real quick, a follow-up, on the current facility, how it's structured now. I know it goes into a one -- if it was not renewed, and I assume this is maybe, like you said, it would be similar on the new facility, it goes into a one year amortization period. Can you tell us if that's a full cash trap or is that interest only or how does that work? Is there any amortization during that one year?

The current one is full cash trap, as you call it. Some people call it turbo amortization, meaning that everything goes to the bank to pay them down. I think that's pretty standard on revolving lines of credit that you have a one year amortization period at the end of the facility, and it's usually everything is used to pay down the debt. We don't expect to hit that. We expect to get our line of credit in place and continue to go forward.

Great. And we will get back in the queue, thanks, David.

All right. Next question, please.

Our next question is coming from Scott Valentin with FBR Capital. Please state your question.

Good morning. Thanks for taking my question. Just in terms of the syndicate portfolio, two quick questions. One, are you seeing any deterioration maybe by industry or by geography, if you can comment on that. And two, in terms of the valuation, you mentioned that the stuff -- the loans you are retaining in the portfolio are discounted cash flow. But yet you sold some loans and have an idea of what price is, is there any material difference between the prices you are seeing versus the valuation on a discounted cash flow basis?

Chip, you want to take that?

Yes, I mean, I think I would focus it two ways. The ones that were sold, if you can -- if you look through the numbers, you can see that they were sold almost directly on our mark. Now there are other ones where we received, for example, we might have received no bid whatsoever because it was closely held and none of the existing buyers wanted to buy anymore or had the capability. So, that's where we say, for example, that the second lien marketplace is still pretty weak.

The ones we did sell were right on the mark, but the rest of them it is going to be hard to tell and the market itself will have to firm up before we will feel comfortable that the indicative bids make any sense whatsoever. In some cases we could not even get an indicative bid. So -- but those are performing companies that are paying their interest. So, that's been challenging.

These are performing loans, the syndicated loans that we have some first and some seconds. And as time goes on, I noticed the marketplace for all the junk bond paper was firming up pretty dramatically, and I think it will firm up over the summer as people get more into the idea that the marketplace is coming back and we will be able to sell some of them as time goes on.

We want to get out of those loans. They're -- were done at the heyday and are not earning us a lot of money. And we don't see a great deal of difference between the price that we are getting on many of them and the price that we had to mark that in the December 31st time frame.

Okay. And just outside of the syndicated portfolio within the portfolio itself, any industries you are seeing more stresses than others, aside -- you mentioned housing in the past, housing related industries. But has the weakness in the economy spread to other industries?

Well, the weakness comes from either housing or autos. The auto industry, obviously, has hurt a lot of small businesses out there. We are lucky we only have a couple that are tangentially rated -- related. We have one, a manufacturer that has some manufacturing facility for some of the large trucks and that got hurt a little bit. But we think that over time -- these are all cyclical businesses and when the economy goes down, as they say in the business, when the tide goes out, all the boats go down. And so all of the -- I think all of the portfolio has seen some pain from the economy going down, but we have been very lucky in that our portfolio has held up better than we expected.

Yes, I'd say the one place where it sort of has spread is in the consumer items. And the good news is we don't have a lot of exposure there either.

Okay. And just one final kind of big picture question. I guess contemplating a lot of tweaks to the model with delevering and different financing sources and different portfolio mix, I'm just wondering in the end, I mean is there a target level of leverage? I think Troy may have asked that earlier, but also maybe what the ROA of the business is and what the ROE is, and can that be competitive, given the cost of capital?

Yes, hard to know now because we don't have any long-term capital on our books. And so as a result, I don't know what that cost will be. We have not gotten into the marketplace yet. We will tap that pretty soon and get a better idea of what the returns can be.

Assuming, for the sake of argument, that some of the long-term debt is going to be 7% or 8%, that would mean that we would have significant spreads, 5% to 7% spreads on our money and that would make us very profitable. If you think that the long-term debt is going to be 10% or 12%, we probably wouldn't issue it, Scott. We would just sit around and wait for awhile and redeploy the capital that we have from lower return income things to higher income situations.

It's highly dependent, as you know, what you can do on the right hand side of your balance sheet. If we found reasonably priced capital, I would not mind being leveraged as we were before and that's about 50%. That is, if you have a portfolio of $400 million, you wouldn't mind having half of that borrowed. So at the end of the day, leverage is the key to getting ROE up, but at the same time, if leverage is very expensive, you are not going to get it up very high. And that means the SBIC would be our best mode of operation for perhaps the next year, if that's the only thing we can do in the long-term debt marketplace.

Okay, thanks very much.

Next question, please.

Our next question is coming from Mark Hughes with Lafayette Investments, please state your question.

Good morning. Just a little bit of clarification. David, you said that don't be surprised if we see a few more losses coming. Are you talking about losses versus cost basis or from where the marks are today?

Well, I'm sure it will be some or both, but certainly from cost basis we will have to take some hits on our syndicated loans when we sell them off. I don't think those are coming back to par in the next year, just because the marketplace has been so weak. I could be surprised. It could come back to cost. I think we would probably not sell a lot below the mark that you see at March 31st during the quarter ending June. So you shouldn't expect that there.

But we also have situations in which we have some companies that are not doing well now. We don't have a lot of them. We may end up finding a buyer for those and have to take a loss on those. We usually take over those companies, work them hard, fix them, get new management, whatever we need to do, but sometimes people come along and want to buy those, a competitor wants to buy them or somebody interested in that industry, and we end up selling them. So I wouldn't want you to be surprised that we take one of our problem children and sell them off and have a loss there.

Is there anything different -- you've sold 13 of the 24 syndicated loans, is that -- is there anything drastically different between the 11 that are remaining from the 13 that were sold?

Most of those are second lien loans rather than first lien loans. The second lien marketplace has not firmed up the way the senior debt marketplace has. But we are watching that and we are seeing it firm up now, and I think by the end of the summer, it will be firm enough for us to get out of those deals.

Thanks. And finally last question. You're in this problem today of lending long and the borrowing is short. Was your intention, the Company's been in existance a number of years now, from the start to try and get some long-term debt on the books, but you weren't able to do it because the market changed as you were kind of ramping up the Company and you never knew from the outset how big it would get, so it was tough to place the long-term debt?

Unfortunately, the whole industry, the business development company industry, went through that same idea. We all were going down the same path; that is, we had a lot of loans that we were financing based on, not only our equity, but also short-term debt. And those lines of credit were meant to be paid off by going into securitization pools and getting long-term debt to replace it. They were never meant to carry our portfolio for the long-term, even though they were from banks who told us they didn't mind rolling over the lines of credit. At the end of the day they did not want to do that.

And so as a result we've had to reprice and rethink the way that we are going to do our business. And as it happens, it's really the way that industry worked before securitization came along. You would always have a small line of credit. You'd use that to finance your next deals and then you would go out and find long-term debt, either as a SBIC or whatever, to make those transitions from short to long. We all got caught, and I can speak for the whole industry here I think, we all got caught with a lot of short-term debt on our balance sheet financing the long-term investments and unfortunately, the banks have not been kind to those of us who got caught in that trap.

Great. Thank you, good luck.

Next question, please.

Our next question is coming from Troy Ward with Stifel Nicolaus. Please state your question.

Just to follow-up on the dividend. When you announced the April dividend of $0.07, can you just kind of give us some color on how you got to that rate, especially based on your $0.26 earnings for the quarter?

Chip, you want to talk about that?

Yes, I mean, our goal was to right size the dividend with the current level of net investment income. We spent a good deal of time looking at our internal projections. As David said in his talk, we did not assume new transactions.

It's highly sensitive, as you might guess, to new transactions because the a), the deals are very accretive -- can be very accretive right now and b), the transaction fees that come along with it can really change a quarter. So we took those out and said, where do we think that for the X-number of quarters going forward we feel comfortable that the net investment income can cover the dividend? And that is how we got there.

What we didn't want to do, Troy, is set the dividend at some expected closing rate and then have to lower it when we didn't hit that. It's much better to say, okay, this is the bottom, we believe we do not have to change it ever again in terms of going down. And then build the dividend back up.

So I don't expect us to raise the dividend in the July Board meeting for the quarter ending September, but I'm hopeful that by the time we get to October, we will have a different view of the world. We will have our line of credit in place. Hopefully, we will have our SBIC and we can make some different assumptions and hopefully change the dividend and move it up.

Okay. And Chip, following up on Scott's question, he was asking about the difference between kind of your DCF valuation versus what you actually got. For instance, if you look at like Bresnen, what you sold as a syndicated piece in the previous quarter or after the quarter end, what I'd like to know is you sold it at, say, $3.6 million, what would the DCF have given you? What was -- kind of what's the difference between the DCF value, what it is giving you versus what you actually sold them for?

Yes, I don't know. I can't answer that question. Where we felt comfortable was that on this particular set of loans was that our marks, the total value received were so close to the marks that we had and that we didn't take significant hits below where we had them marked as a group, that we felt good about going ahead and making the transactions in order to pay down a line of credit. But I don't have that specific answer.

Troy, we didn't bother to do DCF's on ones that we had sold after the quarter, because there would be no reason to do that. If we did, it would not be relevant. You, obviously, are going to use the price that you got. So what we are comparing it to is the DCF that was used at December 31st, and as Chip mentioned, we were pretty close to that.

Okay. And David, this is Greg Mason, you said that at this price you wouldn't want to raise equity capital. In your calculations, where does the stock have to be where that makes sense?

I wished I had an answer for you. We have to do weighted averages cost of capital when we are doing our projections. So as we do the projections, we will come up with some number, but this is -- it's just far too low here to think about it. I'm not sure I can give you an exact number.

Okay. And then two quick questions on credit quality. Lindmark, you mentioned in your press release that you took a control position and then it looks like you wrote it back up to par. Can you talk about how that accounting works where you take the control and write it back up to par?

It's really considered a new loan at that point in time. When we took it over it was O Company, O-Co. So we now own it. And as a result we feel like that the -- there were a lot of mysteries involved before we could get our hands on the assets. And so we wrote it down based on the quality of those unknowns. Those unknowns have been removed now that we own the Company and we believe now that we are going to be able to sell it and get par for our loan.

Then one last question. Last quarter your LYP Holdings investment, the senior term debt was on non-accrual and carried a zero. And this quarter it looks like you provided some additional senior financing -- held at 0. But it doesn't look like it's on non-accrual anymore. Is that paying? And what kind of is going on with that investment with your additional capital?

Yes, we've -- we begin to buy up some additional businesses around there that strengthened the Company substantially. They are beginning to make some payments, not full payments, and so as a result, we had to write it back up or I'm not sure -- S&P wrote it back up, didn't they? Or did we write it?

That was internal.

It was internal. So that one has begun to pay and if you are paying, you can't carry it at a low amount anymore.

Great. Thank you very much.

Other questions?

Yes, our next question is coming from Vernon Plack with BB&T Capital Markets. Please state your question.

Thanks very much. Most of my questions have been answered. I do have a follow-up regarding just portfolio valuation. Excluding reversals, the portfolio was written up almost 5% and I'm trying to get a sense for was that the result of higher valuation multiples offsetting lower cash flows? Or -- I'm trying to get a sense for what was the mix between an improvement valuation versus changes in cash flows from a -- from an aggregate standpoint.

Vernon, this is Chip. I will say that almost across the board when -- on the loans that use an S&P valuation, almost across the board despite performance, the rate D-marks were higher from S&P. And so that's the majority of what you see there, absent the one or two sort of outliers that have already been asked about, the Yellow Pages deal and Lindmark. We saw almost every single loan, despite what performance differentials, go up. And that is where we started to see some comfort level that at least the rating agencies are calming down a little bit.

Okay, so valuation levels offset any declines that you perhaps could have seen in cash flows to these individual companies, correct?

Well, that's what S&P said. S&P looks at the cash flows and determines the quality of the cash flow, the industry that they are in, they have a lot of markers that they use to do the valuation, so we use their value.

Okay. And one other question. David, I don't know if you can give me an answer on this, but as it relates to -- I know that you had on your previous revolver you had a minimum net worth that I believe was somewhere around $250 million, will -- can I assume there will be some relief from that?

Yes, I'm very hopeful that the documents have that in there.

Okay, thank you.

Next question, please.

We have no further questions at this time, sir.

Anybody have a last question? Or otherwise we will adjourn. All right, the meeting is adjourned. Thank you, Claudia. Thank you all for attending.

Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time and we thank you for your participation.