Gladstone Capital Corp (GLAD) 2010 Q2 法說會逐字稿

Greetings, and welcome to the Gladstone Capital second quarter 2010 earnings conference call. At this time, all participants are in a listen-only mode. A brief 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, CEO for Gladstone Capital. Thank you. Mr. Gladstone, you may begin.

All right. Thank you, Jackie, for that nice introduction and hello and good morning to all of you out there. This is the quarterly conference call for Gladstone Capital. Our trading symbol is GLAD and certainly, thank you all for calling in and listening to this. And those who listen to it remotely from wherever over the next couple of months, we're happy that you're listening to our conference call. We wish we could talk to you more often. It's a great deal of fun to get folks on the phone and answer questions and we'll do our best to answer your questions today.

I want to take this opportunity to tell you to visit our website. It's GladstoneCapital.com, where you can sign up for email notices and you can receive the information about your Company on a timely manner. I know it came out late last night; it was about 7:00 before it got on the wire, but it does come out more frequently and quicker.

Please remember that if you're in the Washington, DC, area you all have an open invitation to come by and visit us here in McLean, Virginia. Please stop by and say "Hello." You'll see some of the finest people in the business working every day for you.

Now, I need to read the statement on forward-looking statement. This conference call may include statements that may constitute forward-looking statements within the meaning of the Securities Act of 1933 and the Securities 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're based on our current plans, and we certainly believe those plans are reasonable.

There are many factors that may cause our actual results to be materially different from any future results that are expressed and 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 prospectus as filed with the Securities Exchange Commission. Those can be found on our website at GladstoneCapital.com and also on the SEC website.

The Company, we undertake no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise.

All right. We'll start this morning with the President, Chip Stelljes. Chip is our Chief Investment Officer. He's the Chief Investment Officer of all the Gladstone companies and he'll cover a lot of ground here. So Chip, take it away.

Thank you, David. As most of you know, the difficult economic environment continues and is still compounded by a difficult lending environment. We are seeing some new investments being made with some investors in the marketplace believing that the worst is behind us, but the continued instability of the financial and lending markets, combined with only a few real signs of recovery in the economy, continues to make us cautious.

We did not close any new investments during the quarter, but invested $5.2 million in the existing portfolio of companies in the form of additional investments or draws on revolver facilities. During the quarter, we received repayments of approximately 23.4 million due to loan sales, payoffs, normal amortization and paydown of revolvers. This included the full realization of three investments of $18.(inaudible) sale of the assets of the small loans and 300,000 in the sale of the syndicated loans for approximately 300,000.

So we had more payoffs than advances, resulting in a net decrease in our portfolio of about 18.2 million for the quarter. The net proceeds will be used to pay down our line of credit.

So at the end of the quarter, we made the first installment of $400,000 in a $2 million investment and about 1.2 million in additional investments in existing portfolio companies.

Additionally, after the end of the quarter, we received $15 million in repayments, which included amortization in a $13.5 million repayment from one portfolio company.

I do want to note that Cresford will detail in a minute where that applied, we received all the related prepayment fees, exit fees and capital gains associated with these realized investments, so a very good time for our investment model. Just so you know, the companies where we had exits achieved proceeds representing 107% of our previous quarter values.

So as of this call, we have about 28.4 million borrowed on our $127 million line of credit, so we're in great shape today.

As to the pipeline, we continue to see new investment opportunities with pricing when structures are attractive and with our line taking on its longer maturity, we believe we can start making new investments that attractive rates return.

We do continue to work to increase the yield of our existing investment portfolio in several ways -- first, by refinancing lower yielding senior loans with third-party lenders while trying to maintain the higher yield of junior debt; and secondly, by increasing pricing where the situation allows for it.

At the end of the March quarter, our investment portfolio was valued at approximately 292 million versus a cost basis of 330 million, so approximately 88% cost. The values were stable this quarter, but we're not seeing a resurgence in valuations. We still believe the valuations are more reflective of the higher rates new loans are commanding compared to the lower rates of our older loans, rather than the specific performance of our portfolio. That being said, we continue to closely monitor our portfolio companies revenue backlogs to judge where we think the underlying businesses are headed.

At the end of the quarter, we had loans with six companies on non-accrual and a number of companies experiencing problems that may prevent them from making timely payments in the future. We have taken offerings in full with several of these companies and we're working hard to get them back to current pay.

On a dollar basis, the loans classified as non-accruing have a cost basis of 26.4 million or about 8% of the cost basis of all loans in our portfolio. And on a fair value basis, they're valued at 12.7 million, which is about 4.4% of the fair value to portfolio.

Note that the increase in non-accruals cost basis from 3.7% last quarter to 8% this quarter was primarily due to the addition of one portfolio company. This company has a new CEO and we wanted to give them some breathing room to increase the sales of the business. That company is in the outdoor advertising business. They have about 1,600 billboards and the market is improving, but the company needs to sell the inventory they have.

This change to non-accrual will not affect our net investment income or our dividends since we have not been accruing the interest on this loan during the last year. This was an old performance-based note that only paid -- and we only recognized interest if the company met certain standards. So we decided that they had not met them, so we decided it was better to classify the loan as non-accrual.

Our portfolio of companies are not immune to the current economic climate and we may have some additional non-performing loans and some write-offs, but we do seem to be coming to the end of the recession.

We continue to have a high concentration of variable rate loans, so that when rates do increase, we should participate. While our rates are variable, they often have a minimum interest rate or a floor, so that declining interest rates are mitigated. Approximately 85% of our loans have floors; 2% have floors and ceilings. However, 9% of our loans do not have floors [at all]. The short-term floating rates at all-time lows were generating less income (inaudible) interest so low. The remaining 4% of our loans have fixed rates.

A measure of the quality of our assets is that our average loan rating for the quarter that just ended remained relatively unchanged. This rating system attempts to measure the probability of default in the portfolio by using a zero to 10 scale; zero represents a high probability of default, and 10 represents a low probability.

During the quarter, we modified our risk-rating model to incorporate additional factors in our qualitative and quantitative analysis. While the overall process did not change, we believe the additional factors enhanced the quality of the risk ratings of our investments. No adjustments were made to prior periods as a result of this [computaton].

Our risk-rating system for our non-syndicated loans showed an average rating of 6.3 for the quarter, 7.2 for the same quarter of the year prior. The average risk rating for unrated syndicated loans was 7.0 for this quarter versus an average of 6.8 for the prior year's quarter.

As for our rated three syndicated loans, they had an average rating of B2 this quarter and triple-C class CA1 for the prior year quarter. Overall, the risk profile has remained relatively constant according to our risk-rating model. And while the risk-rating model is only showing slight changes in the portfolio, we do see changes that might not be picked up by our risk-rating system.

In addition to the quality of assets, the quality of the income continues to be good. As we discussed before, we do not intend to generate income from paid-in-kind or original issue discount structures. These generate noncash income, which has to be accrued for both in cash, but is not received until much later and sometimes not at all. This income is subject to our 90% payout requirement, so the Company does not receive the cash, but we have to pay out the income.

From inception through 3-31, 2010, we've made loans to 127 companies totaling greater than 958 million. Our cumulative net losses have been approximately 3% of total investments since inception. We've been repaid or exited from 86 companies as of 3-31, 2010. The average return of the exits has been about 8% for syndicated loans and 13% for non-syndicated loans. Historical returns have dropped some, as we had to sell some our performing loans during the low point in the recession in 2009 to pay down our short-term line of credit.

The senior and second-lien debt marketplace for our larger middle-market companies continued to improve. At March 31, we had a cost basis of approximately 9.5 million in senior and second-lien syndicated loans. This is where we have most of our variable rate loans that don't have floors, and these loans have seen their values decline more than the others. As I stated earlier, we sold the majority of this portfolio since the middle of 2009.

The lower end of the middle market, where we invest most of our capital, has not seen much new competition. Most banks continue a policy of tightened credit standards, especially for the five companies in which we invest. Currently, banks are mostly willing to make purely asset-based loans to that business segment. We normally compete with other BDCs and private lenders, such as mezzanine loan funds and a few remaining hedge funds and some of the small business investment companies out there.

Again, our loan request pipeline was still good, and with our new line of credit in place, we should be able to make some new investments before the end of our fiscal year in September.

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

All right. Thank you, Chip. That was a very good report. Most of you out there couldn't tell it, but Chip's getting very excited about the climate today and he's not one easily excitable. But we'll go now to Cresford and Cresford Gray is our Chief Financial Officer. Cresford, tell us about the financials.

Thanks, David. Starting with our balance sheet, at the end of the March quarter, we had about $312 million in assets consisting of $292 million in investments at fair value and $20 million in cash and other assets.

We borrowed $53 million in our line of credit and had approximately $255 million in net assets. As such, we are less than 1-to-1 leverage and this is a very good and conservative balance sheet for finance companies, which are usually leveraged much higher. We believe that our overall risk profile is low.

During the quarter, we did not close on any new investments and exited from five companies, of which four were payoffs and one was a syndicated loan sale. At quarter end, we had 41 companies in our portfolio and with the [Banacorp] payoff in April, we're now at 40 companies.

In March, we entered into a new $127 million credit facility with KeyBanc, BB&T and ING Capital. Subject to certain terms and conditions, the credit facility may be expanded up to $202 million through the addition of other committed lenders to the facility.

The facility matures in two years on March 31, 2012, and if the facility is not renewed or extended by that date, all principal and interest will be due and payable on March 15, 2013. Advances under the credit facility bear interest at 6.5% per year with a committed -- commitment fee of 0.5% per year on undrawn amounts. We expect that this credit facility will allow us to increase the rate of our investment activity and grow the size of our investment portfolio.

In January, the SEC declared our shelf registration statement effective and as such, we're permitted to issue up to $300 million of debt and equity securities.

At our annual stockholders meeting in February, stockholders approved a proposal that authorizes us to sell our shares at a price below NAV for one year. As such, if our share price falls below NAV, we'll be able to sell our shares if necessary. At quarter end, our NAV was $12.10 per share and given our share price yesterday of $13.29, we're trading at a 10% premium to NAV per share, so that's great news for us.

Turning to our income statement, for the March quarter, net investment income was approximately $4.5 million versus $5.6 million for the same quarter last year, a decrease of about 20%. The decrease was primarily due to a decline in investment income resulting from the sale and repayment of loans, incentive fees accrued and lower transaction fees received in the current quarter and during the prior-year period.

As you all know from our discussion last quarter, for most of last year, we've been deleveraging and that means selling loans and encouraging payoff of lower interest-bearing loans in order to pay down our debt. We are now seeking to increase our assets with better paying loans, and from the loan payoff this quarter, we received success fees and prepayment fees of about $1.2 million.

Consistent with prior quarter, LIBOR remains low, which has negatively impacted the earnings from our syndicated loans. However, since we've sold many of our syndicated loans, even if rates go back up, we don't expect that our income will increase materially.

On a per-share basis, net investment income for the quarter was at $0.21 per share as compared to $0.26 for the same quarter last year. This was a per-share decrease of about 19% which again, was caused by the changes in our balance sheet. As many of you may be aware, net investment income is the most important number to us because it's the number that is closest to our taxable income, which is the income 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. I'll discuss two categories in this section. The first is with gains and losses because they are cash items; and then second, appreciation and depreciation, which are non-cash items.

For the quarter ended March 31, we had a realized gain of $0.9 million primarily due to the gain of our eight expedited warrants, offset by those losses on the CCF payoff in both syndicated loan sales.

Regarding unrealized appreciation for the quarter ending March 31, we had net unrealized appreciation of about $2.5 million. This represents the net change in fair value of our investment portfolio, including the reversal of previously recorded unrealized appreciation or depreciation when gains and losses are realized.

As of March 31, our entire portfolio was fair valued at 80% of our cost basis and the cumulative unrealized appreciation of our investments does not have an impact on our current ability to pay distribution to stockholders. However, it may be an indication of future realized losses, which could ultimately reduce our income available for distribution.

As explained in our recent SEC filings, when markets demonstrate characteristics of illiquidity, we are required to value our syndicated loans using the discounted cash flow method. However, in monitoring the market activity during the quarter ended March 31, we continued to use third-party [bid quotes] to value our syndicated loans.

During the quarter, we had another component of unrealized appreciation, which related to our credit facility. For the quarter ended March 31, we recorded unrealized depreciation of $131,000. Since we entered into the new credit facility during the quarter, the fair value was the same as the cost basis of $53 million as of March 31. As such, on our balance sheet as of March 31, we did not have any cumulative net unrealized appreciation or depreciation on the line of credit.

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're talking about weighted average fully diluted common shares when we use per-share numbers.

For the March quarter, we had a net increase in net assets resulting from operations of $8 million versus a net increase of $10.3 million in the prior-year period. This is a positive $0.38 per share for the current quarter versus a positive $0.48 per share for the prior-year quarter. With the continued uncertainty in the current economy and credit markets, investors should expect continued volatility in the aggregate value of the portfolio.

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

Okay, Cresford. Thank you so much. That was a good presentation. I hope all our listeners are reading these press releases and going through the 10-Qs which we filed with the SEC yesterday. You can access the press release and the 10-Q on our website at www.GladstoneCapital.com and also on the SEC website. That's at www.SEC.gov.

And the big news this quarter is we've completed our goal of paying down our bank debt and renewing our credit lines. We were awfully grateful to the folks at KeyBanc and BB&T Bank and ING Capital for providing a loan to the Company. It's a two-year commitment with a one-year payout of the principal if we need to do that. This is really a three-year commitment and it's a good one for us. It'll bridge us to the point that we can raise low-cost long-term debt, capital and perhaps some preferred stock over the next two years.

We have nearly $100 million available in our line of credit today and are currently working on a number of very good alternatives for long-term investing and it just takes a lot to get me excited, but I'm looking forward to this summer as a time of rejuvenation for our Company as we put new loans and investments on the books. I think we've now seen now that we've gotten through our difficult loans. Those will settle down.

And I was disappointed, of course, in our billboard company. It hasn't come back as quickly as I'd like to see it come back, but they seem to be getting better every month. They're highly dependent on advertising budgets and the budgets are coming back, but unfortunately, the budgets are coming back slower than we'd like them to come back.

I know that this will be a winner down the road. We have a new management team and they're doing a great job for us. They recently landed a big contract with the number one fast-food chain, so they have put up those billboards for that fast-food chain.

The credit markets continue to get better. They're still not a long-term -- not much long-term debt for small businesses and that's really a shame because they create all the jobs in the economy, but we'll be working hard over the next summer, and over this summer and over the next part of the year, to put our brand of long-term capital to work in these small businesses.

And even though we've entered into a nice new line of credit, and it's still a short-term line of credit, and we can use some of that money to put new loans on the books, but we'll be looking, and you should be watching for us to announce that we've raised long-term capital of some form to match up with the long-term loans and investments that we make in these businesses.

In order to make lots of new investments, we will need to raise long-term debt and long-term capital of some kind, or issue preferred stock or additional common stock, in order to finance these investments for the long-term, but we do feel very comfortable about putting 50, 60, maybe even $70 million of new loans on the books, using our line of credit, and at the same time, we'll be looking at our books to have -- rounding out some long-term debt to match that and pay down the short-term debt. And that warehouse line that we have with the lenders now, we'll pay it down with long-term debt and then borrow it up and start to leverage back up.

So we're back in business again and our portfolio of companies, we worry too that they will not be able to get lines of credit and term loans that they need at cheap rates from the banks. And there are a fair number of regional banks that are making new loans based primarily on assets and these asset-based lenders are certainly much more plentiful today than they were last year at this time. I think last year at this time, we maybe had three or four that we could deal with. Today, there's probably 25 or so that are in the business that we deal with and are helping some of our businesses.

But remember, banks are only making short-term revolving lines of credit, and we still need them to come back into the market for the long-term debt. Right now, we're providing the long-term debt and we'd like to see our portfolio of companies get some lower cost long-term debt.

As far as the economy goes, we're still worrying about oil prices. As the economy comes back, obviously, the oil prices, oil demand, will go up and oil prices will go up with it as we see the economy improving. We certainly are worried about inflation and the decision by the lawmakers in Washington to expand the money supply is going to cause inflation to return. In essence, the government is really sopping up all the available credit out there today, and they're having the banks buy Treasury bills rather than making loans to small businesses today.

The spending by the federal government is way off the charts. We look at the stimulus package that has come out and it just filled with spending goodies for many of the supporters of the legislators in order to get them reelected again.

And the amount of money being spent in Iraq and Afghanistan in the war is certainly hurting our economy. All of us support the troops. They are the true heroes of this period in history. They're risking their lives every day for us and we certainly wish for them to come home safe and soon, but we have to recognize that the expenses that we have for the war is very detrimental to our economy.

All this spending obviously means that taxes are going to have to go up. We've going to have more taxes and that'll just cause more dislocation as the government tacks on taxes to virtually everything. And the government keeps talking about increasing taxes on the so-called wealthy, and if you want the definition of the wealthy, it continues to include more and more of the middle class. And that really means just about just about everyone who's listening to this presentation today is going to see their taxes increase either directly or indirectly.

The trade deficit with China and certain other nations is just terrible. China continues to subsidize their industries, their small and midsize businesses, and that's a disadvantage for our companies trying to compete with them as they subsidize oil. For example, it's just a very different price -- difference in oil prices and prices in China than it is here. And this means our companies can't compete with them and jobs, of course, leave the United States and go to Asia or other countries.

And now, even China today has even stopped buying our government paper, so the US government is having a hard time finding people to buy the paper. Japan is down in terms of buying our paper. So the banks seem to be the only place that they can put the Treasury bills these days.

The turndown in the housing marketplace obviously is still a disaster and the home mortgage defaults continue to increase up and I don't think anybody knows where the home mortgages will ultimately come out in terms of the number of failures. And it's just trillions and trillions of dollars being estimated that can have problems over the next several years.

However, we do believe the housing problem is likely to turn around this year sometime in 2010. Housing prices are falling enough to bring back a lot of the qualified buyers. There's only one problem, about 80% of all the new homes that are being financed today are guaranteed by the US government through FHA, VA, or something. So the government is propping up the home-buying business these days and hopefully, that'll change over time and we'll see that housing come back.

There's a lot of negatives in the marketplace, but in spite of all of those, the US economy still is not a disaster. The recession has had an impact on all of us, including our portfolio of companies, but it's not a disastrous one. It's not like 1929 where so many companies were closing.

But like most companies, our portfolio of companies has not seen much in the way of revenue increases or backlog increases. They've cut costs dramatically in order to remain profitable. Perhaps we'll see an increase next quarter and we see some of our companies starting to have increases and that's a good sign.

At this point, we have a low rate of nonpaying loans, so we're in pretty good shape today. To all of you that's been bullish, while I've been so bearish, you called it right a year ago and the economy is coming back, and our Company is in a position to move forward now.

The only thing that's hurting us is the lack of banks lending money today to companies on a long-term basis. All the short-term vendors are out there. However, most of the banks have just about stopped their longer term loans and this is like 1990. The recession of 1990, the federal government was pouring money into the banking system by buying assets and shutting down banks. Today, of course, they're investing in the banks, although we do see them taking over a few banks here and there but it's not like then where about 1100 banks were shut down.

We believe the downturn that began in 2008 will continue as it is today through most of 2010. However, the economy is stabilized now and if that's true, we're going to be able to take advantage of it. It's just a great time for us over the next two to four years. And every time I make a new loan, there's fee income and there's income that comes into us more and more, and that should make it available for us to increase our dividends over time.

Our plans today to seek long-term debt for our fund, that's the next goal and objective on the right-hand side of the balance sheet. Obviously, on the left-hand side of the balance sheet, we need to put more money to work. We'd like to borrow long-term again because we're making long-term loans and we want to match the book, as they say in the business, and make sure that we don't have short-term borrowing problems, as all of us did during this last part of the recession.

We are looking at issuing some preferred stock, but it would be very expensive today, so we'll sort of back off that, but we're still trying to figure out how we can raise some long-term capital, either preferred stock or debt, and that's a major goal for me during the next 60 days.

We're not considering issuing any common stock today while the stock price is relatively high, so the dividend, it doesn't take into account the fact that we expect to increase the dividends over time, and we have to match those on any new shares we give out. Plus, any issuance of shares today would be a dilution to our existing shareholders and all of you know how much I hate to do that.

Our distribution today at $0.07 per share for each of the months of April, May and June, we declared that back in April and our projections, we didn't assume we were going to be making any new investments. So as we make new investments, our projections should come up and hopefully, we can make some use of that extra money by paying out extra dividends, but there's really no guarantee. I'd love to tell you that we're going to increase the dividend next month or next quarter, but at this point until we put deals on the books, we just can't do that. We can't make those kinds of projections.

The run rate that we declared may leave us with the need to pay a small extra dividend at our next meeting, so I hope that problem that we have, and you'll certainly hear about it in our call that we do at sort of the end of April -- I'm sorry -- the end of June or July, we'll give everyone the same information and don't want to hold back.

And I just want to say one thing. I think this is great opportunity, given the yield on the stock and dividend and putting new loans on it, and so I plan to buy some stock. I'm always buying stock and my dividend reinvestment plan, I've been doing that for the last nine years, but I plan to buy some additional shares with the additional cash that I have. I think this is a great time to buy stock in this Company. And that will probably cause us to look at increasing the dividend over time and I'm hopeful that we can do that.

Please go to the website, GladstoneCapital and sign up for our email notifications, so that you get all the information about your company.

And in summary, I'd say that economic conditions are looking like they will change for the future and I think the next six months are going to be very telling. I think the economy is at the bottom today. We're gaining strength every month and I think over the next two years, it's going to be a great time. And again, the next six months are really going to be telling for whether we are flat or going to go up. We are stewards of your money. We're going to stay the course. We're going to be careful and make sure that we make good investments.

And at this point in time, Jackie, if you'll come on and we'll answer some questions from the guys and gals out there.

Thank you. Ladies and gentlemen, we will be conducting a question-and-answer session. (Operator Instructions). Thank you. Our first question is coming from Vernon Plack of BB&T.

Thanks very much. Chip, I just a question about -- I was actually looking for a little more color on the types and the characteristics of the deals that you're currently viewing and are attracted to. So perhaps a little more color there, please?

Yes, the market is -- for the negatives that David mentioned as far as our ability to access senior debt, it's still pretty restricted at the lower end of the middle markets. That's negative for the portfolio, but for doing new deals, it's pretty attractive. You don't end up with a lot of term debt in front of you, so your junior debt is further up the balance sheet at lower leverage levels than we've seen in the past.

At the same time, they've probably got more equity going into deals and we certainly are seeing improved pricing in junior debt. It's the smaller end of the middle market, or lower end, and you're not seeing much get sort of priced at sort of less than maybe LIBOR plus 1,000 with a 2% floor. And we're not seeing a lot of things that are getting done that don't have some level of an equity component to it, whether it be a warrant or an equity co-invest. And you probably remember at the frothiness in '07 and the beginning of '08, it was pretty hard to negotiate those type deals.

So it feels like it's going to be a good time and we'll see what we can find. We'll probably have five or six deals that we're actually at right now, and so I'm optimistic. As David said, it's hard to get me overly excited, but I'm optimistic we're going to find some good opportunities, but that's what we're seeing in our marketplace.

Okay. And is there any industry focus there or what are some of the industries or sub-industries that you're really attracted to at this point?

Yes, we continue to look at most of the same things we've looked at historically. I mean, where we probably have increased our emphasis is we've not been active investors historically in government contractors, but as we talk it around the table here, with 30% of our GDP is going to be government, we thought we'd get interested in it. So we're spending some time studying that and I wouldn't want to tell you anything specific, but -- so basically, business services, light specialty manufacturing.

But we are continuing to look at healthcare services. We've had good luck there, but obviously, as everybody is sensitive to the reimbursement environment and what's going to happen with new healthcare legislation, but it's a big part of the economy. And so we continue to look at it, and as I said, we've had good luck with it in the past.

Okay, great. And a quick question for you, David -- regarding long-term debt, could we expect an announcement on that from you in the next -- within the next quarter?

I don't know. We've engaged a placement agent. They're working on our behalf. We have had several sessions with insurance companies. I just don't know. As you probably know better than I do, most of the insurance companies have for, at least the last 18 months, have said "No" to everything in the finance sector. Whether they're finally now interested in the finance sector, I can't answer, but we are able to talk to them, and which I'd say one quarter ago, you couldn't even reach them on the telephone. They wouldn't talk about -- so I think they're coming back. Whether we could announce something in the next quarter, I don't know. It's too early to tell.

Okay. Thanks very much.

Next question, please.

Thank you. Our next question is coming from Greg Mason of Stifel Nicolaus.

Great, good morning. David, could you talk about -- I think you mentioned you had $1.2 million this quarter of exit and success fees. I think that's up from like 500,000 last quarter. What are your expectations for those fees going forward?

Yes, hard to say what those fees will be like going forward and here's the point. The existing amount of fees that are building up in our portfolio, as you probably know, we don't do paid-in-kind, so it's not being added to our portfolio and you can't see it building up, but we do what we call success fees and those do build up on the balance sheet. You don't see them, but we calculate them here. We have a good amount of those and if those loans prepay and if they want to pay off the success fee at that point in time, that's great; if they want to pay it off when they sell the business, that's fine as well. I just can't predict when they're going to pay off and when they're going to sell their business.

As you know, this Company follows around most of the LBO funds; most of the LBO funds do sell their businesses eventually. So we can collect on those at some point in the future, but right now, it's hard to say. I'm hopeful now that the economy is coming back and more and more people are interested in buying businesses, that we'll see a good number of these going forward. We certainly build an end to all of our new transactions, so you should see a buildup in our warrants or success fees that are being talked about in the 10-K or 10-Q.

Do you have an amount of success fees for the total portfolio that's built up? Are you able to give us that number --

For the --

-- for the total portfolio?

I know we have a memo on our account. Let us go back and look at that. Maybe we should be recording that someplace and telling people what it looks like just to give you an example. I don't think it's -- it's not in the Q, is it?

No, we don't have (inaudible).

But we have a memo account on that.

Yes.

I'm talking to Cresford, our CFO. He tracks all of that. Let us look at that and, Greg, if we have -- we probably should start revealing that in our Qs and Ks, just so people can see it. It's no guarantee that we're going to collect it. It's just sitting out there as something that might be collected. We'll take a look at that and see if we can put it in our Q-and-A section on the website for this quarter that just ended, and then we'll look into putting it in a memo account in the future Qs.

Okay. And just to dig into the origination potential, in the press release, you said now is the time to become active lenders and you talked about 50 to $70 million of capacity on your credit facility. How long -- do you think you can deploy that by the end of this year or is it a 12-month timeframe? I'm just trying to dig down a little further on your expectations.

Well, Chip can answer that better than I can. Go ahead, Chip.

Okay. Let's see, I think we can. With the realizations we've just gotten in with the ability that we have on the line, we've got our origination team in place. As you know, we didn't go through the significant layoffs that a lot of our competitors did, so we've still got our offices open in Dallas, Atlanta, Chicago, New York and obviously, servicing the rest of the East Coast out of McLean. And we've got almost all of our junior and midlevel talent available to do the deals.

As David says, we've gotten the portfolio settled down and there's less work we have to do on individual companies, and so I think we're in pretty good shape to do it. The real thing we never want to promise is that we're just going to book it for the second booking because we want to make sure that we deliver good-quality loans and not making difficult, poor decisions on loan quality.

So part of it's going to be a function of what we see and we'll start to see as the year goes on whether that's still a good number, but I do feel like that's a good number, and certainly it's a number we've been able to meet in the past with our team.

Great. And then David, have you heard anything from the SBA new about a potential SBIC license?

No, we're hung up down there on a number of issues and I just don't know at this point in time whether we're going to go forward or not. Their -- SBA is a different world today than it was when I ran four of these 10 years ago.

Okay. And then one final question -- can you touch a little bit more on credit quality? As we looked at your internal ratings, we looked at the weighted average; I think it went from 7.1 down to 5.9. I think you said your straight-line average went to 6.3. Was there just a couple of movements or -- and when do you expect the credit quality to kind of stabilize in your portfolio?

Well, there was the fact that we changed the rating system and then we made the rating system probably more critical than it was before because we felt like there were a couple of things that weren't being captured in that. So we started to capture those so that they would jump out at us and give us a better indication of what's going on. So this round that happened in March 31st may have been a more critical evaluation of our portfolio. It's hard to say. We didn't go back and risk-rate the portfolio at December or any prior period, so we didn't try to spot-check that.

But Cresford, what have you got in terms of that, any answers to that -- to Greg's question?

Yes, basically, Greg, it's -- as David mentioned, we wanted to do a more objective analysis using the qualitative and quantitative factors that went into the risk-rating model. And what we expect going forward is -- we'll expect the smoothness to continue now. As David said, this quarter, with us making the change, you'd see this modification.

Hey, David, this is Troy. One quick follow up on the SBA commentary -- do you think that -- you said it's a little surprising that some of your background is enabled to security license. Do you think that's a change that the SBA is adding toward BDCs or is there something -- what are you seeing there? Can you add a little more color?

No, I think it's really me and I don't like to say this in public, but I've not been a big fan of the SBA since I left Allied years ago because it was so difficult. And as you know, when I took over American Capital and ran American, we never got an SBIC license because I just didn't want to do that. And money is freeing up now and I'm not sure the attraction of the SBA lower cost money is that great.

We've looked at a couple of situations that, if they come through, would give us money at nearly -- you have to add to the SBA cost of money all the cost that goes into the fact that you've got to do all these extra things. You have to run a different set of books; you have to do different forms; you fill out forms for each time you do a deal.

And all of that adds to the cost of your business model and if you take that business model and compare it then to, say, just straight preferred stock, I think we can raise money either in debt or equity at a rate that would be comparable and not have the difficulty of trying to fit everything into an SBIC model.

It's a great technique for getting started. If you're a two or three man team and you're going out to start an investment company, it's wonderful to have them as your partner because it's just about the only place you can get that kind of capital.

But once you reach a certain stage, it's like all of these government programs. You graduate from it and I would be shocked if Apollo or Aries ever decided that they wanted to have an SBIC, and certainly, Allied, after I left and after they grew a little bit more from where I was, they surrendered all of their licenses. And they had four different license that they surrendered and purchased all of their -- got all their debt back.

So when people look at it and you get a certain size, it becomes non-advantageous to have the SBA, and I know a lot of BDCs ran in to the SBA because there really was no other way of getting long-term debt. And so as a result, they felt like it was necessary. I just am at a point of inflection here in looking at all that we have available to us to think that maybe doing an SBIC is probably not the right thing.

Now, we have a license down there. We haven't prosecuted it perhaps as vigorously as we should and we'll let you know where we come out on this analysis, but I've looked at two situations that, if either one of those came through, I would not go forward on the SBIC license.

That's great color. Thanks, David.

Next question?

Thank you. Our next question is coming from David West of Davenport & Company.

Good morning.

Good morning, Dave.

I just wondered if you could give a little bit more color on your -- the repayment activity and what has been the source of the repayment? Is someone providing refinancing for some of these portfolio companies?

Do you want to answer that, Chip?

Yes, sure. I mean, of the main ones that were realized this quarter, one exception of the sale was (inaudible) and the others were repayments and refinancings, which is good news for our model. I mean, those companies have done well. We received our success fees and in a couple of cases, prepayment fees, and that obviously generates capital that we can put back to work at higher returns, but the majority of it was the -- were refinancings, but the large payment on (inaudible), but ours was the sale of that company with the warrant gain that Cresford mentioned.

And you'll also note, Dave, that I think all of those were valued by Standard and Poor's at a lower number than we actually got when they paid off. Obviously, they were discounting it for the fact that it's private and of course, they paid off at 100 cents on the dollar. So that's an indication of how conservative Standard and Poor's is and we don't begrudge them for being conservative. We run in that mode as well, but you should know that generally speaking, we do collect all the money under our loans.

Okay. And just to get a better grasp on this, just who are the other parties providing the refinancing in this market?

Yes, in a couple of cases, the senior lender had enough assets and they stepped up in the case of the [Apacorp] [Banacorp], the equity firm actually decided to take all the debt off the balance sheet, junior debt, and go with an equity-structured balance sheet. So they actually wrote an equity check for that and the other ones were just other lenders that came in and again, had enough assets to be able to do it and give them more senior-debt pricing.

So they paid off their more expensive debt, which would be ours, by borrowing from their bank on their revolving line of credit, and they were able to do that because they had paid down the revolving line of credit from the time they were acquired. The typical fashion for us is that a business will be bought and be loaded up with debt, including ours, and then over time, it pays down the debt and obviously, ours is the first one they want to pay off because we're the most expensive.

And that's good for us; it proves our model; proves that we selected correctly. And that's going to happen more and more as the capital markets get better, but at the same time, there's still no one out there providing the long-term debt to do the new transactions. So we're still in good stead in terms of putting that to work. It's just that over time, we'll get paid back.

And we did have one issue where a junior lender who was junior to us decided to step up because they liked our loan and they replaced us, and quite frankly, it was a relationship that had been difficult over the years. The [cut in] performance had somewhat improved and we weren't necessarily sorry to see that one go, so --

Okay.

Okay. Other questions, David?

Thanks for that color. Just one other question -- on the, I assume, the Lindmark loan, the billboard company, I don't quite understand, given what you said, that you hadn't been recognizing income in the past on that. Why was that not put on a non-accrual before?

It was a loan -- we took over that company and when we took it over, we put some of the loans in a category of you pay it if you have the money to pay it. And so it really didn't have to pay it and so as a result, we were sitting there not collecting the interest because they were building the company on the inside and making lots of changes. And then we decided, look, it's better to reclassify this.

I think it was after nine months of looking at their ability to pay and said, "We ought to just classify this not as a loan that's paid when they have money to pay, but put it on a non-accrual." So we moved it over to that category. So that's why it didn't have an impact on the earnings of the company, because -- and didn't have an impact on our ability to pay dividends simply because they weren't paying under the performance-based analysis that we put in place.

Now, that company has come a long way since the time that we took it over and a lot of that was due to the very aggressive acquisition schedule that they had. They were acquiring lots of smaller billboard companies and also building billboards at a rapid pace. And of course, they hit the recession head-on and started having cancellations of their billboard signs and at the same time, had obligations out to continue to build things.

So it was an unfortunate circumstance, but we've now sold off some of the extraneous pieces where they were trying to go into new areas and we're taking that money and plowing it back into improving the existing operations. And my guess is that, oh, it may be six months away, but I think it's -- that company will come back pretty strong in the next six to eight months.

Thanks so much.

Other questions?

Yes, thank you. Our next question is coming from [Mark Hugh] of Lafayette Investments.

Good morning.

Good morning, Mark.

Hi. First a comment, then a question. David, I appreciate your sensitivity to diluting shareholders and the restraint in issuing new shares. If you can place some long-term debt or a preferred issue, it's certainly appreciated by the shareholders that you're sensitive to that issue.

And then just a question -- on the decline in the average asset risk rating, is part of that because -- part of it's because you've changed how you're accounting for the -- how you're computing the model, but is part of it because you've made basically no new loans the past six months, and the ones that have paid off might have had a higher risk rating than the ones remaining? And if that's the case, what is -- what was the -- your internal risk rating of the payoffs, of the loans that have paid off in the last six months?

Oh, that's a difficult one. Let's see. What was the risk rating from the ones that paid off, do you remember, guys? We can take a quick look; we've got a schedule here.

We're just -- the general -- in general, were they higher than the average of what's remaining?

Oh, I wouldn't be able to do that one on cue, but it looks like we had two 6's and a 7 and where's the other exit? Let me see; oh, there it is. So three 6's and a 7 were the four payoffs, so they were a little higher perhaps than the average, but not much, not material. They look like they're sort of right in line.

So I would say that speaks very highly to your conservatism then, that you're able to get a mark higher than -- a price higher than your mark at payoff and [surface] a 6 or 7 seems very average, but if you're getting paid off above your book on it, that seems very commendable.

Oh, I think we're in good shape today. Mark, you're probably the only person that compliments us for our conservatism. Everybody else calls us too picky and not going fast enough and all those other things, but unfortunately, that's our nature here.

Okay, terrific. Thank you.

Another question?

We do have one more question coming from John Rogers with Janney Montgomery Scott.

Good morning, David.

John.

Got a question for you on the out-of-period adjustment from the Q. I think you talk about in the Q a reversal of interest income and adjustment related to professional fees negatively impacted that investment income by about $0.02 per share. I'm just wondering what that relates to and if you have more detail on that?

Yes, I'll let Cresford -- I do want to go into one part of it. We had a law firm that we were doing a workout with and they were sending their bill out, and they were sending it to an unknown address. And so we never got the bills, but the good news about that is after we all found them, we were able to negotiate with them because they were a bit too high and we got them down substantially. I think if we'd been paying them on a current basis, we probably wouldn't have gotten the discount that we got. But that was one that kind of slipped and should have been in a prior period.

But Cresford, why don't you wade in on that? You know the numbers behind it much better than I do.

Um-hum. Yes, for the interest reversal, John, it related to one portfolio company in particular and we were working very closely with that portfolio company throughout fiscal year '09 on restructuring the loan. And as time went on, we did an internal analysis and we determined that it was prudent to basically write off that loan based on the financial condition of the company. We did that in the current period, FY2010, and then we basically said, "Look, as of 9-30-09, this amount should have also been written off." So that's why it was an out-of-period adjustment.

That was about 500,000 of the 900,000?

That's correct; that's correct.

The others were small adjustments, smaller adjustments, and we had the law firm of about 200-and-some.

Yes.

And then what was the --

Those are the two.

Those are the two that made up about 700 of the 900,000, so the others were minor adjustments.

Okay. Thanks a lot.

Okay. Other questions?

(Operator Instructions). Thank you. Mr. Gladstone, there are no further questions. I'd like to hand the floor back over to you for any closing comments.

All right. Well, thank you, all, for calling in and we feel pretty bullish about the future and we'll talk to you again next quarter, and hopefully, have a lot of good news. That's the end of this conference call.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you all for your participation.