NewtekOne Inc (NEWT) 2016 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Newtek Business Services Corporation Q2 2016 earnings conference call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions). I would now like to introduce your host for today's conference call, Mr. Barry Sloan, President and CEO. You may begin, sir.

Thank you, operator, and we appreciate everybody attending our second-quarter 2016 financial results conference call. The call is hosted by myself, Barry Sloan, President and CEO of Newtek Business Services Corporation, NASDAQ stock symbol NEWT, as well as Jenny Eddelson, our EVP and Chief Accounting Officer. Jenny, I'd like you to read the forward-looking statement comment.

Sure. This presentation contains certain forward-looking statements. Words such as plan, believes, expects, plans, anticipates, forecasts, and future, or similar expressions are intended to identify forward-looking statements. All forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially from the plans, intentions and expectations reflected in, or suggested by, the forward-looking statements.

Such risks and uncertainties include, among other things, intensified competition, operating problems and the impact on revenues and profit margin, anticipated future business strategies and financial performance, anticipated future number of customers, business prospects, legislative developments and similar matters. Risk factors, cautionary statements and other conditions which could cause Newtek's actual results to differ from management's current expectations are contained in Newtek's filings with the SEC and available through www.SEC.gov.

Thank you, Jenny. I'd like to turn everyone's attention to the PowerPoint that we have hung on our website, NewtekOne.com. Go to the investor relations section and PowerPoint is there present and will also be archived along with audio presentation of the call.

I'd like to turn everyone's attention to page 2 of the presentation, talking about Newtek's differentiated BDC model. I'd also like to thank everyone attending the call today. We've had a very nice jump in our stock price with a preview of how our business has been doing over the last week or so. I'd also like to remind investors that if you look at reports from some analysts that have followed us, the Company has returned 25% to shareholders over the last three years, 25% in the last year. And from a performance perspective, the Company anticipates, subject to Board final approval, the payment of five cash dividends this year, which would include the payment received in January from the fourth quarter of last year.

Last year we benefit shareholders by doing a special dividend in the fourth quarter of 2015. The fourth quarter dividend effectively earned from the fourth quarter of 2015 was paid in January of this year. So investors that own the stock as of January 1, based upon forecasts and the Board declaring dividends, should earn a forecasted $1.53, plus the $0.40 to equal $1.93. Now let's go forward.

Why we think our business model is better. Importantly, we are an internally managed BDC, so we say we don't pay a 4% external management fee to an external advisor. A typical deal out there is 2 and 20. There's a lot of fees that are going out the window that are not going into calculating the dividend yield. So, in our world, we believe there is no free lunches. We'll get into that a little bit deeper into this slide, but essentially in order to get the 10% to 11% yields that our competitors are offering, they've got to start with significantly higher coupons and significantly higher leverage, which mean significantly higher risk.

We invest in and importantly originate primarily senior secured loans, and an operating businesses at portfolio companies which are wholly-owned, most for over 10 years by Newtek Business Services Corp. We are not buying packaged loans in an auction process from Wall Street or brokers. We are in the lending business. We are originating loans directly with retail clients, doing our own assembly, our own package, our own underwriting and our own closing.

From a standpoint of conflict of interest, the inside ownership is very much aligned with the external shareholders. The insiders -- which includes myself, the other large founders, the Board, management -- owns about 15% of the outstanding shares. Bullet number four, which relates to bullet number one, when you look at our risk profile; extremely important. Not a lot of leverage. So most of our competitors have got to invest in higher risk type assets that are paying off higher coupons in order to get through the 4%.

Some of these have an equity kicker. You can call the mezz capital, you can call sub-debt. Even the players that claim they are doing senior secured are typically doing senior secured LBO deals that may not have collateral behind them, that are at very excessive EBITDA numbers. So if you really want to take a look at our business model, please understand that what we are investing in are things that we as a management team and ownership structure have had familiarity with over the course of 10 years. We are not investing in other people's securities or things.

We do do a little bit of that. We obviously lend money to other people, but we've been in the lending business now for over 13 years. We are not acquiring equity investment in CDOs, which is another form of excessive leverage. Many times I'm asked by investors, do you have SBIC debt on our portfolio? The answer is no. Now, SBICs are very good way for BDCs to actually get higher levels of dividends. But I've got to tell you, SBIC debt is SBIC debt. You've got to pay it back. It's extra leverage. Yes, it doesn't count for the BDC test, but the fact of the matter is it's extra leverage. So the fact that we currently don't have it, that's not to say we won't use it in the future, also accrues to the fact that we are earning a really good return without excessive amounts of leverage and cash -- without excessive amount of leverage or risk.

We are forecasted to pay an annual dividend of $1.53 per share in 2016. That's up $0.01 from the previous forecast. To equate to an annual dividend of approximately 11%. Another comment I'd like to make on how the Street estimates dividends. They typically take the most recent quarter that's earned to calculate what the dividend yield is. Well, our dividends quarter-to-quarter are not stable. They do change from time to time. They have a little bit of volatility. As a matter of fact, over the last three years we've consistently said most of our earnings come in the second half of the year. There's nothing we can do about that. Christmas only comes once and it's in the fourth quarter, where our payment processor does a significant amount of its business.

The lending business also tends to be skewed to third and fourth quarter closings. So I think it's important to note you get a little bit more volatility from quarter-to-quarter in the dividend yield, but we think it's worth it. Potential NAV upside as operating businesses grow, and we get larger sizes in the portfolio companies versus public valuations. If you look at our competitors in this space, NAV can and would grow if rates fall -- good luck on that, although it could go negative here -- or credit spreads tighten. I also say good luck on that, because we are fairly at historic tight spreads with respect to credit.

With our NAV, you're investing primarily in businesses that are getting larger, that are having earnings growth, that are doing a great job in managing their risk. And from a total valuation standpoint, we hope and expect to deliver to our shareholders -- I say this again: we hope and expect to deliver higher NAV upside as these operating businesses grow and approach larger sizes.

There's no derivative securities in the BDC. We avoid second lien or mezz financing at the business line. And we haven't feasted on oil and gas or volatile industries as we are putting money out. Our industries aren't very sexy. They could be a funeral parlor, could be a bowling alley. The good news is they typically have historic cash flows, historic operating histories, and we think stability in the credits is extremely important to us. Where our competitors have to go for things that are more volatile to be able to acquire a higher rate and/or maybe an equity kicker.

One last point on this page. Last year approximately 35% of the dividend that we paid to shareholders was qualified. It was qualified because the portfolio companies, which are already taxed once upstream, its income to the holding company. Makes a difference. So when the market looks at our dividend yield, it needs to differentiate between the fact that 35% of our dividend yield to taxable entities is taxed at a qualified rate of 20%, because it's already taxed once, versus a typical high rate in a non-qualified dividend of 38%, 39%.

Let's move to slide number 3, second quarter 2016 financial highlights. We bumped our dividend to up $0.01 to $1.53, and it's based upon management's improved outlook for the second half of the year. We also want to elaborate that we do think we get the majority of our earnings in Q3 or Q4 on a quarterly calendar year. Our NAV came in at $14.11 per share at June 30, 2016, as compared to $14.06. Mind you, this bucks up against the BDC trend that has a declining NAV based upon credit concerns as the economy seems to weaken and credit spreads are widening.

Dividend income from controlled portfolio companies, a 38.9% increase. Debt to equity ratio of 76.3%. We are very mindful of where we are here. We just did a fairly significant baby bond deal in the second quarter, raised about $40 million of debt. Those bonds trade on the NASDAQ NEWTZ, NEWTL. The recent raise, NEWTL, a $40 million transaction. Total investment portfolio increased by 14.6%, and the second quarter dividend was $5.1 million, paid $0.35 a share.

Some people are looking at the fact that the dividend we paid in Q1 and Q2 for the second quarter was below the adjusted NII. Once again, I want to repeat, most of our income comes in in the second half of the year. It's historically been about 60%, so what we are trying to do is to placate some of the investors by having the first quarter dividend and the second quarter dividend be closer to the third and fourth. But I think all of you can calculate the math, and based upon a $1.53 forecast, we're looking at about $0.85 dividend in the second half of the year.

Going to slide number 4, SBA lending highlights. We funded $75.8 million in the second quarter of 2016. This is based -- this is basically where we had expected the number to come in at, an increase of 40%. For the six months ended June 30, 2016, loan fundings are up by 27.4%. Once again, realize, the first quarter less than the second quarter. That's just our business model. In July 2016 we funded $25.9 million; very valuable. Typically we have funded less in the first month of a quarter. We are starting to even that out as we're -- improved our technology. We've improved our management resources and our total flow in the lending business.

We reaffirmed loan funding forecasts of $320 million. We changed the breakout a little bit; about $300 million of 7(a), $20 million is 504. And as of July 1, 2016, approximately $105 million of 7(a) loans were sitting in underwriting. We believe we are well-positioned to achieve another outstanding quarter and meet our guidance for the rest of the year.

Going to slide number 5, a comparison of internally managed BDCs versus externally managed BDCs. I really want to focus to the bottom part of the chart. Triangle, Main Street, and Hercules: these are the BBCs that we obviously aspire to reach their types of valuations. They are all internally managed. They typically invest in portfolios of securities. Look at the seasoning of these entities. They're around for nine years, they're around for six years, they're around for 11 years. That's Triangle, Main Street, Hercules; KCAP been around for 10 years.

One of the reasons we believe that they have multiples of 1.34 times NAV, 1.6, 1.39, is the longevity. Also, the market cap. Significantly larger. So as we grow our business model, obviously we plan on being around for a long period of time. We also plan on growing the market size, putting more shares out, growing the investor base and growing the liquidity. These are the types of NAV multiples that we hope to aspire to. As we closed yesterday we were pretty close to NAV. I would also -- and I'll use the word boast -- we believe our business model is a better business model than our competitors. That remains to be seen over the course of time. We are approaching our two-year anniversary in November of this year as a BDC.

Moving to slide number 6, new Company headquarters in Lake Success. A couple of important aspects here. We have 180 workstations, 40 offices. We finally got four of the primary operating businesses in one location. We think that's going to lead to tremendous operating efficiencies over the course of time. That's going to take many quarters to happen, but I think you'll see it quarter-to-quarter. Should lead to more efficient and effective cross-selling and cross-marketing.

We also recorded a three-month loss in the end of the quarter of $1.5 million relating to the remaining liability under the West Hempstead lease, which the majority of the staff relocated here. As we sublet space in West Hempstead, as we recently did in our New York City office, which we moved out of and closed, some of that $0.10 a share will hopefully come back to us. There's about 22,000 square feet in the West Hempstead office.

Moving to slide number 7, debt to equity ratio. We talked about 76.3%. We also want to talk about at the end of each quarter, we typically have -- and this was somewhat apparent on June 30 -- about $19.9 million of extra leverage. In the event that we ever got tight to the leverage cap at the end of a quarter, we could basically curtail funding and selling within the last two weeks of the 12-month cycle to effectively collapse that position. That would get us under the cap. That's about 10% of our total asset size. I think this is a valuable consideration to look at. I had recently somebody come up to me and say, you are raising equity money in the third quarter. And I just said, I don't really know what planet you are on.

I know the third quarter is out and I'm never going to see never. People have gotten a lot of trouble doing that. But I also would say it's pretty unlikely. But I think when people are trying to figure out what our leverage is, they don't understand how our business model works. This is a business model that we have some functional control over. Please also understand that our Goldman Sachs line, that we currently have about $22 million drawn, which is currently outstanding of $38 million, which we are in the process of renegotiating that cap up, because our cash flows are better, our EBITDAs are better, to get more availability to enable us to use a little bit more leverage versus raising equity. These are the things that we are looking at in the marketplace. So really enhance our performance for all of our stakeholders.

Moving to slide number 8, a couple of important data points. On June 29, 2016, we completed our investment in banc-serv Partners. On May 20, 2016, we acquired the assets of ITAS and Deer Valley. I think these are important items to note. Notice that they are pretty much toward the end of the quarter. Our funding from the baby bond deal came in in April, so we picked up around a little over $500,000 worth of interest expense, which is somewhat punitive. But we just started putting that money out.

So many of you take that slide rule out, and it's all straight line. And we'd love you to put that slide rule away because we are not necessarily straight line. We've been a public company for a long period of time. Our stock performs because we do what we say. We think you should look at the overall business model. But I think the important aspect here is you certainly can be punitive if you want to look at the $518,000 of interest expense and not giving us time prudently to put the money out. So the money is now out. We should be able to start to deploy more of that cash as we go forward, both in loans, possible acquisitions, and other real attractive risk versus reward opportunities that come to us. We killed two things off of our pipeline, previously reported. That was an insurance agency and a payment processing company. We are currently looking at a staffing company and [PEO], which could be interesting for us.

Reflecting back on banc-serv Partners. Banc-serv is Indiana-based, has 40 employees, great management team. They have relationships with 350 lending institutions that they perform historically in outsource service, of assembly underwriting, and servicing and compliance. The value prop with banc-serv is -- we think we acquired a company with attractive cash flows at an attractive EBITDA multiple. But importantly, banc-serv's clients, which are typically smaller entities that may not be able to fund opportunities that are out of their footprint; maybe a little too large; maybe doesn't fit an industry classification or an underwriting classification that we have.

We expect to get, as a banc-serv service to their clients, funding opportunities that we will fund in Newtek Small Business Finance or BDC. We also believe that of the 350 clients, many of those are now interested in a lot of our other services. Our payments solutions opportunity, the payment and benefit solution opportunity, insurance opportunity, technology opportunity. So we will, over the course of time, approach banc-serv's clients. There's 350 [million] of them. That adds our portfolio. To be able to get the other originations going. We think banc-serv conservatively has the potential to increase our SBA 7(a) loan fundings in 2017 by $30 million.

Slide number 10 is a slide that many of you are very familiar with. It shows our pedigree in originating 7(a) loans. We have been doing this for 13 years. I think it's extremely important. We're the eighth largest SBA 7(a) lender, which includes banks. We have a 13-year history of loan default frequency and severity. We have six rated securitizations. Average loan size is $172,000. That's the uninsured piece that sits on our books. We finance those through securitizations.

Looking at slide number 14, and there's a lot of discussion over the next several pages which talks about growth. I think the most important aspect of growth with respect to our lending opportunities. In our business model, given that we are not buying BDO product, we're not buying packaged loans in an auction, we are not buying brokered commodities that are shopped to multiple lenders, and if you get the highest price and the worst credit risk ratios. We are dealing directly with small businesses. Yes, through alliance partners, but the intermediary isn't involved in the coaching of the structuring process.

The secret to us making good credits and growing is to have a lot of looks and opportunities which, through the first six months of the year, I think came in at $2 billion in Q1, $1.7 billion, $1.8 billion in Q2. I'm sorry. I apologize. Lending some -- I got it right here in front of me, I guess I should just read. $3.7 billion of referrals submitted through June 30, 2016. Year-over-year comparison $2.3 billion, 62% increase in referrals. So what does this do? This gives us an opportunity to pick and choose through a lot of opportunities, directly dealing with borrowers. Units closed of 57%.

At the end of the day this is the secret sauce, to be able to cost-effectively look at large quantities of opportunities, pick the best ones, and fund small businesses, which is an important part of our charter. Our average loan size has been declining. That is a concentrated effort for us as we improve our efficiencies with technology and staffing. Smaller funding sizes gives us greater diversification and greater prices in the secondary market, and a greater ability to securitize with higher advance rates.

Moving on to slide number 10, you can see the growth in 7(a) fundings. Six months ended June 30, 2015 versus 2016, up $131 million versus $103 million. Year-to-date we are looking at $157.8 million versus $107 million. That includes July 31. In July 2016 we funded $25.9 million; largest dollar volume of SBA loans funded in a single month. If we take a look at the pipeline, prequal loans and underwriting and approved pending closing. Pipeline is up by 78.4%. We are proud of that. We've left out a few categories like loans sitting in suspense, and just totaled gross referrals in the prequal category.

We are doing a much better job of cleaning out the pipeline early. Obviously, people come to us from all different areas, all walks of life. Many times they come to us and they are not ready to borrow, but they are just kicking tires. We are cleaning that out quicker, we are putting that in suspense. We have people that will have a couple of conversations with that we can't get on the phone for a month or two or three. That could be for a variety of reasons. So we are doing a much better job of keeping the data, being able to go back to customers, but really focusing on the live, hot, warmer opportunities, which is leading to better close rates and higher credit quality in the portfolio.

Net premium trends for the first six months of the year, 12.28%. That's up from 11.72% last year. We anticipate those trends continuing with our good track record relative to default severity and frequency, relative to the interest rate climate that currently appears to be stable. So we don't expect any major changes, but obviously report that quarter-to-quarter. And if we saw anything that was significant on an interim basis we would report that to the marketplace.

Going to slide number 15, we put this slide up to basically demonstrate that the gain on sale, although in most BDCs is totally sporadic. With us, we don't say it's reoccurring income; we say it's a reoccurring event, and this reoccurring event has happened over the course of 13 years.

Slide number 16 shows the average loan balance that we funded in 2016: $650,000. That includes the government and nongovernment guaranteed piece.

Looking at our loan portfolio performance on slide number 17, real good statistics that are showing our nonperforming portfolio as a percentage of total outstanding loan portfolio. Through the first six months of 2016 it's 3.68%. I think we give a lot of transparency to the market showing how loans affect our NAV. So immediately when we have a non-performer, we write the NAV down, or nonaccrual, we write the NAV down. We take a loss on the loan once it is liquidated. And all of our loans are on our books at fair value. You can look at our Qs and Ks every quarter, you can see what performers and nonperformers are on our books.

And you can see the trends. When you go from 2013 to 2014, 2015, 2016, they're very good trends, and we believe this is not just a function of an increasing size of the portfolio. I want to make one particular note. For those of us out there that are looking at us real closely, I want to make you aware of the fact that an SBA portfolio is very different than the types of loans that you might be familiar with, whether it's residential or some commercial. We have a lot of small businesses that sometimes you have a situation where borrowers have a sickness in the family, there's some kind of a change of control, they have some interruption of payments.

Many times our loans will go nonaccrual, and then they come back to us. I think it's important to note. We had one particular loan, it was a medical practice, had a cost basis of $664,000. We had somebody taking a look at this loan, saying it was not accrual. The fact of the matter is it did go to nonaccrual. They happened to do a chapter filing, but they made payments from the beginning the loan was originated to the end. When the loan was well over collateralized, and this loan is back to a performing status today. As I said, it was a medical practice. They are cash flowing, they are doing well, but they did declare a bankruptcy to remove certain obligations.

I will say this: I'm not particularly fond of lending money to businesses that might declare a bankruptcy on an interim basis. But the fact of the matter is we believe the money -- the loan was money good. It had plenty of collateral? And the proof is they have never been late on a payment.

Slide number 18. This slide reflects the actual charge-offs. As you can could see, through the first six months of the year, a really low number: $784,000. I want note to the market our realized losses, our loan charge-offs, have a lag factor. We don't expect to have zero charge-offs on loans. And importantly, we expect to have higher charge-offs on loans than a conventional loan portfolio would as a 7(a) lender. That is part of our charter and it's important that we do that.

Slide number 19, not an unfamiliar slide to investors that have attended our calls regularly: comparative loan portfolio data. We think our portfolio continues to get stronger and stronger. I'd like to point out one thing. When you look at current weighted average LTV, it's gravitating to an 85% number. We think that's more of a normal number than the historic, lower number. That is a function of the fact that our seasoned portfolio which we acquired in 2013 has really diminished. So we have less seasoned loans in the portfolio and more newer loans.

Slide number 20 and 21 I'm not going to go into. Many of you are familiar with how cash works on 7(a) and how income works. Slide number 22 and 23 focus on the 504 market. This has been more of a slower starter for us. We have a pretty decent pipeline building in this segment. It will show how cash works as well as accounting on 504.

Looking at our business from a comparative basis, Live Oak Banc trading at 2.15 book value. Obviously if you take a look at our book value, we don't trade at that type of a multiple. A very different business model. I think the only thing that's similar is they do 7(a) loans, we do 7(a) loans. And the market is valuing their book value at a much higher multiple. Take a look at BankUnited, recently acquiring Certus' small business finance transaction. They paid a 10% premium above the face value of the uninsured loans. 10% premium on the face value of their uninsured loans. Jenny, the face value of uninsured loans at the end of the quarter? $160 million, $170 million?

$175 million, yes.

Right. So, I think all you smart investors can do the math. Obviously BankUnited wanted a big portfolio. They paid a 10% premium over the face. Certus at the time was not originating. Arguably they did not have anywhere near the business model that we have in terms of being able to produce value. So I think these are two very good comps for what we do.

Page 26, drilling down into the portfolio companies. Good quarter for the payments business. Adjusted EBITDA, up 24%. When you look at our mark for NAV, we're valuing about 5.8 times 2016. Adjusted EBITDA, look at the public comps, were all high double digits. Newtek Technology Solutions, still unfortunately struggling. We believe very much in the management team and the vision. We believe we'll be able to turn this, as management is deploying a lot more resources into managed tech. We think this business has a tremendous opportunity for us and our shareholders. As every survey out there, whether it's Gartner or Forrester, is telling us that there's going to be a significant, large spend for independent business owners, particularly with security issues and technology. We will get this right.

Slide number 30 just gives a general breakdown. This is not meant to value us on EBITDA across the whole business, which really doesn't make sense for anything relating to lending. But it just gives the marketplace a general understanding, that close to 40% of our cash flow and dividends comes from the reoccurring business service side of our business, which is taxed at a beneficial rate to shareholders. And it's qualified because it's already taxed once at the portfolio level.

Slide number 31. As we've mentioned in the previous quarter, Newtek Business Service Corp., Your Business Solutions Company; website Newtekone.com. You can see the word solutions provider for payments, a solutions provider for technology, a solutions provider for insurance, a solutions provider for payroll and benefits. We are in the process of revamping our entire website.

We've made some great hires in the recent quarter, which I'll chat about. Michelle Flaherty just joined us, Vice President of Human Resources. We'll be paying particular attention in the merchant solutions area as well as insurance and payroll, but primarily in the merchant solutions area. Michelle joins us in our Lake Success office. She was VP of Human Resources at EVO, a large payment processor on Long Island. During her 11 year tenure, she was responsible for over 1,000 affiliated employment -- company employees and 320 direct. So we really welcome Michelle with her Long Island base here to help us grow the payments staff, and also be helpful in recruiting payroll and insurance.

We are also proud to announce, who has not yet arrived, but we welcome his arrival on Monday, Andrew Cohen. Andrew joins us directly from Wells First Data. He recently worked there, where he was CFO of Wells Fargo Merchant Services. I think it's important to note, Andrew will not be focusing on debits and credits here. Andrew has a history there and in his background of business development. While at Wells First Data he managed an outbound sales team. And he basically approved and developed a financial plan that consisted of $250 billion of processing volume, revenues of $850 million, an operating budget of $300 million, and EBITDA of $550 million, and provided the strategic direction on the development of 200,000 merchant portfolio business.

So we're excited to bring a major player from a major organization into our shop to teach us different ways to grow our business. Andrew obviously has got extensive experience in Internet online payment processing, which he picked up from AmEx, as well as technology solutions that he held at Juno Online. So we are thrilled to have Andrew joining us. We welcome him with open arms on Monday, and his reward will be flying out to Phoenix and taking a redeye back on Tuesday.

Darlene Hayden joins us as SVP, Director of Web Solutions and Marketing. We are bringing web solutions fully in-house. We're going to be offering enhanced, enhanced plus, and premier web solutions to our existing customer base. We are excited about Darlene joining us. Web solutions should help us across the board in all areas of eCommerce in addition to Tech Solutions, but also give us a nice list in payments.

Before I turn this over to Jenny, I would just like to summarize the investment opportunity in Newtek Business Service Corp. An internally managed BDC that doesn't pay 4% management fees to external managers. The ability to generate an 11% dividend yield with we think significantly less risk than our comparable BDCs in the market. Looking at internally managed BDCs, we are trading at a significant discount. That as a function of size and time in the market. So while you have an opportunity to buy us at these prices, if you believe we are comparative to a Main Street, Hercules or a Triangle, and how we generate cash flows, risk for reward, for consistencies, and also we are not new to the rodeo -- we've been a publicly traded company for 16 years; we've owned and operated these businesses for over 10 years -- this is an attractive opportunity versus where the median internally managed BDCs trade.

Not investing in derivative securities. No SBIC leverage current. Not investing in CDOs with equity kickers. Primarily first liens; no direct lending exposure to volatile industries like oil and gas, lead us to believe that we certainly appreciate what the investment community has done with us since converting to a BDC. It's enabled us to return 25% to shareholders in the last year. We hope to have those types of numbers this year for our shareholders.

With that, I'd like to turn the financial review over to Jenny Eddelson.

Thank you, Barry. Good morning, everyone, and thank you for joining today's call. I'd like to start with some financial highlights from our second quarter 2016 consolidated statement of operations on slide 37. In total, we had investment income of $7.2 million, a 28.6% increase over $5.6 million in Q2 2015. The majority of this increase was from the growth in dividend income period over period. We had a $706,000 or 39.5% increase in dividend income for the second quarter of 2016 versus the same quarter last year. Specifically, we earned dividends from Premier payments of $450,000, $1.5 million from Universal Processing Services, $330,000 from Newtek Technology Solutions, and $200,000 from small business lending.

Overall, our dividend income from our controlled investments was $2.5 million for the three months ended June 30, 2016, versus $1.8 million for the same period last year. During the quarter ended June 30, 2016, we recognized a $1.5 million loss on lease related to the recognition of the remaining liability associated with the West Hempstead office space that we vacated to move to Lake Success, which was a significant contributor to the total expense increase of $3.4 million period over period. We also incurred approximately $755,000 in interest expense related to the notes due 2021 and 2022 for the 2016 period versus zero in the prior period.

Other G&A increased approximately 39.7% quarter-over-quarter and was due to an increase in referral fees and loan processing costs of approximately $402,000, which was the result of our increase in loan funding quarter-over-quarter. We also had some additional expenses that occurred specifically in the first half of the year related to the 2015 audit, stocks and valuation work, as well as an IRS audit determination, which accounted for approximately $400,000 in additional G&A that will not repeat in the second half year. In addition, Board fees increased by approximately $42,000 quarter-over-quarter.

Overall, we had a net investment loss of $4.1 million as compared to a net investment loss of $2.3 million period over period. Our net realized and unrealized gains totaled a positive $9.5 million and primarily represents gain on the sale of the guaranteed portion of SBA loans sold during the period. In the second quarter of 2016, we originated 100 loans totaling $75.8 million and sold 90 loans for $51.2 million, generating $7.5 million in realized gains. The average sale price as a percentage of the principal balance was 112.17%. During the second quarter of 2015, we originated 85 loans totaling $53.9 million and sold 80 loans for $52.2 million, generating $7.7 million in realized gains at an average sale price of 112.46%.

The net unrealized appreciation on our controlled investments was $2 million for the period, which included $900,000 in unrealized gains in Universal Processing Services and a $2.3 million unrealized gain on our investment in Premier Payment. In addition, we recognized unrealized losses on two of our investments, CDS Business Services and Small Business Lending, based on weaker than projected financial results. We also had an unrealized gain on SBA guaranteed non-affiliate investments of $706,000 for the quarter versus a $1.5 million unrealized loss in the prior period. This gain was attributable to marking the $8.6 million in guaranteed loans we held at June 30 of approximately $982,000, offset by $276,000 of unrealized gains that we reversed in the quarter and recognized as realized gains when they were sold during Q2.

Overall, our operating results for the second quarter of 2016 resulted in an increase in net assets of $5.4 million or $0.37 per share, and we ended the period with NAV of $204.4 million, or $14.11 per share. With that, I'd like to now turn the call back to Barry.

Thank you, Jenny, and we appreciate everybody attending today. We will roll into Q&A. Just a couple of quick comments as we saw some analyst notes. I want to reiterate. There was some general comments on income. I'm going to repeat this again; it doesn't hurt. We have the majority of our income in the third and fourth quarters of this year, and that's our story and we're sticking to it. On SG&A, as Jenny pointed out, there were some people who looked at a large jump in SG&A. Well, we happened to have a lot of one-time expenses that come in in the second quarter. A lot of them are relating to public company expenses, auditing etc. We don't expect to have that type of growth.

We believe our margins and the majority of our cash flows are stable. Mind you, we are growing, so part of the SG&A is referral fees paid to third parties, but that's variable. And Jenny, I know historically has been at about 75; do you know what that number was for the second quarter?

I believe it was around 75 again.

Okay. So no change there. It's just that you do more loans, you're going to pay more fees. That shows in SG&A, and I guess when everyone sees the Ks and the Qs, you will be able to see that no alarm for rising expenses. I will tell you Jenny and I and the executive committee have probably made some changes in compensation that probably reduced our payroll by about $1 million over the last quarter. That's just a function of looking at team members at all levels, particularly senior executives that are not performing up to standards from an accountability standpoint, and making changes.

That's not to say we won't hire those people back, but to be frank with you, most of these people we don't miss. That's part of being in a large organization. When I worked at Smith Barney, I remember -- under Sandy Weill. He had a regular routine of downsizing and adding back. It's not really hard to get rid of the bottom 10% of your workforce, and then add them back. And that's what you're supposed to be doing. With that said, I'd like to turn this call over to the operator for Q&A.

(Operator Instructions). Leslie Vandegrift, Raymond James.

Good morning. Just got a quick modeling question to start out. Jennifer, you went through the other G&A increases this quarter, and I'm afraid I missed the first and the last one. The increase in referral fees and loan processing costs, did you say $400,000 this quarter?

Yes, that's correct.

Okay. And then on the Board fees, was that $200,000 or --?

It was $42,000 for the quarter.

$42,000. Okay, got it. And then on the dividend income for the quarter, you had $2.5 million this quarter. That was $1.8 million last year, and a little bit closer to the $2.3 million last quarter. Now, is this the same portfolio companies that are now paying regular dividends that we can look to? Is it a different mix each time? And how many new players in there were there that was paying dividend income?

I'm going to answer this question; yes on everything you just said. Look, it's a little bit of the fact that you now have banc-serv is in there, you now have the ITAS portfolio. We are doing well in payments, and mind you, we closed the quarter out with cash. This is a living, breathing model, and it's difficult to follow. I'm not arguing that it's not. But unlike a portfolio of debt securities with leverage where you just have to figure out coupon clipping, this is going a little bit back and forth.

So I'm not quite precise, but we expect to get an increasing amount of dividends from our portfolio companies. Here's the important aspect. We believe our return on equity in the 7(a) business is risk-adjusted 25% to 30%. We believe when we are acquiring businesses in the business service space at 4.6 times EBITDA -- and look, I'm not saying we're always going to be at 6, maybe even at 8, but look, it 6. You're getting close to a 20% pretax return without any leverage. Now, you're taxed there; put a little leverage on it, you're up in the 20s.

So I say, would you rather invest in a company that's managing these businesses, knows the businesses for 10 years, and is generating these types of returns with leverage with the ability to grow and move towards market multiples of bigger companies and bigger size, than invest in mezz capital or high risk loans to be able to get the 10%, 11% or 12% coupon with leverage? That's really what the model is. And I appreciate your question. I know I went off on a little bit of a tangent. But we feel very good about our guidance. We tend to do what we say we're going to do, and we would love everyone to stick to what we are telling them, and we'll be in good shape.

Okay. All right. And my final question here, you went through your leverage and you had a 76% this quarter, well under the cap at 1 times there. But going forward, what kind of target leverage can we see? Obviously you sell off the guaranteed piece, and so that reduces that a bit each quarter. But with the increase in originations, what can we look to as a target or maximum you'd be willing to go to with each new loan as you have to meet the regulatory test each time you do that?

You just finished strong. We're going to meet the regulatory test.

Okay. Is there (multiple speakers) you're willing to go to?

Yes, the regulatory max. So, I know that might make people nervous out there, but it shouldn't. This is how we manage our business. And I don't have any SBIC debt. And I don't have a lot of leverage on my business services businesses, which have a gross value of -- I think $100 million. I've got $20 million of debt on it. And I'm trying to get you guys to look at us differently. I think it's really important. I need you to look at us differently. We are not like the other guys. Because if you count the other guys' BDC -- SBIC debt, they're over levered. So here's my job. My job is to make sure I comply with the BDC regs. My job is to manage the equity markets and investor markets and to grow this business. Because if I can get this business bigger and consistently pay a double-digit dividend, we're going to be just like the other guys. So I'm trying to avoid getting put into the box.

All right. Well, thank you for that. Appreciate it.

Mickey Schleien, Ladenburg.

Good morning, Barry and Jenny. A couple questions. Just speaking from personal experience, I've noticed the implementation of the chip card processing seems to be really hit and miss, depending on the vendor. And certainly the wait time for payment processing seems to be longer than when we used to swipe. So I'm just curious what kind of obstacles or opportunities that's providing you in your processing business.

I appreciate the question. I think when you look at EMV -- Euro, Master, Visa and chip cards -- I hate to say this, but market confusion is an opportunity. By the way, it also can hurt you if you are not communicating with your clients as to what the standard fair is. So we do have clients that -- frankly, they are in point-of-sale systems, that they have investments in. And they are stuck because they can't get an EMV-compliant solution and/or, as you are familiar with, when you go into some of your locations and you put your chip card into a terminal, some of the terminals have an inordinate amount of time to clear the transaction.

There's also been some recent studies that say it's not that difficult to steal the data off of a chip. So, with that said, this is where the entities that are more nimble, really paying attention to their customers, doing an outreach. The markets don't have all the solutions for EMV. The worst thing you can do with a client is not talk to them and to be silent. So our goal is for our customer service people and our [outbending] unit to inform customers what's out there, what's important. We also do have an advantage that if we have a client that has an antiquated terminal, antiquated POS system, and they are good credit, we can also provide them funding to enable them to protect themselves and to grow their business in a difficult world or environment.

So that's how we holistically look at the relationship with the customer. This is an opportunity, and the payments business is going to change, and it's going to churn and it's going to be different.

Okay. Thank you for that, Barry. That's useful. A couple of modeling questions. I don't recall if you mentioned in the prepared remarks, did you fund any 504 loans in the quarter?

Did not.

Did not. And are there any synergies available that you can talk about from the banc-serv acquisition?

Yes, appreciate that. I think one of the main synergies is the banc-serv could, number one, speak to their smaller banks that currently see a loan opportunity and just say, well, I can't do more than a $1 million loan, so I'm not going to do it. Banc-serv will now be referring those opportunities, plus they have to get out end market this. Not just to the bank but then to the bank staff and train people; it takes a while. Although I will report we've already funded some loans from banc-serv. That's synergy number one.

Synergy number two is they have 300 relationships. I'm sure many of those relationships are looking for an outlet for their payments business or an agency basis. Because they are all smaller, so they can have their own payment processing in-house. They can't do their own payroll in-house for their clients. They don't have an insurance agency. These are $100 million institutions, maybe a couple of billion, but for a banking institution today, the regulators are really getting them to focus on fewer things. And there's capital allocation issues, so that's the second area where there's really good synergies.

I appreciate that, Barry. And my last question is GLS reported that SBA 7(a) prices were down about 1% during the quarter. I'm just curious what your thoughts are on 7(a) pricing in the second half of the year.

Well, as you can see, ours were steady. Now, I think there are certain issuers that have prices that are down. We have not found that. The function -- pricing is a function of expectations of voluntary and involuntary prepayments. Voluntary obviously is, I've got extra cash, I'm going to pay the loan off; involuntary is default. It's somewhat of a function of the interest rate environment, which I think is extremely favorable to prices. We don't -- there's one other thing, Mickey, with respect to our prices. The mix of 10 year loans versus 25 year loans, which I don't have that data at the moment but I don't think there's been a tremendous change one way or another. But we do keep an eye on that. So realistically speaking, if we are doing -- our 10-year loan pricing is typically 2 to 4 points less than our longer-term pricing.

Would you be willing to share your assumptions in 7(a) loan pricing that support your budget for the year?

I'll just say I think it's consistent with our view that we do not see any major changes in the interest rate environment. At most we see maybe a 0.25 point rate hike from the Fed. We see tremendous amounts of liquidity. We see, with a market that's got GDP of 1% or 2%, there's an insatiable appetite for structured product, whether that's a rated securities or our government guaranteed. So I think the best thing that we can comment on is stability, but also you could look at our dividend guidance and you could probably back into that number.

Yes, I appreciate that. Those are all my questions for today. Thanks for taking them and look forward to talking to you soon.

Arren Cyganovich, D.A. Davidson.

On terms of the ramp in the second half, clearly you can see from the SBA fundings that you've done first half relative to your guidance, you have a nice pickup there. And you mentioned that the payments business is obviously more purchase volume in the second half. Are there any other aspects of your business that tend to boost your earnings in the second half of the year beyond those main things?

Look, I'd be a little bit too aggressive to state third or fourth quarter, but I think the move to the Lake Success office, that's got four businesses in one unit, recent hires that we've made, capital that we've raised. We are significantly better and more efficient than we were a year ago. The technology solutions, the recent addition of our Chief Information Officer, Nilesh Joshi, building out more models with our dev team in Phoenix. So I think that, as we grow and get bigger, we are just in a better spot.

We have more resources. We'll be able to get more attractive capital. It's expensive to be a $200 million public company. I've got $500 million companies, I think it's expensive to be a $500 million company. Try being a $200 million company. But we are embracing technology and that's the key to being a survivor in the economy today. If you are not investing in technology which enables you to acquire credits more cost effectively, process business opportunities more cost-effectively, you will not be in these businesses. There's no way.

Thanks. And looking at your loan pipeline, just to help me understand the different buckets, you approved pending closing loans and underwriting prequalified. What's the ratio of close for those different markets? Loans and underwriting, typically the bulk of those actually go into closing, or is it more of a smaller proportion?

I think the best way to look at it at the moment would be we're probably closing between 2.5% to 5% of gross referrals. When you get down to prequal and underwriting, it gets a little sticky, because it can be notchy. But I can give you wide ranges, if that's helpful. I think at prequal you're looking at between 50% and 60%. Now, when a loan is in underwriting, that's -- you got stuff that kicks out, it gets rolled out into future quarters. Because the borrower gets a bad appraisal, doesn't have a certain amount of information. So it's very hard to figure -- really, the close is out.

I would say the best way for the outside world to manage that would be to really look at gross referrals to try to do forecasting. As well as -- I know you guys don't like to do this, listen to the management team's guidance as to what they think they're going to close (laughter) because -- I know. We've actually been pretty good at it. So I think that's the best way to look at right now. I would say the underwriting component in particular can be volatile. Although it's the closest bucket, but let me just say this. Here's the easy one. Approved pending closing? 90% to 95%.

Okay. And then just a little bit more detail on the banc-serv acquisition. If you could tell me a little bit more about what they do, how they can fit into your lending business, and what it actually takes to drive that incremental originations that you think that they can provide for you.

Sure. Banc-serv is -- in the industry is known as an LSP, lending service provider. And they service loans for third parties; servicing portfolio is about $550 million. They assemble and underwrite. So for a smaller financial institution or a non-bank lender that can't afford the multimillion dollar investment in SBA loan assembling, SBA loan underwriting, SBA loan servicing, to comply with the 1,600 page policy and procedure manual, but they want to put loans on their books using their own license, they subcontract out that to an entity like banc-serv, that provides that service.

Banc-serv has been in the business over 11 years. They're really good at it. They're one of the market leaders. So what they help the smaller bank do is assemble, underwrite and service. Important, the credit decision resides at the bank, so they make the credit decisions. Credit decision is made at the bank. So I think that is what banc-serv does and they've levered their staff, they generate cash flow. And for us they're a really good conduit into these entities that want to do other things than what banc-serv does. And that's -- banc-serv is staying as banc-serv. They get their name on their building. They're powered by Newtek. They do yoga once a day; we don't, but we think it's a great acquisition. We picked up a great executive in Kerri Agee that's very dynamics, and we look forward to working with banc-serv as a portfolio company and a shareholder.

Okay, but you won't be combining any kind of servicing aspects of the two businesses?

No.

Okay. All right, thank you very much.

Lisa Springer, singular research.

Good morning, Barry, and congratulations on a good quarter. I wanted ask you about the two acquisitions in the technology solutions space. Could you give us a little bit more color on those? And if you are seeing there may be other acquisitions in that space to get the business to where you want it to be?

Sure, I appreciate it. We were able to do ITAS/Deer Valley at one times revenue. It was of a lift of service and software right into our data center. It was pure cash flow. We love to do those. It's tiny; obviously it's not a lot of money, but it works. And banc-serv, we bought at a low cash flow multiple. We see growth opportunities within their core business, but realistically, let's say in a given year, banc-serv is able to refer $30 million or $50 million of loans to us that, on a gross margin basis, are worth 9 or 10 points. That's $3 million to $5 million. Forget the fact that we now have introductions at the 300 other entities that can introduce payments, technology, insurance, payroll to us. Those are the kinds of things that we think are good things for banc-serv's customers and for our shareholders. And we will pay referral fees back to banc-serv.

Okay.

So, looking at -- we are always looking for new acquisitions. We always take a look at cost of capital and where we are going. We've done nothing that's really warm or hot on the fire.

Okay. Thank you.

David Scharf, JMP Securities.

Good morning. Most questions have been exhausted, but just wanted to check in. First, I may have missed it, but can you just recount what would need to be one-timers on the SG&A side in Q2?

One-timers and SG&A. Jenny will answer that.

We had some one-time expenses related to our SEC audit, our stock audit, valuation work. And we also had an IRS determination that occurred in the first half the year totaling approximately $400,000 to $450,000. So those expenses are sort of one-time, should not reoccur in the second half of the year.

Okay, about $450,000. Got it. (multiple speakers) And then on the compensation side, the comment about reducing -- that was $1 million run rate that was effectively reduced during Q2?

Yes.

And as we net that out against some of the management additions, just trying to get a sense for how we ought to be thinking about the net change going forward.

25 (multiple speakers)

Clearly there's margin.

Yes. Look, I think we are very expense conscious here, I can assure you of that.

No question. This is just fine-tuning, that's all. Just understanding the magnitude (multiple speakers). Got it. On the merchant side, any -- obviously a lot of acquirers -- and as you mentioned, been battling some of the EMV conversions. Have the issues around just some of the point-of-sale -- terminal conversion issues and so forth, has there been among the small merchant base, any sense of delayed purchasing, people who are on the sidelines, or are we over that EMV hump?

That's a great question. I've been very surprised that the smaller merchants are just -- I'm talking about the really small ones. You're talking, like, $8,00 a month, or maybe $20,000 a month. They are not involved. They are just deer in the headlights. And I've also -- I don't know what you found from other participants. We've been less fortunate or industry -- we have not seen -- I'm probably jinxing it, I should probably keep my mouth shut. Let me just make this comment. It hasn't really been an issue on either side.

Got it. (multiple speakers)

I'm surprised at it.

And for those sized merchants, is integrated payments even a requirement or a demand in the market? Or are you pretty much well situated with -- don't want to say a plain-vanilla merchant processing, but is there any --?

I think the ultimate trend has got to be everything has got to be totally encrypted. But we are not there yet. There's no real universal solution out there that anyone is pushing. And the EMV thing has just been -- it's just really been a messy rollout. I don't think it's been -- you wouldn't see it in Visa or MasterCard stock, but it's just really hasn't been -- hasn't done very well. And the big processors, they really haven't fully captured what needs to be done, and the customers are kind of shaking their head. And the customers are mad. The customers are not happy.

No, no, clearly. That's all. Perfect. Thank you.

Scott Sullivan, Merrill Lynch.

Congrats on a great quarter. Could you give us a little bit more color on the banc-serv? Obviously they're bringing over the EBITDA. and have you guys run a one plus one is five, to give us any kind of -- what they are really going to be bring in terms of leverage, cross-selling opportunities, etc.?

I've just tried to keep it simple. And we've put out, for example, conservatively, $30 million of originations in 2017. If that's totally incremental, that would be worth about $3 million. That has nothing to do with their EBITDA that we bought the business on.

Right. Okay. Thank you very much.

And I am not showing any further questions. At this time I'd like to turn the call back over to our host.

All right. Really appreciate the quarter, appreciate the analyst work and following us. The questions were great today. And I also appreciate obviously the faith the investment community has put in Newtek, particularly recently. Obviously January and February were tough for the market. We also had a few entities moving their portfolio around that had been in the stock for over 10 years. We understand that. And we appreciate adding people back and forth.

But I think based upon some of the calls that I get, that Jayne Cavuoto gets, investors are starting to understand the business, the opportunity. We are definitely not in a box like everybody else. So I really appreciate people paying attention and doing the work. Jenny and I, always available to answer questions. And once again, thank you very much for your faith in the Company and look forward to reporting in the third quarter.

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day.