NewtekOne Inc (NEWT) 2017 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Newtek Business Services Corporation Third Quarter 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference call may be recorded. I would now like to introduce your host for today's conference, Barry Sloane, President and CEO of Newtek Business Services Corporation. Please go ahead.

Good morning everyone. This is Barry Sloane, CEO and President, Newtek Business Services Corp. NEWT is our stock symbol on the NASDAQ. And this morning Newtek will be presenting our third quarter 2017 financial results conference call. On the call today I also have the pleasure of having Jenni Eddelson with me, EVP and Chief Accounting Officer. I'd like to call everyone's attention to our website, Newtekone.com, going to the Investor Relations section and in under Events and Presentations you'll be able to follow along the conference call with our PowerPoint presentation.

If I can point you to Slide number 1 we have our note regarding forward-looking statements. So I'd like to suggest that all of the people following on the call would have the opportunity to read that at their convenience. I would like now to roll forward to Slide number 2, small business lending, SBA lending highlights. Newtek Small Business Finance funded a record $103 million of SBA 7(a) loans during the 3 months ended Sep 30, 2017, a 20.6% increase. Newtek Business Credit Solutions, a controlled portfolio company, funded $4.8 million of SBA loans for the 3-month period ending September 30, 2017. We continue to maintain our annual forecast of $415 million in all SBA loans, which would represent a 31% increase in total SBA fundings over 2016.

Moving to Slide number 3, third quarter 2017 financial highlights. Our NAV grew by 0.7% over the $14.30 at Dec 31, 2016. At the end of the recent quarter it stands at $14.40. Last year we grew about 2% to 2.5%. The company does endeavor to grow its NAV on an annualized basis, that is a goal of ours if it is available to us, as well as to grow the dividends. We'd like to point out that our net investment loss, we reported net investment losses because gain on sale which is a reoccurring event is not included in this GAAP number. Now we're at for the 3 months ended to $0.07 a share, an improvement of 53.3% from $0.15 a share for the 3 months ended September 30, 2016.

Adjusted NII came in at $7.9 million or $0.45 a share. That was down a $0.01 from $0.46 a share for the 3 months ended September 30, 2016. The primary reason for that adjustment is the difference in equity share count which we'll talk about throughout this presentation. We're very well positioned from an equity perspective going forward. And slightly modest adjustment in contribution from the portfolio companies. We would like to add the total investment income of $9.6 million for the 3 months ended September 30, 2017, was a 22% increase over the 3 months ended September 30, 2016. And debt-to-equity ratio of 89.6% at Sep 30, 2017.

However, it is important to note, and we'll go into this in the following slide, that because we sell government-guaranteed pieces that were sold prior to Sep 30, 2017, the debt -- the pro forma debt-to-equity ratio was approximately 81.7%. And if you actually included $20 million of governments that were held, that most likely will be sold in the near future, that number will get down to 74%. So we actually believe we're in pretty good shape from a debt-to-equity perspective going forward. And where traditionally we raised a significant amount of equity, approximately $25 million to $30 million in quarters, that may not necessarily be the case going forward.

And I think that we ask investors and analysts to pay very close attention to the annual forecast that we give. The annual forecast of dividend of $1.64 is a 7% increase. The annual forecast for NAV growing approximately 2% to 2.5% a year, and not look at the quarter-to-quarter adjustments. We'd also like to point out the total investment portfolio increased by 21% to $418.2 million at September 30, 2017.

On Slide number 4 for those of you thrill seekers out there, you could take a look at the debt-to-equity ratio explanation relative to computing a pro forma debt-to-equity. Obviously we're in a little bit of a different model because we sell government-guaranteed participations which we've done for the last 14 years straight. After the broker receivable comes in, post to September 30, the debt-to-equity pro forma at September 30 was 81.7%. And as I pointed out earlier, we have about $20 million of government carryover, that will most likely be sold in the next quarter or two, that will reduce that number further.

Moving to Slide number 5. Looking at the company on a 9-month basis which we certainly suggest vis-à-vis a 3-month quarterly basis. Net investment loss of $5 million of $0.29, a significant improvement over $0.52 in the 9-month period a year earlier, a 44.2% improvement. Adjusted NII over the 9 months, an important number, $1.26 per share versus a $1.14 per share, a 10.5% per share improvement, very nice growth in adjusted NII. And total investment income, $28.5 million versus $21.9 million, a 30.3% increase.

Going to Slide number 6. We talked about our forecast for the 2017 annual dividend of a $1.64. We paid a third quarter dividend of $0.44 per share in 2017. Anticipate over the next week or two declaration on our fourth quarter dividend. But you could see the company has increased its dividend from 2016 to 2017, a 7.2%. And the company also states that it has been its historic performance and its future hopeful anticipated goal. The dividend will be paid out of taxable income between 90% and a 100% of that particular statistic.

Moving to Slide number 7, progress on recent investments. On July 23, 2015, we completed our investment in Premier Payments. That's a payment processor. That's been an important acquisition for the company in addition to buying attractive and expensive cash flows. The company was also able to move major resources of its payment processing business to its new Lake Success facility where we've got the majority of our staff currently in the payment processing space. So in Lake Success we've basically gone, for New York we've gone from 0 people effectively in the payments business, I think our headcount is probably close to about 45 or 50. Wisconsin which had originally been close to 60 or 70 is down to about 15.

We have recently renewed our lease in Wisconsin for I think 3 to 5 years. So we plan on being in Wisconsin going forward but with a reduced headcount. On June 24, 2016, we completed an investment in banc-serv Partners, LLC. Banc-serv Partners was a company we bought a little bit over 4x cash flow. We've owned that business for approximately 15 months. And we've -- as we've recently reported in a press release on October -- actually I think the press release was on -- no, press release on October 13, the company announced that it's a portfolio company. ADR Partners LLC, dba banc-serv Partners was served with a search warrant from the FBI on October 12th. The FBI entered banc-serv's offices in Westfield, Indiana, they did a search, they took company records. Before the end of the day they left and banc-serv was open for business and continues to be open for business.

Banc-serv recently was one of the primary sponsors at the NAGGL Conference, National Association of Government Guaranteed Lenders. I went to the conference, spoke to many clients of banc-serv. It is business as usual in banc-serv. Newtek invested $5.4 million in banc-serv. That is approximately 1% of its total assets which are in excess of $500 million. It is approximately 2% of NAV.

What I would like to state to people on this call is that there is currently an FBI investigation in the marketplace. And it is in its early stages and it wouldn't be appropriate for us to make any further comments at this point in time. The comments that we have made to date reflect what Newtek believes is material to its financial statements ongoing business. I will state that the current forecast that we've had for dividends and adjusted NII basically include 0 to de minimis contribution from banc-serv partners which we have the ability to upstream income and dividends as the board of banc-serv sees fit. I will also point out once again banc-serv is a controlled portfolio company, it is an investment. And we have made all the statements that we're going to make with respect to banc-serv.

On April 6, 2017, we completed an investment in IPM, an information technology consulting company, also an acquisition at 4x EBITDA. We're very excited about our technology opportunity going forward. We continue invest excess cash flow and earnings into our technology platform because many people that have invested in Newtek and have seen its stock performance 300% over 5 years, 25% in 2015 calendar year, 27% last year, look at Newtek as a growth BDC which is kind of unusual for a business development corp. What the company has historically done, has invested and reinvested in business opportunities going forward, we will continue to do that.

We recently completed an acquisition on October 25 which was discussed in our press release yesterday at the close of business in United Capital Source generated for commercial financing opportunities.

Moving to slide number 8, this is an acquisition that we paid a total consideration of $3 million -- approximately little over $3 million with approximately $500,000 shares of common and $1.9 million in cash. Approximately $2 million was paid upfront and there was a $600,000 earn out. We look at this at a little bit over 4x.

We're very excited about the opportunity to work with United Capital Source that will be relocating to our Lake Success facility. United Capital will help us grow our outbound effort calling into our current customer based, alliance customer basis. They're a very good company with respect to digitized social media marketing. They've got a budget over $1 million. And we anticipate that United Capital going forward will help us with our initiatives in out-bounding and helping our sales and marketing effort in the areas of tech solutions, payroll health and benefits, insurance solutions as well as obviously lending and payment processing.

Moving to Slide number 9, our current investment pipeline. We're looking at a payment processor with a 0 cost technology fee solution. We do believe that there's a growing trend in the payments business which we're excited about to basically pass the cost of payment processing fund from the merchant to the consumer by offering them a technology solution. This would be a significant savings to our customers of anywhere between 2% to 3%. We're excited about this. We think this is a potential great acquisition and a significant growth opportunity, particularly with the technology for the payment processing area.

We're also looking at a software point of sales vendor. On a going forward basis when you look at what [Square] does and some of the other people in the space, they're able to offer a software solution, a payment solution and in certain cases, finance, the ability to offer payments as a service, PaaS, is attractive and can be done by offering our clients software for e-commerce and software for POS.

Moving to Slide number 10. We always like to talk about growth and new alliance partnerships. One of our existing clients, a major wealth management firm, we anticipate announcing that we will be their insurance agency provider for their thousands of wealth managers, major opportunity for our insurance agency.

We also are working with 2 major software vendors and one major hardware vendor to grow alliances where they drive SMVs and smaller commercial clients to us for us to book and bind tech solutions in our Newtek managed tech solutions facility which has 65 to 70 full-time equivalents in Scottsdale in Phoenix. We also have a major wealth management firm that we're in discussions with to offer payroll, health and benefits that would also be a game changer for our payroll unit and our insurance agency unit. And lastly, we continue to add to our financing solution partners which will be able to demonstrate as you could see the growth in our referrals.

On Slide number 11 we have a slide that we tend to repeat in our presentations talking about our status as an SBA 7(a) lender. We finished off the SBA calendar year which ends September 30, 2017, as the seventh largest SBA Lender including banks and the largest non-bank lender. Our average loan size in the portfolio, $182,000. So for those of you that are looking at trying to gauge the risk in our loan portfolio, we have average balances of senior secured loan participations of $182,000, clearly shows tremendous amount of diversification.

I would also like to point out that in a rising rate environment with less than half the portfolio levered, rising rates would produce significant interest income on half the portfolio without an offsetting expense. So we think rising rates on with respect to the spread between interest income and interest expense would be significantly beneficial.

As we move to Slide number 12 we look at loan originations and pipeline comparison. Loan fundings increased by 20.6% and you could see a very nice growing pipeline. We look forward to a record fourth quarter.

On Slide number 13, loan referrals. I would like to point out once again for those analysts and investors that like to take out a slide rule and look at everything being symmetric and growth, we just don't work that way. Yes, we are a little lumpy, we are a little bit misunderstood, but we like to deliver to shareholders which we've been able to do with increasing NAV historically as well as increasing dividend growth historically.

I want to point out that we've got very robust growth in loan referrals. Mind you, this might go back and forth as we look at our referral partners to see to which partners are bringing us good quality originations NAV, those partners do change in and out. I would like to point out that Q3 2017 loan referrals were up 30% over Q3 2016. The month-to-date October 28, 2017, loan referrals were $1.2 billion.

If you annualize that, I'm not suggesting you would, that's $12 billion a year. We're on a really, really good run rate. We've so far through October 28, 2017, loan referrals were $8.2 billion, a 25% increase. If we keep up picking up stream in October we should pierce $10-plus billion, and that would be a significant increase over $8.5 billion of last year.

And when you look at loan units, we're getting smaller amounts of loans coming through the system which is great for diversification. Loan units referred Q3 2016 3,300, loan units referred Q3 2017 7,900, a 135% increase. We're very, very excited about the growth in loan referrals which gives us the ability to pick and choose the best credits to be able to make our growth projections and numbers. And most importantly, doing so without the use of BDOs or brokers who coach borrowers and structure loans. We're dealing directly with borrowers in the assembly, in the underwriting, in committee, using real five C's of credit using technology to move loans through the process.

Net premium trends, you could see over the course of 5, 6 years, very flat. People talk about rising rates affecting gain on sale. Rising rates in it of themselves will not change gain on sale in this particular market. What will change that number is the prepayment expectation. So unless you've got very high prepayment expectations which would be driven by higher levels of defaults in the industry or super hot economic activity where businesses are refinancing commercial real estate or selling their businesses over, the anticipation is that these trends hopefully will stay in place. We netted 12.31% in premium for the quarter ended.

On Slide number 15 we continue to have really good performance of non-performing as a percentage of the total portfolio. Quarter ended 9/30/2017 down to 3.8%. When you look at charge-offs, 12 basis points of charge-offs in September 30, 2017. Slide 17 and Slide 18 are our classic slides. I won't go into them. They're available for new potential investors and analysts to the transaction. They show classic cash created on a SBA 7(a) loan transaction as well as income related.

Moving forward to Slide number 20 we like to talk about our portfolio company Newtek Business Credit. This is a growing business. It's done very well. It should provide more and more contribution to other dividend income away from the BDC that would be distributed up to the BDC and ultimately be distributed to shareholders in the form of a qualified dividend.

We talked about 504 Loans and how they worked in past presentations. We've so far funded $9.6 million of 504 Loans. We're anticipating funding between $20 million to $40 million of SBA 504 Loans in 2017. We do believe there's approximately another $10 million of loans that we'd fund within the next 2 weeks that would get us to the lower end of that range. And we're hopeful that we hit the higher end of that range and feel very good about the 504 loan business. As you could see on Slide number 22 this is typically what a SBA 504 loan is made up of. It's a very good attractive borrowing opportunity where borrowers can get 90% LTV from commercial real estate to purchase, refinance or rehabilitate.

On Slide number 23 the return on equity in the 504 business, extremely high. Particularly given that once the SBA loan is made and the first lien is sold off to private investors and the second lien is taken out by a CDC through government debentures we are left with no balance sheet and gain on sale. And we're also left with the servicing income when we sell the loan servicing retained. Sometime we sell the loan servicing release. This is a growth business for us.

On Slide number 24 we are very pleased to announce both in a press release and here today that we acquired the talents of Tony Zara, EVP of Credit Risk Management, at Newtek Business Credit. Tony has 15 years of experience in the area of SBA loan evaluation credit and 504 loan products. He was recently an EVP and Director at Mercantile Capital Corp, a wholly owned sub of IberiaBank. While he was there he oversaw a national sales team that funded over $2.2 billion in 504 loans.

We have recently set up our office in Orlando which is staffed with 2 people. We have a third coming on shortly. And we believe that Tony will build out a great 504 presence which will be term-loaned and will also do some construction. I do think going forward in 2018 we may start to do some construction in 7(a) as well as some construction in 504. Now that we've got this expertise, this should enable us to continue to meet very high growth targets without increasing the risk of what it is that we're doing on a going forward basis.

On Slide number 25 we talk about our payment processing business. We've been in this business since 2003-2004 from the Newtek level. We anticipate closing this business out in excess of $6 billion of payment. This business typically grows and will be growing this year, high single digits, low double digits. On the bottom line it's a great business for us. We process payments for between 15,000 to 17,000 customers in the portfolio. Valuations are quite fair and modest as you could see.

Public comps, Vantiv, Global, First Data obviously much bigger companies. But I will point out that recently First Data acquired CardConnect for $750 million with $26 billion, BluePay $760 million with $19 billion of processing volume. We're at $6 billion. We feel very good about this space, particularly with our effort in 0 cost and e-commerce.

Slide number 26 generally talks about some of the opportunities that we see that present itself in the payment processing space. Slide number 27 we talk about our technology portfolio companies. We have 3 of them; Newtek Managed Tech Solutions, IPM and Sidco which does businesses' Cloud Nine Services. We're very excited about this space, the growth of technology spend according to Gartner and Forrester doubling and tripling over the next 3 to 5 years depending upon what study you look at, and the amount of under-spend in the SMB to small commercial space. And small commercial space in the tech business is 2500 seats or lower.

We're very excited about this opportunity. We recently announced in a press release this past week that we've put $2 million into our data center and hardware and software and upgrading. That's going to improve our level of customer service. We're also putting greater knowledge and emphasis in certification and things like Citrix and VMware and Microsoft and other solutions. We are very, very well positioned for the future to be a major technology solutions provider for SMBs and small- and medium-size business commercials.

So for those of you that want to ask me the question why you keep investing in this particular space, I was actually asked that question in 2009 and 2010 in the lending space. We believe what we do is acquire small-, medium-size business in commercial accounts cost effectively. Recent months our referrals on a [nightly] basis are between 250 to 400 a [night]. We have large amounts of customer cuts. And just like GEICO and Amazon that has taken opportunities from consumers and businesses, driven them to remote locations to be able to deliver the service, that's what Newtek does.

We acquire customers cost effectively and develop a different distribution channel and an operational process to cost effectively book and bind the client remotely. Obviously Amazon does this with technology, but sells all -- everybody else's products and services. And GEICO has done it with insurance agents, unlike Allstate and State Farm that have got agents that people take -- that take people out for breakfast, lunch and dinner they have branches all over the place. GEICO has done it effectively with an 800 number, internet-based, that's what we're doing here at Newtek and we perfected that in certain markets. We will continue to perfect that and continue to grow and anticipate that will provide value to shareholders as it has in the past.

Moving to Slide number 29 to talk about technology with Newtek Technology Solutions IPM and C9. We are able to go after SMBs and commercial accounts with a 5-point plan. We're able to have a conversation with a customer on a consultative basis. Tell me about your business, tell me about your operations, tell me about your technology platform. We're then able to provide a strategy to them which we can charge them an upfront fee or put into a plan and earn the income over time. We're able to sell them the hardware and software. We're then able to implement it and deploy it, take the software, put it on the hardware, give them the server back for them to manage on prem or in category number 5, manage it for them remotely which is the growth in the business of managing Cloud, Hybrid Cloud or we could manage their software on premise.

We could also manage workloads in Amazon or Azure. So many cases say why you try to compete with Amazon or Azure, the answer is we're not. We are in the customer acquisition business. We are in the solutions business. We provide truly remarkable service to our clients. And when clients finish with us we endeavor to have them say that’s the best damn company I've ever done business with.

Moving the presentation to Slide number 31 in summation. When looking at Newtek Business Service Corp we pay a very healthy dividend. We also believe that we do not have excessive leverage which is factually true as a BDC. But importantly, a lot of BDCs pay this dividend but invest in what we believe are riskier assets. Externally managed BDCs typically pay 2 in 20 out to a management team and then they pay their dividend. So that's 4 percentage points of yield or return on equity that goes out the window. Our dividend yield is fully loaded because we're an internally managed BDC. So we don't pay the management team any external fees. Our interests are very much in line with shareholder interests.

When you take management and the board combined, we own 6.4% of the outstanding

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September 30, 2017. There's no derivative securities in the BDC. There's no SBIC leverage. When you look at the average size of our loans, it's 182,000. If you look at Apollos and Prospects and some of the others, the average loan sizes are $5 million, $10 million, $15 million, $20 million dollars. We're much more diverse. We've established a track record as a BDC. We're coming up at our third anniversary. We're still small in size. We're $300 million market cap approximately, approximately $0.5 billion in total assets.

So as we are able to continue to grow and put these assets on by acquiring businesses that 4 to 5 to 6 to 7x EBITDA multiples and invest in our loan businesses that are throwing off very high returns on equity, we believe we'll be able to deliver great returns to shareholders in the form of a dividend paid out of earnings as well as grow NAV over the course of time. And importantly without taking significant risk by investing in high-yielding MES debt, subordinated debt, debt with equity kickers or using hidden leverage in an SBIC structure of where we currently sit, don't have any.

And with that said I'd like to turn the financial portion of this presentation over to Jenny Eddelson.

Thanks, Barry. Good morning everyone and thank you for joining today's call. Please turn to Slide 33 to review our third quarter 2017 results. Total investment income increased by $1.8 million or 22.3% in the third quarter of 2017 from $7.9 million in Q3 2016 primarily due to increases in interest and servicing income offset by a decrease in dividend income quarter-over-quarter. Interest income increased by $1.9 million as a result of a higher average outstanding performing portfolio of SBA loans, as well as an increase in the primary. Dividend income from controlled investments in Q3 2017 was $2.6 million, a decrease of $382,000 from the same quarter of 2016, and represented $1.75 million from Newtek Merchant Solutions, $375,000 from Premier Payments, $200,000 from Newtek Business Credit Solution and $200,000 from IPM.

Total operating expenses increased by $817,000 quarter-over-quarter. Salaries and benefits increased by $1.1 million, representing higher compensation levels and an increase in the number of employees resulting primarily from increases in loan origination, underwriting, closing and servicing activities required to manage a growing loan portfolio. Interest expense increased by approximately $645,000 quarter-over-quarter, primarily due to higher average debt outstanding during the third quarter of 2017 and a higher average interest rate as compared to the same period in 2016.

Included this quarter in total expenses is change in fair value of contingent consideration liabilities which resulted in income for the period of $748,000. The company reduced the contingent consideration liability related to the IPM investment based on the probability of IPM attaining specific EBITDA level for 2017 and 2018. Overall, our net investment loss for the period decreased from a loss of $2.1 million in Q3 2016 to a net investment loss of $1.2 million in Q3 2017. The company had net realized and unrealized gains of $9.3 million in the third quarter of 2017 as compared to $12.2 million in Q3 2016.

During the third quarter of 2017, we originated 122 SBA 7(a) loans for $103.6 million compared to 96 loans in the same quarter of the prior year for $85.9 million, an increase of 20.6% on a dollar basis and an increase of 27.1% on a unit basis. We sold the guaranteed portions of a 117 loans with $68.5 million in the third quarter of 2017 as compared to 98 loans for $66.5 million in Q3 2016. The realized gain on sale was $10 million compared to $9.5 million for the 3 months ended September 30, 2017 and 2016 respectively, a 5.6% increase.

The weighted average premium increased to 12.31% to the third quarter of 2017 versus 11.84% in the same period last year. As a reminder, premiums on SBA 7(a) loan sales greater than 110% must be split 50-50 with the SBA. The $2 million decrease in net assets quarter-over-quarter was the result of a decrease in changes in the unrealized appreciation and depreciation on portfolio investments and servicing assets of $4.1 million offset by an improvement in net investment loss of $933,000 and an increase in net realized gains of $1.2 million. Overall NAV at the end of the quarter was $255.6 million or $14.40 per share, an increase of $0.10 per share or 0.7% from NAV per share at December 31, 2016.

Back to you, Barry.

Thank you very much. Operator, we'd like to open up the call for Q&A.

(Operator Instructions) Our first question comes from the line of Nick Grant with KBW Financial Services.

So you guys have just over $30 million remaining of 504 to kind of hit guidance there. So how strong is the backlog right now, what's the pipeline? And then how should we be thinking about that business in 2018 given the investments?

Thanks, Nick. I think that CDS which does businesses with NewTek Business Credit, particularly with the addition of Tony Zara and new staff for Orlando and staff that’s anticipated, that's a nice growing pipeline, particularly with Tony's expertise in the area of construction. And this construction is not ground. This is not very risky construction. It's construction that he is very, very familiar with. We have not gone out into 2018 and given a forecast yet. That's probably something we're going to be doing over the next 30 to 45 days internally. But we feel very good that the 504 business which we've had people say, oh, gee, when are they coming, when is it coming?" Well, sometimes these things take time and sometimes they take having the right people in the right place doing this. I would tell you I've got 2 draft term sheets on my desk for a leverage lines for 504 that are significant that will enable us to grow the business. We have recently sold some 504 loans in the secondary market at very nice premiums. This business is working out real well. So I know I haven't given you that much color with a number, but we hope to do that in more recent times and to give people a feel for what we think we might be able to do for the contribution to 504. With that said, we do make it a -- we do make it a practice, Nick, of not drilling down into these portfolio companies to give guidance on that. So we try to give everybody a feel and flavor for how we're doing. We ask the street and the market to really pay close attention to our annual dividend forecast. So nobody gives annual, we go out and give annual. And we feel pretty good about it. So hopefully that answers your question.

All right. Great, thanks. Then kind of on to the M&A pipeline, how active are conversations right now? And kind of more specifically in the payments business, what targets are you most interested in in terms of like annual volumes?

Yes. So I would say this. The pipeline is a little bit low. I frankly feel pretty good about that because it's going to give myself and the management team an opportunity to digest. And we've got a lot going on, and a lot of great things going on when you look at these leverage lines. And there's a lot of opportunities for us, A, in the capital market. But when you look at the 2 targeted entities, both are technology oriented. So when you look at the recent sales that were done with BluePay and CardConnect, they were payment processing entities that had a growing business but they also had an interesting technology twist. So for the ability of Newtek to offer, for example, a POS system to people that are coming in for payments account and to work out the concept of, hey, we can give you POS software as a service, we can give you payments which I think could wind up being payments as a service over time as the market moves. As well as we think this 0 cost processing. And I -- let me see if I can elaborate on that. When you check in to a hotel today you're going to pay -- in many hotels you're going to pay a resort fee. When you pay your taxes online you wind up paying a fee to the IRS for the use of the card. We think that there will be a trend in the payment space, it's currently selective but we think it's going to be more pervasive particularly in the area of e-commerce, to be able to switch the cost of the payment from the merchant to the consumer and that leaves a tremendous opportunity for market share if you've got the right technology and the right pitch and the right presentation. So these would not be big numbers for us relative to portfolio but they would give us tech solutions with adding to the existing portfolio as well as size of customers coming into the system. That could be quite additive down the road. So -- and we're always looking for opportunities where we can get inexpensive cash flows with good technology that fits into our customer base.

Okay. Then I guess following up on that. Do you see investments on the tech side of that business is kind of the key to driving valuation higher in payments or is that more of a scale and volumes question?

That’s an interesting question. Look, I know there are -- I would say those are 2 separate questions. I think in the tech based we're very focused on the movement of businesses to take their hardware and software move it into the Cloud for the purposes of increased securities -- increased security against third party attacks, better efficiencies relative to cost, having external people manage hardware and software 24/7, and really importantly better security not having the server in the closet or under one's desk. The payments business is very much driven towards point of sale technology as well as e-commerce. I do think that they are somewhat separate growth initiatives.

Our next question comes from the line of Harold Elish with UBS.

So you come through loud and clear that you view Newtek as a growth BDC, and you certainly come through loud and clear that the payment processing and tech divisions are really great vehicles for client acquisition. Is there some sense as to what we could expect over the next 5 years in terms of the financial results those divisions could have in terms of what they'll contribute to growth in and of themselves?

I appreciate the question. I guess and I've got my Chief Legal Officer sitting on my right shoulder, my external counsel on my left shoulder to talk about a 5-year projection. But what I will tell you is Newtek has been around as a public company since September of 2000. I'm one of the original founders since '98. And I've always built the business in conjunction with the management team and the board for what I call strategic objectives. And when I look out in the market, I look in the economy, does anybody think that the technology sector or segment is not going to be the biggest growth segment in the U.S. economy? Does anybody not think that the way business is being conducted today is going to dramatically shift and change? And the answer is almost nobody. Our goal is going to be able to -- is going to be -- to be able to use the best software vendors, the best hardware vendors and to be able to provide the state-of-the-art technology solutions that businesses can operate on. Tell me what supermarket acts like Amazon. Tell me what book store acts like Amazon. Tell me what drugstore acts like Amazon. My point is the world's going to change. We need to be positioned for our customers to be in the middle of that but to do it on a more efficient basis. So rather than have hundreds and hundreds and hundreds of sales people calling on SMBs and branch offices everywhere we need to have conversations with customers to bring them the best technological solutions the way GEICO brings the best auto solutions remotely without having that whole infrastructure and physical presence. That's how we are positioned today. So we're excited about the tech space. And our goal as managers and the board is to bring best-of-breed people in to effectively perform what I would call a disruptive distribution channel to the way technology products and solutions are currently acquired and distributed to SMB and small- to medium-size commercial accounts. We think it's a big opportunity. And we think it will be, down the road, a contributor that will matter to Newtek shareholders which is why we're willing to invest what I call excess cash flow and excess earnings back into these businesses so that we can grow. I do recall very specific conversations with other board members that don't exist today on Newtek's board to get out of the lending business in 2010 and '11 et cetera. I'm glad we kept that infrastructure. It is very valuable. We are a world class player in this space. That will by the way be able to take the $10 billion, $11 billion or $12 billion worth of opportunity start to put it into additional loan products to what we have and to be able to grow the business and drive the bottom line. We're very excited about the business model, particularly with the growth in referrals over time as well as bring in -- able to bring in people in different segments to drive better payroll, better insurance agency opportunities. When you look at like insurance companies, they've got to rely upon independent agents to distribute, same thing with tech companies. We're going to wind up being their partners.

Our next question comes from the line of Leslie Vandegrift with Raymond James.

Just start off with one for Jennifer. I'm sorry if I missed this. My phone was acting up in the middle of your review, but on the dividend income breakdown for the quarter. If you said it sorry for making you repeat it.

Well, the dividend breakdown income we have forecasted $1.64. To date, Jennie, we paid how much through 9 months?

I think Leslie is talking about the dividend income from portfolio company.

Oh, okay.

Is that right, Leslie?

Yes. Yes, sorry.

Okay.

Didn't mean to be -- need to be clear. Yes, thanks.

Sure.

Sure. So for Q3 there is $1.75 million from Newtek Merchant Solutions, $375,000 from Premier Payments, $200,000 from CDS and $200,000 from IPM.

Okay. And then on the 504 loans, obviously, a big jump in growth there are expected for that newer program. But on the return comparison to the 7(a) loan if you have cash to go to the 7(a) versus the 504 for the shareholders, what's the argument there for going with the 504 which is just dividends rather than the 7(a) with the gain?

Sure. So it's a great question. First thing I'm going to start off with is the customer. So there are some customers that want a 504 loan versus 7(a) loan. There are some customers that want a 7(a) loan versus a 504 loan. So let me kind of –- a customer that would want a 7(a) loan would want a fixed rate for 5 years. That was -- that's attractive to them. And they probably are quite -- a 504 loan is for the acquisition, maybe a little rehabilitation or construction of commercial real estate. That's the only purpose for a 504 loan, no working capital. On the SBA side you can get a working capital component, maybe a little less LTV on the real estate, [AMP] schedules are similar. And that's kind of the differential. From our perspective we have equity invested in the balance sheet consideration on 7(a) loans. And on 504 loan, the whole -- the whole component is ultimately sold. So returns on equity are comparable, but we have some clients that would qualify for a 504 loan that don't for a 7(a) loan. An interesting characteristic. Businesses are capped at $5 million. For 504 loans, I do not believe they're -- For 7(a) loans I do not believe there is a cap on 504 loans. So there are differences. And by the way we don't -- we don't think that they are importantly -- we don't think one cannibalizes the other.

Okay, perfect. Thank you. And then on the 7(a) loans, obviously sales percentage wise versus the fundings was down a bit this quarter, but the premium still looked attractive. Just some color there around why that was down.

We were carrying over a significant amount of government-guaranteed pieces from Q3 into Q4. I think it's in excess of $20 million. This is an approximation on a liquidation basis that could be a carryover of say $2 million or $3 million. And I think that our goal is to manage the business to its appropriate level, make sure we are within constraints for debt-to-equity. And we don't pay that much attention to quarter-to-quarter variabilities. We're very, very focused on delivering what we say we're going to deliver for the year.

Okay, perfect. And just lastly, you mentioned the little bit of equity dilution in the quarter and so was that entirely due to the restricted cash or restricted payment to ECS?

I think that this is -- this is a -- not entirely. I think some of it was from small-than-anticipated contributions from the portfolio companies. But also we have switched our method of equity raising from large capital markets transactions where we'd raised between $22 million and $35 million of equity which typically would occur at a significant discount to the last trade and 4 to 5 to 6 points of fee to being able to ATM. And that's been a good strategy for us. So we believe that as we sit here today we're very well positioned. And although it is possible I would say it's unlikely that we would do any kind of a major announced large scale equity raise which we did do last year and the year before that in Q4 and in Q1.

And how many shares were, come under the ATM this quarter?

Jennie, how many?

Well, through the 9 months it's 455,000 shares.

455.

Our next question comes from the line of Lisa Springer with Singular Research.

When you secure a new referral partner how do you go about educating them about your products and services and how long does it take those relationships to ramp up typically?

Yes, it's a good question. That's not instant. Tim Ihlefeld, who is Executive Director of Strategic Alliances, manages about 10 regional Vice Presidents around the country that do manage these alliance relationships. And they do take quite a period of time they incubate. And on many cases we'll have an alliance partner that might have 1 or 2 products and they come back and pick a third or a fourth, or. Recently we have anticipation that we're going to pick up one for insurance that has been a partner of ours for many, many years, and they just decided that they want to offer insurance through the distribution channel which we think is significant. But then you've got the work of educating the alliance partner, the producers in the middle which could be wealth managers, they could be commercial bankers, they could be branch officers or people in call center to be able to drill the offering down to the ultimate customer to generate referrals which then close at a close rate. So I would say from a dead start it's going to take 3 to 6 months if somebody is really geared up to start flowing these referrals in. But we have a significant pipeline of referring partners coming in and out. We think we have more resources at this business than we've never had before. At the NAGGL conference we had about 6 or 7 people total that were speaking to a lot of banking institutions that are very favorable to our methodology of working with them. So we feel pretty good about where we are in the -- in the process. And it's showing up in higher referrals, particularly in lending.

Our next question comes from the line of Peter Heckmann with D.A. Davidson.

This is Franco Granda in for Pete. And first of all, great job on hitting the 7(a) milestone. And then a quick one from me. I'm hoping you could provide some insight into any impact you saw from the hurricanes in both Texas and Florida. And whether things are getting back to normal?

Appreciate it. So as we were all watching weather, and I have to say, Peter, I really appreciate the question because it's interesting. 45 days ago everybody was freaked out about Houston, Puerto Rico and Florida, and it's kind of almost forgot to be honest with you. And now we're -- we're worrying about other news events which kind of comes in and out of people's minds very quickly. We were fortunate that, number one, although we do have a reasonable amount of Florida business most of it does tend to be in southern Florida and on the East Coast and the storm did most of its damage on the West Coast. Although clearly there was significant impact given the size of the storm on the East Coast as well. We're very well protected. It will show up in our -- in our NAV calculations if in fact any of our loans were impaired. I don't have specific data to tell you except that I don't think that there was any material. I shouldn't say I don't think, there was no material changes in our portfolio or in the performance of these loans due to the effect of the storm. I would also say to you that if a storm did affect one of our clients it is highly likely that they would immediately go to the SBA for disaster loan, get capital on a 20 to 25 year term with a 1%, 2% or 3% interest rate with a lien that will be subordinated to all of our other liens. So it's almost like instant equity. So in a perverse way, as you're aware, sometimes these storms are actually good for businesses and good for GDP. But we really have not seen any impact for the storms that hit in Houston and in Florida.

(Operator Instructions) Our next question comes from the line of Casey Alexander with Compass Point Research.

Can I ask a question, is there something that drives SBA 7(a) originations to the end of the quarter that requires that explanation of the debt-to-equity ratio? Does it bulge at the end of the quarter and therefore each quarter you have a larger-than-normal carryover than you might have if measured at the middle of the quarter?

I would basically gravitate towards my psychologist, Catherine, why do businesses in all aspects of life tend to do things when the deadline is up. Whether that's a college student studying for an exam, or business owners that need their funding by specific times, whether it's the end of year, end of a quarter, I don't know of any company that does not have -- I'll use the word multi-car pileups at the end of a quarter. I mean I've got a good friend of mine that’s in a software company and he says the last 3 days of the quarter are like a freak show. Got to get these things done, we got to get the contracts close. So I will say this, over the course of our 14-, 15-year history, oh, man, it's gotten so much better relative to before. Now I will tell you this. Although I guess as a percentage it's fairly significant, I would think we -– Jennie, what's the number? $20 million, $25 million, $30 million?

At the end of the quarter?

Yes.

Yes.

So I mean we look at $20 million, $25 million, $30 million at the end of a quarter on a $100 million quarter. So it's not like it's totally crazy. And sometimes it could just take a couple of loans to do that. We're aware of it. But here is the good news. It doesn't really matter. As long as you're within the guidelines, and we watch that very closely, it doesn't matter. Matter of fact, if you look at the ones that are settled which we've done because we think that was the fair way to present it, it's 81%. And you look my other [governments] that are carrying over, it's 74%. So if I was -- and I can't do this because it's non-GAAP. But if I was to present this on a non-GAAP basis, you go 74%, that's low. So instead people that are not looking at it like you are going, oh, my god, it's really high. We watch it. We're paying attention to it. We know what the regs are. And then given these governments sell within 10 days, it is not a big deal.

Okay, great. Thank you for that answer. Secondly, can you give us a little bit of color on that change in the fair value of the contingent consideration liability for IPM?

Yes, Jennie can.

Sure. So Casey, when we actually invested in IPM, there was an initial cash payment and then there was contingent consideration with that investment of approximately $1.4 million to be paid over 2 years. And that payment is based on achieving certain EBITDA levels in both 2017 and 2018. So what we need to do from a GAAP perspective is look at that liability each quarter and measure whether or not we think the company is going to hit that EBITDA level in each of those years and basically apply a probability percentage to the different scenarios. And what that equates to is, either your liability is going to stay at the initial measuring amount or you are going to mark that liability down. So we did the analysis this quarter, we think it's improbable that IPM will hit its actual EBITDA target that was part of the total purchase price. So we marked down that liability which actually created income for the period by $748,000. And I do want to just point out that that adjustment is deducted from adjusted net investment income. So we are including that as an adjustment to NII. Does that answer your question?

Yes, it does. Thank you. Barry, I understand that at the end of the day none of a 504 loan stays on the balance sheet, but this is inside of a portfolio company. So we don't really see the balance sheet of that portfolio company and the entire 504 loan does stay on the balance sheet for some period of time. Does that limit how much you can originate at any one point in time because we don't really know what the balance sheet of that portfolio company looks like?

Right. So leveraged portfolio companies do not consolidate for the BDC test.

Right.

Maybe I didn't answer your question.

No, because obviously we don't know what the leverage in that portfolio company is, so we don't know how much that portfolio company can afford to carry of a 504 balance at any one point in time. Understanding that it all rolls off eventually but in any one point in time you have a certain amount on the balance sheet until that time period is over. How much can you originate there and carry at any one point in time?

Yes. We currently have an 85% advance on 504 loans. And if we close on these 2 new term sheets we will announce those. And I think I could indicate without putting a number on it that there will be a lot of capacity. I mean we'll fund $40 million -- between $20 million and $40 million this year. Obviously we've indicated $20 million is in a very low end of the range. I think we'll be very good on our range without question. I would like to double or triple that business next year but that's my wish and that's not a forecast.

Right, okay. And…

I think that we'll have the capital and the leverage lines to do it.

All right. Now we'll repeat for of all the SEC guys, I use the word I think and anticipate. Thank you.

And that does conclude today's Q&A portion of the call. I'd like to turn the call back over to Barry Sloane for any closing remarks.

Thank you, operator. Look, I really appreciate the quarter that we had. I like the staff. I like to thank my executive management team and staff. You've done a great job. You're working hard. I'd like to thank the investment community that had really good faith in what we do here with respect to how hard we work at level of integrity, and we will be clear to be very transparent and report things to the community as we go forward. So we thank you for a great quarter and look forward to reporting the fourth and have some nice events going forward. Thank you all.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a great day.