NewtekOne Inc (NEWT) 2018 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Newtek Business Service Corporation Quarter Two 2018 Earnings conference call.

(Operator Instructions).

I would now like to introduce your host for today's conference, Barry Sloane, President and CEO.

Please go ahead, sir.

Good morning, everyone, and I'd like to welcome you to our Q2 2018 conference call.

And on this morning's call with me is Jennifer Eddelson, our Chief Accounting Officer.

For those of you that would like to follow along with our PowerPoint presentation, we welcome you to go to our website, newtekone, n-e-w-t-e-k-o-n-e.com, and go to the Investor Relations section and our PowerPoint presentation is there.

It will also be our archived in an audio format.

I would like to draw everyone's attention to Slide #1 regarding our forward-looking statement and would appreciate if everybody could acknowledge that and read that.

Moving to Slide #2, we always like to start off our call with our stock's performance, and the number that we have here were derived from Bloomberg.

Our 5-year total rate of return including dividends, 220%; our 3-year return is 102.2%; our 1-year return, 27.5%; and NEWT's total return from January 1 to July 27, including reinvested dividends so far this year, 17.6%.

On Slide #3, clearly we typically compare ourselves to other investment opportunities in the BDC segment.

According to a report recently issued by Ladenburg, Newtek tied with 2 other BDCs for top-performing BDCs for the year.

Total rate of return of 36% over the last 12 months, comparing that with the S&P 500 at 17%; S&P 600 Financials at 20%; Russell 2000 at 22%.

The report included 45 BDCs, most of them externally managed, some internal.

The mean return for BDCs over the last 12 months is 3%.

Recently, the company announced it is increasing its dividend for 2018 forecast to $1.80 per share.

That would represent a 9.8% increase over the company's paid 2017 annual dividend of $1.64.

Once again, that is a forecast.

We believe that our returns that we're able to deliver to shareholders set us apart in the BDC segment as we clearly manage and operate the BDC different than a lot of our brethren.

We're one of the few publicly traded BDCs, internally managed, that also trades at a premium to NAV based upon a stock price of July 31, and the NAV as of July 31 of 1.4% -- 1.4 times NAV.

Moving to Slide #4 and looking at growth metrics that's driving our overall performance in cash flow, dividends and stock price.

Clearly we have year-over-year percentage increases in our SBA 7(a) loan volume.

The reason why we've been able to grow our loan volume and keep credit quality is growth in loan referral volume, which we'll cover.

We've talked about our ability to process loans using a proprietary technology.

The growth in net interest income, which is going to become more and more relevant in coming quarters and years particularly in a rising rate environment for the floating rate loan portfolio.

Net interest income increased by 48.5% in the second quarter of 2018 compared to the year-over-quarter in 2017 when you excluded an $852,000 non-recurring interest earned in the second quarter of 2017.

That non-recurring interest occurred by buying back a participation out of a pool from the SBA where we were able to recoup past interest, which does happen from time to time.

Pricing in the government guaranteed bond market historically has been fairly stable.

I would like to point out that in the recent quarter Q2 2017 -- 2018 -- our weighted-average price on government guaranteed sales, approximately -- actually, $111.67.

That's down about $0.40 from the fourth quarter of last year.

And we've recently, I would say within the last week, the industry statistics have come out on CPRs relative to pricing speeds, and due to the economy heating up -- and we've talked about this for years -- it's not rising rates that change prices; it's changes in prepay speeds.

And I think you've heard me say that if we had a white-hot economy, we would see pickups in speeds.

I wouldn't say we're white-hot, but we're pretty warm or maybe even hot; 4% GDP, which has been brought upon by recent changes in the administration, has increased significantly economic activity.

And the amount of prepayments are basically caused by loans that were originated in the '12, '13, '14, '15 vintage years.

But that is how the industry prices bonds.

It looks at the industry as a whole.

It doesn't look at cohort years.

And we believe that on a going-forward basis there will be a softening.

We have included that in our model as a forecast and a guess, and this is totally unpredictable and I would say not something that is reliable.

We anticipate approximately a net $111 price for the next quarter coming forward.

Now that's going to depend upon the mix.

It's going to depend upon market figures.

But we try to be fully transparent with that.

And I want to be very, very clear.

We have increased our dividend guidance, which is typically based upon being between 90% and 100% of taxable income, based upon this change.

So we have already factored into a softening of prices, it is important to note.

We feel very comfortable with the movement in prices.

We feel very comfortable with our ability to pick and choose between $4.6, $4.7, $4.8 billion dollars of opportunity a quarter to maintain the volumes and to maintain the gain on sale numbers with growth that we've been able to obtain historically.

Our portfolio company, Newtek Business Credit, also has had its line of credit business growing nicely.

We're currently getting income on an excess of $17 million on that portfolio.

We have been able to reduce our cost of capital in borrowing lines.

Capital One recently increased our lines to $100 million and reduced our cost of borrowing by 50 basis points.

And we're happy to report an increase in capacity in lending lines for portfolio -- for a portfolio company of those SB 504 loans to be created.

That's Newtek Business Lending.

We have gotten a closed transaction with Capital One Bank with a $75 million to $150 million accordion for 504 loans.

Moving to Slide #5, total investment income for the 3 months ended June 30, 2018, an increase of 15.1%.

Net investment loss did go against us in the recent quarter of $2.1 million.

That's up from $1.7 million.

However, if you remove the $850,000 of non-recurring, non-related, non-performing interest that was repaid in 2017, we'd have a 15.7% increase in this important, important category.

Adjusted net investment income, which is one of our important categories because it includes the gain on sale of governments in the 7(a) market, which has been reoccurring for 15 years; that's an increase of 7.3%.

And our adjusted net income was able to beat analysts' estimates by about $0.02 a share for the quarter.

Our NAV, up 4.9% June 30, 2018 over June 30, 2017.

Debt-to-equity ratio of 90%.

Obviously we'll talk about the increase in leverage both from a regulatory perspective and shareholder vote perspective.

98.8% is no longer an alarming item, which we've historically said it's not given our ability to manage that, because a lot of our leverage is based upon government guaranteed loan sales.

And our total investment portfolio has increased by 24.3% to $487 million.

That size of the portfolio increasing is great.

A growing size of a publicly traded company is important given all the expenses, and it gives us significant operating leverage so we are happy about that growth.

And we're an internally managed BDC so management doesn't necessarily profit from increased total assets or the investment portfolio by external fees paid.

We profit by equity performance and dividend increases and stock price appreciation.

Our interest is very much aligned with our shareholders.

Going to Slide #6, an important slide that we've been using about for 2 years in trying to look forward and look at things that might change in the BDC market that would be important to investors in our BDC, BDC at large, and the investment community.

New Section 61(a)(2) of the Investment Company Act of 1940 as amended by the Small Business Credit Availability Act gave BDCs the ability to leverage from 1:1 to 2:1.

Recently, our board approved our ability to leverage up to 2:1 and our shareholders, in a recent vote where we got 95% for, of people that -- of our shareholders that voted, allowing us to increase our asset coverage effective immediately.

Very important, very valuable.

We'll talk about that a little bit later.

Second important item that we've followed, the AFFE Rule.

And for those of you BDC technocrats, you're very much aware of the AFFE Rule, which, I believe in the summer of 2014, tossed certain BDCs out of the S&P 500 Index.

It tossed certain BDCs out of the Russell 2000 Index.

Significantly problematic for those BDCs as well as the BDC industry.

And it made owning a BDC in mutual fund real problematic because of the expense ratio issues and calculations.

The House Appropriations Committee recently included language in its fiscal year 2019 Financial Services Government Appropriations Bill recommending that the SEC make regulatory or guidance changes.

We do think that the SEC is viewing this favorably.

We are -- we also think, and it is our opinion, it's not something you can bank on, but it is our opinion that the SEC also, we hear from the industry trade association, views this as favorable.

And this change would allow BDCs back into a Russell 2000 Index, the S&P 500.

It prospectively would also allow mutual funds to buy into BDCs without the issue of the expense ratio.

This is a big deal.

It is a very big deal.

BDCs could potentially be re-indexed.

And it opens up an institutional market that is significant.

I would also like to point out our market cap is somewhere near the $400 million mark, approaching the magic $500 million mark.

And that is extremely important; that small cap investors could be able to be more receptive to buying into our particular BDC as well.

The third, I view this as extremely speculative but possible, there has been discussion that BDCs do not get tax treatment like REITs or MLPs.

REITs and MLPs have their dividends count as qualified.

There's no delineation.

If this were to occur to BDCs, this would be significant.

I would like to point out that the REIT versus BDC comparison; REITs typically clear the market, on average, between a 3% dividend yield, maybe 4%; BDCs, 8%, 9%, 10%.

Huge spread between these 2 different '40s Act companies.

Obviously REITs have got real estate backing their investments.

BDCs have got primarily cash flow.

We believe that there is an opportunity where the BDC market prospectively could out outperform the other markets as it grows in size, as it grows in popularity, particularly if this AFFE issue takes place.

Everything I've said on this slide, I have to say, with the exception of the first bullet, is speculative and is opinion and shouldn't be relied upon.

And my Chief Legal Officer will be happy I said that.

Slide #7, special meeting of shareholders, which we had recently.

We were able to vote, which we talked about, to increase leverage from 1:1 to 2:1 effective July 27, 2018, which will allow us, going forward, to have a more balanced approach, do more debt than equity.

However, it's important to note that we are still going to be using our ATM to raise equity from time to time and grow the business appropriately and not increase leverage in any kind of a dramatic fashion in the near term.

I'd also like to note that the company has historically, every single year, gone out to a shareholder vote to enable it to sell shares below NAV.

We know this is sensitive.

I have conversations on a regular basis every year, “Why are you asking for this?

Particularly, why are you asking for this when your stock is trading 1.35 to 1.4?” We would use this situation if the board and management deemed it to be appropriate in the best interest of shareholders.

There is no alignment of -- dis-alignment of interests.

If there was an emergency, if there was a problem in the capital markets and the equity raise was important, I think management and the board would consider it in a dire situation.

We appreciate the investors giving us this vote of confidence, as did ISS recommending it, Glass Lewis recommending it.

They recommended it this year.

They recommended it last year.

I believe we got approximately 85% of the vote for those people that voted.

This is always a tough slog, getting enough votes for a quorum.

We want to thank the shareholders for helping us put the votes in, whether they voted for or against, to make this happen and give management the ability to make decisions and manage the company appropriately.

On Slide #8 I think the key here on this slide is we want to emphasize that with this change and ability to achieve higher leverage we're going to be able to more effectively utilize our lines of credit and securitizations primarily to grow the balance sheet.

Our line of credit from Capital One on a blended basis, if you look at where the governments get borrowed out and the uninsureds, about 4.5%, we typically do not use the full amount of the $100 million line.

Now we'll be able to.

Securitizations also are clearing the market in the 4s.

A much cheaper cost of capital and we could raise that line of credit and go up and down off of it.

We will attempt to give some guidance and indicate that it is our intent over the next 6 months to remain at 1.2 debt-to-equity or less over the next 6 months.

That is our intent.

That is a forecast.

We can't guarantee that's going to be achieved.

But I think it's important to note.

We plan on using equity ATMs.

We plan on using our lines of credit more.

And we do not have any interest in buying a portfolio of loans and zooming up to increase leverage, because we don't buy loans.

We are in businesses that do generate needs for capital, growth capital and equity.

We're a growth BDC.

And we believe this change is significant and was additive this year to some of the reason for increasing our guidance to 1.8 in a dividend forecast from 1.72.

Most of this change in capital will be from increased or growth in our 7(a) lending business.

The other businesses typically fall at the portfolio company.

We currently don't have any acquisitions teed up.

We are looking at one, but it's not of a major number at this point in time.

Slide #9, we talk about our $100 million credit facility with a 50 basis points rate reduction.

The unguaranteed is Prime less 0.25.

That would be 4.75.

Guaranteed is Prime less 0.75.

That would be 4.25.

We announced that we recently closed our Capital One Bank 504 lending facility, $75 million to $150 million accordion.

And that will go into a newly formed Newtek business lending entity known as NBL.

Newtek Business Credit, another portfolio company, has entered into an existing line of credit.

That will need to be moved over into NBL subject to final documentation.

We have a term sheet, which discusses a $40 million line increased from, I believe it's $22.5 million, up to $100 million.

On Slide #10, since our original N-2 in the fourth quarter of 2014, the company has talked about utilizing its infrastructure.

That's assembly, underwriting, pre-close, credit committee, post-close and its ability to acquire large quantities of loan referrals through its alliance relationship and NewTracker system to grow and expand across many different areas.

So continue to grow in 7(a), continue to grow in line of credit.

We've got business in place for 504, and we're looking forward to launching our non-conforming conventional loan program where we could do loans up to $15 million.

A term sheet is currently being negotiated for $100 million line of credit up to $200 million.

That will be a facility to NSPV.

The term sheet being negotiated from a $10 billion money manager for equity capital in a joint venture.

This would be done and it would be a non-consolidated leveraged opportunity for the BDC and loans to be originated and funded and securitized out of NPL.

We're excited about the non-conforming conventional business.

This will enable us to leverage our infrastructure, generate additional benefits to shareholders and be able to leverage our infrastructure and create a very nice intrinsic value within the BDC as an organization that has a full menu of products for small- and medium-sized businesses all across the United States.

And we're very excited about all the opportunities that sit in front of us going forward.

On Slide #11, we talked about our second quarter dividend of $0.42.

We increased our annual dividend to $1.80.

That was an 11% increase over -- $0.11 increase over original guidance, a 9.8% increase over the 2017 dividend.

If you go back in time, our original dividend in 2016, $1.50; our original dividend in 2017, $1.57.

We encourage the investment community to view dividends on an annual basis rather than quarterly.

Occasionally I still see headlines of various -- the API, the UPI, “We increased or decreased our dividend from sequentially the quarter prior.” It's not relevant.

It's the one-year guidance that we want investors and think investors should focus on.

On Slide #12, our SB lending highlights.

Loans funded, $106 million.

That was a 32.2% increase over $80.5 million for the 3 months ended June 30, 2017.

We're forecasting between $465 million and $485 million of 7(a) loans.

That will be a 23% increase.

And NBC, a controlled portfolio company, closed $7.5 million of SBA loans for the 3 months ended, up from $1.4 million.

And NBC funded $9.6 million of 504 loans for the 3 months ended June 30, 2018.

As of August 1, between 504 loans -- and we had a conventional loan which started off as a 504, we converted it to a conventional loan and then sold it subsequently -- $20.2 million of loans funded away from SBA 7(a) and not line of credit in what I would call the conventional and 504 market.

We're still forecasting loan closings of $75 million to $100 million in 2018.

Closings are different than fundings because in this market you do get draws over time for capital.

Sometimes these loans have a construction element so closings will be different than fundings and have different income ramifications.

We're real optimistic about our 504 loan program due to growth in the total referral volume, which we'll cover shortly; pipeline growth and further establishing our growth through loan processing offices in Orlando and Boca.

In Boca, we plan on moving in the next 3 weeks to a larger facility.

That will have 50 seats up from 20.

Slide #13 looks at our SBA 7(a) pipeline.

$246 million June 30, 2017; June 30, 2018, $407 million.

That's a fairly significant pipeline increase, almost 65% increase for the 3 months ended June 30, 2017.

On Slide #14, looking at 504 and conventional loans closed and the pipeline, significant pipeline increase June 30, 2018, $158 million up from $18 million the year prior.

I point out loans in underwriting and approved pending closing; the $50 million in underwriting, $24 million almost $25 million in approved pending closing.

I think this will enable us to hit our closing and funding guidances.

It is typical that we do more business in the second half of the year than the first, but also this is a growing business and the pipeline has rolled out in the future.

Slide #15, investment in staff to support growth.

Both at the BDC level and down at the portfolio company level, we've made a lot of investment in staff.

The investment in staff that we're making, the investment in software and hardware that we're making in increased provisions for security are all factored into our $1.80 dividend forecast, which, once again, is estimated to come out between 90% and 100% of taxable income for the year.

We're excited to welcome Natasha Gordon as Chief Revenue Officer to Newtek Business Service Corp.

Natasha is working directly with me to help grow the revenue base particularly of the smaller, less statistically significant portfolio companies.

Josiah Meurer, who was an executive at IPM, is moving over into an executive role over at Newtek Managed Tech Solutions as Chief Technology Officer, really focused on making sure that the strategy that we have down at that portfolio company, which is to manage our clients' technology, we want to manage it and provide the right technological solutions.

Josiah will be adding his expertise in that particular group.

Joe Vuica joined us, VP Business Development.

Joe joins us from GoDaddy.

Joe managed 10 executives there, who managed a team of 10 focusing on Microsoft O-365 sales, marketing and implementation.

Mike Hempel joined us as SVP of Technological Operations at Newtek Technology Solutions.

Those 3 executives are all exhibiting their skills out of the Phoenix business.

Mike was Chief Information Officer for a public enterprise in Arizona, a great talent to join our company to help manage technical staff and engineers and help David Miers, Chief Operating Officer, out there.

We hired Jim O'Halloran, Boca-based, SVP Inbound and Outbound Telemarketing.

We know we've talked about this for years and we don't roll things out until we believe we have them right.

Well Jim joins us from Citrix where we had an expertise in hiring and recruiting people out of universities with undergraduate degrees, putting them in seats to obtain opportunities and referrals in hardware and software.

Jim will be working out of Boca, but helping us build our ability to call in to our database.

Scott Haynes joined us, I believe recently, from I think it was FIS, formerly of First Data, SVP Merchant Partner Relationships, helping us with our alliances for improving our EPP business.

Mark Seliman -- Seligson, excuse me -- a business service specialist specializing in life insurance particularly for our small business lending operations, which do require key-man life on businesses.

Bill Franey, Controller for Newtek Business Lending, our newly established entity, reporting to Jenny Eddelson.

And Martha Williams, Director of Marketing and Business Development for IPM.

Martha has an expertise working with software vendors, getting marketing dollars to enable us to further launch into our digital marketing campaigns.

Slide #16 is a slide most of you are familiar with, I am not going to cover due to time constraints, but it shows our pedigree and expertise in the SBA lending business.

Slide #17, extremely important, loan referrals.

Q2 2017, Q2 2018 in units, 148% increase.

We looked at 4,600 referrals in Q2.

Excuse me.

That's in millions of dollars so that's $4.6 billion up from $1.8 billion.

That's 148% increase.

That's dollars and that's $4.6 billion.

Why is that relevant?

It's because we believe we're going to be able to find enough loans that are of high quality, pick them and choose them, with the right characteristics to be able to meet whatever gain-on-sale characteristics are required to meet or beat or exceed our guidance without cutting into credit.

We feel very comfortable about that.

I would say the biggest limitation that we have relative to volume and being able to meet our projections is more along the lines of human capital.

Do we have the right assemblers in staff?

Do we have the right underwriters in staff?

Do we have the right pre-closers, post-closers, legal talent?

With that said, being able to improve our internal technology and software development; beefing up what we're able to do in the human resource area, hire, training, recruiting; the growth of our Boca office, we've been great at it.

So we're very, very comfortable with the changing market conditions that we have to deal with because you're not always going to wind up being in a Goldilocks- or a Cinderella-type economy where everything is going in your favor.

So in addition, many of these referrals are good credits.

They just do not fit a conforming government guaranteed loan program.

Which is why we're launching our non-conforming business with similar underwriting criteria, which is why the 504 program has developed so nicely, which is why our line of credit business is growing.

We have an infrastructure that's positioned to be the best player in small- and medium-sized business lending in all 50 states across the United States, getting in referrals, not using brokers, using subject-matter experts in remote locations to make loans as well as provide insurance solutions, payroll solutions, technology solutions and payment processing solutions.

Q2 2018 loan referrals referred in units, 298% increase.

We looked at 15,000 opportunities in Q2 2018 thanks to our staff, great management and great technology.

Slide #18 graphically depicts that referral growth.

Slide #19 shows referral growth from alliance partners, and it shows the referral growth from 2007, '08 and '17.

So this is the increase in actual partners and individual partners increased by 49% during that period of time.

Premium trends, we talked about it.

I look at this as stable.

This is a government guaranteed floater that the price change will primarily be driven by prepayment speeds.

And to be honest with you, I wouldn't say we're tapped out at prepayment speeds increasing, but these loans just typically don't prepay in the first couple years.

So when you look at prepay speeds of 17%-18%, which is currently where the market is -- I think in our model for NAV, I think we use over 20% -- there's a point in time where these loans just are not going to refi much greater than the numbers that we currently have.

Now you may wind up with a situation where, all of a sudden, rates spike up at a ridiculous amount and you may get some prepayments, which, of course, by default, just to fully transparent.

However, I think my point is we feel fairly good about our future going out many, many years to be able to continue to reap the benefits from net premium trends in the business.

Would you go to Slide #21?

Our charge-offs on a rolling basis for 12 months, 50 basis points.

We did have a pickup of loans going into the default category to 4.6%.

I want to remind many people, in many instances we have loans that go into the default category.

However, they still could be paying.

And that happens a lot in small business.

You could have a technical default where they missed a payment or 2 and they can't catch up.

You've got personal guarantees.

We've had situations where we've had the business go out of business, but the borrowers continue to pay the loans not to affect their credit rating.

The point is that this is going to happen from time to time.

We think this is a temporary spike and not a trend.

We see the economy being good.

Slide #22, this is good evidence of why our business model works.

And when we look at performance over time and the mix, the balances that you see on Side #22 in 2017, $11.7 million; $44.9 million in commercial real estate; in 2017, $8.7 million.

These are the unguaranteed balances of SBA loans.

So the whole loans obviously are much bigger.

You could see that as time has gone on, because we have the bigger opportunities to pick and be selective, we do less loans backed by residential real estate as the primary collateral, less loans with machinery and equipment, more loans by commercial real estate, which is always the preferred collateral.

This depicts an improvement in credit quality.

Slide #23, purpose of the loan.

I must say startup businesses have high propensities to fail.

In 2017, only 3.5% of our businesses were what were defined as startups.

Business acquisitions also tend to have greater failure rates although many of them still make good credits, 9.08%.

But if you look at the changes, like startups in '07, 31%; now 3.5%.

This is why our model is good.

We stay away from BDOs or brokers.

We are able to pick through large quantities of opportunities.

And it helps us make our numbers from an accounting and economic and growth perspective and maintain credit quality.

Geographic diversification, which is depicted on Page 24.

We keep our concentrations lower.

We had high concentrations obviously in '07 and '08.

That's flipped.

Florida is now only 8% of the portfolio, down from 22%.

And New York has taken the top spot with 12%.

Slide #25 and 26 are our classic 7(a) math for accounting income and cash flow.

Slide #28, we've talked about how our 504 loan program works in the past.

29 shows a typical example of what a 504 loan looks like.

#30 shows the equity on a 504 loan.

504 loans leave us with no balance sheet.

The second loan gets taken out by a CDC.

The first loan gets sold into the capital markets out of the lending facility, generates a high return on equity just like our 7(a) loan business.

That's why we're able to generate great returns, great high on equity returns to our shareholders, because we're investing in businesses and business processes, which generate high returns themselves.

Versus our other BDC players that buy debt, lever it up, clip the coupon out, and it's pretty hard to get NAV or valuation increases because there's no real intrinsic value within the portfolio of securities from our competitors where the value of our securities are worth more based on the business model.

Slide #31, our payments business continues to do very nicely.

The industry comparisons also for publicly traded entities.

It is not something that's inconceivable, although we think it's very small at this point in time and not in the cards, any one of our portfolio companies could be available for spinoff down the road.

And this is important to always look at these other valuations from a comparative perspective.

In our payments business, our focus is on the 3-legged stool of going to customers and improving their e-commerce.

What does that mean?

Better security, lower costs, better ability to find through search engine.

POS, upgrading their point-of-sale hardware and software; we can help with that.

We can finance that.

We've got the best solutions in-house.

As well as the move towards mobile payments.

For those of you that are shopping in retail or restaurants where people are coming up to you with devices to take the payments on the spot, you're going to see more and more of that, we are positioned for that.

The payments business is a good business.

Slide #32, we name our technological portfolio companies IPM, Sidco, Newtek Technology Solutions.

Fair market value of $22.3 million.

Our goal here is, through these entities, to be able to have business owners outsource their technology to us.

Let us manage it.

What's the play here?

The play is there's a significant migration to the cloud, which hasn't begun in the middle markets.

We want to position ourselves to take advantage for that.

We believe this is the important growth segment within our portfolio of companies.

And Slide #33 is our investment summary.

We like to remind everybody we're an internally managed BDC.

We do not pay a 4% management fee like other managers.

We've typically owned and operated our portfolio companies for over 10 years.

We have a 15-year track record in lending history through different multiple lending cycles; up rates, down rates, good credit, bad credit.

A majority of our loans are floating rate with an average loan size of 180,000 for risk.

Tremendous diversification of credit, extremely important.

Most of those loans are senior secured opportunities to small- and medium-sized business all across the United States.

Management's interests are aligned with shareholders.

The board and management own a 6.3% of all outstanding shares.

No direct lending to volatile industries like oil and gas, no derivative securities, no SBIC leverage.

And we don't invest in CDOs or loans with equity kickers.

With that said, I'd like to turn the financial portion of the presentation over to Jenny Eddelson.

Thanks, 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 2018 consolidated statement of operations.

Please turn to Slide 35.

In total, we had investment income for the quarter ended June 30th, 2018 of $11.4 million, a 15.1% increase over $9.9 million in the second quarter of 2017.

The majority of this change was from an increase of 20% in interest income due to several factors.

Interest income increased due to the size of the average outstanding performing portfolio of SBA loans increasing from $220.7 million at June 30th, 2017 to $276.9 million at June 30th, 2018 coupled with increases in the Prime rate during the 1-year period.

For the quarter ended June 30th, 2018, we had an increase of $399,000 over the same quarter last year from interest income earned on holding guaranteed portions of loans held for sale.

Offsetting these increases was $852,000 of interest income recognized in the second quarter of 2017 related to a non-accrual loan that paid off during the 2017 quarter.

Servicing income increased by 16.5% quarter-over-quarter from $1.7 million in Q2 2017 to $2.0 million in the same quarter of 2018, which was the result of the SBA loan portfolio, for which we earn servicing income, increasing from $755.7 million to $949.6 million quarter-over-quarter.

Other income, which relates primarily to legal, packaging and other loan-related fee revenue, increased by approximately $158,000 in the second quarter of 2018 as compared to Q2 of 2017 primarily as a result of an increase in loan originations volume year-over-year.

Dividend income in the second quarter of 2018 increased by $110,000 to $2.6 million from $2.5 million in 2017.

For the quarter ended June 30th, 2018, our dividend included approximately $1.75 million from Newtek Merchant Solutions, $400,000 from Premier Payments, $250,000 from Sidco and $125,000 from IPM.

Total expenses increased by $2 million quarter-over-quarter or 16.9%.

The $232,000 net increase in salaries and benefits was the result of an increase of $422,000 in payroll resulting from an increase in headcount at NSBF offset by a decrease in stock-based compensation expense of $190,000 period-over-period.

The additional headcount relates primarily to employees performing loan processing, closing and servicing functions as a result of increase in loan origination.

The increase in interest expense of $1.2 million period-over-period is primarily related to interest from the notes payable securitization trust, notes due 2023 and notes payable related parties.

The increase from notes payable securitization trust was the result of an additional securitization transaction completed in December 2017.

The company recognized $218,000 of additional interest expense quarter-over-quarter, which was attributable to the $57.5 million in 2023 notes at 6.25% interest outstanding in the second quarter of 2018 as compared to the $40.25 million in notes due 2021 at 7% interest that were outstanding during the second quarter of 2017.

As a reminder, the notes due 2021 were redeemed in March 2018 with the proceeds from the notes due 2023, which were issued in February 2018.

Origination and servicing expenses increased by $899,000 in the second quarter of 2018 as compared to the second quarter of 2017 due primarily to higher referral fee expense, which was the result of an increase in loan originations period-over-period.

Overall, we have a net investment loss of $2.1 million as compared to a net investment loss of $1.7 million quarter-over-quarter.

Adjusted NII for the 3 months ended June 30th, 2018 was $8.2 million, or $0.44 per share, as compared to $7.2 million, or $0.41 per share, for the second quarter of 2017.

A reconciliation of adjusted NII for the quarter can be found on Slide 37.

Net realized and unrealized gains totaled a positive $9.8 million, an increase of 13.3% for the 3 months ended June 30th, 2018 versus the same period last year, and primarily represents realized gains on the sale of the guaranteed portions of SBA loans sold during the quarter.

In the second quarter of 2018, NSBF originated 147 loans totaling $106.5 million and sold 130 loans for $78.1 million generating $10.9 million in realized gains at an average sale price of 111.67%.

During the second quarter of 2017, NSBF originated 134 loans totaling $80.5 million and sold 121 loans for $61.1 million generating $9 million in realized gains at an average sale price of 112.44%.

Overall, the company had a net increase in net assets resulting from operations of $7.6 million, or $0.41 per share, for the quarter ended June 30th, 2018 as compared to $6.9 million, or $0.40 per share, for the quarter ended June 30th, 2017, an increase of 2.5% on a per-share basis quarter-over-quarter.

I would now like to turn the call back to Barry.

Thank you, Jenny.

Operator, we are open for Q&A right now.

(Operator Instructions).

Our first question comes from Robert Dodd with Raymond James.

Just going to your comments on the premium if I can, Barry.

I mean obviously we'd seen the data for July and there seemed to be some compressing and you're saying that's likely to last for all of Q3.

But then again you then said you felt comfortable that it's probably stable and prepayment rates probably can't go up.

So I mean can you just give us a little bit more color on or be more explicit?

Like do you believe that that 111 for Q3 is likely to be a floor rate, provided nothing weird happens in the economy, a floor rate going forward with margin for error?

Or can you give us a little bit more color on what your feel is there?

So Robert, definitely appreciate the question.

And we've been doing this for 20 years, 18 as a public company, and we've been very good and, I think, accurate in being transparent to the investment community.

As a matter of fact, when rates started their move a couple years ago, I kept getting asked by many, by analysts, by investors, “Hey, what's going to happen?

Rates are going.

Are your prices going to go down?” And I said, “No, they're not.” I said, “It's driven by prepays.” And we've been very right.

As a matter of fact, all the way through the end of last year, we held that sort of 112 pricing mechanism.

And there's also sort of a supply-and-demand component here.

I feel very good about the overall guidance that we've given.

I think that's really what's important because, in many instances, we have the investment community looking at volume and price and then everything else is just sort of noise.

And now we've got; okay, you've got volume, you've got price, you've got other business lines that are growing, you've got -- which is why we do what we do.

I mean many times people say, “Hey, can you just do 7(a)'s and go home?” And after doing this for 20 years, I've learned that things cycle in and cycle out, just like '08-'09.

So I feel very good about the guess.

Now here's what I want to be really clear about; I have absolutely no clue as to whether we're going to be a 111, 111.25 or 110.75.

Here's what I did give you.

I gave you my real good transparency and best guess and a forecast, and importantly what I've tried to do is give comfort to yourself and people in the investment community that we have enough opportunity in the looks that we had last quarter of, I think, $4.6 billion, $4.8 billion in Q1, to be able to I'll use the term meet and hopefully beat our numbers.

We can't always beat our numbers.

Sometimes you just meet them.

But we really try very hard not to disappoint and that's been our 4-year track record.

So I don't know if that cleared things up because I can't -- I have no idea where we're going to be for the quarter.

But that's our best guess.

Yes.

I appreciate both the clarity and that comment.

So one more follow-up.

On the non-conforming loan, the JV you're going to do, on the conformings for the 7(a) obviously you do not need SBA pre-approval.

You have one of those, the special licenses -- I can't remember its name -- where you're a trusted partner.

On the JV, on the non-conforming side, are you going to have that same level of -- freedom isn't quite the right word for it -- or are you going to have to run every loan past your JV partner for approval, which could slow things down?

Or are you going to have the same kind of freedom and trust from your partner that the SBA gives you in growing that business?

That's a great question, Robert.

Look, to be 100% clear, in this partnership there will be equal say on approving a loan or not approving the loan with the partner.

So with that said, I could be very clear; if the partnership doesn't work, we'll have the ability to end the partnership and do the loans ourself.

So we're not going to tie ourselves up.

We're not going to give the keys to the kingdom away.

And by the way, one good question might be, “Well, gee, why are you doing a partnership then?” Well we're doing a partnership for the purposes of being prudent because we believe it's really important to have many different outlets for capital, which is why we have a lot of different banks, a lot of different equity participants.

So this is a really great way for us to be able to bring in outside capital in a side-by-side and not have to -- if we force stock out into the market, particularly if this business takes off the way we think it can, it might use a lot of capital.

So we're really excited about it.

We're still negotiating finalities.

We think they're really a good partner.

Hopefully, they're listening.

And we're excited about the opportunity.

And our next question comes from Frederick Cannon with KBW.

This quarter you had what I consider very good operating leverage, certainly against my estimate in terms of both revenue beat me and then your expenses came in very contained.

And then but I'd like a little -- perhaps you could talk a little bit about expenses going forward.

I was -- especially given the new hires that you have and what Jennifer mentioned about the stock compensation coming down for the quarter.

Maybe kind of just how should we be thinking about expenses going forward?

I would say this, Fred, and I appreciate the question, when I'm in the New York office, Jenny is 2 offices down from mine.

And when I had these talented people, I walk into Jenny's office and say, “You got that one?

You got that one?

And is it in your budget?” We feel good about these adds.

All these adds are baked into our budget.

I would say, generally speaking, we're looking at our expense lines as being stable.

I think we're also going to get some benefits from some reduction of interest expense going forward versus in the past.

We did a nice bond refinancing recently this year.

We knocked off, I think, 1.25% on $40 million.

We have some other things that we could look at.

Our NEWTZ bonds, I believe is NEWTZ, are callable in September.

There's an opportunity.

So we feel pretty good about our operating expenses.

We feel good about our cost of capital, debt expenses.

So no, I think we're very good on the expense line as well as CapEx.

We've really made significant investments in the business so as things go on and things change we'll be able to continue to do what we've done historically and deliver it to shareholders.

Okay.

So kind of the concept of operating leverage should be maintained, it sounds like.

Is that fair?

Clearly maintained and hopefully, frankly, continue to benefit.

I mean I realize this isn't operating; it's more financial.

But for example, with the ability to not be worried about 1:1 anymore, I can hold a government guaranteed piece for another month or 2 and my coupon on that government guaranteed piece is 7.75 and my cost of money is 4.25.

So I get a 350 basis point asset liability match on a Full Faith and Credit U.S. government piece of paper.

Speaking of that, Barry, in the slide deck you stated that you're going to kind of move to a 1.2 debt-to-equity in the next 6 months or so.

As you know, we kind of have to push things out a little bit.

Any kind of guidance for us on how we should think about beyond that 6 months especially as we think about the share count and whether you would kind of continue to let the leverage move up a bit?

Yes.

I think to be clear; I think we indicated we won't go beyond that.

And I know this is a little bit of a tough one.

First of all, look, we're not forecasting 2019 yet.

We hope to do that maybe after the next quarter.

But I think we've given enough general feel for you to get a guesstimate on what shares may or may not be issued between now and the end of the year.

We look at that every day depending upon what makes sense and what's going on in the market.

Look also, issuing shares is -- I was reminded by one of our astute shareholders when you're at a premium that actually helps pull up your NAV so it does have, I'll call it, a secondary and tertiary benefit.

But the utilization of more leverage is very beneficial for us in that -- and by the way, this is important to note; more leverage is more risk.

That's obvious to most.

But we don't think growing -- and we're not going to 2:1, but we've managed 4:1 in the past.

That's not a big deal, because we were a non-BDC for a period of time, particularly given when you looked at our diversification, our asset size and liquidity through securitizations and things of that nature.

So I think what you can expect is a balanced approach.

We will have an equity ATM in the market.

We'll have a debt ATM.

We're going to look at all aspects of the capital markets.

And we don't think we're going to need to put pressure on any aspect of our sources, both our shares or bonds.

We don't have rating agency issues.

I don't have debt covenants that are problematic.

It's all -- it's a good situation for us.

And the 1.2 number was -- that's not beyond that.

And that's -- and by the way, I'm not going to guarantee it.

It's just a forecast.

And it's possible, if it made sense to go beyond that, we would.

Let's say if it was an amazing acquisition to do, it's possible.

But now we don't anticipate it.

And that was done to give all of you some feel and sense through February-March of next year.

(Operator Instructions).

Our next question comes from Lisa Springer with Singular Research.

I wanted to ask you about cross-selling opportunity between 504 customers and 7(a) customers and if you're already starting to see some cross-selling opportunities now.

Yes.

So, Lisa, that is a good point.

The 504 loan is -- it can be used for machinery and equipment and we typically don't.

I'd say, typically, I'd say almost never.

It's usually used against real estate purchased, refinance or rehabilitation or construction.

You can't use 504 for working capital.

There are times where a business owner -- because these are business loans.

They're not commercial real estate loans.

So it's a loan made to a business that has cash flows, that has personal guarantees, and we're able to give them a greater advance on the commercial real estate collateral.

There are times that we're able to do both.

That puts us at a tremendous advantage from other lenders that are just 7(a) or lenders that are just 504.

And the ability to do the conventional financing will be quite advantageous as well as line of credit against inventory and receivables where our goal is to be the enterprise that is dealing with what I'll refer to as the non-bankable segment.

Now this is important; non-bankable doesn't mean non-creditworthy.

I'll define non-bankable.

The borrower wants an amortization of 10 to 25 years.

Banks don't do that.

The borrower wants an over-advance on the primary collateral.

Over-advance could be anything greater than 75%, let's say 80% against the primary first, not counting the secondary or tertiary, which banks don't for regulatory reasons.

So this -- it was astute for you to bring up the point because by adding these programs, it's going to help the 7(a) business, it will help the line of credit business.

Very additive and we'll be able to get, we think, significant operating leverage off of the infrastructure of $4.6 billion to $4.8 billion of referrals, which most likely would maybe increase based upon opening up the bucket.

It's very, very symbiotic to be able to cross-sell between different loans.

Many businesses do have a need for financing in 2 different loan programs.

And I'm not showing any further questions at this time.

I would now like to turn the call back to Barry Sloane, President and CEO, for any further remarks.

Thank you, operator.

And thank all of our shareholders for attending and participating in our recent proxy solicitations.

We certainly appreciate you voting your shares.

And we look forward to reporting in the third quarter.

Thank you so much.

Ladies and gentlemen, thank you for participating in today's conference.

This does conclude today's program.

You may all disconnect and everyone have a great day.