NewtekOne Inc (NEWT) 2018 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Newtek Business Services Corporation Q3 2018 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, President, Founder and CEO, Mr. Barry Sloane.

Sir, you may begin.

Good morning, everyone, and appreciate everybody attending our Third Quarter Financial Results Conference Call.

This morning, the call would be hosted by myself as well as Jenny Eddelson, EVP and Chief Accounting Officer.

For those of you that would like to follow along with the presentation, we have a Power Point presentation that exists on our website, Newtekone.com, and please go to the Investor Relations section of website and you'll be able to see and follow along with the presentation that exists in the Presentation section.

I'd like to turn everyone's attention to slide number 2, and we have onto our historical stock performance.

Over the last 5 years, according to Bloomberg 220%, 3 years 102%, last year 27.5%.

According to a research report issued by Ladenburg on October 10th, Newtek ranked in the top 5 performing BDCs with a total return of 21% over the last 12 months, outperforming the S&P 500, the S&P 600 Financials, and the Russell 2000.

We are one of the few publicly-traded BDCs that trades at a premium to NAV at approximately 1.3 to NAV.

That's as of closing price on 11/6/2018.

For the last 9 months ended September 30th, our total return including re-invested dividends, 20.3%.

Year-to-date through November 6, 14.5%, also outperforming the Russell 2000 and the S&P 500.

Moving to slide number 5, the rationale or reasons for our performance from a stock perspective and business perspective.

We continue to have year-over-year increases in SBA 7(a) originated loan volume.

We continue to have quarterly and annual growth in loan referral volume.

The key, obviously, to our ability to lend without cutting into credit quality is the ability to be selective off of a very high base of loan referrals, which we'll go into later on in the presentation.

Our ability to process business, both in the lending arena as well as the other 4 business areas, extremely important.

We continue to invest in our ability to utilize proprietary technology to improve the client experience as well as the worker experience, and overall process business at a much higher rate and better rate, and higher quality rate, than our competitors in these various different business lines.

Our net interest income continues to rise.

Obviously in a rising rate environment with a floating-rate loan portfolio that is not highly levered, is extremely attractive.

That interest income increased by 29% in the third quarter as compared to the third quarter in the prior year.

We've had very steady performance and growth in the payment processing business.

It's our second highest valued and cash-flowing business.

That business is growing in the single digits in revenue and high-double-digits -- I think it's growing at about 15% EBITDA year-over-year for the first 3 months of this year versus last year.

We continue to grow our portfolio line of credit business and CDS.

We've also demonstrated an ability to reduce our cost of capital in our borrowing lines.

We anticipate this week closing on a new bank line of credit, refinancing an existing Goldman Sachs line of credit which would reduce our cost of borrowing on the margin by 350 basis points in LIBOR.

We've been able to increase our capacity in lending lines for SBA 504 loans as well as our 7(a) portfolio and recently had a cost reduction in the 7(a) portfolio from Capital One Bank.

Moving to slide number 6, financial highlights for the third quarter.

Total investment income of $12.4 million, that's up 29% over the prior year and the quarter ended September 30, 2017.

Net investment loss of $1.4 million for the 3 months ended September 30, 2018 versus a loss of $1.2 million.

There's some one-time issues in there that Jenny will be able to cover in our financial presentation in the Power Point and in the discussion today.

Adjusted net investment income of $9.3 million or $0.50 for the 3 months ended, that was an increase of 10% on a per-share basis.

Very important.

We were able to beat analysts' estimates it's by about $0.03 a share there.

Net asset value $15.28, a 1.3% increase over the NAV on December 31, 2017.

Debt-to-equity ratio, as many of you are aware that follow BDCs, legislatively BDCs are now able to grow up to 2-to-1 leverage.

At the end of the recent quarter we were at 104.9%.

If you take away the broker receivable which are the amount of leveraged assets as we sell 7(a) loans that typically settle within 5 to 10 days, our leverage would have been significantly less, 93.6%.

So as we have indicated to the market, we plan on taking up our leverage slowly and methodically over the course of time.

Total investment portfolio increased by 12.4% to $513 million from $456 million on December 31, 2017.

Slide number 7 goes into a little bit more elaborate explanation of the debt-to-equity ratio calculation, when you take out the broker receivable, which in my opinion indicates that we are less-levered than the 104% might imply.

We believe it's closer to 93.6% once you take out the government-guaranteed broker receivable against the firm take-out from 11 different investment banks.

On slide number 8 we'll be chatting about our dividend payments and dividend forecasts.

We paid a third quarter cash dividend of $0.48 on September 29th, and we also declared a $0.50 per dividend payable on December 28, 2018.

We reconfirmed our $1.80 per share dividend guidance which is a 9.8% increase over the prior year of $1.64 in 2017.

And we have, as of close of business yesterday, forecasted a $1.84 per share cash dividend which represents a 2.2% increase over the 2018 dividend of $1.80 this year.

We'd also like to call investors' attention to the fact that over the past 4 years, the initial dividend has been able to have been increased over the course of time as we get deeper and deeper into the year and get more comfortable with our metrics.

We obviously forecast dividends a year in advance, which is not typically something that's done in the BDC market, or for that matter, with most businesses today.

But we're very comfortable doing so.

We think it's the best way to follow the stock, due to the quarterly fluctuations in dividend.

I will also note our annual cash dividends have been paid out of taxable income, and we always indicate that we aim to come in right in the midpoint of 95% of that range.

Moving to slide number 9, SBA 7(a) highlights, we funded $122.4 million.

That's an 18.1% increase over the year prior.

And we are forecasting and maintain the forecast of $465 million to $485 million in 7(a) loans for the 2018 calendar year.

And that would be a 23% increase at the midpoint of that range.

We've also given some guidance for 2019 7(a) fundings, between $580 million and $620 million.

Moving to slide number 10, growth in the 7(a) business will obviously be able to grow other businesses as well off of that big referral book which we'll get into.

But focusing very much on the 7(a) loan funding forecast, we've always said when asked on conference calls and with investors, what are your limitations to growth?

We've never said in recent times that it's been capital, securitization exit, it really has been several things relating to having the right technology in place, having the right people, having the right real estate.

So I think it's important to note, we're forecasting similar growth rates in SBA 7(a)-type loan funding without having to cut into credit.

We are currently closing loans at a rate of about 2.5% of gross referrals.

We believe that we can add between $90 million to $125 million of 7(a) loan fundings in 2019 while maintaining the credit quality to loans by just increasing the close rate to 3%.

That's going to done through investments in technology and human capital.

2018 was a year of investment.

We've hired new staff.

We promoted existing seasoned staff to more senior levels to be able to service clients better, and pushed loans through the system faster with the same amount of quality.

We've added over 100 new workstations in our New York Lake Success office, Boca Raton office, and Orlando, Florida office combined, for our lending operations.

We continue to invest and improve our technology for the lending platform.

We've gained new alliance relationships.

We also expect to see growth in total loan referrals.

I will comment that we're on a $18 billion to $19 billion run rate as we sit here today for loan referrals for 2018.

We do expect that to increase next year.

On slide number 11, we talk about the recent securitization that we priced and believe we're funding that transaction today.

We issued our largest deal ever.

It was the 9th, all Standard & Poor's-rated, $108.6 million in unguaranteed 7(a) loans.

There was a Class A certificate rated single-A and a Class B rated BBB minus.

We had the best advance rate that we've ever had, 83.5%, 4% improvement over the recent securitization.

Part of the rationale for that was good credit quality as well as the fact that we were able to put seasoned loans in the pool from a prior deal.

The notes were priced at an average yield of 4.32%, that was spread over LIBOR.

That was the best pricing in our securitization history with a 30 basis point reduction in the A class on the LIBOR notes compared to our November 2017 securitization.

Deutsche Bank was the sole bookrunning manager, and Capital One Bank acted as co-manager on the offering.

One of the things that we were able to do on this deal, was we were able to exercise a redemption in our 2013 deal which had been upgraded to AAA, by being able to call the loans in the pool and pay off the notes.

We were able to release approximately $15 million in cash from a $33 million collateral pool.

Some of that cash came from reserve fund.

Some of the cash came from overcollateralization that we were able to obtain by putting these loans in the current 2018 deal.

Moving forward to slide number 12, and obviously we have a lot of pieces in our business, gain-on-sale being one, interest rates in the portfolio being 2. As we're seeing rising interest rates, which has increased prepayment speeds and lowered prices for gain-on-sale, one of the benefits to that is it's actually increased the coupon on our loan portfolio.

We have a prime plus 2.75% portfolio which is equivalent to an 8% current coupon.

The notes in our recent transaction of 2018, one deal had an average cost of funds of about 4.32%.

So you've got a very nice asset liability spread between 360 basis points to 370 basis points, match-funded, non-recourse.

The other thing that's a benefit to a faster economy, which is causing -- a more and more robust economy, which is causing rising rates, is that we've got higher prepayment speeds.

Those higher prepayment speeds have had a negative effect on the pricing of the government-guaranteed pieces.

On the other hand, that's led to higher rates, giving us a higher coupon on the portfolio.

Also higher prepayment speeds could lead to more frequent exercising of redemptions of older securitization transactions which allow for greater cash flow in the securitization, which effectively enable us to finance our growth.

As I just said, the $15 million of cash that we were able to get from the prior collapsing of the 2013 deal was very beneficial to us, because that's $15 million of growth capital that effectively we don't have to obtain from issuing shares of stock which are dilutive to the overall stockholder investor base.

We expect to be a more frequent issuer in 2019 with larger deals as we grow our loan platform, and we continue to exercise redemptions of older deals due to higher prepayment rates.

On slide number 13, we talked about this refinancing.

We anticipate that hopefully getting done today or tomorrow.

It's a $50 million financing.

The deal was led by Webster Bank.

There was 2 syndicate funders in the deal.

It was a great transaction for us in that it gave us a 350 basis point improvement over the prior transaction that we had in our books.

We believe that this interest rate reduction on a 5-year loan will increase the available distributable income at the portfolio companies which would positively impact the company's earnings.

We also announced in the prior quarter and then today, we're getting closer on finalizing an investment joint venture with a global money manager where there'll be a $100 million investment in the funding of non-conforming conventional C&I loans.

We're excited about this opportunity and the joint venture has been negotiating a letter of intent for a $100 million senior secured revolving credit facility, with an accordion feature for another $100 million.

We're excited about both these opportunities and look forward to announcing that these transactions are closed in the near term.

The loans would be originated and funded and securitized by the joint venture, and we do believe when in place this joint venture activity in the non-conforming conventional loan area could have a positive effect on 2019 performance.

Slide number 15 is a general explanation.

We have this slide in repeated calls.

It talks about our pedigree as an SBA 7(a) lender and talks a little bit about how the business works.

On slide number 16, we talk about our pipeline growing.

On September 30, 2018, $342 million up from $232 million the year prior.

We're very excited about 18% funding growth in the quarter and a pipeline increase of 47%.

Looking at units, we certainly looked at a very large quantity of loan referrals in 2018, both in units and in dollars.

In units, it was 119% increase.

For the 3 quarters of this year, we looked at 17,000 different businesses that were interested in a loan opportunity and we were able to process that in the right manner, with great customer service, quick yesses, quick nos.

In dollars, it was approximately a 93.3% increase.

Slide number 18 depicts the amount of referrals that we're looking at for this year.

We think it'll come in between $18 billion and $19 billion, almost double the $10.8 billion received in 2017.

We do expect growth next year.

I don't believe it'll be quite as robust, however, we clearly have a lot of new referring partners coming onstream.

We have a conference coming up in San Diego, the Nagel conference, and we plan on meeting with a lot of different parties that are interested in referring deals to us because of our capability in funding 7(a) loans as well as providing lender service provider services to that client base.

I should note that we recently announced that Newtek Small Business Finance is the largest non-bank government-guaranteed lender at the close of the SBA's fiscal year this September.

Including banks, we're fifth largest up from seventh.

Slide number 19 refers to the net premium trends, and as you can see, it's been extremely stable over our history with the exception of the recent quarter.

9.29% was the price that we sold the government-guaranteed pieces.

This market has stabilized since most of the selling that was done in the third quarter.

It's actually increased slightly and we have very conservative forecasted numbers to come up with our $1.84 premium for 2019.

On slide number 20, we always discuss and offer the status of the portfolio relative to the percentage of non-performing loans to performing loans, as well as charge-offs.

I have said in many previous quarters, and many previous calls, we're not going to be at very low numbers forever and they will increase.

Part of the rationale for the increase is the weighted-average seasoning on our portfolio is ramping up into the belly of the curve.

We're approximately 26, 27, 28 months on seasoning in the portfolio.

The maximum amount of charge-offs typically occur after the second year and between the second year and the third year, so we're moving into the belly of the curve there.

I will also note that approximately $2.5 million to $3 million of our current non-performers are current-pay loans that are in a workout position.

It's sort of the nature of 7(a) lending which is very different than a CRE loan or residential mortgage which most securitization people are comfortable with.

I will tell you that our forecasted charge-offs for 2019 are probably 30% to 35% higher than we received in this current year.

We're very comfortable with our portfolio.

We are in full compliance with the SBA and I just want to make sure that the investment community understands this is an SBA 7(a) portfolio.

When looking at slide number 21, you can see that the mix of the portfolio has changed significantly over the course of time.

We clearly believe, for the better.

When you look at the collateral behind loans on slide number 21 you can clearly see commercial real estate is, we believe the best form of collateral.

Also important to note that the valuations of commercial real estate for loan severity purposes continue to improve.

As the economy improves and as rates rise, the owner-occupied real estate market has done very well from a liquidation perspective for us.

We have less and less machinery and equipment, from 36% down to 13% as well as residential real estate, some of the lessons that we learned from the '08-'09 credit crisis.

Moving to slide number 22, the purpose of the loan.

Obviously, startup businesses had a high of 31% in '07.

We've reduced that amount to under 4% which is a major reason for the improved quality.

Business acquisition is also another tough category.

Existing businesses are the best and that's why we are able to pick through $18 billion to $19 billion worth of loans to pick the best credits for us.

When we look at geography, in the past we did have concentrations, Florida being 22%, now underneath -- Florida at one point in time was 22% of the portfolio.

Florida now is under 8%.

We are big fans of diversification both in industry and loan pipe.

Slide number 24 and 25 is our classic SBA 7(a) loan.

Cash effects, income effects, adjusted for new pricing.

Moving into portfolio company review, we do get asked a lot of times -- gee, can I have more granularity on all these portfolio companies?

I need to state to the investor audience and the listening audience and the analyst audience, the only entity that we really give detailed information on based on SEC guidance is our payment processing business, which is significant and material.

The SEC looks at the portfolio companies as investments, as do we, and they don't consolidate.

So there is a rationale for us not giving very detailed disclosure, number one, on non-material, insignificant cash flows, but those entities over the course of time based upon our business model are anticipated to provide great value.

The SBA 504 loan business, which we are excited about and have talked about previously, is on pace to perform according to previously-given guidance.

We have forecasted 2018 loan closings $75 million to $100 million and fundings $4.5 million to date.

We're very (technical difficulty) optimistic about our 504 loan business due to the growth in referral volume, which we'll shortly disclose, pipeline growth and further establishing our growth for our loan processing group in Orlando, Florida, and in Boca.

Growth of the 504 pipeline quite significant.

We have approved pending closing $34 million worth of loans.

Page 30 gives you the typical structure of an SBA 504 loan.

I should point out these loans are not -- do not have a government guarantee on them.

They have a 40% take-out from a CDC, community development corp., which ultimately gets taken out by government debentures and we're left with a conventional first, which we sell off.

Slide number 31 shows the cash flows and activity when you create an SBA 504 loan, in effect what happens.

Slide number 32, we have and always depict our electronic payment processing business.

We've owned and operated this business for over 10 years, processing in excess of $6.1 billion worth of payments.

We talked about the refinancing of our current Goldman debt which is about $40 million outstanding.

We will have a call premium that we'll have to pay on that transaction, however, the interest rate savings of 3.5% on $40 million should be quite substantial to this particular business and should help and improve our cash flows.

I would like to point out, we recently added to comps some publicly-traded entities that are a little closer in size, i3 Verticals which is a new recent IPO; Jet Pay which was recently sold to a third party; and EVO Payments.

We feel very comfortable about our valuation here, and we like this business quite a bit.

And it's growing very nicely for us.

In the technology side, which is our third largest component, we have a fair market value of $20.1 million.

We said it in other conference calls, we believe that over the long term the technology space, migration to the cloud for SMBs, extremely important segment.

We believe that the technology sector will be a major contributor to our business going forward.

In summary, on slide 34, Newtek is an internally-managed BDC.

We don't pay management fees and extend the fees to third-party providers.

Our interests are very much aligned with shareholders.

Management and the board combined own 6.3% of the outstanding shares.

The average loan size in our portfolio from a risk perspective, $181,000.

Our floating rate loans, prime plus 2.75%, quarterly adjust.

It's an attractive portfolio in this market of rising rates.

We have a proven track record -- established in '98, publicly traded since September of 2000, and we're forecasting our cash dividend of $1.84 in 2019 which is anticipated to be paid out of taxable income.

With that, I'd like to pass 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 third quarter 2018 consolidated statement of operations.

Please turn to slide 36.

In total, we had investment income for the quarter ended September 30, 2018 of $12.4 million, a 29% increase over $9.6 million in the third quarter of 2017.

The majority of this change was from an increase of 34.7% 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 $233.5 million at September 30, 2017 to $286.7 million at September 30, 2018, coupled with increases in the prime rate during the 12-month period.

For the quarter ended September 30, 2018, we also had an increase of $445,000 over the same quarter last year from interest income earned on holding guaranteed portions of loans held for sale.

Servicing income increased by 21.3% quarter-over-quarter from $1.8 million in Q3 2017 to $2.2 million in the same quarter of 2018, which was the result of the SBA loan portfolio for which we earn servicing income, increasing from $791.5 million to $996.6 million quarter-over-quarter.

Dividend income in the third quarter of 2018 increased to $3 million, or 15.7% quarter-over-quarter.

So the quarter-ended September 30, 2018, our divided income included approximately $1.9 million from Newtek Merchant Solutions and $550,000 from Premier Payments which were the primary drivers of the $400,000 increase in total portfolio company dividends quarter-over-quarter.

Other income which relates primarily to legal, packaging and other loan-related fee revenue increased by $423,000 in the quarter of 2018 as compared to Q3 2017.

Total expenses increased by $3 million quarter-over-quarter, or 28.1%.

Contributing to that increase was a $748,000 reduction in expenses in the 2017 period for a change in the fair value of the contingent consideration liability related to the IPM investment.

Salaries and benefits increased by $693,000 due to an increase in headcount coupled with higher compensation levels.

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

Total interest expense increased by $1.1 million in the third quarter of 2018 primarily due to higher average outstanding balances on our debt as well as an increase in interest expense resulting from the February 2018 issuance of our 6.25% notes due 2023, offset by a decrease due to the redemption of our 7% notes due 2021 in March 2018.

Origination and servicing expenses increased by $550,000 in the third quarter of 2018 as compared to the same period in 2017, due to higher referral fees for the current quarter as well as other loan-related expenses period-over-period.

Overall, we had a net investment loss of $1.4 million as compared to a net investment loss of $1.2 million quarter-over-quarter.

Adjusted NII for the 3 months ended September 30, 2018 was $9.3 million or $0.50 per share as compared to $7.9 million or $0.45 per share for the third quarter of 2017.

A reconciliation of adjusted NII for the quarter can be found on Slide 38.

Net realized and unrealized gains totaled $13.8 million for the 3 months ended September 30, 2018, as compared to $9.3 million for the prior comparable period, an increase of $4.6 million.

Realized gains recognized from the sale of the guaranteed portions of SBA loans sold during the quarter totaled $11.4 million as compared to $10 million during the same quarter in 2017, a $1.4 million improvement.

In the third quarter of 2018, NSBF sold 161 loans for $100.6 million at an average sales price of 109.29%, as compared to 117 loans sold during the third quarter of 2017 for $68.5 million at a weighted average sale price of 112.31%.

Total net unrealized gains and losses for the period resulted in net appreciation of $4.1 million which was mostly attributable to the unrealized appreciation on our SBA unguaranteed non-affiliate investments.

Overall, the company had a net increase in net assets resulting from operations of $12.4 million or $0.66 per share for the quarter ended September 30, 2018, as compared to $8.1 million or $0.46 per share for the quarter ended September 30, 2017, an increase of 43.5% on a per-share basis quarter-over-quarter.

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

Thank you, Jenny.

Operator, we'd like to open up the call to questions from the investment group.

(Operator Instructions) Our first question comes from Peter Heckmann with D.A. Davidson and Company.

This is actually Alexis on for Pete today.

I have a little bit of a high-level question and then just a little bit more of a clarification question.

So over on the payments processing business, do you have any information on volume growth?

So it was great to see the $6.1 billion processed in 2017, but do you have any information in front of you in terms of growth trends over 2018 or in between 2018 and 2017?

Volume -- I can give you revenue growth.

I don't have volume growth.

But revenue growth for this year, year-over-year, I believe is around 6%.

EBITDA growth I believe is close to 15%.

That's the first 9 months of this year versus first 9 months of last year.

And then just to make sure that I'm understanding the -- that we're understanding the net premium difference, so, it's down a little bit this quarter due to the prepayment.

But you were talking about earlier in the call, you have prepayments being a benefit.

So would you say that you expect the net premium being down, which is the trend that you would expect going forward?

And would you say that the other benefits of having higher prepayments outweigh that?

That's a good question.

I think that to a degree, there's been somewhat of a focused look at the price of the government's regain-on-sale, and I think that's an important metric.

And that particular gain-on-sale price on a fairly rapid -- which we haven't seen -- I could sort of explain why, but it's a -- I'll call it a market phenomenon more than anything else -- is definitely a negative.

What I was trying to comment on is the offset to that is, we've had rising rates which significantly give us a higher coupon on the portfolio.

We could see our interest income keeps expanding as we have an 8% coupon on our floating-rate portfolio.

It also leads to faster prepay speeds on the bonds, which leads to higher overcollateralization.

So we're able to pick up about $15 million worth of cash capital that would have been locked up normally in a securitization, which are effectively $15 million worth of equity shares that we wouldn't have had to have sold or gotten debt elsewhere.

So what I was trying to basically say, is that there are somewhat offsetting factors to those price changes.

We also believe that obviously for the third quarter, as well as the fourth quarter, things that we're doing in the company overall drive offsetting factors to our business model which is multi-dimensional and helps offset a fairly significant change.

It wasn't small.

That was a fairly significant change in gain-on-sale between Q2 and Q3, and what we tried to demonstrate that, and I've said all along, it's a diverse company.

We have a lot of intrinsic value in our operation.

For example, the ability to get $18 billion to $19 billion worth of referrals, replace that dollar volume -- or I should say, price gain -- with increasing volume as well as to utilize a significant amount of that volume for 504 loans and hopefully launch into the non-conforming sector, we believe will enable us to make up for changes and negative factors in the market.

So that was really what we were trying to portray and we wanted to put all the factors out there for the investment community.

Our next question comes from Leslie Vandegrift with Raymond James.

Just a little bit more color on the premium, obviously thank you for the color you've already given about the higher prepayment rate and kind of what we saw in the market as well.

But specifically for your premium, does the mix in 10-year versus 25-year loans you were doing on the 7(a) side have any impact there?

Great question.

There's a major difference between a 25-year loan and a 10-year loan.

So a 25-year loan after the 50% split will clear the market, net to us today, at around I'm going to say 110-5/8 and today, a 10-year loan will clear around 109-5/8.

There's almost 2 points different in pricing.

And we also experienced a mix in the third quarter that was not a mix that we thought we would see.

It was actually blended more to the 10 years.

Now, one of the benefits of our model, which is to get real retail referrals, speak to thousands of referring partners, gives us the ability to pick and choose the best credits.

And obviously we could lean more towards looking at more 25-year deals backed by real estate.

We just happened to get caught in a fairly radical shift in a short period of time.

But your question is very good.

I think that for the fourth quarter we're looking at our pipeline, we'll probably be near 50/50.

Our pipeline in the third quarter was about 2/3 10-year and 1/3 25-year.

Perfect.

And then for the fourth quarter about 50/50, but given the loan referral system does it seem more likely that maybe not an even split going forward?

But in the future, you might be a little bit more weighted to the 10-years than you have in the past just given the nature of those referrals?

Yes.

It's a great question.

We forecast a lot of things, and it's real hard to exactly forecast 10 years versus 25 years.

But we believe that there is enough 25-year opportunity with good credit in that $18 billion to $19 billion that we'll be able to make our numbers.

And there are a reasonable amount of moving parts in our model.

We pay very close attention to that in all aspects of the business, both financially, operationally, and from a credit side.

So I mean, I think that 50/50 is probably a good range but we're not concerned that we're not going to be able to find good credit opportunities in 25-year deals going forward.

It's not -- there's no market change.

And we think our origination sources will continue to increase next year.

And at the end of the day, our goal was to make sure we deliver good results and make our numbers and do good credits.

And on leverage, obviously you got the ability from shareholders in the quarter to increase your leverage cap or in other words, decrease the asset coverage ratio.

And you've already started to utilize that a bit.

I know you said it will take time to leverage up, but when you do eventually move up, what's kind of the new target cap?

I know 2 times is the regulatory one now, but kind of the target range you're shooting for?

At the moment, it's -- I'm going to say slightly over the 1-to-1 but that's not the long-term target.

Part of it, Leslie, is we are looking for some guidance from the rating agencies which is kind of far and few between at the moment.

We are an A-minus Egan-Jones-rated entity, which I'm not sure is -- it's been helpful on baby bond issuances, but not the be-all and end-all.

So I don't think you will see us super-levered.

However, I don't -- we have absolutely zero issues with concern from a risk standpoint, managing 1.6, 1.8.

We were not however, a BDC prior to 2014.

So we've managed 3-to-1 and 4-to-1 leverage as a non-bank lender.

That's really not an issue.

Our issue is to sort of feel out where the market is.

We're very comfortable with increased leverage.

Why?

My average loan size is $181,000.

It's a floating-rate portfolio.

We've done this over 15 years.

We're primarily senior secured, collateralized lender.

So unlike other BDCs that have hidden leverage in the assets because they're [mez] and sub-debt lenders, therefore should be limited to this amount, as a non-bank lender primarily doing senior secured loans we're very comfortable within the 2-to-1 boundary.

And if I remember, we had this conversation back I think a year ago when we were like, 0.85 versus 0.78.

It was like, oh my god, you know?

But the reality is the market perception is the reality.

So I say that and I think what we've indicated is that we anticipate staying under 1.2-to-1 through March.

Hopefully we'll be able to keep that, but it doesn't bother me that we can't manage that risk.

My concern would be more what's the market thoughts and where's the rating agency thoughts.

But we're not uncomfortable managing that additional leverage at all, particularly given the unlevered status of our assets.

And on the dividend income, you gave the breakdown in the prepared remarks and I heard the $550,000 from Premier and the -- excuse me, $1.9 million from Premier and $550,000 from Newtek Merchant.

But -- or I actually got that backwards?

Sorry.

But what was the remaining $475,000 dividend income from?

Sure.

I could answer that, Leslie.

The additional $475,000, $375,000 came from [Sico] and $100,000 came from Mobile Money.

Perfect, thank you.

And then we talked about the 504 loans, for the past few quarters quite a bit, and you're starting to be able to grow those fundings.

But when it comes to the BDC income statement, Barry, if you could just walk me through exactly how maybe 2, 3 years from now as it grows, how that really impacts the profit/loss statement for the company?

Sure.

Leslie, the 504 business will I'm going to say primarily -- I won't say exclusively, but I'll say primarily -- come through a controlled portfolio company and will be taxable.

And then the after-tax income will be distributed up through dividending, and most likely the entity that that business will come out of, I'll say almost exclusively next year will be an entity called Newtek Business Lending.

As we've shifted that business into that entity, that's where our Capital One Bank leverage line is.

So the income is -- you know, your coupon on the loan, versus your cost of money in the warehouse line, origination fees that you receive, and then gain-on-sale when you sell the conventional first-off into the market.

Do the regulatory requirements around 504 and part of it being non-profit impact how much you can pay out on that dividend?

Yes.

I'm not familiar with any aspect of non-profit in 504, so in the 504 business we're lending to for-profit companies and there's no prohibition on our ability to distribute the money up.

And just a last quick question, what was the previous cost of debt at Premier and Newtek Merchant that you were able to bring in by 350 basis points?

Because that's a big change, that's a good savings there.

Yes, LIBOR plus 6.

Our next question comes from Mickey Schleien from Ladenburg.

Barry, could we just step back a minute?

I mean, it was -- the prepared remarks are fairly extensive and we're all scribbling our notes.

Can you just sort of give us your base case view of the economy next year that's baked into your budget and what you're sort of assuming in terms of prime rate increases for next year and CPR and pricing for SBA 7(a)?

And then I have another follow-up.

So I'm glad I have the opportunity to answer this post- the election, because that helps a little bit with a split Congress.

But we believe that we have a very strong economy that most likely now will not get derailed given that the regulatory changes, which I think is probably a significant portion of the driver for economic growth, probably won't change much.

The tax cut was beneficial to our small-to-medium-size businesses that pay taxes.

And the Fed's forecasting a rate hike in December, and I believe they're forecasting 2 rate hikes next year.

And with personal income growing and inflation starting to show its head, I don't believe we will see any changes there until, I'm assuming, those 3 rate hikes happen.

From a speculative perspective, I think that trade deals will continue to get done, so a trade deal with Mexico and Canada was kind of a surprise.

I think we're likely to get a trade deal done with China.

I think that'll be fairly constructive to the market.

It'll also be somewhat inflationary.

So we think that market continues to have very good growth, tight unemployment, some inflationary trends which will keep the Fed tight.

And just can you give us an update to the extent that you can on banc-serv?

I think that occurred about a year ago.

I'm just interested in what's occurred since that initial event.

Sure.

So basically, as we sit here today, that is an ongoing investigation of a portfolio company that we made an investment in.

We've written the investment down significantly.

We have stated that we have a similar organization, small business lending, that's in the LSP business.

And the -- we believe that this is not a bank-serv issue.

We strongly believe this is not a Newtek issue at all.

And that this is an issue that's primarily based upon employees that used to be at bank-serv many, many years ago.

So we have valued the bank-serv investment appropriately.

We think that the bank-serv brand has been tarnished, and we're minimizing assets and activity in bank-serv but are able to service those customers in affiliated entities.

We've been very supportive of bank-serv since the September of last year issue, for the purposes of supporting clients that had business in bank-serv and supporting the small business administration because effectively bank-serv provided services to banks, who in turn used bank-serv as an agent.

So I mean, the best thing that I could tell you is, we think this is a non-event to Newtek Business Services Corp.

We think that we have appropriately valued bank-serv's assets in the right spot.

The bank-serv staff has recently changed and downsized its location, and is now cohabitating with the sister company, the affiliated entity, Newtek Small Business Lending, in Indiana which will enable us to service customers and the SBA in the best possible way.

But this has really had no effect on us with the exception of the write-down of the bank-serv investment.

(Operator Instructions) Our next question comes from Fred Cannon with KBW.

Just 2 kind of bigger-picture questions, Barry.

We see this decline on gain-on-sale, and it appears to be driven by prepayment speeds accelerating.

Could you talk a little bit about the background behind prepayment speeds accelerating?

I mean, I see it as a combination of interest rates rising and small businesses being fairly flush with cash as a result of the tax bill, but maybe there's more to it than that?

So the prepayment speed changes for a small business loan are night and day, for example, between for a residential mortgage or even an auto loan.

The driver for a small business to refinance a current SBA loan, or sell its business which drives the prepayment speeds, has to do with economic activity.

It has to do with the slope of the yield curve.

And currently with the coupon at 8% because short rates are almost as high as long rates.

And if you own commercial real estate, which we might have advanced at 85 or 90, and now you can get an advance at 70 or 75, you might be able to go to your local community bank, get a fixed-rate loan at 6% or 6.5% for 5-year fixed or 10-years fixed, which is significantly better than the current floating rate.

And you don't need the over-advance, because the value with the real estate and/or the business has appreciated.

That's the primary driver to refinancing.

The secondary driver would be, hey, the market's up, my business is worth more, the real estate's worth more, I'm selling the business.

Or I'm selling the real estate.

Those are the drivers by refinance.

Honestly, that's 90% of the refis.

Okay great, so when I said rising rates it's really a combination of rising short-term rates and a flattening curve at the same time creates this kind of refi opportunity, if you own some commercial real estate?

Big time.

If you had a sloping yield curve so the 10-year wasn't at 320 but was at 5% -- which by the way, when you think of where short rates are at 3% -- in my lifetime, 200 basis points between short rates and 10-years wasn't a big deal.

I mean, we've been in this weird market for a long time with fairly flat yield curve.

That's not absurd.

That takes away this refi opportunity as well.

Sure, of course.

We'll have to see what happens with German bonds and the rest of the world on those things.

Yes.

The second challenge, and this is kind of my challenge, Barry, or Luke and my challenge, is in terms of modeling moving forward.

And that is, if 3 months ago we had correctly expected gain-on-sale margins to come in where they did this quarter because of accelerated prepayments, we couldn't have gotten to -- we would have had to kind of cut our estimates because we couldn't have gotten to your number.

Although you know, through the portfolio company improvement and expense improvement, you continue to generate good numbers.

This afternoon, we have to kind of put in a 2020 estimate, and we're probably going to since we have a fairly flat curve into the future, keep gain-on-sale relatively kind of in the current line.

But I suspect the company will continue to be able to, through various things, be able to offset that with improvements in some of the non-7(a) program.

Maybe you could just help us from a modeling -- but yet, what we find is it's been very difficult to model the income from the portfolio companies.

Maybe you could just help us kind of work through that challenge, if you don't mind?

I appreciate it, Fred, and your challenge is my challenge.

So we're very careful running our business.

We've been doing this for a long period of time, and we give one-year guidance out in advance.

And we look at all the different inputs that go into driving the number.

One of the things we did on the call today, was that we expressed that given the amount of referrals we get, a very modest change in the close rate with no increase in referral volume would equate to an increase in 7(a) that would almost make up for the price difference.

We also talked about the refinancing of debt and lower cost of capital, which will reduce interest expense and improve cash flow.

And we also feel that you're going to need to use some pricing number which -- Jenny's given me an okay on this -- we're using around a 109 for our forecast for next year.

Now, I will tell you that when you look to start to model these floaters, that at 109 have a coupon of net prime plus 1.25% -- prime, I think, is 5.25% now, I think -- so 1.25%, you're almost at a 6.5% coupon.

And now you're amortizing even at a 28 or 25 CPR, that floater is still a very attractive floater, even at all-time high prepay speeds.

I don't think there's a tremendous amount of downside as you start to model these things out.

We have a pretty good feel for the metrics in our portfolio companies, so I think that we could look at our track record of dividending funds up from the portfolio companies for income.

Jenny, I think last year was like between 30% and 33%?

Correct.

Of the dividend.

That's not -- yes.

I think that's -- and by the way, this is a forecast.

I could be wrong.

But you know, I've got my Chief Legal Officer on my right shoulder here.

You may want to use past history to use that number to give you some guidance.

We're trying to be as transparent, as helpful as we are.

And then you could sort of look at it quarter-to-quarter in terms of what those dividends are, and we'll be here every quarter to walk you through it.

That's helpful, Barry.

We have the same challenge.

I appreciate it.

Thank you, Fred.

Thank you very much, and look, we always try to be careful.

And we've had a good track record historically going forward, and that's why we want you to take a look at what we've done historically and how we try to forecast these things.

Our next question comes from Casey Alexander with Compass Point.

There was an entry in the income statement, a $300,000 gain from something called conventional loan.

Was that the first sale of a 504 loan, or the first group of sales?

That actually was a straight conventional loan.

We had teed the borrower up for a 504.

The borrower had an earlier financing need.

We did do the loan conventionally and we subsequently sold the loan.

Okay.

So that's going to be non-recurring in future quarters then, most likely?

Correct.

Particularly from the BDC level, absolutely, 100% yes.

Right, okay.

Secondly, I was looking at your debt-to-equity ratio explanation, and if you have $39 million -- and this could very well be just because I don't understand the timing of this -- but if you have $39 million that are rolling over the edge of the quarter and you funded $122 million during the quarter, does that -- is that $39 million all fundings that were done in, you know, essentially the last week, week-and-a-half of the quarter?

Yes, Casey, that was a fun last week.

Peter really appreciated my presence in his office that week, yes.

Okay.

So 32% of your funding for the third quarter basically came right at the end?

That happened in the last quarter, and that's not supposed to happen.

Okay.

Secondly -- or I guess, thirdly -- your forecast of fundings for 2019 -- if I take the midpoint, and the midpoint of '18, presumes 26% growth.

But the economics of a new SBA 7(a) loan are exactly the same economics as an existing loan because of the floating rate nature.

Your existing earn 8%, the new that you're underwriting are at 8%.

The factors that are impacting the prepayments, why would those not also be impacting the demand for SBA 7(a) loans, if the economics are compelling for a larger group of people to refi their SBA 7(a) loans?

Casey, great question.

So I point you to our referral volume.

Our referral volume is blowing away industry statistics, for the industry has been down I think 10% for the last year in fundings.

And look at our referral volume.

And our referral volume is where it is because we do our business not just in lending, but in payments, insurance, technology, entirely differently than anybody else because of the alliance partner relationships, because we use technology, because we process the business better.

So I think that the secret sauce that we have isn't based upon industry trends.

We continue to beat industry trends and we make SBA 7(a) loans.

So I think one of your questions might be, Barry, why do you think you will be able to make an SBA loan when the market is at 8%, when it was easier to make it in the past at 7%, or 6%, versus the competition?

And it's because of how we do the business.

And our loans are interesting to borrowers that want a long am schedule, that want to not have a financial covenant that banks typically charge, and are okay paying the extra rate because they can get a slightly better over-advance than a commercial bank can.

I also want to point out that this is a program that's been around for 64 years, so it was around when prime was at 10%, 12%, 14%, etc.

And therefore, there are borrowers that will do well in that interest rate market.

We will have demand and if you look at our types of loans, the typical SBA lender is in convenience stores and gas stations, they're in hotels, they're in car washes.

The percentage of that business for us is always very, very low.

We have a very non-traditional way of working with borrowers to suit their needs with the primary functionality of an SBA loan being the long am schedule, which a bank won't do.

So we have certain customers that once they get to be able to refi out because they have a higher LTV, they'll refi out.

That's really the issue.

Thank you for that.

I appreciate your statement that it's just -- that based upon seasoning, we should expect some increase in non-performers and charge-offs but that you're well within the SBA guidelines.

In relation to non-performers which are 5.8%, or charge-offs which are 0.84%, what is the level where the SBA would start to become concerned?

Casey, I could never answer that question.

I can appreciate the difficulty of parrying the thrust from a government entity.

Let me ask you a different question.

Were you --

Well, let me try to -- let me try to give you an answer.

We're in good standing with them.

They were just in here in August.

Our PLP status is intact.

They just approved $109 million securitization.

We're a lender in good standing.

Okay.

To what degree is the increase in rates actually contributing to the increase in non-performers or charge-offs?

That's a good question.

I think that the increase in rates -- so we've talked about this in prior calls, just tax rates went down which benefit our borrowers.

But the increase in rates take a borrower that's marginal and puts additional stress on the borrower.

So I do think that the increase in rates will stress borrowers more and cause weaker borrowers in the portfolio.

By the way, you could make a loan and the borrower's strong, then over the course of time based upon whatever, they become weaker.

And the rate stress will weaken a portfolio.

So I would tend to agree with the assumption that higher rates are problematic, but it's not like -- when you look at the percentage of change, on a million-dollar loan, depending upon the size of the business if you bump rates up by 1% on a million-dollar loan, it's $10,000 over the course of a year.

To any business that's significant, it's not a lot of money.

I can appreciate that.

This is my last question.

As it relates to the payment processing business, the 2018 forecast of revenue and adjusted EBITDA did not change.

The companies that you used as comps at the end of the second quarter, their multiples declined quarter-over-quarter but you added 3 higher-multiple companies to the mix and then increased the multiple that you used against a business where you forecast didn't change, and then marked the business up $4.5 million.

Is that fair?

You're asking me if my mark is fair?

Based upon my SEC standard and all the processes that we've gone through, and the fact that my mark is 7.4 times EBITDA and all those entities are double-digits?

So I got one guy on one of my shoulders saying it's marked too low, and you're telling me it's marked too high.

And let me tell you --

I'm just saying, on a quarter-to-quarter comparison, one would fairly ask, why add these other portfolio companies and then mark it up when the ones that you were using in the second quarter all came down?

So I give you an A for all your questions except for this one, and you could give me -- you can give me a C failing grade too at times.

But I will tell you, Casey, these are businesses that we're marking as securities and what we do is on a quarterly basis, look at moving averages, trends, and we think that given the valuations in these businesses the trend of a higher price value on this business is totally appropriate.

And when you look at, like i3 Vertical, that just went public over the summer.

And the stock price screamed.

EVO stock price is screaming.

Which, by the way, for the most part, those entities respectively would love to have our customer base.

So these are the things that go into our valuations along with discounted cash flow and cost of capital, and we're very comfortable with that number.

It's totally appropriate.

Our next question comes from Scott Sullivan with Raymond James.

My phone dropped off as you were talking about the non-performing JV, so I missed that commentary.

I'll definitely go back to the transcript, but my question to that is, number one, is there any material contribution to that JV in any of your guidance going forward?

I would say, Scott, at this point in time we -- without that being inked, and starting in the process, the answer is no.

It would be zero.

I respect that.

So I've owned the stock for quite a while, and obviously you guys have put together a very nice process.

And what's always struck me has been the incredible volumes of referrals.

And I see that you're using or utilizing, finishing off if you will, around 2.5% of that large volume of referrals.

And yet, you're continuing to grow your loan book.

And I guess I would sort of put a weird question in front of you.

What are you guys doing so well that the rest of the banking community is not, where they're actually seeing pressure on their loan growth?

Well, thank you, Scott.

I think that the real issue, once again, it relates to our business model and the fact that we know how to handle, interface with, business owners where banks go after business owners with very high-priced bankers that are incented to make these kinds of loans.

They do it very manually.

Matter of fact, most of the time they're taking documents from clients on a totally unsecured basis.

And we've been in this business now for 15 going on 16 years.

So it's the way that we relate, number one, to the client.

The fact that we don't use brokers, which are the easiest way.

The fact that we've had a long-term approach to this business and other businesses, despite pressures to -- as a public company you could see by the nature of this call, we're under a microscope.

You know, we've got people in our ears, they want to know every little thing that's going on.

We try to be as transparent as we possibly can.

But the reality of it is, Scott, we made an investment in this business model a long time ago and it always has -- it hasn't always been pretty.

But right now, we've got it right and we make it very easy for some business to get to us and say, I'm interested in a half-million dollar loan.

And instead of having a banker who really doesn't want to make the loan -- because it's a $500,000 loan or it's a $1 million loan and there's not a lot of deposits, which they're rated on -- we give them a technological file vault to upload documents so it makes the borrower's life really easy.

They don't have to chase their outside accountant, they don't have to chase their outside lawyer for the formation documents.

They don't chase their inside controller.

We make it very easy to get a quick yes or quick no.

So people that have gone through the process, go, oh my god, this is fantastic.

I want to do more of this.

And banks -- I meet with a ton of banks, and they look at this and they go, gee, I can't get my people to act any differently.

Nobody wants to change.

Whether it's a technology company, it's a bank -- so we've developed this over the course of time, and it's really the model that allows us to connect with a business owner when they want to connect.

Not necessarily 8:00 a.m.

to 5:00 p.m., because what business owner wants to talk to you from 8:00 a.m.

to 5:00 p.m.?

They want to talk to you when they want to talk to you, when their business isn't open, in the evening, on the weekends.

And we make it very user-friendly for them.

And that's the reason why the business models work and the referrals keep increasing.

So, you obviously have a wide moat from that respect relative to other institutions trying to make a loan book grow.

If you had suddenly the capacity of a mid-size regional, would that materially suck up a lot of those referrals, conceptually?

If we had the -- I think I missed the question, Scott.

Sorry.

If you had the capacity to handle a lot more than 2.5% of this referral book, wouldn't that be material?

Well, I think that it wouldn't be a big deal for us to go from 2.5% to 3% with referrals being the same.

So you know, what we've tried to portray is in the last year, we've expanded our footprint geographically in Lake Success and in Boca, and in Orlando.

We've increased our staff.

We've hired some really good additional talented people.

And we continue to improve our technology.

So our ability to process and close greater volumes of loans without stressing the system at all is there.

So we're pretty comfortable with that.

In addition, we think there's significant volumes in the $18 billion to $19 billion that will fit 504 and will fit non-conforming when it's in place, and all that will be additive.

Right.

And obviously the non-conforming is the big question mark for the horizon, I guess, and that's all I have for today.

Thank you so much for taking my call.

Thank you, and I am now showing any further questions at this time.

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

All right.

Well, thank you all for attending.

We certainly appreciate your investment, your patience and your studying our company, and look forward to reporting fourth-quarter results.

Thank you very much.

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

This does conclude today's program and you may all disconnect.

Everyone have a wonderful day.