NewtekOne Inc (NEWT) 2018 Q4 法說會逐字稿

Thank you very much, operator.

And to our investors present today, we greatly appreciate you attending our full year 2018 financial results conference call.

We do have a PowerPoint presentation that is attached to our Website, newtekone.com, Investor Relations section.

And we'll be following along with that presentation.

I'd like to point all your attention to Slide number 1 on the forward-looking statements and would appreciate if everyone would have the opportunity to absorb that.

We'll now move to Slide number 2. And as we do on these calls regularly, we like to look at the company's historical stock performance.

Obviously, last year was a challenging year for most public companies with respect to stock performance.

However, if you look at our 5-year, 3-year, and 1-year returns, all quite stellar.

Newtek's total return for this calendar year, which does not include the first quarter dividend, 13.8% as of Feb 28, and that's with the stock trading at $19.84.

We are higher than that.

We closed yesterday at like $20.19.

Moving to Slide number 3, relative to outperformance for the year ended December 31, 2018, total return, which would include reinvested dividends, Newtek up 3.5%.

We clearly outperformed the S&P, which was negative, the Russell 2000.

And we look forward to continuing to be able to deliver that type of performance to our shareholders.

On Slide number 4, we added a slide that we usually don't and probably won't in the future.

However, there was a foreseeable jump in short interest on our shares.

If you follow along from the middle of November to February 15th, which was the last active date, we've gone from about 3 days in cover to 14.6, 3 days in cover.

We see this activity as unusual.

We wanted to point it out to the market.

Our stock will go ex-dividend on March the 14th.

Moving to Slide number 5, we're very, very happy and excited about talking about our performance in 2018 as well as future forecasting for 2019.

Our future looks very, very bright.

Obviously, in looking at growth in key metrics, we had a year-over-year increase in the 7(a) business, which historically has been a driver for us.

We look to add additional drivers, which we'll talk about on the call.

Our loan volume was up a little over 20% for the year, and we're forecasting 20-plus percent growth for 2019 in 7(a) volume alone.

On referral volume, which obviously is key to us being able to grow the business as well as pick good credits, we grew to about $18.8 billion, a very healthy growth in loan referral opportunities over the prior calendar year.

We have a slide on that in the presentation.

We've clearly been able to improve and increase our technological advances, which allow us to process loans quickly, get them through the system.

We use technology to improve the customer experience as well as the employee experience and get loans through pre-qual underwriting into committee as quickly as possible.

Obviously, things do change over time.

And probably on the last call, everyone was concerned about rising rates.

Listening to Fed governors and certain pundits, that's a little bit less concerning.

However, we clearly have a floating rate portfolio without any caps.

Our liabilities are also floating rate.

It's very well asset-liability managed.

We've been able to reduce our cost of capital by evidence in a 50 basis point reduction in our Capital One line last year, a refinancing of our Goldman Sachs line with Webster Bank, a savings of 350 basis points on approximately $40 million of debt.

We've increased our capacity in lending lines for 504 loans, which if you add in the accordion features on that business, we have approximately $150 million from Capital One, are in negotiation with Sterling to bring that line up to $100 million.

So clearly, our organization is bullish on the 504 component and being a growth segment and a future engine of growth at the portfolio company level in 2019 and beyond.

Moving to Slide number 6, focusing on 2018 financial highlights, total investment income up 27% for the year.

Our NII, which most of you are aware comes in at a loss due to the fact that gain on sale is eliminated from a GAAP standpoint, however, the loss narrowed to an 11.1% increase on a per-share basis, so NII improvement of 11.1%.

Adjusted NII, which includes gain on sale that most of you are familiar with, we had a 9.6% increase to $36.4 million, or $1.94 per share for the year, which did beat analysts' consensus estimates by $0.02 to $0.03.

NAV, year-over-year increase, not quite 1%, but given the challenges in the fourth quarter, where cost of capital clearly widened out, we're proud of our performance in having a steady NAV for the year.

From a leverage perspective, debt to equity came in on a GAAP basis at 117%.

If you exclude the result of government-guaranteed portions settling over the quarter, that would get knocked down to about 105%.

Total investment portfolio also increased by 18.5% for the year.

Moving to Slide number 8, we like to focus on sort of the rationale for why people own Newtek Business Service Corp shares.

Obviously, it's a dividend-paying stock as a BDC.

And [according to that] company, we must pay out between 90% to 100% of our taxable income in the form of a dividend.

And as we always state in our public releases as well as to investors, we always and have always endeavored to pay that out of taxable income, which has been the case so far.

So if you go back in our history, and people say, "Gee, why has your stock performed so well?" Well, look at the dividend increases.

We started off at $1.50.

Last year, we delivered $1.80.

We're forecasting $1.84, so 34% increase over that period of time over $1.50 base.

It's a real nice increase, extremely impressive for a BDC.

Dividend growth is clearly one of our primary objectives.

And as we look to add additional lines of business in at the portfolio company as well as a growing 7(a) business, we are clearly excited about our future.

Moving to Slide number 9 on 2018 SBA highlights, we funded close to $470 million of 7(a) loans, a 21% increase over $385 million.

We're forecasting a midpoint range of $600 million, $580 million on the down, $620 million on the upside, and that would be a 27% increase.

Given the volume that we have in 2018, which we do expect to increase this year, if we just nudge that close rate up from 2.5% to 3%, which we are adamant about will not cut into credit quality, we pick up another $90 million of funding.

So we feel very good about being able to increase the amount of fundings in 7(a), be able to execute better and close more as our 504 business matures.

And we're extremely excited about the opportunity in our nonconforming segment, which we'll talk about shortly.

On Slide number 10, some highlights, we talked about the reduction in our line for the payment business with a refi of Webster, saving 350 basis points.

In November of 2018, we closed our ninth and largest securitization with Deutsche Bank and Capital One Bank as the underwriters.

It was a great transaction for us that significantly sold a deal at greater spreads, 3.7 cover.

And it was the largest deal that we have ever done.

We look forward to doing more of those in 2019 as well as other securitizations, particularly in nonconforming.

In February of 2018, we closed an underwriting of $57.5 million of baby bonds trading above issue, stock symbol NEWTI on the NASDAQ.

Baby bonds will be something that we'll continue to participate in going forward as well as our equity-based ATM, both of their shelf.

And lastly, as we mentioned, we had a 50 basis point reduction in our $100 million revolver through Capital One.

On Slide number 11, forecasting 7(a) loan fundings, as we've said, capital is sufficient, both via equity or debt as well as capital on the balance sheet.

We do think that our referral volume will grow significantly in 2019.

We talked about our close rate being a very modest 2.5%.

We also talked about expansion in our offices, both in the Boca office and the Orlando office, Irvine office to help us grow our lending platform.

We're picking up new alliances on a regular basis.

That's adding to our referral count.

And obviously, the launching of the nonconforming conventional loan program we think will also be additive to the 7(a) and 504 business.

On Slide number 12, we talk about our securitization in a little bit more granular basis, 83.5% advance rate, the best advance rate that we've had.

And the notes were priced at initial yield of 4.32% with a gross coupon on those notes prime plus 2.75, which is about 8.25.

So on the loans that were paying interest through the bonds versus the coupon, look you've got a close to 390 basis point spread asset-liability, and then you've got 17% of the pool that has no debt.

That's the equity in the securitization, throwing off an 8.5% coupon.

So you could see the more of these types of transactions that we're able to add, we'll be able to get more interest income, less expense.

Clearly, that's a growing segment of our contribution, which is one of the reasons why our GAAP NII continues to improve year-over-year.

On Slide number 13, something we haven't historically talked about relates to exercise of optional redemptions in our securitizations.

So our typical securitizations have a call option at around 20% of the bond phase.

That's value because our bonds are -- we use the term turbo structured, meaning that the collateral is fully dedicated to pay off the senior debt.

So when we get to that call option, we're able to relever the collateral plus the cash in the reserve fund.

So last year, we were able to redeem the 2013 notes and add them to our 2018 securitization.

Through that call option, as a result, we were able to increase our borrowing ability by approximately $15.6 million, which represents the cash in the reserve fund plus the ability to lever the collateral in first a warehouse line and then in a securitization.

The advance rate in the securitization at 83% is clearly above the advance rate that exists in the warehouse line of 55% and is also well in advance of the overcollateralization as the bonds pay down in turbo.

So this is useful to us because we're able to take that additional cash, and that's cash that's useful to making new loans, grow our business without having to raise additional equity.

Very important, it pushes equity rates into the future and enables us to increase our adjusted NII and NII per share to investors.

We do anticipate in 2019 announcing another such redemption, which we haven't done at this point in time, which will provide us a similar benefit that we had to the 2013 deal.

On Slide number 14, we talk about the positive effects of rising interest rates.

Who knows?

On the next call, we could talk about what happens in the declining rate environment as the world has changed.

But clearly, with our portfolio being well asset-liability matched, quarterly adjust, but plus floating rate on the liabilities, we're in a good position with a pretty good margin.

And although higher prepayment speeds are negative with respect to the servicing asset and possibly to premiums, they are helpful in generating additional cash, paying the bonds down faster and reducing our need for equity capital.

On Slide number 15, we have previously announced through an 8-K and on this call that we, through a wholly owned affiliate of Newtek Business Service Corp, signed a joint venture with BlackRock TPC -- TCP, sorry, Capital Corp.

And the purpose of the JV will be to originate commercial business loans to middle-market companies as well as small businesses.

We're excited about the venture.

Newtek and BlackRock TCP are committed to contribute up to $100 million in equity capital each.

We're working on closing a leverage warehouse facility, $100 million to -- $100 million at the start, up to $200 million in an accordion feature.

We're very excited that we believe out of the existing $18.8 billion of referrals that there could be close to $300 million of out those historic looks that could be available right out of the chute to be able to do this type of business.

Company believes the JV investment in nonconforming conventional loan program could have a positive impact on [2019] performance, but we have not put it into our dividend at this point in time of $1.84, which also relates to being paid out of taxable income.

On Slide number 16, obviously, we talked about that refinancing with Webster Bank, very positive.

And in Slide 17, we affected a very nice attractive sale on a wholesale portfolio, wholesale meaning they were wholesaled to Elavon, Elavon owned by US Bank, one of our processing platforms.

So we sold 1,200 merchants back to Elavon on their platform.

This is a portfolio that we picked up in the Premier Payments acquisition, which was approximately 3 years ago, I think a little short of 3 years.

And in that sale, we recorded a $5.6 million pretax gain.

After tax, I think that's around $3.8 million.

Some of those funds, which Jenny will talk about, and earnings were upstreamed, but there's still a healthy amount that's sitting down within our merchant processing portfolio company.

We received a $7.5 million upfront payment with a $500,000 earn-out, which we think and are hopeful we will receive, equates to a total of $8 million.

We paid $16.5 million for Premier a little less than 3 years ago.

So if you look at the math, and this -- and the Elavon portfolio was about 25% of income and processing volume.

So that would equate to approximately $4 million of the $16.5 million.

You're looking at a double basically in 3 years.

So we're very proud of our payments unit, growing the business, making good on a solid acquisition.

Now what this does to (inaudible) is, when you sell it, you lose that recurring income, which was somewhere approximately around $1 million.

We also exercised a call option on approximately 1,200 merchants with our distribution channels.

That allowed us to improve our cash flow by approximately $1.5 million.

So that will offset the $1 million.

And we're excited about this.

We have a nice forecast of about $15.5 million of EBITDA from our payments unit going forward.

And that helps our valuation, nice growth business for us.

And we're pleased to also note that one of our largest acquisitions to date has worked out well for the company and its shareholders.

On Slide number 18, that's sort of our pedigree in 7(a).

We are still the largest nonbank 7(a) lender.

In the fourth quarter, we're the fourth largest 7(a) lender, including banks.

And when I say fourth quarter, that's fourth quarter calendar.

It's first quarter government because the government closes its books on September 30.

I think it's also always important to note, when you look at the risk in our loan portfolio, you're looking at 181,000 average balances floating-rate coupons, no caps.

We think, when you look at our portfolio versus other BDCs, the level of risk and diversification that's inherent in our portfolio, extremely attractive, given a $1.84 dividend vis-a-vis what is currently a $20 and I think it's $0.16 or $0.19 price.

Slide number 19, our 7(a) loan pipeline, up about 35%.

Now one thing about our pipeline, our technology is allowing us to clear loans through the pipeline quicker.

So you're going to see lower and lower growth rates.

Don't fret.

This is based upon efficiencies.

It's based upon our ability to pick and choose through the credits, decide which ones we want to close, maintaining modest growth rate, not an out-of-control growth rate.

What's the difference between a modest growth and an out-of-control growth rate?

A modest growth rate for a lender means that you've got the right talent in place.

You've got the right technology.

You've got the right systems.

You've got the right policies and procedures versus just pushing things through the system to make accounting gains.

Well, we've been very successful in managing this business over the course of 16 years.

And we think that controlled growth, particularly making sure that you've got the right staff in place to do the business the right way and maintain your risk-reward parameters, is really, really important.

On Slide 20, growth in loan referrals, in dollars, $10.7 billion to $18.7 billion, a 74% increase.

And in units, we looked at 64,000 units.

That's a lot of people to talk to and, in many cases or in most cases, say no to.

21 is a graphic depiction of referrals.

22 talks about pricing in the secondary market or the government pieces and trends.

So for the 3 months ended September 30th -- I think this is a typo.

So that should be for the 3 months ended December 31.

We basically moved our gain on sales sequentially from the end of the third quarter to the end of the fourth quarter from 109.28 to 109.97.

For the year, we averaged 10.52%.

Look, we talk about the decline in the weighted average net premium.

And we believe, obviously, it's an increase in the speeds, which has a correlation to higher levels of rates.

But the decline in pricing is based upon prepayment speeds.

On Slide number 23, and we talked about this in the previous call, we're looking at an NPL portfolio about 5.7%, charge-offs about 85 basis points.

As we mentioned previously, we don't think that we have a 35 basis point charge-off portfolio in a given year.

We are now in the belly of a default curve.

The seasoning of our portfolio I believe is 27, 28 months.

The belly of the default curve is from 24 to 36 months.

So this should begin to level off.

If you go to the next slide on 24, sequentially from the quarter end in September to the quarter end in December, you can see that as appearing to flatten out.

And it not only is appearing.

It is.

On Slide 25, looking at the context of the portfolio, loans that are backed by commercial real estate, important to note we are not a commercial real estate lender.

We are what's referred to in banking parlance a C&I lender, commercial and industrial.

We make business loans.

In the course of making the business loan, our credit thesis is the business must demonstrate the ability to pay the P&I.

Then we take all personal guarantees.

We take all collateral available.

The collateral of choice which has the best recovery for us, obviously, is commercial real estate.

That's what we choose.

Now just because we take commercial real estate as a first, it doesn't mean that we're not taking marketable securities for the principle, inventory, accounts receivable, a lien on the home, machinery and equipment as a second, third, or fourth.

We take all available.

That is the key to our underwriting.

And you can see real estate is important to us between commercial and residential liens as the primary still in excess of 55%, quite a difference from '07.

When you look at Slide number 26, the purpose, obviously, we're not a huge startup fan.

We're also not a huge business acquisition fan.

But we do do them.

It's important to note.

Existing businesses, clearly the bread and butter, 83%.

Loans made to businesses that are around 2 to 3 years plus have a much higher likelihood of survival.

These are things that we've picked up over being in this business for 16-plus years.

When you look at geography, we love diversification.

And you can see, particularly versus 2007, we're diverse, and we're now -- I think we've gotten big enough that we can avoid what I'll refer to as domination of the 4 biggest GDP states, Florida, Texas, California and New York.

If you look at the math, you're probably close to 40%.

From GDP perspective, they probably represent 65% to 70%.

We clearly prefer to be diverse in the other states beneath that and will continue to endeavor to do that.

Slide 28 and 29 are slides that have been present for 10 years in our presentations.

I'm not going to go over them.

But for newcomers to the story, it is important to note how we generate cash on a 7(a) loan and how we generate income on a 7(a) loan.

Looking at our portfolio company review, which represents approximately 30% to 35% of our annual dividend, our 504 business has continued to grow, albeit at a slower pace than I'd like, but steady.

The government slowdown did impact that a reasonable amount.

We were able to close in the calendar year 2018 between 504 loans and a conventional loan that we moved over at the last minute $42 million of those types of loans, which enabled us to meet our guidance.

And we feel very good about our business going forward due to growth in referral volume as well as establishing growth in our loan processing offices in Orlando and Boca.

Moving to Slide number 33, it's important to note for the analysts that all 504 loans will be originated out of NBL, standing for Newtek Business Lending.

We had done some of the 504 loans out of CDS.

CDS will wind up being a pure play on conventional line of credit against inventory and receivables, with NBL being the origination entity that will be responsible for 504 loans and -- as well as originating the nonconforming loans.

We're excited about a full year 2019 forecast of fundings of about $100 million.

The end of the first quarter, we will adjust that and to see how the shutdown has affected that financing.

Closings are higher.

Closings are represented by the fact that, in many (inaudible), 504 loans are done on a construction basis.

So even though you've got a contract to fund, the fundings haven't occurred.

We make money in the 504 business on the points on the first and the second loan.

We make money on the fundings on the coupon versus the cost of financing.

And then we make money on the sale of the conventional first.

So there is a cycle associated with income in the 504 business.

And although we have a de minimus contribution of 504 earnings to the $1.84 in calendar year 2019, we do believe this will be a nice engine of growth for us for the future and, importantly, lever the great infrastructure that Newtek Business Service Corp has created.

Slide number 35 is a simple sample of what a 504 loan looks like, 36 with the economics.

Slide number 37, we have a valuation on our payments business of approximately $116 million.

That's a significant part of our NAV that we have across the whole organization.

We have owned and operated a payments organization I believe since 2003 or '04, so quite a bit.

We know the business well.

We've processed over $6.1 billion of volume.

We've reduced our cost of capital by 350 basis points on about a $40 million draw.

That's about a $1.4 million annualized savings in interest expense.

The business had grown nicely, and obviously, we came in at a $14.7 million adjusted EBITDA.

That came in a little lighter than expected because we sold off a piece of the Elavon portfolio in which reduced some of the recurring income.

But we talked about the change in 2019, A, with respect to income coming in from the call on the other residuals.

I believe that $15.5 million figure does not include much or any of an increase between gain on sale that's sitting down at the portfolio company.

So we look at that $15.5 million and look at it as conservative.

We're excited about the payments business, a lot of really good things changing.

And in the publicly traded segment, entities like i3 Verticals.

Jet Pay just got bought, EVO trading at very nice publicly traded multiples.

Slide number 38, we talk about our technology portfolio companies, obviously, about a $20 million market value, represents a little under 10% of our NAV, an important growth vehicle.

We're working hard to get these businesses online, on track to make significant earnings and cash flow contribution to the company.

When people ask us, "What are you doing in this particular segment?" the goal is for Newtek to have a full suite of IT infrastructure services.

There is a huge opportunity existing in the Cloud services space.

We want to lever our existing customer base.

We want to lever our existence to provide a managed service to clients, both new and current.

We believe we can cost effectively provide timely solutions by providing -- and providing a significant market opportunity for Newtek Technology Solutions.

Products such as IT as a service, desktop as a service, disaster recovery as a service, security as a service, secure email, hybrid Cloud, private Cloud and managing public Cloud and managing workloads in Azure, AWS, and Google are our goals.

In summary, looking at Newtek, for those of you that are new to the story, we're an internally managed BDC.

We don't pay 2 and 20 to a management company.

All our expenses are fully loaded.

We have a differentiated business model, as you could see.

We've got operating businesses underneath the publicly traded mutual fund.

We believe that we've obviously got a proven track record, established privately in '98, publicly since September of 2000.

We're clearly not new to business lending.

We lend through multiple lending cycles and have tremendous depth and experience in this particular space.

It's important to note we don't buy packaged loans.

We're true retail-based originator using strategic alliance relationships.

Our average loan balance of $181,000 exudes diversification and distribution of risk throughout the portfolio, geography, loan type, etc.

We do not invest in derivative securities.

There's no SBIC leverage.

We don't buy CDOs with equity kickers.

And we are not a second lien or mezzanine lender and have no direct exposure to volatile industries, like oil and gas.

We frankly like stable businesses that repay principal and interest.

And with that, I will hand over the financial presentation to Jenny Eddelson.

Thank you, Barry, and good morning, everyone.

You can find a summary of our fourth quarter and full year results on Slide 42 as well as a reconciliation of our adjusted net investment income, or adjusted NII, on slides 44 and 45.

For the fourth quarter of 2018, we had a net investment loss of $1.1 million, or $0.06 per share, as compared to a net investment loss of $2.9 million, or $0.16 per share in the fourth quarter of 2017, a 63% improvement on a per-share basis.

Adjusted NII, which is defined on Slide 43, was $10.8 million, or $0.57 per share, in the fourth quarter of 2018 as compared to $9.2 million, or $0.51 per share, for the fourth quarter of 2017, a 12.6% improvement on a per-share basis.

For the full year of 2018, we had net investment loss of $7.5 million, or $0.40 per share, as compared to a net investment loss of $7.9 million, or $0.45 per share, an 11.1% improvement on a per-share basis.

Adjusted NII for the full year of 2018 was $36.4 million, or $1.94 per share, as compared to $30.8 million, or $1.77 per share, in 2017, an improvement of 9.5% on a per-share basis year-over-year.

Focusing on some of the fourth quarter 2018 highlights, we are pleased to report $14.7 million in total investment income, a 40.7% increase over the fourth quarter of 2017.

Both interest and dividend income were the primary drivers for the increase, with interest income increasing by 34%, resulting from a higher interest rate on our SBA loan investments year-over-year as well as an increase in dividend income from our controlled portfolio companies.

Our dividend income in the fourth quarter of 2018 included $2.4 million from NMF, $375,000 from Citco and $1.6 million from Premier Payments, which included a portion of the gain that Premier recognized on the sale of the Elavon portfolio in the fourth quarter of 2018.

Total expenses increased by $2.5 million quarter-over-quarter, or 18.5%.

Salaries and benefits increased by 13.1% due to an increase in headcount coupled with higher compensation costs.

And total interest expense increased by $1.4 million in the fourth quarter of 2018, primarily due to higher average outstanding debt balances.

Origination and servicing expenses increased by $821,000 in the fourth quarter of 2018 as compared to the same period in 2017 due to higher referral fees for the current quarter as well as increases in other loan-related expenses period over period.

Realized gains from the sale of the guaranteed portions of SBA loans sold during the fourth quarter totaled $13.1 million as compared to $12.8 million during the same quarter in 2017.

In the fourth quarter of 2018, NSBF sold 158 loans for $108.6 million at an average sale price of 109.97% as compared 136 loans sold during the fourth quarter of 2017 for $94.3 million at a weighted average sale price of 111.44%.

Looking at realized losses for the full year, we recognized $2.7 million in 2018 as compared to $1.2 million in 2017.

Net unrealized appreciation on investments totaled $5.7 million in 2018 and $10.8 million 2017, a decline of approximately 47%, which was primarily due to higher appreciation in 2017 on controlled investments.

Overall, our operating results for the fourth quarter resulted in a net increase in net assets of $7.6 million, or $0.40 per share, and for the full year, $35.7 million, or $1.91 per share.

We ended the year with NAV per share of $15.19, an improvement over our 2017 NAV per share of $15.08.

And in terms of capital resources, our liquidity remains strong at the end of the year with approximately $48.4 million of availability under our credit lines and $2.3 million of unrestricted cash.

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

Thank you.

Operator, would love to take questions now.

Good morning, everyone.

Thanks for taking my questions.

Thank you, Peter.

Barry, what are you contemplating?

You may have said it.

I may have missed it.

But in terms of average debt to equity for the year, do you see that ramping with -- going within a range, but kind of where you see an average now that you can lever up a little bit more?

Sure.

Well, I think that we look at the real risk, not necessarily what is reported on a GAAP basis at the end of a quarter, where we get a little bit inflated.

But we're averaging a little bit over 1 to 1. And we've historically stated that we want to modestly grow that side of the leverage and take it in.

Now when you look at leverage and risk, it's important to note, once again, we're primarily leveraging loan balances of $180,000.

So these aren't mezz.

These aren't subdebt.

These aren't leveraged buyout loans at 4x, 5x, 6x multiples that require growth.

So we feel that we can clearly handle substantially higher levels of leverage.

But we're going to monitor what we're doing.

We're going to look at the capital markets, the ability to issue equity at attractive prices.

We've been very modest.

I think -- Jenny, I don't know if you don't have the number handy, but in the fourth quarter, we raised a small amount of equity.

Yes.

Couple hundred thousand dollars, yes.

So we keep our eye on stock price.

That's important to us.

And we've been a premium to NAV.

We don't hit the accelerator.

We don't want to hurt shareholders.

So I think that, Pete, the best way to describe it is do not expect us to zoom up to 1.8 or 1.9.

It'll be modest.

We want to demonstrate to the markets that we can handle this.

Realistically speaking, most nonbank lenders are levered 3 to 4 to 1. Forget BDCs.

Now BDCs are a little bit special in the sense that they typically have to go a little bit out on the risk spectrum to pay the 2 and 20.

I say it's 2 and 20.

Maybe it's 1.5 and 1.5, the markets conceding a little bit more there.

But we don't do that.

We've got an infrastructure.

We have a higher return on equity.

So I would say a modest slow increase quarter by quarter.

Got it.

That's helpful.

And then I didn't understand the mechanism of exercising the call option on that block of merchant accounts within the payments business.

Is that -- you're taking those in from like an ISO network?

It's a little bit convoluted.

I also want to mention, Peter, that, that particular option is not something that you'll see recurring.

It was something that we acquired when we acquired Premier as one of the assets.

But we had a basic -- we had the opportunity to call the portfolio at modest valuations.

And we took advantage of that.

So that allows us to pick up significant cash flow with very low cost of acquisition.

And we manage those accounts over a period of time.

And that helps our overall cash flow.

So when you look at the transaction that we did in Q4, even though we gave up about $1 million of recurring cash flow to Elavon, we picked up approximately -- and this is conservative -- $1.5 million by calling in other residual that were going to third-party participants in the distribution channel.

Okay.

And was the considerations to exercise that call significant?

Was the consideration what?

I'm sorry.

The consideration was cash.

We had to pay cash for those.

But the math and the accounting treatment was favorable to us.

Okay.

Okay.

And then just last question, and I'll get back in the queue.

But on the joint venture with BlackRock, in terms of timeline, getting the funding in place and then starting to actually look at underwritings and loans, you expect that to happen summertime or so?

I would like to answer that question with a song: "Yesterday, all my troubles" -- I'm just kidding, for others that are listening.

No, I would've liked this to have been completed by now.

So I'm hopeful we'll have a spring fling on this.

Great.

Good to hear it.

Thank you.

Thank you.

Our next question comes from Casey Alexander with Compass Point.

Your line is open.

Hi, good morning.

Good morning.

The JV, if I read it right, it's sort of a hybrid vehicle.

Am I guessing that you're going to be sort of contributing half of the assets, and BlackRock is going to be sort of contributing half of the assets from an underwriting and origination standpoint?

Do I get that right?

You're pretty close, Casey.

So relative to the concept of -- I'll use the word contribution.

The venture is clearly an origination venture.

And BlackRock TPC will contribute half of the equity.

Newtek Business Service Corp will contribute half of the equity.

We'll get a leveraged line from a third party.

And that -- through the new track -- the Newtek system, we're going to be taking in the referrals, just as we always have been, creating that big funnel.

And when appropriate, we're going to take referrals and direct them, assemble them and underwrite them to the conventional business.

BlackRock TPC and Newtek will each control 50% of the credit committee.

And both require an approval to be able to fund the loan in the venture.

But the infrastructure for creation of the loan, which won't be bought, won't be previously made, will be the Newtek infrastructure through it's alliance relationships, so that the UBSs, the Morgan Stanleys, the Raymond Jameses, and (inaudible) credit unions, et cetera, et cetera, will be bringing us referrals as they always have been and will be channeling when appropriate those referrals into what we refer to as a nonconforming -- we use that term because it's nongovernmental program -- bucket in which BlackRock and Newtek will each own half of the equity in a special purpose vehicle in which we will be doing securitizations out of and generating good returns for the equity.

The equity, Casey, will show up on our schedule of investments.

And the leverage in the SPV will not consolidate because this is a true joint venture between BlackRock and Newtek.

Right.

So this is then similar to -- from a portfolio standpoint to how other BDCs do JVs that just your equity is going to show up like a portfolio company, and it will pay dividends to the BDC?

Yes, sir, exactly right.

You got it right, yes.

Okay.

Great.

And thank you for clarifying what nonconforming means because sort of nonconforming conventional sounds sort of like an oxymoron.

The dividend, should we think in terms of the dividend from portfolio companies as in 2019 sort of ratcheting back to the trend that it had been working on, given that this dividend included a part of the gain from the Elavon transaction?

It's a good question, Casey.

I think that, realistically speaking, in the last couple of years, we have been between 30% to 35% in contribution from the portfolio companies to the ultimate dividend, of which that 30% to 35%, given that they come from taxable entities, is considered a qualified dividend.

I think, for the 2019 purpose, it's fair to assume that we're going to be within that range.

That's our forecast.

However, I would say, as a goal, I would like to get that number to be a higher number.

And that's beneficial to all the shareholders because it just demonstrates diversified sources of revenue apart from just what you might call 7(a) gain on sale and the spread of the 7(a) loans on the book.

So we look to grow dividend income from payments, from 504, from nonconforming, from tech solutions, from insurance agency, from payroll health and benefits to grow that side of the business.

Okay.

I appreciate that.

I also appreciate your commentary about the nonperforming loans and the charge-offs that you believe you're sort of at the belly of the loan curve, and so they should be stabilizing here.

But let me ask you a question.

If you expect referrals to increase and you're going to increase your capture from referrals from 2.5% to 3%, even though your NPLs and your charge-offs are at manageable levels, if you're increasing the size of that funnel, should we expect to see those reset at some higher level than where they're at right now?

It's a good question.

I'll try to give you a kind of a blanket answer.

I think that, as a percentage of the portfolio, we're hopeful and optimistic that, from a 7(a) standpoint it levels out.

Some of the things you're going to start to see is a decoupling because we're going to wind up putting a bigger percentage of nonconforming loans on our books.

So Jenny and I have had conversation.

And what you're going to see in Q1 is you'll begin to see a breakout of that particular number, which loans are 7(a) and which loans are -- and I want to define conventional and nonconforming for you because -- for you and everybody else.

As an old Ginny Mae and Fanny Mae and Freddie Mac mortgage-backed security salesperson, any loan that went into a government program was called a government loan.

Any loan that was done private was considered conventional.

And the concept of nonconforming means it doesn't conform to a government program.

By the way, Casey, these are my definitions.

So I kind of use them synonymously.

With that said, we are hopeful that the 7(a) portfolio, which is in the belly of the curve, if it picks up a little bit as a percentage of the total portfolio, it shouldn't grow.

It may grow a little, but it shouldn't grow.

And we'll start to begin to segregate out there are certain loans that are in that category.

Here's an example.

I've currently got loans that are in the category that are current pay, but the borrower's in bankruptcy.

Now why would you say a company in our business is currently paying it, but in bankruptcy?

Well, they've got other obligations outside of our obligations that they are renegotiating.

We don't think that's a nonperforming loan.

However, based upon how we historically defined it, it's sitting in that bucket.

We are going to redefine that going forward in our upcoming Q and reset the parameters.

We have been extremely conservative in defining, what is an NPL?

To me, if the loan is current pay and performing in the segment, I'm happy.

I'm very happy.

And we have some loans that are in that bucket.

We also have some loans that are in that bucket that are conventional.

They will need to come out.

All right.

Thank you very much.

I appreciate your taking my questions.

Thank you very much.

(Operator Instructions) Our next question comes from Leslie Vandegrift with Raymond James.

Your line is open.

Hi, good morning.

Hey, Leslie.

How are you?

Doing well, back in Memphis this morning.

All right.

You mentioned the guidance on the call for 7(a) in 2019 about 20% plus volume growth.

That's pretty healthy growth.

How much of that is because competitors such as (inaudible), etc., are starting to move away from it a bit?

I definitely think some competitors that don't have our system and efficiencies back out of the market.

And that's going to be helpful.

But -- and maybe that will wind up giving us more business and more opportunity.

And we do have a lot of people coming to us saying, "Oh, gee, I give you all my business.

Just pay me 2 or 3 points for a loan." And we say, "Sorry, not interested." It's just not what we do, and it's not our model.

But putting that aside, I think that a lot of that growth is based upon the fact that, when we launch the nonconforming program, when we look at getting a -- so by launching a nonconforming program, we're just going to get more looks.

Businesses come to us not looking for a 7(a) loan or a line of credit, what we -- they just come to us for funding.

So by being able to state that we can do loans up to $15 million by broadening our horizons with alliance partners, we just think that's where the growth is coming from.

We believe that, by going into the market and saying, "We lend money to businesses, 10- to 25-year AM schedule, no covenants, single-digit interest rates," that's our business.

That's totally different than on deck, [cabbage].

They're like 6 to 24 months.

They're 25% to 80%.

They're not long-term capital.

So our ability to position ourselves in the market as a real provider of credit to this market based upon our 16 years' worth of experience in dissecting this market and being able to take a funnel and weed through 64,000 referrals in a given year, it's funny because people say to me a lot of times, and they go, "Oh, you're an SBA lender." And then I like -- my head tilts, and I'm kind of bummed out.

And no, that's not what we do.

What we do is we figure out a way to create distribution channels to process business, whether it's a loan, technology, payment, etc., faster and better.

So we think that our growth is not based upon our competition.

It's not based upon market conditions.

It's based upon the fact that we have created what we believe is a better funneling system, distribution channel, mousetrap to improve the client experience, to improve the alliance partner experience and to improve the employee's experience in processing a lot of business more efficiently.

We think that's why we're going to grow.

Okay.

And then on the third quarter call, you gave a bit of guidance for what you were seeing possibility for premiums in 2019.

You said about the 109 handle level would be your expectation.

Is there any update there?

Yes, so we finished off the year close to 110, and the market is higher in the first quarter.

I'm not going to say how much higher.

This is publicly available information.

I try to stay away from price discovery.

But I think the other factor in price is, what's your split between the 10-year paper, which tends to trade close to 109, 110, give or take, and the 25-year paper, which tends to trade close to 114 plus, but we net 112 because we split the premium?

So I would like to think and hope, and the quarter's not over, and we have a lot of work to do, that we could be north of 110 in the first quarter.

And we've given guidance that our models are based on 109.

So hopefully, that's a little helpful to you.

That is.

Thank you.

And our next question comes from Mickey Schleien with Ladenburg.

Your line is open.

Yes, good morning, Barry and Jenny.

Barry, I wanted to start by asking you about how the government shutdown affected your business in January.

Thank you.

Well, like all government shutdowns are always challenging, this one was a little more challenging, given the duration.

So approaching December 21st, when it became apparent to us that the government was shutting down, I think, at the same time, the market and cost of capital was going crazy, which frankly it did affect our NAV marks for the year and will most likely rebound in Q1.

Stock market down 10% in December, up 10% in January effectively.

So the government shutdown basically forced us to push some of our fundings back into the quarter.

But frankly, we've been through this.

We got our -- being a PLP lender, we were able to cover the existing pipeline.

We sold forward that pipeline as it closed.

We held back on fundings through the first 4 to 6 weeks, which by the way, if there ever was a shutdown, having it happen in January isn't a bad thing because that's usually our weakest quarter.

People typically don't do much borrowing in Q1, or I should say closing.

So I think you will not see an effect.

I think that this won't affect our guidance, won't affect our loan quality.

And what happened, Mickey, was we were able to build up a substantial portfolio which, when the government opened, we then got guarantee numbers and were able then to close loans which we were in the process of doing and consequently sell them into the market.

So we're in good shape.

So from a volume perspective, you think you'll be able to make up for whatever opportunity you lost in January in February and in March.

Is that correct?

That's what Pete Downs tells me.

And I know he's listening.

So I just put some pressure on him.

Barry, in terms of the close rate, that's obviously an important factor for this year.

We're almost -- well, we're a couple months into the year.

It's early days.

But have you seen signs of that close rate improving so far if you look at the year-over-year numbers?

I think, Mickey, that what we try to do is we try to maintain what I'm going to call modest controlled disciplined growth in our lending business.

And I think, relative to the close rate and focusing on the close rate of 7(a), we're very comfortable 2.5, 3, 3.25, 2.25.

We're going to do what's required to put the best credits that we see on the books within our numbers.

So we're very comfortable with the numbers that we put out into the market and do manage to -- the generic close rate.

I say this because there's going to come a point in time where our referrals aren't growing by 74%.

That's just unsustainable.

The reality of it is we have such a huge portfolio of opportunities to pick and choose good credits from, given the underwriting guidelines.

The close rate -- I'm not saying we're going to go from 2.5% to 15% because our model -- the referrals that come to us -- and this is a good question.

They're raw.

They're not packaged.

They're not assembled.

They're not structured.

That's what our great team under Bob Raybuck does, who manages 25, 26 people.

So I think that the key question is we are very comfortable -- I'm going to use the term with a 2.5% to 3% close rate and the current 7(a) growth, although we're going to be scrambling a little bit, but I think we're going to be able to do it.

Okay.

Thank you for that, Barry.

Looking ahead, for the last few years, all we've talked about are rising rates.

But if you look at the forward curve now, the market's expecting rates to start to decline next year.

And we all know that the curve can be wrong.

But I'd like to understand -- I do understand that the balance sheet is match funded.

But when you consider also CPR and how an economic slowdown could affect all of your businesses, net-net, how would an interest rate decline impact Newtek, particularly since you've lived through cycles before?

Yes, so I'm going to also assume -- this is important -- an interest rate decline with a subsequent slowdown in the economy.

So I'm going to take that hand of it because, look, rates can go wherever they want to go.

We believe that holding everything else constant, by the way, it doesn't make a difference.

However, rates moving I think are a consequence of the economy speeding up or slowing down.

So assuming that the economy slows down, look, I think that gain on sale will pick back up again.

We've -- we get higher prices for the government-guaranteed securities.

And I also think that loan demand in a slower economy would pick up because banks become a little bit less aggressive in a slower market.

So we'd be a little bit more competitive.

But look, Mickey, for 16 years we've been doing this, we don't feel we -- in this one segment of the business -- I'm just focusing on 7(a) lending -- that we get much affected by rates going up or down.

I think we've kind of proven that in an up-rate scenario.

Now by the way, one of the provisions is that we continue to get a good asset-liability match on our portfolio, the capital markets do well.

I think we're in pretty good shape, Mickey.

I'm not overly concerned about rates going in either direction.

I don't think we benefit or lose by a rise or an increase in rates.

It's pretty balanced.

I understand.

Barry, I do want to follow up on the questions about the JV.

Maybe to get a little bit away from the jargon in the market, can you just sort of give us a bigger picture of what kind of a loan might go into the JV that just couldn't go into 7(a) or 504, to give us a sense of what kind of assets you're looking at for that vehicle?

Sure.

So first all, the balance.

So if you are a borrower and you need more than $5 million, you can't qualify for an SBA 7(a) program because it's -- the max loan is capped at $5 million.

That's item number one.

So someone comes in for a $7 million loan, a $10 million loan, they're going to go into this bucket.

Then there are certain vagaries of the SBA program.

First of all, the only loan that we do under 7(a) is prime plus 2.75.

So if you've got a borrower that says, "I've got to be fixed," this program will be fixed for 5 years.

So if somebody wants a fixed-rate loan and won't do a floating-rate loan, they'll wind up going into this program.

That could mean, if they could be a $2 million borrower, but they're going into this program.

Let's say you've got 3 guarantors that own 30.33% of the business.

One of the guarantors that is an outside investor will not personally guarantee the loan.

But a debt service coverage 2 to 1, commercial real estate behind it, been in business 5 years, can't get an SBA loan, that's going to go into this program.

So the concept of the term nonconforming, loans that do not conform to the strict SBA policies and procedures within the $5 million cap will be offered this program.

And we think there is voluminous amounts of those opportunities.

Secondly, borrowers that want more than $5 million will go into this program.

In addition, we have borrowers in the portfolio that have used up their $5 million of SBA guarantee.

They're great operators.

They're great owners.

And they've got a new business opportunity.

We now can offer them additional financing.

So Barry, taking all of that into consideration, and I'm sure you analyzed this backwards and forwards before you launched it, what sort of coupons are you talking about and cost of debt and leverage and ultimately ROE in the JV?

Sure, I think that, on a gross coupon, we're probably going to be out on the street from like 8% to 10.5%.

And that'll be fixed for 5 years.

Okay.

And I know you haven't finalized your debt capital, but what kind of spread can you capture?

And how much leverage are your lenders going to allow in that JV?

Yes, I think I'm going to have to stop at that point until that's baked, Mickey.

But I certainly appreciate the question.

And I know that you and others are going to be working on building a model for this.

So we'll try to be as helpful as we can.

Until this gets baked, I think we're going to hold off on that.

I would hope to be able to give you more guidance at the end of the next quarter.

And we've been pretty clear not to include any of this income for 2019.

But it is on the table.

And it could generate some income for 2019.

Okay.

Well, do you suspect that it could generate ROEs at least in the low double digits?

Is that a reasonable target?

Well, let me say this.

Given that we've got to pay out a healthy market dividend and we'd strongly prefer -- look, when we look at stuff at times -- sometimes, I look at stuff, and it's like, okay, we could earn 9% or 10%.

So one of my challenges are, okay, do I do that?

Because that'll basically pay the dividend, right?

So that's okay.

But the more of that that I do, the more it dilutes from the higher returned activity like 504 lending or like 7(a) lending.

We would like to believe that this activity as we've modeled it will be a higher return on equity after charge up and severity than our dividend coupon, so that it's not dilutive to shareholders.

But that's our forecasted guess at this point in time.

And my Chief Legal Officer has an imaginary figure on my shoulder.

He's telling me to stop talking.

Okay.

Fair enough.

But maybe just one last broad question on the JV.

Given the collateral constraints in your funding on your balance sheet, maybe a question for Jenny, how does Newtek fund the cap -- the equity commitment for the JV if it happens in the next few quarters?

Well, I think what we'll be doing, Mickey, is on a balanced approach, number one, we're liquid at the moment.

We've got a lot of capacity on our lines of credit across the board.

We've got ATM.

We've got baby bond capability.

So we definitely try to stay away from giving out our plans, lest the market jumps in front of us and starts front-running us.

But we're -- I'm very pleased with our capital structure receptivity in the market.

Every baby bond we've done is trading at a premium.

I think you'll be hearing positive news on our lines of credit as well as additional lines to fund these businesses.

So I guess, after 16 years of paying people timely and principal interest, they get comfortable with you.

And they should.

I will be honest with you, and I've said this on a regular basis, I look -- I wake up every day and figure out what crane's going to hit me on the head.

And we are not carried away with where we sit in the market.

We have a lot left to do.

We have a lot of blocking and tackling.

And I think we're just at the beginning of really doing a nice job for our clients, that being medium-sized companies all across the United States as well as stock investors and creditors, etc.

So we can't be more excited about 2019 and going forward than where we are today.

We're very well set up.

And I thank all the investment banks and investors and creditors for being helpful in that endeavor.

Okay.

So just to follow up on that, the credit lines would allow you to draw with the use of proceeds to be injected into the JV?

There's no restriction on you --

Yes, I've got underutilization on every single one of my lines.

Okay.

I was just curious from collateral perspective.

And lastly, I just want to --

Mickey, I just want to say -- now that you're on that, I want to say one thing.

So given that somebody that really wants to have multiple avenues, I could draw my credit lines, we do baby bonds.

We could do ATM.

We could do just -- not this -- the joint venture is specific, but mind you, our goal from Jenny and my perspective is to always be diverse, have diversified pools of capital because markets do shut.

They do change.

So we have always made sure we've got as many levers to pull as possible.

We don't want to be reliant on any one thing.

No, I agree with that and appreciate it.

And just sort of a housekeeping question.

I think, in the past, Barry, part of the 504 business was actually reflected on Newtek's income statement.

But now that all of that business will be in NBL starting this year, will that business completely be reflected through the dividend from NBL, or will there still be some sort of straggler affecting the income statement at the Newtek level?

Broadly speaking, the 504 business should be reflected out of a portfolio company, NBL.

And that would relate to spread, underwriting fees and gain on sale.

That's the goal, and that was why we put that slide in there today.

It's been a little convoluted in the past as you sort of put things together.

And part of it was with CDS.

And I think there was one point we made a -- think we made a conventional loan out of the BDC.

But that's a portfolio company.

Okay.

That -- so that'll be cleaner that way.

I appreciate your time this morning, Barry and Jenny.

Thank you.

Thanks, Mickey.

Thank you.

Our next question comes from Fred Cannon with KBW.

Your line is open.

Hey, guys.

This is Luke on for Fred.

How's it going?

Hey, Luke.

How are you?

Good.

Just a housekeeping thing.

Jenny, my speaker went out when you were giving the loans sold in dollar amount for the SBA.

Do you mind just reiterating that?

Sure.

For the fourth quarter?

Yes.

So in 2018, we sold 158 loans for $108.6 million, and that was at an average price of 109.97%.

Okay.

Perfect.

Thanks.

And then just a couple questions.

I'll keep it quick.

On the origination and servicing expenses you guys saw, that was a little bit higher than previous quarters, but it looks like it was similar last year.

Was that just year-end seasonal?

That's -- exactly.

That's basically referral fees that do tend to be higher in the fourth quarter.

Okay.

Gotcha.

And I know there's a lot of talk earlier about the sale to Elavon.

Did you guys quantify the dollar amount that that was impact -- or that their dividend income was impacted by that?

About $1 million.

$1 million.

Okay.

Thank you very much.

And then just one last one.

You guys have talked extensive over the past couple quarters about how you've been able to bring down some of your interest costs on credit lines.

How do you see your interest expense going forward?

Well, obviously, with a growing business, the total number will definitely increase.

But I think that tapping a variety of different markets, being diverse leaves us in a pretty good position.

We've got longstanding relationships with a lot of our capital providers.

And we're appreciative of that.

So we try to keep a good balance on that.

I would say this.

I do believe that our thought process going forward is not a major change in rates up or down in the next 12 to 24 months.

So from that perspective, being floating rate is useful to us because it gives us the most value without a lot of volatility.

Baby bonds being fixed are problematic, but they can be swapped back into floating.

And we haven't done that yet, but that might be something that we look at.

I think when you look at the spread of our assets with a floating cost of money to the fixed coupons we're talking about, it's attractive.

And we -- I don't see -- and you've got to be careful here just because the trade issue is the big swing in the market right now.

That could move equity and debt markets in a big way.

So I reserve the right to see what happens in the next 60 days regarding trade.

I will -- I'll tell you if Trump -- this is a -- if Trump cuts a deal with China and our whole trade balance -- all bets are off, going to be a lot of changes.

So we'll answer that question again at the end of next quarter.

Thank you.

And then sorry, just one other one.

I know there's been a lot of talk about the conventional loan program.

You guys have -- and as you said, you were trying to target a 2%, 2.5% to 3% close rate on referrals.

The rest of the conforming -- or the nonconforming loans could come out of that other 97.5%, right?

100%.

Perfect.

Thank you very much.

Thank you for taking my questions.

Thank you.

Thank you.

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

I'd now like to turn the call back over to Mr. Barry Sloane for any closing remarks.

Great.

Well, wanted to thank everybody for their participation today and want to thank the staff, all the employees, associates at Newtek.

They're doing a great job.

We are optimistic that we'll deliver equal to or better results next year and look forward to our first quarter call, which'll come up very quickly.

Thank you, everyone.

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.