New Mountain Finance Corp (NMFC) 2012 Q4 法說會逐字稿

Good morning and welcome to the New Mountain Finance Corporation fourth-quarter 2012 earnings conference call. All participants will be in listen-only mode. (Operator Instructions). After today's presentation, there will be an opportunity to ask questions. (Operator Instructions). Please note this event is being recorded.

I would now like to turn the conference over to Rob Hamwee, CEO. Please go ahead.

Thank you. Good morning, everyone. With me here today are Steve Klinsky, Chairman of NMFC and CEO of New Mountain Capital, and Dave Cordova, CFO of NMFC. I am pleased to introduce Dave who joined us last fall and was promoted to CFO at the beginning of the year. Adam Weinstein, our prior CFO, has been promoted to an oversight role of Executive Vice President and Chief Administrative Officer as previously planned.

Steve Klinsky is going to make some introductory remarks. Before he does, I would like to ask Dave to make some important statements regarding today's call.

Thank you, Rob. I would like to advise everyone that today's call and webcast is being recorded. Please note that they are the property of New Mountain Finance Corporation and that any unauthorized broadcast in any form is strictly prohibited. Information about the audio replay of this call is available in our earnings press release.

I would also like to call your attention to the customary Safe Harbor disclosure and our March 6, 2013 press release and on page 2 of the slide presentation regarding forward-looking statements.

Today's conference call and webcast may include forward-looking statements and projections and we ask you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these statements and projections. We do not undertake to update our forward-looking statements or projections unless required by law.

Any references to New Mountain Capital or New Mountain are referring to New Mountain Capital LLC or its affiliates and may be referring to our investment advisor, New Mountain Finance Advisors BDC LLC where appropriate.

To obtain copies of our latest SEC filings and to access the slide presentation that we will be referencing throughout this call, please visit our website at www.NewMountainFinance.com or call us at 212-720-0300.

At this time I would like to turn the call over to Steve Klinsky, the Chairman of New Mountain Finance Corporation, who will give some highlights beginning on page 4 of the slide presentation. Steve?

Thanks, everybody. Before turning the call back over to Rob and Dave, I wanted to welcome you all to New Mountain Finance Corporation's fourth-quarter earnings call for 2012. Rob and Dave will go through the details but I am pleased to present the highlights of another strong quarter for New Mountain Finance.

New Mountain Finance's adjusted net investment income for the quarter ended December 31, 2012 was $0.36 per share which is above our previously announced range of $0.33 to $0.35 per share. Full-year net investment income of $1.36 per share more than covered our full-year regular dividend of $1.34 per share.

The Company's book value on December 31 was $14.06 per share, a decrease of $0.04 from Q3 but an increase of $0.10 prior to the Q4 special dividend of $0.14. Book value is up $0.46 from December 31, 2011 and we paid $1.71 in total aggregate dividends in 2012 including special dividends.

We are also able to announce our regular dividend for the current quarter ending March 31, 2013. The regular dividend will again be $0.34 per share consistent with our previously communicated view that we have reached a fully ramped steady-state dividend level.

The credit quality of the Company's loan portfolio continues to be strong with once again no new loans placed on non-accrual this quarter. As a reminder, we built our models based on a 3% assumed annual default rate and a 1% annual loss assumption from the date of the IPO. In fact, we have had only one issue or default since October 2008 when the debt effort began and it represented just 0.6% of the cost basis of our existing portfolio and just 0.3% of cumulative investments made to date.

New Mountain Finance's pace of new investments was very strong in Q4. The Company invested $267 million in gross originations in Q4, fully deploying the proceeds from December's $53 million equity capital raise and related credit facility upsizing.

Targeted yields on new investments continue to be consistent with our previously communicated expectations. Our portfolio continues to emphasize positions in recession resistant acyclical industries pursuant to New Mountain's overall strengths and strategy. We continue to be very pleased with the progress of New Mountain Finance to date and we are pleased to address you as fellow shareholders as well as management.

With that let me turn the call over to Rob Hamwee, New Mountain Finance Corporation's Chief Executive Officer.

Thank you, Steve. As always, I would like to start with a brief review of NMFC and our strategy. As outlined on page 5 of our presentation, NMFC is externally managed by New Mountain Capital, a leading private equity firm with approximately $9 billion of assets under management and approximately 100 staff members including nearly 60 investment professionals.

NMFC takes New Mountain's approach to private equity and applies it to corporate credit with a consistent focus on defensive growth business models and extensive fundamental research. Some of the key hallmarks of defensive growth business models include acyclicality, sustainable secular growth drivers, high barriers to competitive entry, niche market dominance, repetitive revenue, variable cost structures and strong free cash flow.

With this historically successful business model focused approach in mind, our mandate since the inception of the New Mountain's debt investment program in 2008 has been to target what we'd believe to be high-quality businesses that demonstrate most or all of the defensive growth attributes that are important to us and to do so with an industry that are already well researched by New Mountain. Or more simply put, we invest in recession resistant businesses that we really know and that we really like.

We believe this approach results in a differentiated and sustainable model that will allow us to generate attractive risk-adjusted rates of return across changing cycles and market conditions. To achieve our mandate, we utilize the existing New Mountain investment team as our primary underwriting resource.

Turning to page 6, you can see our total return performance from our IPO in May 2011 to March 1, 2013. We continue to be very pleased with both our absolute and relative return performance.

As outlined on page 7, credit markets have been very strong since the beginning of the year. In addition to ongoing QE and the expectation of extraordinarily low risk-free rates for an extended period of time, a dearth of supply from new issuers coupled with strong demand from resurgent CLO markets have served to compress spreads and corporate credits.

Recent history has shown that market conditions can change quickly so I'd like to reemphasize that New Mountain Capital and accordingly NMFC have always been proactively focused on defensive acyclical business models and that our financing is termed out until late 2016 and not subject to traditional mark to market margin calls.

Our single highest priority continues to be our focus on risk control and credit performance which we believe over time is the single biggest differentiator of total return in the BDC space.

If you refer to page 8, we once again lay out the cost basis of our investments both the current 12/31/2012 portfolio and our cumulative investments since the inception of our credit business in 2008 and then show what if anything has migrated down the performance ladder. In Q4, no assets had negative credit migration. We have one SLF asset with a cost of $14.6 million and a bear market value of $10.3 million that previously migrated from an internal rating of 2 to an internal rating of 3 indicating operating performance materially below our expectations but no near our medium-term expectations for nonaccrual. We continue to have only one portfolio on nonaccrual representing at cost 0.6% of our total portfolio and under 0.1% of fair market value.

Over 98% of our portfolio at fair market value is currently rated 1 or 2 on our internal scale.

Pages 9 and 10 show the operating company, and SLF respectively leverage multiples for all of our material holdings when we entered an investment and leveraged level for the investment as of them end of the current quarter. While not a perfect metric, the asset by asset trend and leverage multiple is a good snapshot of credit performance and helps provide some degree of empirical fundamental support for our internal ratings and marks.

As you can see by looking at the two tables, leverage multiples are in almost all cases trending in the right direction and even more importantly, no single company on either page has had a material increase in leverage multiple with the exception of one lone in the SLF.

On page 11, we show a table depicting how NMFC's publicly traded float has more than doubled based on the 30 equity offerings we have completed since our IPO. We now have 24.3 million shares in our float representing 60% of the total shares outstanding and liquidity and daily trading volume has increased commensurately.

The chart on page 12 helps track the Company's overall economic performance since its IPO. At the top of the page we show how the regular quarterly dividend is being covered out of net investment income. As you can see, we continue to cover approximately 100% of our cumulative regular dividend out of NII. On the bottom of the page, we focus on below the line items.

First, we look at realized gains and realized credit and other losses. While you can see the individual quarterly data, I draw your attention to the number highlighted in blue which shows cumulative net realized gains of $12.8 million since our IPO.

Next, we look at unrealized appreciation and depreciation. As you can see highlighted in gray, we had cumulative net unrealized appreciation of $9.3 million. For clarity, our mark to market loss on our one defaulted investment, ATI, of $5.1 million is reflected in this number along with various other mark to market gains and losses reflected on our schedule of investments.

Finally, we combine realized with unrealized appreciation to derive the final line in the table which in the yellow box shows a current cumulative net realized and unrealized depreciation of $22 million. The point here is to show that on both a realized and combined realized, unrealized basis, we have offset any credit losses or impairments with below the line gains elsewhere in the portfolio. In fact, by this methodology, we have built a $22 million cushion to offset any future credit losses, some of which we have paid out as special dividends.

While market-driven volatility around unrealized appreciation and depreciation may cause the bottom-line number to vary, over time true economic gains and losses will accumulate in the realized bucket where we will strive to retain a positive balance.

Moving onto portfolio activity, Q4 originations continued to demonstrate our strong sourcing capabilities as we took advantage of a relatively lender friendly market as borrowers rushed to complete transactions ahead of 12/31 tax code changes.

Specifically as seen on pages 13 and 14, in Q4 we made material investments in 12 portfolio companies, had a record total gross origination of $267 million. Repayments totaled $109 million and opportunistic sales were $47 million for total net originations less sales of $111 million. All of the investments in keeping with our strategy are in industries and businesses that are well known to us through our historical private equity activities.

For instance, KRONOS, a business we have successfully lent to multiple times over the last four years is a classic enterprise software business, an area where New Mountain has nearly a decade of successful private equity investing across multiple platforms. Enterprise software generally and KRONOS in particular is characterized by many of the attributes we prize, highly recurring revenue with very high annual renewal rates, niche market dominance as the overwhelming industry leader, very high free cash flow given limited CapEx and positive working capital generation, and limited cyclicality given the mission-critical nature of the product and its deeply embedded position.

Another good example is our investment in PRA, a specialty contract clinical research organization providing outsourced drug development services to leading biotech and midsized pharma companies, a business, an industry our private equity group has studied extensively for a number of years.

As in other cases, we have been able to leverage our detailed knowledge of the business and strong relationship with management into an investment thesis in which we have a very high level of conviction. The key elements of our thesis include acyclical end markets, positive long-term secular growth drivers, high degree of revenue visibility and sustainability, attractive free cash conversion, and a best in class management team.

Pages 15 and 16 show the impact of Q4 investment and disposition activity and asset type and yields respectively. Asset net originations type was skewed toward second lien investments upon absolute basis and relative to repayment. For full-yield yields, we are slightly up increasing from 10.2% to 10.3%.

Moving on to page 17, while origination activity has slowed down in Q1, our pipeline has grown substantially in recent weeks and we expect a much busier Q2. While credit spreads have contracted meaningfully in the first two months of the year, we continue to believe that our integration with the broader New Mountain platform allows us to focus on opportunities with high-quality businesses where we already have great insights into how those businesses are likely to perform based on our industry research.

Despite this modest activity level in Q1, we are deploying roughly as much capital as we are getting back from repayment so we continue to operate with our credit facilities fully deployed allowing for an optimized level of earnings. Just like in Q4 where we raised only as much capital as we had visibility to deploying in the near term, any balance sheet expansion from here will be a function of how the pipeline of attractively priced and structured opportunities develops going forward.

In terms of the portfolio review on page 18, the key statistics as of 12/31 looked very similar to 9/30. As always, we maintain a portfolio comprised of companies in the defensive growth industries like software, healthcare, business services and education that we believe will outperform in an uncertain economic environment.

Finally as illustrated on page 19, we have a broadly diversified portfolio with our largest investment at 4.1% of fair value and the top 15 investments accounting for 45% of fair value down from 49% in Q3.

With that I will now turn it over to our CFO, Dave Cordova, to discuss the financial statements and key financial metrics. Dave?

Thank you, Rob. For more details on the financial results and today's commentary, please refer to the Form 10-K that was filed last evening with the SEC.

Before we turn to slide 20, I want to mention that we have included a structure chart as Appendix A in the presentation. Similar to prior calls, I will spend a moment reviewing the Company's structure as a brief refresher.

The structure was set up similar to an up-REIT structure whereby the public company, PubCo has no direct operations of its own and its sole asset is its units of our operating business, OpCo.

Today the other units of OpCo are held by a private BDC owned by New Mountain's private equity fund, AIB Holdings. This structure is a master feeder whereby the financial statements for OpCo, floats of PubCo and AIB Holdings pro rata based on their respective ownership. All discussion throughout this call and presentation is focused on OpCo and its operations.

Additionally, OpCo owns the equity of a nonrecourse vehicle, DSLF. This vehicle originates lower yielding first lien loans but with greater leverage at 2 to 1. For GAAP, asset coverage and presentation purposes we consolidate this SLF vehicle into the operations of OpCo.

Now I would like to turn your attention to slide 20. The OpCo and SLF portfolios have approximately $989.8 million in investments at fair value at December 31, 2012. We had approximately $12.8 million of cash and about $23 million of other assets which includes approximately $10 million of unsettled sale proceeds related to one portfolio company which we received in early January, $6.3 million of interest and dividend receivable much of which we have already received, $5.5 million of deferred credit facility costs. These costs get amortized over the life of our credit facilities, an increase from last quarter due to the $40 million aggregate increase on our two credit facilities and $1.2 million of other assets including deferred offering costs, receivables from an affiliate and other prepaid expenses and assets.

We had total debt outstanding of the about $421.2 million on our two credit facilities which is made up of $206.9 million on our OpCo credit facility which had $210 million of capacity at 12/31 and $214.3 million on our SLF credit facility which had $215 million of capacity at 12/31.

We had the about $34.5 million of other liabilities which is made up of approximately $11.2 million of dividends payable, $11 million of payables to affiliates from management and incentive fees, approximately $9.7 million of outstanding commitments on one investment which already closed in early January, approximately $0.7 million of interest payable and $1.9 million of vendor payables for a various expenses. This all gets us to a net asset value of $569.9 million or $14.06 per share at December 31, 2012.

This compares to an NAV per share of $14.10 at September 30, 2012 and $13.60 per share at December 31, 2011. The NAV increased $0.10 per share from September 30, 2012 prior to the declaration of the special dividend of $0.14 that was declared on December 27.

Our consolidated debt to equity ratio at 12/31 was 0.74 to 1 which is at the high end of our targeted debt to equity ratio. As a reminder, the OpCo credit facility allows us advance rates of 25%, 45% or 70% depending on the type of the underlying asset at a rate of LIBOR plus 2.75% and the SLF facility allows us advance rates of 70% on qualifying first lien assets at a rate of LIBOR plus 2%. Both facilities do not mature until October 2016.

Importantly our credit facility covenants are generally tied to the operating performance of the underlying businesses rather than the marks of our investments at any given time.

On slide 21, we show our consolidated income statement for the full quarter at the OpCo level. As was discussed in prior quarters, the main reason for the creation of our up-BDC structure was to make sure that the built-in gains that were in the portfolio at the time of the IPO are only allocated to AIB Holdings; therefore, not burdening the public shareholders with any of those taxable gains or increased accretion on the predecessor investments over time.

Since we were not able to step up the assets for GAAP, our income statement will generally show greater accretion than if the step up had occurred until the predecessor assets are sold, mature or are repaid.

Therefore on this slide we show the actual income statement in the left column and then adjust the income statement to reflect it as if all the assets were stepped up to the fair value at the IPO in the right column. We use the adjusted income statement to judge our performance of the portfolio during a period and it is also the basis for calculating our dividend and incentive fees.

As has historically been the case, our interest income is predominately paid in cash. Specifically we had $22.7 million of interest income which breaks down as follows -- cash interest income of $20.5 million; PIK income of about $600,000; net amortization of purchased premiums and discounts and origination fees of about $500,000; and about $1.1 million of prepayment fees on five investments that fully or partially repaid above par during the quarter.

Dividend and other income of $1.2 million was made up of dividends on warrants owned and preferred stock, delayed compensation, revolver fees and consent and amendment fees. Our part one incentive fee was approximately $3.4 million reflecting higher adjusted pre-incentive fee net investment income than the previous quarter and our management fee was approximately $3.2 million.

Our interest expense of $2.8 million is broken out to represent about $2.4 million of actual interest expense on our borrowings, $75,000 of non-usage and custodian fees and about $335,000 of amortization of our upfront borrowing costs.

We have capped the amount of our expenses reimbursable to the administrator for our second year as a public company at $3.5 million and so for this quarter, our combined amount of professional fees, accounting expenses and other administrative expenses are approximately $0.9 million in total. These amount relate to legal costs, audit and tax, court costs, other administrative expenses and indirect expenses reimbursable under our administration agreement.

The bottom line for the fourth quarter is adjusted net investment income of $13.6 million or $0.36 per weighted average share. This exceeds the adjusted net investment income range discussed on our November 7, 2012 call of between $0.33 and $0.35 per share. We are pleased that we were able to deploy the proceeds from the December offering and still deliver adjusted net investment income above our expected range.

Moving to below the adjusted net investment income line, we had adjusted net realized gains of $2.7 million as a result of refinancing and sales at prices above our adjusted cost basis.

Unrealized gains of $1.6 million were driven in large part by write ups resulting from continued performance of the underlying portfolio and broader market appreciation. Additionally we accrued $860,000 for our part 2 incentive fee in the fourth quarter as under GAAP we are required to accrue incentive fees assuming a hypothetical liquidation of the entire portfolio at the balance sheet date.

However as of December 31, 2012, cumulative net adjusted realized gains did not exceed cumulative adjusted unrealized appreciation and therefore we have not paid any part 2 incentive fee.

In total for the quarter ended December 31, 2012, we had a net increase in capital resulting from operations of $17 million.

Turning to slide 22, I would like to give a brief summary of our annual performance for 2012. For the year ended December 31, 2012, we had total adjusted interest income of $80.2 million and dividend and other income of $2.1 million. Our part 1 incentive fee was approximately $11.5 million and our management fee was approximately $11.1 million.

Interest and other credit facility expenses were approximately $10.1 million and our combined amount of professional fees, accounting expenses and other administrative expenses were approximately $3.4 million. This all results in 2012 total adjusted net investment income of $46.1 million or $1.36 per weighted average share.

For the year ended December 31, 2012, we had total adjusted realized gains of approximately $11.9 million, unrealized gains of $20.4 million and total accrued part 2 capital gains incentive fees of $4.4 million. In total for the year ended December 31, 2012, we had a total net increase in capital resulting from operations of $74 million.

Finally for 2012, we declared total regular dividends of $1.34 per share and total special dividends of $0.37 per share resulting in total aggregate dividends of $1.71 per share.

There is one more administrative item to note. Our expense cap of $3.5 million that was in place since April 1, 2012 will expire on March 31, 2013. We have decided to continue to subsidize the expenses of the BDC for the next year by imposing a cap of $4.25 million on direct and indirect expenses.

New Mountain Capital is very committed to the BDC and believes that supporting the expense burden based on our size is prudent.

Now I will turn your attention to slide 23. As briefly discussed earlier, the $13.6 million of actual adjusted net investment income for the fourth quarter exceeded the range we discussed on our Q3 earnings call of $12 million to $13.1 million or $0.33 to $0.35 per share which was primarily a result of higher pre-payment fees, dividend and other income of approximately $2.2 million compared to $1.6 million in the prior quarter.

We paid a $0.34 per share dividend which we believe to be our fully ramped run rate adjusted net investment income excluding the impact of capital raises. Therefore we expect to fall within the range of $13.2 million to $14.4 million of adjusted net investment income in the first quarter of 2013 or $0.33 to $0.35 per share although this is simply an estimate and could materially change.

Given our belief that our fully ramped run rate dividend will continue to fall in the previously declared expected range of $0.33 to $0.35 per share, our Board has declared a Q1 2013 dividend of $0.34 per share in line with the previous three quarters. The Q1 2013 quarterly dividend of $0.34 per share will be paid on March 28, 2013 to holders of record on March 15, 2013.

At this time, I would like to turn the call back over to Rob.

Thanks, Dave. While once again, we do not plan to give explicit foreword guidance, it continues to remain our intention to consistently pay the $0.34 per share on a quarterly basis for future quarters so long as the adjusted NII falls below between $0.33 and $0.35 per share, in line with our current expectations.

In closing, I would just like to say that we continue to be extremely pleased with our performance to date. Most importantly from a credit perspective, our portfolio continues to be very healthy. Once again, we would like to thank you for your support and interest, and at this point turn things back to the operator to begin Q&A. Operator?

(Operator Instructions) Jonathan Bock, Wells Fargo.

Good morning and thank you for taking my question. So first, just a few housekeeping Adams, Rob, related to the market. In light of spread tightening and what we have seen across the levered finance landscape with little supply and significant amount of demand, can you walk us through the value proposition that you see today in second-lien loans versus true first-lien collateral because we have seen quite a migration towards second lien in new originations? And some might think that second-lien loans carry a bit of a higher risk, so if you could walk us through that value prop, we would appreciate it.

Absolutely, Jonathan. So we always start with the business, right, and it is always the same thing; how well do we know it and based on that how much do we like it, and how do we feel about the volatility around the future earnings stream as we position ourselves as a lender. So when we look at some of the second-lien stuff we did -- I mentioned two on the call, KRONOS and PRA -- we are doing second liens where our attachment point goes to the high 4s or up to the mid to high 5s.

When we are talking about businesses that have enterprise values, in our judgment as sophisticated private equity investors in those industries of 10, 11 times, we feel very good about the value proposition of being at those leverage multiples earning the spreads that we are earning with that type of loan to value, which we think compares very favorably to other things that are available in the market today.

And we also believe that when we focus on second liens, we are extremely delving into our intensity of knowledge on the businesses, and as when we have that high conviction we get comfortable with that type of leverage issue. So I don't think it is fair, the blanket statement, to say all second liens are riskier than all first liens.

I think there are bad and good risk reward opportunities in first lien; there are bad and good risk reward opportunities in second lien. I think as long as you take each opportunity on a sort of one-off basis and analyze it appropriately, I think you can be to some degree agnostic about what the security is called.

That is very helpful color. And again, we understand that the reliance on the private equity manager does provide some significant synergies and value. Maybe getting to that, we have noticed over the past you have got quite a strong track record in government services. And so perhaps outline the risks, if any, that are faced by portfolio companies involved in federal services as it relates to government sequestration.

That is a good question and it is something we have spent really a lot of time on as a firm, both thinking about our private equity investments as well as thinking about our debt investments in the space and really re-underwriting that. And this goes back six months ago because we saw this coming. And we have been spending the last six months talking to managers at our own companies, to companies we lend to, and to our broad network of people in that world.

And I think that's the bottom line, and now obviously we are living under sequestration, is that it is obviously not helpful for the equity values of the Company, but as a lender to these companies, particularly the ones that we are involved with, we really don't think it is a material issue. I mean we think sequestration has a sort of zero to 10% impact on the revenue and profitability of the companies.

So when you are, again, as a lender the way we underwrite loan to value, that doesn't have a material impact on our coverage. And really the fact that we are positioned primarily in companies on the federal service side that are really mission critical in terms of dealing with cyber security, dealing with terrorist threats, NSA, that type of signal intelligence work, and we are seeing this, there really hasn't been nor is there expected to be a material change in their revenue or profitability.

So we've spent a lot of time on the issue. We certainly had to question ourselves, but we have satisfied ourselves through very thorough investigation that it is not a material risk to the portfolio going forward.

Okay, that is great. Then maybe a few balance sheet growth questions, one in particular. As spreads have come in slightly and it has been a rather, we will call, frothy 1Q, and then we also see kind of limited at least to this point net portfolio growth, which is understandable based on the strength in 4Q. Would it be fair to say that growing the equity account might be more of a secondary item perhaps because you -- not necessarily to dilute investors -- in light of the fact that really the growth or the near-term expectation of supply is really rather modest and we're nearing the end of the quarter? How are you looking at that growth in the equity account just over the next month and a half?

We have always taken the position that we raise capital, one, when our leverage is fully deployed, and two, when there is actually something to do with the money. So it is not about raising equity when you can, it is about raising equity when there is something -- either the market is broadly attractive which it is not right now, or there are niche opportunities which we are always seeing because we have a very broad reach, that accumulate in a pipeline that is very actionable.

And again, we saw that in Q4 when we did the equity raise in December. It was a modest equity raise and we had very targeted uses for that money, and we deployed it within weeks. I think that is the guiding principle going forward. So as I said in the prepared comments, our equity raising will be a function of how the pipeline develops in the coming weeks and months.

So we would expect it to be targeted as opposed to saying, hey, broadly the market's great; let's raise a boatload of money and we will figure out what to do with it. So I think we have hopefully demonstrated to the market over the last two years that we are very focused on optimizing our ROE and our balance sheet, which allows us to take the least possible risk at the asset level and still deliver the dividend and ROE that the market expects from us.

Excellent. BDC investors do appreciate that all-in focus on return on equity. Then maybe kind of rephrasing, would you say the current supply environment for 1Q is better than expected or just slightly lighter than one would have expected to this point?

I think it is about what we expected. Back when we raised the money in Q4 in December, I did make the comment that while we had some great opportunities immediately ahead of us, I was meaningfully concerned about entering into January with any meaningful excess capital, because it wasn't obvious that there would be a lot of stuff to do in January and February.

That kind of played out. We actually, as I mentioned on the call, our pipeline is definitely improving in a meaningful way, but it has only been a couple of weeks, so I want to see how that develops over the next couple of weeks before we make any decisions on our ultimate capital raising approach. But whatever we do, again, it is going to be -- absent a dramatic change in the overall market, it is going to be targeted and smaller as opposed to non-targeted and bigger.

Perfect. And then last question just on a specific investment, it is a healthcare IT entity you mentioned. It has an SLF loan. But Virtual Radiologic, just in terms of the writedown this quarter, it was a bit more meaningful than things we had seen in the past. Maybe just an update on that company and the situation, and how you are looking to continue to realize value for investors.

That is one way are obviously actively involved in. We are working with the company the best way possible to maximize value for everybody. We obviously have to be careful, Jonathan, just because we are subject to confidentiality and I want to be as transparent as possible with our shareholders, but at the same time respect those confidentiality obligations.

But I can say we are in the senior position. I think we have taken a prudent reserve against the loan, but as I did state, we don't see any high risk of near-term nonaccrual and, therefore, I think we are comfortable where we hold it and hope that it stabilizes there, and that it ultimately returns back to full value.

That is very helpful. Thanks a lot, guys.

Thanks, Jonathan.

(Operator Instructions) Troy Ward, KBW.

Great, thank you. Just following a little bit on Jon's conversations, as you said in December 7 you did the, call it a $45 million to $50 million public offering, and by the end of the year you were levered at 0.74 with $12 million of cash. Can you just describe to us -- I mean that is a lot different than most of the BDCs we see that have a lag before they put that capital to work.

Can you describe to us the process that you go through to not only invest the equity but the leverage in such a short period of time?

Yes, I think when we came into December, we had a very robust pipeline of things that were lined up for closing. So while I think entering Q4, I was not expecting to do a capital raise, but the deal flow and the attractiveness of the deal flow drove the desire and the need to raise the capital. So again, I think our approach is to let the deal flow drive the capital, not to let the capital drive the deal flow, because that is kind of backwards.

But at what point do you make the commitments to your partners in the transactions that you will fund?

We are obviously not getting long risks that we can't deliver on if the market goes away from us at any time. So we are not signing anything or committing to anything prior to having the capital in hand.

One of the things I think we are good at, though, is teeing up opportunities, having visibility, and it is all probability weighted, but having really good visibility into what we are going to likely close on before getting along a lot of capital. But at the same time, we are obviously not putting ourselves in a position where if the market were to go away tomorrow and our plan to raise capital failed because they equity markets imploded, that we have any risk of not delivering on a commitment. So that is a balancing act and it is something we are good at.

Okay, that is fair. Again, kind of where Jon was leading as well down the equity path. When you think about, obviously, as you correctly stated you don't raise capital and just put it out unless -- you don't raise capital unless you have a need for it. But how do you view the appropriate accretion to earnings and the dividend to shareholders versus just growth?

We have seen too many times where the balance sheet as a whole grows but dividend and earnings basically stay the same. Maybe the shareholders aren't hurt, but they are not really helped. So at what point do you say we can help shareholders; what is that level of accretion that makes it worth it to go out and raise additional equity?

I think there are three or four factors driving that. The obvious one is if the equity can be raised at any type of meaningful premium to book value, that is by nature accretive. So that is one factor to take into consideration.

The second factor is to the extent the new opportunity sets have a higher return for the same risk as the existing portfolio, that is accretive because that just means the average yield on the asset goes up.

The third driver will be to the extent we get to the scale where we are really leveraging our fixed cost infrastructure, and we are kind of getting there but we are not 100% there. But that is another way to make -- and all else being equal -- to make a capital raise accretive.

So those are some of the factors that we look at. So again, it is not growing for growth's sake. I think our main driver, though, is sort of the first do no harm principle. So we want to make sure that we are able to not add any incremental risk to the portfolio as we grow, as well as not have any meaningful dilution to the near-term dividend. That is why we have been so, I think, controlled about raising capital the way we have.

And then one final comment, question, on the liability side of the balance sheet. You mentioned that your liabilities are termed out to 2016 and aren't subject to mark to market covenants. But can you provide us -- remind us I guess what the covenants in those facilities are? And also how do you view adding additional lending partners to your liability structure or different structures to your liability side of the balance sheet, whether it is baby bonds or something else?

Sure. So let me address the covenants first, and then I will talk about the different types of ways we can access debt capital. Just a reminder, the way the covenants work is we basically have a borrowing base that is built up asset by asset. So what we do is when we put a loan into our borrowing base, and there is a certain level of earnings on that loan or on the company that we are lending to, the covenant is set around that earnings level. So if the earnings level deteriorates by a certain amount, at that point that loan would become subject to mark to market.

But that is at pretty meaningful levels of deterioration, and as you can see again by the numbers we put out on page 9 and 10 where we show that EBITDA multiple drift -- and that is what the covenant is set against -- we really have had only a very small handful of instances where that has been an issue. In fact, there is really only one right now that we are dealing with.

So against a borrowing base that has $1 billion of assets in it, you have one $15 million asset that becomes subject to mark to market, it is really a pretty immaterial impact. But that would be the way we would get potentially hurt, is if our underwriting was just poor and we had a bunch of things that we thought were going to have $40 million of operating earnings and it turned out they had $25 million of operating earnings; then those things would fall into that mark to market basket. But it all ties into what we think we are good at, which is underwriting future earnings.

And then other structures within the liability side?

So, as you know, all of our debt today is with Wells who has been a great partner for us and, obviously, has their own $1 trillion balance sheet. So despite the fact that we are at $400 million and change with them, we are not at this point bumping up against capacity issues.

But we are thinking about, are there other people to bring into that syndicate at the right point in time as that becomes appropriate and necessary. And then we are -- we are thinking about obviously the pros and cons of different sources of capital, given the historically low interest rate environment. Do baby bonds make sense; does a convert make sense? And there are some other things we are kicking around.

So I think we are very -- we are financial guys at heart in many ways, so we are always trying to optimize the liability side. And there may be things over the course of the next year or two that you will see that will take advantage of that.

Great. I appreciate the comments, guys.

Yes, thank you.

J.T. Rogers, Janney Capital Markets.

Good morning, guys. Thanks for taking my question. I guess how do you expect other general administrative expenses and administrative expenses to scale as you grow the portfolio? What do you see as the fixed cost number in there?

I think that as we continue to grow, we are probably going to cap out in the $5 million to $6 million range. So the caps for the next year at $4.5 million means we are still eating a modest amount of that at the parent company. But as you think about us getting bigger, it won't be too much longer before even if the cap goes away, we start to get the benefit of leveraging our fixed expense base across a larger earnings stream. So we are getting close, but that is the range I would use, J.T.

Okay, that is great. Then just wondering what you guys are seeing. I know it is hard to predict, but given the current environment and assuming things stay the same, do you guys have a sense as to what private equity activity will be this year on the M&A front? Do you expect a more active year or less active year than last year?

I think it will be consistent with last year. I think the timing of it is kind of building now as we speak. We had that sort of big rush at the end of last year, I think, and now a pause, and now both on our private equity business, obviously, is a player in the market as a private equity investor. And then all the sponsors we cover as a lender, we are definitely seeing a market pickup in volumes.

How much of that converts into deals, we will have to see, but I do think there are still some pretty strong forces that will drive very meaningful private equity activity this year. And again, I think we have some pretty good insights into that, given where we sit. So we expect a pretty busy year.

I think the bigger issue for us will be that issue around what -- within our universe of what we like, what are the spreads and how wide or narrow is that filter. I am confident in the deal flow being there. I think the question will be how much does the risk reward line up to our criteria.

That is helpful. And then you guys have done a great job maintaining optimal leverage and maximizing ROE. And at the current level, you guys are just covering the dividend with NII. This may be a ways off, but when we go through the next credit cycle and presumably earnings take a hit, at least in the short term, what tools do you guys have to maintain earnings power and maintain the dividend? Or is it your expectation that the portfolio is of sufficient quality that the credit cycle won't impact you to the extent it puts the dividend in danger?

Yes, I think there is two things going on there. I do think our goal and our expectation is that the credit profile of the portfolio is such that we would expect to go through a cycle, and we back-test late to the last cycle, in such a way that we would not see a meaningful impact on our NII from defaulted items not generating the types of interest payments we are currently receiving.

That being said, we are using the good times, if you will, to build up that positive reserve, that $22 million I talked about on page 12, I believe. And I think that will continue to grow. So that is something that -- some of that we pay out currently in the form of specials, and some of that we keep behind to deal with the situation you are talking about.

So we kind of always operate as if another credit cycle is just around the corner, and that is what drives our defensive investment approach, and I think we are structuring the dividend to be coverable in all circumstances irrespective of the credit environment.

Okay, great. Thanks a lot.

All that being said, obviously no guarantees, so we are not guaranteeing anything but we have confidence in that.

That makes sense.

Great. Thanks, J.T.

This concludes our question-and-answer session. I would like to turn the conference back over to Rob Hamwee for any closing remarks.

Thank you. Thanks, everyone, for taking the time to listen in today. We appreciate again the interest and the support, and look forward to coming back to you in a couple of months to talk about Q1.

In the interim, of course, our phone lines are always open. So any questions, follow-up, etc., just call myself, call Dave, and we will be always happy to talk. Thanks and have a good day.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.